Is the Agency Model Broken, or How Should SEM Be Priced?

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Last week, I pontificated on SEO pricing, from both a marketer and provider perspective. Today, I’d like to touch base on the difficulties of pricing paid search services.
Paid search is, typically, an online marketer’s biggest line item expense. And the traffic and revenue that results from that spend is an enormous part of any online marketer’s value. Paid search is dependable, scaleable and, ultimately, able to be measured and controlled. Paid search is like a digital sales accelerator, and buying paid search services can be really tricky.
Most service providers use the agency model, whereby they charge based on the amount of media that the marketer buys. This is a tried and true model where the bigger the splash, the higher the bill. And on some level, this approach makes sense. It is democratic. A penny paid to Google, or Bing or Baidu all cost the same agency fee. All of the upside belongs to the marketer. At first glance, this model is clean, but in reality, it is fraught with compromises and crossed agendas.
The marketer always wants to spend less and get more. In the agency model, the provider wants the marketer to spend more. Immediately, the agenda is muddled. Marketer wants best ROI, and provider wants best I (investment, the pablum word for spend). So, marketer wants small spend. Provider wants big spend. Who wins? Well, in reality, nobody does. The marketer wants to exercise every advantage in order to maximize profitability, but the provider wants to maximize effective spend. (There are providers that just want to maximize spend, but most are focused specifically on generating spend that delivers minimum acceptable return for marketer.)
The obvious answer is that the marketer will spend to their predetermined budget and not a penny more. What happens then is amazing. Provider tries to maximize return to keep the business. Marketer can then benchmark this return and shop providers for lower spend or increased return. This is a slippery slope…provider must continually add more services and potentially reduce cost to fend off competition. Marketer has the tools to drive down the market in terms of commissions paid because it has an effective benchmark. This sets up a race to the bottom. The same dynamic will occur when provider is paid on actions. A discrete return generates a benchmark that can be commodotized.
How are the marketer and provider ever to be in alignment? I think there is a way – let the provider share some cost or upside.  Perhaps 10% of media is paid for by provider and 10% revenue of campaign paid back to provider (though that drives down profit for marketer). Or maybe the marketer will share some profit dollars above a threshold with providers based on reduced commission (lower the floor, raise the ceiling). This has some drawbacks, but it focuses the alignment. Cost per action or hours based solutions are flawed because the provider wants more and the marketer less.
What are your best solutions? What are the creative ways that you’ve dealt with this pricing friction?

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