While there are several ways advertising agencies get compensated for the services they provide, the commission-based compensation system is the granddaddy of them all, having existed since the 1920s. The standard advertising agency commission rate for media placement -- for example, television -- is 15 percent, while the standard rate for advertising and collateral material production invoices is 17.5 percent.
Invoices from media companies typically reflect the "gross" cost for advertising placement. If you spent $10,000 to advertise on a local television station, the media company would include the agency's 15 percent commission in the invoice that it sent to the agency. Your agency would send you an invoice for $10,000 with a backup copy of the media company's invoice as proof of performance. You would pay the $10,000 invoice to the agency. The agency would remit $8,500 to the media company and pocket the 15 percent commission of $1,500.
Whereas media invoices from vendors are "gross" charges, because the agency 15 percent commission is included, production invoices from vendors, a photographer, for example, do not include agency commissions. They are "net" charges and must be "grossed up" by 17.65 percent to calculate the correct 15 percent commission on the gross charges. For instance, if production invoices to create a magazine ad amounted to $5,000, your agency would gross up the invoices by 17.65 percent to calculate the 15 percent commission ($5,000 multiplied by 1.1765 equals $5,882). Subsequently, the agency would send you an invoice in the amount of $5,882, which includes the 15 percent commission on the gross amount (15 percent of $5,882 equals $882).
Commission compensation continues to exist at significantly reduced rates from the standard 15 percent model and may include additional compensation to make up the difference. Other forms of agency compensation are typically fee-based similar other professional services such as lawyers. Agencies might charge a monthly retainer for a set number of hours, or an hourly rate on a per-project basis. Under these hourly rate schemes, agency non-administrative personnel are assigned billable rates that usually include a staff person's direct compensation and a markup for agency overhead and a contribution to profit.
Under fee-based schemes, advertisers are basically "buying time" from advertising agencies. This is a far cry from the traditional standard compensation model when advertisers essentially got the advertising material for "free" and then spent a ton of media money to expose prospective customers to the advertising if they liked it. Today, the challenge for all advertisers, especially small business owners, is to get effective advertising material before their budget is exhausted. You can minimize wasting your agency's time, and your money, by starting with a strategic advertising plan. A strategic plan is required to determine your agency's "Statement of Work." Then, in collaboration with the agency, you can assess the hours required to complete the advertising as described in the statement.