Contractual audits explained
What’s discovered in a contractual audit of your marketing agency?
By Christine Moore, Managing Partner, RAUS Global
It’s vital that advertisers use all the tools available to them to validate corporate governance across all their partners, suppliers, and vendors in the marketing supply chain. It’s also well-established best practice that, to validate overall risk management of a company, large ticket items are prioritized. Media and marketing often account for between 10% and 15% of a company’s total expenditure. This is why it’s so important for brands both to institute an annual program for media price/quality benchmarking and to assess the extent to which key partners in the marketing space are complying with their contractual obligations.
Contract compliance
The contract compliance audit allows advertisers to establish whether its agency partners are delivering against these obligations. In many cases, advertisers see funds — left on the agency’s financial books for a variety of reasons — returned to them. Fundamentally, an audit identifies whether the client is benefitting from the standards of media management that have been promised by its agency partners. When an advertiser engages an audit firm, they perform a comprehensive audit that validates each of the key areas of media management, as well as identifying potential gaps where the agency could provide “even better if …” service. RAUS Global then work with our clients to develop solutions to close these gaps and minimize overall risk.
Many areas that are audited lead to major financial, legal, and operational improvements on both the client and the agency side. These are the key to securing significant improvements in the risk profile for the client.
Many auditors have a long-established but ever-evolving audit methodology, based on their own proprietary approach as well as standard audit principles accepted across all industries. Audits are typically focused across four work-streams, focusing on:
1) Agreement compliance
2) Remuneration
3) Financial stewardship, and
4) Digital and technical charges
Areas under focus in audit
Within each category, it is important to look at specific data and processes to confirm the activities that agencies undertake on behalf of clients. Among the key areas of concern to clients are transparency gaps in reporting terms and data retention issues.
In many markets around the world, as well as in specific media categories, annual volume bonus (or AVB) schemes exist. Through the audit, the accuracy of the reported AVBs is validated, as well as how and when they have been returned to clients. Another issue that has been on the increase in recent years — and percolated to the top of the agenda during COVID — is the use of affiliates and third parties. These entities are usually partly owned by the agency group or holding company that the client works with. Examples of affiliates include barter companies, programmatic media buying platforms, out-of-home media, and inventory media.
Beware the march of affiliates!
Because there are so many services that can be offered through agency affiliates, advertisers often lose transparency into the media cost and performance when affiliates perform media planning and buying duties. This is why it’s so important that clients are aware of the control and insight that they give up by accepting to work through affiliates. In many cases, the approval process to use affiliates is weak, sometimes referred to as the “may contain nuts” clause. This means that, when the agency sees fit, it can deliver on a media plan simply by listing affiliate company products and services but without a stand-alone approval process.
Many clients fail to see past initial promises and assume that using affiliates will inevitably deliver better value. Agencies often argue that working with affiliates leads to lower media prices for similar or identical quality media, but clients should insist that agencies quantify the value of the benefits that buying and planning via affiliates deliver to them. Remember that value can be quantitative (reduced pricing) or qualitative (increased quality).
Remuneration fair for all?
Another area that has been very unpredictable during the past few years is remuneration, with methods of remuneration evolving from commission to FTE based fees, fixed fees, value-based fees, and every flavor of combination of these different methods. In setting fees, advertisers need to have a baseline of what is to be delivered at which fee and with which resources. This allows many different variables to determine the right price for agency services. By performing an annual compliance audit, clients have a stake in the ground and can identify trends to better set the strategy and negotiate the best remuneration formula moving forward.
When auditing remuneration, it is important to distinguish between fixed fees and reconcilable fees. A client can implement both a fixed fee and reconcilable fee. A reconcilable fee means that the client can validate that the services received equal the remuneration paid. This is done by comparing the hours of work per FTE on the scope of work with the actual time sheets that the agency keeps for all their employees. If the fee is fixed, the client will not receive a cash refund, but it helps to better understand, plan, and negotiate the remuneration for the following year. For clients to have a fixed and non-reconcilable fee is not especially helpful for strategy setting and negotiation, as this combination of legal language does not provide any insight as to what the true cost of the services rendered is or should be.
