What is Performance Marketing | How it Works

Pay for Performance is a growing trend and for very good reason.

In the ever-expanding world of digital marketing agencies, a different kind of agency is emerging. With business needs changing to suit economic conditions, digital agencies had to adapt to meet a growing demand for improved profitability. and management of digital advertising campaigns.

In this article we explain;

What is performance marketing (also known as pay for performance)
How performance marketing works
The definition of performance marketing
Advantages of this model
Disadvantages of this model
Different Types of Digital Agency payment agreements
Is performance marketing a good fit for your business

Performance Marketing Definition

Performance marketing (by definition) is a outcome based renumeration that is paid to marketing companies for delivering results. Results are often measured by Return On Ad Spend (ROAS), Volume of Leads, Cost Per Lead, Cost Per Sale, Percentage of profit and even click through rates and/or website visits.

The chosen result will be agreed upon in advance by the performance marketing agency and the customer beforehand. This is very important and I’ll outline why later in this article.

If you compare performance marketing to a traditional marketing agency pricing model there are some significant advantages and some disadvantages.

How Pay for Performance Works

Both the client and the agency agree on an outcome and how much that outcome is worth. The client will generally calculate how much they’re prepared to pay for the outcome based on how much revenue that outcome generates.

Having a historical record is vitally important to help clients understand how much they can afford to spend to make a sale. For service based businesses, knowing how many leads it takes to convert into a single sale is important. So the more data you have, the better it is for both the client and the agency to make an informed and comfortable agreement that is Win-Win for each.

Percentage of Sales Example:

A percentage of sales outcome may be 15% of sales revenue.

So if you sell $25,000 worth of product in the month, the agency will be paid $3,750.

The agency fee would then be counted towards your COGS (Cost of Goods Sold) and is just an overhead to manufacture and sell your products.

For ecommerce businesses, try our social media ROI calculators which take into account agency fees to manage campaigns.

Pay per Lead Example:

A pay per lead outcome might be $55 per lead so long as the overall cost per lead is less than $125 in Ad spend.

So if you get 46 leads for the month, the agency will be paid $2,530.

If you had an average sales conversion rate of 10% (1 in 10 leads buy) with an average revenue per sale of $10,000 you would generate $40,000 in sales.

As you can see from the above examples, scale is very important.

If a certain number of leads or sales can’t be reached, then an agency has no way to make enough money to do the work required. This would typically be because a client can’t spend $X in advertising each month.

Advantages of Performance Marketing

There are several advantages of pay for performance marketing over traditional agency pricing for both the client and the agency.

Client Advantages

The most obvious and important is that a client only pays for a desired result.

If you choose an agency who charges a monthly retainer, that agency will deliver the work but may not deliver any of your desired results.

Regardles of results, the agency still gets paid.

But if you needed to generate sales in order to pay the agency and the advertising cost, then you’re at a loss. But the agency still gets your money.

Another advantage is when seasonal work is needed (Holiday sales such as Black Friday Sales, Christmas Sales, Special Day Sales) there is no additional billing by the agency. Instead, the agency will complete the extra work required to boost sales knowing they will be paid more due to increased sales revenue over the sales period.

The client then has the money in the bank thanks to the boosted sales and the agency receives a fair amount of compensation that covers all the additional work over the sales period.

Another advantage is the ability to scale rapidly so long as you can meet the demand. When a pay for performance model is in full swing, the agency can continue to increase ad spend which generates more sales and leads so long as the return on investment is there. This is why many eCommerce businesses thrive on these kinds of agreements often going from generating $10,000 a month to $50,000 a month very quickly.

These are Win-Win relationships where both the client and agency wins. Rarely does the client lose out when a performance marketing agreement is in place.

Agency Advantages

As an agency, there’s always a goal to generate great results for clients regardless of how they are paid.

But to receive additional reward for great work boosts revenue and allows more time to be invested in that clients strategy, campaign creatives and account management.

This incentivises the agency to work hard(er) on the clients accounts and to put in extra time that would not normally be covered in a fixed price monthly retainer arrangement. This includes bringing in senior strategists and creatives to improve campaign performance, instead of the usual allocation of time that is allowed in a fixed price monthly retainer.

Another advantage is that there is no hourly billing.

Hourly billing is sometimes received as a nasty or unplanned surprise for clients. This is especially true when the amount of work required to complete tasks is unfamiliar to a client or if the work is problematic to complete. Additional hours accrue and is billed to a client only after the agency records, measures and invoices for the work. All take time to manage which also gets added onto the hourly billing.

Performance marketing invoices are much easier. Simply review the months performance and apply the agreed percentage. Done.

Disadvantages of Performance Marketing

If it all sounds too good to be true, it often is. There are plenty of occassions where performance marketing isn’t a good option for clients and agencies.

Client Disadvantages

Marketing for an agreed outcome is great, but what about all the other marketing that doesn’t produce a direct profit.

Brand awareness is highly effective when executed well. But if an agency isn’t paid for ‘brand awareness’ why would they do it? There many other similar examples where campaigns of a certain type can prove highly beneficial to a business, but are difficult to directly attribute sales. However we do know that an holistic marketing approach that includes multiple types and multiple channels is the best overall approach for businesses.

