Incentive Alignment: Fixing the “Agency Problem” at agencies

Written by: Karl Sakas

Many of your headaches as an agency owner stem from what economists—coincidentally—call the “agency problem.” Investopedia defines this economics term as:

“A conflict of interest inherent in any relationship where one party is expected to act in another’s best interests.” … “The agency problem is also known as the ‘principal–agent problem.'”

The agency problem is normal whenever an owner hires non-owners to work in the business. Fortunately, you can solve most of the problem—via incentive alignment.

People Put Themselves First…

The underlying issue here is that people tend to act in their own self-interest. Investopedia continues:

The manager, acting as the agent for the shareholders, or principals, is supposed to make decisions that will maximize shareholder wealth. However, it is in the manager’s own best interest to maximize his own wealth.

While it is not possible to eliminate the agency problem completely, the manager can be motivated to act in the shareholders’ best interests through incentives such as performance-based compensation, direct influence by shareholders, the threat of firing and the threat of takeovers.

…So Align Incentives to Get What You Want

To put it another way—no employee’s ever going to sell as hard as you would, keep an eye on the budget as closely as you would, or focus as much on deliverable quality as you would.

But if you structure incentives correctly, you can counterbalance many (if not most) “agency problem” issues. Find what you and they have in common, and use that to get what you want.

“They” can be business partners, employees, clients, vendors, or anyone else you work with.

Examples of Incentive Alignment at Agencies

Depending on the circumstances, you can use big incentives and small incentives. Here are some examples of ways to align incentives at marketing agencies:

  1. Having a “no kickoff ’til we receive the deposit” policy encourages new clients to pay you promptly, instead of pressuring you to start before you get paid.
  2. Paying sales commissions encourage salespeople to sell more.
  3. Paying-out sales commissions after clients pay each invoice—rather than 100% up front—encourages salespeople to sell work the agency can actually deliver.
  4. Performance bonuses for finishing projects on time encourage employees to get things done faster. (But be sure the incentives are contingent on minimizing errors, or your team will do it quickly and poorly.)
  5. Having a “work stops if your account’s past-due” policy encourages clients to pay on time.
  6. Paying commissions for upsells (even to non-sales employees) encourages every team member to find upsell opportunities.
  7. Equity vesting for new owners encourages people to stay with the agency, rather than take their money and leave. You’ll see similar results with phantom stock.

The key is to ensure that your incentives and their incentives align as much as possible. When your team gets what they want, you simultaneously tend to get what you want.

Question: How do you align incentives at your agency?

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