It’s a pet peeve of mine when an agency throws the term “profit” around loosely. Many agencies rave about how profitable their services are for their clients, yet make little to no attempt to measure or report on how much profit their services yield for the client.
Many of these agencies report on KPIs that are either solely efficiency or volume-based. I.e. Revenue, Cost Per Order (CPO/CPA), Ad to Sales Ratio (A/S/COS/ERS), Return on Ad Spend (ROAS), etc. are all common KPIs. These metrics alone are flawed, as they do not account for the expenses of the business, outside of channel-related costs such as media spend. If you have no COGS, no variable overhead expenses, no returns, no pick/pack/ship costs, no credit processing fees, etc. then maybe relying solely on these metrics is suitable for you. However, if you don’t identify as a business with zero of the above liabilities, then you should instead account for these expenses when managing your SEM channel.
Which raises the question – if your agency is not actively measuring and reporting on profit, then how can you expect to maximize profits while working with them?
Here’s an example of why this is so important. This retailers’ agency is currently reporting on either efficiency or sales metrics. Here’s their annual SEM KPIs.
This agency has been told that they need to maintain an average CPO no greater than $30. While not reported above, this agency has also driven a 100% increase in SEM revenue this year vs last, while managing to come in under the CPO target which the retailer set for them. These are great results which the agency should be proud of, right?
Let’s factor in COGS and VOH expenses now.
COGS and VOH expenses total ~68.4% of revenue, which changes the picture quite a bit. Following the approach of optimizing for efficiency and volume targets, this agency managed to drive $8,816 in contribution on $638,532 in revenue, or a 1.4% contribution margin. That’s not necessarily great, but at least the retailer didn’t take a loss on the channel this year, right?
Now let’s factor in the cost of the agency and return rate.
Ouch – this retailer actually lost $30,171 on their SEM channel this year. Even without accounting for the return rate, this retailer still posted a loss on the channel. In this relationship, the only ones who made a profit were the ad network and the agency, while the retailer has been hung out to dry. In this example, the value of the work which the agency produced for this business was not sufficient to cover their own cost. Will this retailer make up for these losses through the LTV of the new customers which were acquired this year? Perhaps – but the current agency isn’t measuring that either.
Who benefits the most in your client-agency relationship? Is it you, the retailer? Or does the agency walk away the winner? If profit is not being measured, it cannot be maximized. If your agency tells you profit is being maximized, ask them how they can be so sure. Ask them to prove it to you. Force your agency to measure profit. Force them to be transparent.