Expanding to new markets can also be problematic. Lets say you are profitable in the Australian market and want to expand to New Zealand, USA and Canada. The agency will be required to create those campaigns with the hope of achieving the same results – which often isn’t the case. Different countries have different competitors, different seasons, different stereotypes and even nuances in language even if they all speak English.

If the expansion isn’t successful, the agency will make a loss as they won’t get paid for the work and may lose interest in working for nothing.

Agency Disadvantages

Performance marketing reduces the risk for the client, while increasing the risk for the agency.

Essentially, the agency is saying ‘we’re good enough to make this work in our favour’. They are taking the lion share of risk.

If an agency enters a performance marketing agreement with a client who doesn’t have a proven record already, then the agency is flying in blind. It’s a big mistake for the agency to do this and is almost always very costly. An experienced performance agency won’t make this mistake.

Clients may leave even if you get outstanding results.

This has happened to us several times. At some point, you’ll do such a good job at generating sales and profits that clients will decide to leave because ‘they can pay less somewhere else’. That kind of thinking doesn’t always turn out to be true though because many factors are overlooked and too many assumptions are made.

We know this as some clients have returned (and shown a lot of humility in doing so) after their new in-house team failed to deliver.

Hiring an in-house marketing team sometimes works but often doesn’t. There are lots of reasons why it doesn’t work out – with the primary reason being that collective experience and knowledge from running many client accounts across many platforms improves performance. Whereas running only 1 businesses marketing leaves you isolated in your own echo chamber without any ability to learn from other businesses successes and failures.

Types of Agency Payment Agreements

Pay for Performance is just one way to work with an agency. Even at our agency, we have many clients who aren’t hiring us as a performance marketing agency. Instead, we’re a better fit for them under a different pricing structure.

Hourly Rates

This is pretty self-explanatory. You request work from the agency and they get paid an hourly rate to complete the work.
In many cases this is the only fair way to conduct business. A good example of how this works is if you request a one-off brochure or some updates to your website.
These are often difficult to quote, so an hourly rate works best.

Fixed Price Quote

Often work can be quoted for a fixed price where the scope of work is easily established. Examples would be; A new website, landing page design including copywriting & images, setting up a new Google Ads account or building a marketing automation sequence.

Monthly Retainer

This is what most agencies and clients will work with. A fixed price retainer is a good way to manage a marketing budget knowing your expenses are fixed with a set agency retainer and set monthly media spend.
When an agency works to a monthly retainer, they calculate the amount of hours are used on average each month on different tasks by different people within the agency.
That may include; Copywriters time, Ad managers time, Graphic designers time, Account Strategy by a senior staff member, Monthly reporting

Monthly Retainer + Percentage of Media Spend

This is our most common arrangement currently. Our mix of clients want us to do a set amount of work to optimise their advertising campaigns each month, but they also want to expand as well as promote products seasonally.
This means their media spend isn’t fixed at the same price each month and we aren’t consistently doing the same amount of work each month. So the percentage of media spend covers our time when we create, launch and optimise seasonal promotional campaigns and also when we expand into new territories and markets.

Pay for Performance

For businesses with an established track record and a good understanding of their metrics, pay for performance (performance marketing) is very popular.
With this model the client will agree with us on the metrics that matter most and how much they are prepared to pay if we meet their goals on those metrics.
We then assess if that is a reasonable and achievable expectation by reviewing their account history. If it is, we’ll enter into this agreement.
Win-Win.

Is Performance Marketing Right For You?

If you’re wondering if performance marketing is right for you and your business, there are a few questions you can ask yourself.

Are you too hands-on?

If you are the type of person that wants to be involved with everything, then you’ll get in the way of the agency doing their best work. Agencies working under a performance marketing agreement will want a level of autonomy that hands-on owners and managers don’t allow. Instead, look to enter into a monthly retainer agreement.

Do you have a proven track record of sales?

If you don’t have a track record of sales then it will be very difficult for an agency to take you on under a performance marketing agreement. However if the agency is very familiar with your niche, they may agree to work with you. If you don’t yet have a track record or are a startup business an hourly rate, quote or monthly retainer may be best.

Do you have a good history of trackable metrics?

Asking an agency to ‘trust your numbers’ won’t cut it unless they can see and verify the numbers themselves. It also doesn’t work the other way around if an agency says to ‘trust their numbers’.

An agency will need full transparency of your numbers to have confidence that they can track and measure current and future performance accurately.

If they can’t or if too much is done offline, then the extent of trust is usually untenable. Instead consider a monthly retainer.

Do I have a history of ads and sales conversions and want to grow?

If you have 6 months or more of solid data that shows past campaign performances and you’re itching to grow your business… then Bingo.

You probably want to lean towards a performance marketing agency to help with that growth.

Lots of business owners get to this stage but don’t have the time or expertise to go beyond their current level. Which is why they’ll approach an agency to take on this portion of their business so they can focus on other important activities.

Pay for Performance (Performance Marketing) is probably your best choice or monthly retainer + percentage of media spend.

If you’re looking for a digital agency to help you with your digital marketing, then request a proposal from us today.