Finally, the impact of COVID on agency remuneration and the subsequent talent shortage has driven more scrutiny of FTE-based remuneration models, as positions have been left open for longer than average. In today’s market, we often see contracts that require agencies to inform the client and reduce the fees for open positions over 30, 60, or 90 days. A comprehensive audit can confirm whether this clause has been upheld.
Scopes of Work
We have also seen a lot of changes in Scope of Work (SOW) deliverables across agencies, particularly as e-commerce, influencer marketing, and digital services have become top priority for many brands. Clients quickly had to change marketing strategy and demanded nimbleness from agencies to access talent with new skillsets faster than in historic, annual SOWs. It is key to make sure that the MSA (Master Service Agreement) and the SOW (Scope of Work) is updated annually to include the new services that clients buy from agencies. It is all about being agile in managing corporate governance and minimize partner risk.
Financial stewardship
A third bucket of improvements can often be found in processes linked to financial stewardship. It is critical that an agency — which handles large amounts of client funds to book and execute a media plan — reconciles billings in a timely manner. There are often a huge number of transactions between clients and agencies, particularly for digital ad campaigns. Agencies often provide bills to estimate, which are approved by the client. Once the media is booked and the final media price is confirmed, the agency then reconciles the estimate with the actual cost and often a debit or a credit is identified.
In some cases, the media owner does not bill the agency as soon as the agency bills their client, and an unreconciled media buy lands on the agency’s financial books. Since agency financial records are not released, clients have very limited ability or recourse to identify the actual value of these unreconciled media costs. The statute of limitation (SOL) varies across markets, making it even harder for clients to understand the potential monies left on the table. Once the SOL has expired, monies essentially become the property of the agency. In this instance, it can then be moved into revenue, effectively bolstering agency income.
When an advertiser stops working with an agency partner, it is even less likely that they will be able to identify and request the funds to be returned, and agencies can move these funds into revenue before the expiration of the SOL. Since there is work involved in moving debits and credits from the agency to client bank accounts and vice versa, the funds are often just left sitting on the financial books of the agency. The client is then not aware of the credit amounts sitting on the agency side and so rarely uses the credits to offset a payable invoice. Through an audit, these credits are identified and returned to the client. Most agencies acknowledge that this is a challenge and are happy to issue a credit note to the client in a timely manner.
Fixing the holes in the leaky bucket
When agencies buy different types of media through different channels — such as out-of-home, digital or programmatic media — they sometimes add mark-ups to the media cost. These can be valid charges for licensed platforms, research, or other necessary tools. But they can also be hidden charges that simply bolster agency revenue. Again, during an audit these additional charges, commissions, and fees are identified and validated against the contractual agreement to inform the client of potential improvements in transparency and identify precisely where the holes are in the leaky bucket.
An issue that has gained much attention in the past five years is payment terms. Many advertisers are pushed by their finance colleagues to improve working capital by offering blanket 60, 90, or 120-day terms to all business partners, suppliers, and vendors. This approach has created a lot of push-back from agencies and holding companies, as they act as agencies in most markets around the world. A much better way of dealing with payment terms is to validate the actual “float” an agency has through an audit. The client will then know exactly how many days the agency either retains the client payment before they pay a media owner or how many days an agency is floating the client by paying before, they receive the funds from the client. This eliminates most negotiations based on assumptions, LIBOR rates, and other win-lose discussions around payment terms.
Summing up
These are just a few of the most prominent and important trends that we see through our work around the world. Most of these issues can be assessed and validated in most marketing categories. Media is usually the biggest single line item of expenditure for marketing clients, but we often undertake annual audits for agencies delivering creative, PR, influencer marketing, social media, e-commerce, and sponsorship services.
Wherever there’s a contract for marketing services, it’s wise to audit. Clients typically enjoy a ten-to-twenty-times return on investment relative to audit fees. We are happy to provide case studies across markets, audit type, and size of spend.
