Attention Digital Agency Owners: How to Solve The Principal-Agent Problem to Build A Successful Agency

7 minutes read
Attention Digital Agency Owners: How to Solve the Principal-Agent Problem to Build a Successful Agency

Early in 2018 as a digital agency owner, I developed a deep interest in Psychology and Philosophy. During my reading and research, I came across a term called Mental Model and the frameworks related to it for the first time. It piqued my curiosity, and I went on to learn more about this brilliant concept.

When applied correctly, it can help transform your personal and professional life. But before we get into that, let’s first take a quick look at what a Mental Model is.

What Is A Mental Model?

According to the Wikipedia:

“A mental model is an explanation of someone’s thought process about how something works in the real world. It is a representation of the surrounding world, the relationships between its various parts, and a person’s intuitive perception of their own acts and their consequences. Mental models can help shape behavior and set an approach to solving problems (similar to a personal algorithm) and doing tasks.”

Sounds a bit complicated. doesn’t it?

Shane Parrish from Farnam Street Media Inc. explains it in an easy-to-understand language.

“Mental models are how we understand the world. Not only do they shape what we think and how we understand but they shape the connections and opportunities that we see. Mental models are how we simplify complexity, why we consider some things more relevant than others, and how we reason. A mental model is simply a representation of how something works. We cannot keep all of the details of the world in our brains, so we use models to simplify the complex into understandable and organizable chunks.”

Let me break this down a little more using an analogy I like.

As a digital agency owner, you have to make literally so many decisions every day. Mental models help you think in the simplest way to solve complex problems with a reason.

I have read and followed several mental models. But in this blog post, I specifically want to talk about one of the most useful ones and my personal favorite – the Principal-Agent Problem.

What Is The Principal-Agent Problem?

The principal and the agent are two different parties.

A principal is an owner, while an agent is an employee.

The Principal-Agent Problem arises when the incentives for the Principal and the Agent are different, although they are working towards the same goals.

Now, let’s see how this applies to the agency world.

You, as an agency owner, are the principal.

And a person or a company that works for you (it could be your employee, freelancer, contractor, OR white label partner like us) is the agent.

Naturally, you will hire an agent to fulfill your clients’ requirements on your behalf of you.

Your goal is to provide the best customer service and client satisfaction. So, you always wish that the agent working on your clients’ projects must think and act like you. The two of you should be on the same page. Essentially, you want the agent (employee, contractor, white label partner) to think like the principal (agency owner).

But imagine your incentives are totally different than the people working for your clients on your behalf.

That’s where the Principal-Agent problem starts to take root.

I know that as an agency owner, you take more risks and your rewards/incentives are higher than the agent (people) who work on your behalf. But this gap shouldn’t be so significant that the agents lose interest and their goals no longer align with yours.

Let me put it like this when everyone working on your clients’ projects has the same goals as yours, achieving the highest level of client satisfaction is easy. It’s a win-win for both the principal and the agent.

This also means you don’t want people who don’t care enough about your clients to work on your behalf. That’ll cause more harm than good to your agency as the agents won’t be able to deliver the best output to your clients.

How We Solved the Principal-Agent Problem at E2M

The question is, how do you get out of this pickle as an agency owner?

At E2M, we took a few measures to address this issue.

1. Close a Fair Deal

When closing a deal, you would want it to be fair. So, when onboarding a new agency partner, we ensure both of us have the same incentives. If one of us gets the better deal, the other will lose interest. Eventually, the person at the short end of the stick will figure it out and walk away.

2. Maintain the Highest Level of Transparency

As you can imagine, closing a fair deal isn’t possible without maintaining the highest level of transparency. It also needs to be a part of your daily routine. When both the principal and the agent remain transparent, it’s easier to be on the same page.

3. Under Promise and Over Deliver

This is one of the most successful customer service strategies. At E2M, we believe in giving our customers more than we initially promised. There is no better way to make your clients feel valued and happy. If the converse were true, the principal-agent problem would immediately ensue.

4. No Surprises from Either Side

Trust me when I say this, surprises aren’t always good. Whether you are a principal or an agent, you would want to stir clear of any such surprises. And we achieve this by maintaining the highest level of transparency from the get-go.

As you can see, agents’ incentives need to align with the principal’s incentive. In our case, our company is the principal, while all our employees are the agents.

We work with over 100 agencies as a white label partner. Technically speaking, our agency partners hire our team to keep their clients satisfied. And we make sure that our team and the agencies we work with share the same goals.

Principal Agent Problem Is the Root Cause of Outsourcing Failures

I keep hearing all the time that outsourcing doesn’t work. I have even heard some agency owners say that outsourcing is a scam where people don’t deliver what they promise.

Unfortunately, it’s true. In some cases, it does happen where outsourcing agencies fake promises only to get clients’ business. They often overpromise and underdeliver OR do not maintain transparency at all.

But that’s not always the case.

Sometimes, agencies (principals) may not pay a fair price and still expect the highest work quality. This usually forces outsourcing or white label agencies to use cheaper alternatives (agents) to get their clients’ work done. And this leads to the principal-agent problem.

How to Solve the Principal-Agent Problem in Your Agency?

Now that you know how this problem can arise and affect your agency business, let’s understand how you can solve this issue in your agency. I have compiled a list based on my experience as an agency owner.

It all boils down to three things. They are:

  • Be sure you do a fair deal with your clients where your incentives align with theirs.
  • Your incentives and incentives of people who work on behalf of you for your clients should also be aligned.
  • If you’re working with a white label partner, their team must be motivated, and their goal should align with yours. Only this will lead to the highest level of client satisfaction.

Keep these three things in mind, and you will be able to build a successful agency.

References to learn more about Principal-Agent Problem:

In Conclusion:

The principal-agent problem can prevent you from building a successful agency business. However, your agency can enjoy long-term success if you know how to avoid this problem. Hopefully, this post will help you figure out if there is a principal-agent problem at your agency and resolve it as soon as possible.

If you want to know more about increasing profitability without adding a new business, I would be happy to have a chat. Book a time on my calendar and you will receive a calendar invite along with Zoom meeting details.

  • Manish Dudharejia is the founder and president of E2M - a full-service white label digital agency. E2M helps agencies scale their business by solving bandwidth/capacity problems when it comes to websites design, web development, eCommerce, SEO, and content writing. E2M has been helping agencies for 10 years and currently works with about 130 agencies across the U.S., Canada, UK, Ireland, and Australia.