What Is A Back-End Deal?

In advertising, a back-end deal is an agreement, typically between an advertising agency, and an advertiser, where the Agency agrees to finance all, or part of a client’s marketing costs, in return for a future cash flow, typically a percentage of the client’s product or service sales. Historically, these deals were common in the 1980s and 1990s, but because of changing economic conditions, and overall mixed results, back-end deals have steadily declined and all but disappeared in the past two decades.

The Agency Cash Flow Reality

Although back-end deals may initially seem attractive to marketers because they reduce up-front costs, and share risk more equally between Agency and client, in reality they present hidden risks that are likely to have a negative impact on the success of a campaign.

The greatest risk to marketers in back-end deals is the financial condition of the Advertising Agency who will be their counterpart in the deal. Very few agencies can afford to finance the marketing costs of their clients from their own balance sheets. Adding even more risk for marketers, struggling Agencies are more likely to offer prospective clients back-end deals to make their Agency more attractive, in order to win accounts they desperately need to stay in business. There have been dozens of cases of this catch-22 situation documented in the past several years, especially during the recession, when business lines of credit were unavailable to even long established advertising Agencies. When an Agency in financial trouble offers its prospective clients a back-end deal, it sets the stage for an almost inevitable campaign failure, including worst-case scenarios when the Agency is unable to complete the campaign at all, or delivers the campaign on a severely delayed timeline.

Another type of back-end deal is structured so that the Agency does not explicitly finance marketing costs for its clients with cash, but defers the compensation of owners and employees in order to execute the campaign with less funding than is typically required. This also presents numerous risks for clients, as the owners and employees of the agency still need to find other ways to earn income while working on their “non-compensated” campaign. This can lead to the back-end client’s campaign going on the back-burner, while Agency owners and employees seek other ways to earn income in order to earn a living and finance continued operations. Again, this under-funded condition often leads to negative consequences for the client, including incomplete campaigns, delayed campaigns, severely degraded creative quality, and media underperformance.

The “List Price Strategy”

The List Price Strategy” is an all to common tactic used by Agencies to win business using back-end deals, without actually financing any of the up front costs, or deferring any compensation. For example, an agency may agree to provide $50,000 in services for $20,000, and receive a back-end cash flow as compensation for “financing” $30,000 in services up front. Instead of actually investing that $30,000 of cash and/or uncompensated time into the marketing services, the Agency attempts to spend a lesser amount, $15,000 for example, to produce the deliverables while earning a tidy profit of $5,000 and also receiving the back-end cash flow at a 100% profit margin.

In these situations, it is often very difficult for a client to get transparent reporting on actual Agency costs, and the first sign of trouble is usually when the final deliverables are presented. Unfortunately this example is one of many real life stories, which led to several years of legal disputes, an unusable marketing campaign and a substantial loss for the client.

Back-End Deal Complexity & Disclosure

Setting up a back-end deal adds an additional layer of legal agreements and negotiations to the client-Agency relationship. Although many agencies claim to have experience with back-end deals, the skill set required to value the back-end cash flow, interpret the clients financial forecasts, and understand the cash flow impact of undertaking the deal for their own business resembles the core competencies of a Venture Capital bank, not an advertising agency. Long story short: an advertising organization just isn’t designed to undertake these activities.

The client on the other hand may find that a back-end deal requires it to provide complex financial reporting, which may need to be verified by a third party accounting firm to their advertising agency. Additional complications inevitably arise if the cash flow forecasts do not match actual cash flows: if the product or service underperforms, the client may find itself locked into an adversarial relationship with its agency, and if it overperforms, the client may end up paying too much for marketing services. Caps and performance guarantees can be added to contracts to mitigate these risks, but add yet another layer of complexity to the negotiation process.

Long Term Considerations

The tradeoff between the size of each back-end payment and the length of the back-end financing period is a key consideration for marketers considering a back-end deal. Back-end deals typically last 12-36 months, with longer deals of more than 36 months reported occasionally.

Marketers should consider the implications of being locked into a back-end relationship with an Agency for that long, considering the average advertising agency tenure in 2010 was only 18 months. There are many reasons why marketers change agencies, including growth, need for new creative resources, major changes in business strategy, the need for a wider range of Agency services, and of course because of underperformance and the desire for a better overall working relationship with their agency. Backend deals that outlive the agency relationship diminish the client’s flexibility to make timely decisions for their businesses, and may make it difficult to move the business forward.

Conclusion

In today’s marketing environment, back-end deals present more of a risk than an opportunity to marketers. The structure of Advertising agencies, along with their inability to properly fund back-end marketing campaigns leads to many more failures than successes for clients. Financial risks, compounded by dishonest tactics, including the “List Price Strategy” and the inherent complexity of the back-end deal structure, make back-end deals extremely risky. It is clear that if a company can not immediately finance their own marketing campaign, it is best to wait and raise the appropriate amount of money to fully fund marketing activities from operations or from a third party source such as a bank or a venture capital company.

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For business owners thinking about ways to get the word out about their product or service, the thought of advertising can be overwhelming. Today’s generation of business owners have thousands of places they can advertise, including many new digital choices like social media and mobile. What’s more, new technology and data allow marketers to use complex criteria to segment the audiences, further complicating the decision making process.

These are the top two reasons, combined with a perceived high cost, that deter startups and small to mid-sized businesses from investing in tv advertising. At Greytv we’re structured to help small businesses navigate the complex advertising market, with budgets that are effective, and match the resources of the company.

Goals that startups and small businesses CAN accomplish with TV advertising:

1. Raise Awareness Instantly

“If only more people knew about what I have to offer…”

Like us, you’re probably in business because you believe in your product, and that you deliver it in a unique way that makes it better than the offerings of your competitors. Having success with the people that are already coming in your door is a great indication that there is a broader market for your services. Advertising on TV, Radio or Online is a fast way to raise awareness of your product, and motivate them to buy it, because now they can hear and see how great it is.

2. Work With People Who “Get” Small Businesses

“I need to work with a partner who understands small businesses and startups”

Most agencies are not built to support many clients. They prefer to serve a few large clients, and avoid smaller ones by setting extremely high minimum media buys, and charge high premiums on creative and administrative services. Small businesses need to work with advertising agencies that are using technology and new client account management strategies to provide them with excellent service that is scalable. This gives smaller businesses the opportunity to use advertising and media at a price level that fits their budget, and follows a step-by-step growth plan.

3. Don’t Waste Money

“I want to reach only people that are a good match for my product or service”

Many of our clients come to us with interest in an advertising campaign, but they have serious concerns that their money will be wasted on buying media that will not be seen by customers that match the product or service they are selling. For new or smaller businesses that provide more specific products in smaller areas, the solution is new technology and detailed data that is now available from media sources, as a result of advancement in set-top cable boxes, Internet search data and incorporating direct response market data. These new tools are essential to reducing the chance that you waste money, or don’t get a return on your investment.

4. Know That It Works

“If only there was a way I could tell what advertising works, and what doesn’t”

Historically, marketers have found it very challenging to connect the marketing dollars they spend with their sales results. This has been true regardless of the complexity or cost of the marketing plan. The process to understand what works and what doesn’t, before spending the entire marketing budget, is called “testing”. Testing attempts to correlate different marketing strategies with variations in sales results. The key for startups and small businesses is to take best practices from the field of Direct Response marketing, to design a test that can connect each individual lead or sale with a specific commercial, banner ad or magazine page. Again, technology has made this once impossible concept a reality, giving marketers the ability to decide what’s working at their own pace, and in real time.

5. Level Up On Competitors

“I need to develop an advantage over my competitors”

In general, there is a perception that TV or Radio advertising is too expensive for most businesses. As a result of new account management technology, and new media buying strategies, that’s no longer true. It’s now possible for an advertising agency to provide excellent service to clients that buy smaller amounts of media, through many agencies have resisted advances in technology and strategy to preserve the inherently higher profit margins associated with doing it the “old fashioned way.” This presents a competitive opportunity for startups and small/mid-sized businesses to partner with new savvy agencies to have a presence in major media channels like TV and Radio, while competitors still feel like access is too expensive.

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