How the Wrong Incentives Create the Wrong Outcomes
Charlie Munger, Warren Buffett’s long-time business partner, once said: “Show me the incentive and I’ll show you the outcome.”
It’s simple. Pay people to do something, and they’ll do it. The trouble starts when what you’re paying them to do isn’t what you actually want them to achieve.
Most business owners understand this with their own teams. Pay salespeople purely on volume and quality suffers. Reward customer service on call speed and satisfaction drops.
” The incentive shapes the behaviour, which shapes the outcome.”
Yet when it comes to marketing agencies, this logic is often overlooked. Business owners readily pay their agency fees linked to the size of their marketing budget, then wonder why their costs keep climbing whilst their returns stay flat.
The incentive structure makes this inevitable.
When Incentives Backfire
The term “cobra effect” comes from colonial India, when the British government offered money for dead cobras to reduce the snake population. It worked at first. Then people started breeding cobras to kill for the reward. When the government caught on and cancelled the scheme, breeders released their worthless snakes, making the problem worse than before. This
This pattern repeats throughout history. When Hanoi paid for dead rats in 1902, people started finding rats with their tails cut off, released back into the sewers to breed more. When Mexico City paid people to scrap old cars, they bought cheap vehicles specifically to claim the payment.
” When you create a financial incentive, people optimise for the metric being measured, not the outcome you want.“
How Percentage-of-Spend Shapes Everything
An agency charging 15% or 20% of your media spend isn’t just charging a fee. They’re operating under an incentive that shapes every decision.
The account manager on your business gets measured on account growth. Their bonus, their promotion chances, their standing in the agency all depend on increasing what you spend.
Research from Harvard Business School shows how this cascades through organisations. When partners get rewarded for revenue growth, junior staff learn that revenue growth is what matters. The culture crystallises around that metric, regardless of what the website claims.
In a typical marketing agency, this means the account manager who suggests cutting an underperforming campaign works against their own interests. The strategist who recommends a more efficient approach undermines their team’s targets. The analyst who spots a way to get the same results for less money destroys value, from the agency’s perspective.
This isn’t about ethics. Put honest people in a system that rewards increasing spend, and they’ll find ways to increase spend. They’ll convince themselves it’s right. They’ll develop sophisticated reasons for why more budget is always better.
The Cultural Problem
A 2019 study in the Academy of Management Journal found that pay structures don’t just influence individual decisions. They determine what behaviours get celebrated, what skills get developed, and what knowledge gets passed down.
In agencies built on percentage-of-spend, the skills that get rewarded grow budgets. Pitch new channels. Recommend expanding campaigns. Suggest testing more keywords. The account manager who grows a client from £10,000 to £30,000 monthly spend gets promoted, whether or not that £30,000 delivers better results.
The account manager who keeps a client at £10,000 whilst doubling their returns gets overlooked. They haven’t grown the account.
Over time, this creates a predictable culture. Optimisation becomes something you mention in presentations, not something you do. Efficiency becomes a box to tick, not a goal to pursue.
What This Looks Like in Google Ads
The mechanics of Google Ads management make this especially problematic.
An agency charging a percentage of your ad spend has dozens of ways to inflate your costs and create waste without obviously hurting your results:
Recommend broad match keywords over exact match, increasing volume and cost whilst decreasing relevance. Suggest expanding into Display or YouTube when your returns come from Search. Add new campaigns before optimising existing ones. Keep underperforming ad groups because cutting them reduces spend.
Research from the Journal of Marketing shows how this plays out. A 2021 study tracking media buying found that agencies charging percentage fees recommended solutions costing 27% more on average than agencies using fixed or performance-based models, with no improvement in outcomes.
None of these decisions are obviously wrong. Each can be justified. That’s what makes it dangerous. The agency isn’t lying. They genuinely believe expanding your campaigns is good strategy, because their experience has taught them that budget growth equals success.
” It’s just their definition of their success and yours are misaligned “
When the Measure Becomes the Target
Economist Charles Goodhart observed: “When a measure becomes a target, it ceases to be a good measure.”
For percentage-of-spend agencies, the original goal of delivering marketing results gets replaced by the metric of growing spend. The metric stops being a proxy for success and becomes the definition of success.
This explains why agencies produce detailed reports showing increased impressions, clicks, and reach whilst their clients’ business results stagnate. They’re optimising for what their incentive structure rewards, not what their clients need.
A 2018 study in Strategic Management Journal found this problem becomes worst when three things align:
- Financial incentives tied to measurable output,
- Clients unable to evaluate quality properly, and
- Long-term relationships that make switching difficult.
Marketing agencies hit all three.
The Alternative
Understanding the incentive problem points toward different pricing structures.
Fixed monthly fees align the agency’s interests with efficiency, not spending. Performance-based pricing ties revenue to business outcomes. Hybrid models balance base pay with bonuses for specific goals.
Each has trade-offs, but they solve the fundamental problem. They stop rewarding the agency for increasing your costs.
Research from MIT Sloan Management Review shows fixed-fee arrangements correlate with higher client satisfaction and better long-term outcomes, precisely because they remove the incentive to oversell.
What This Means
If your agency charges you percentage of spend, they’re probably not incompetent or dishonest. They’re simply operating under an incentive structure that makes certain outcomes nearly inevitable.
“Their account managers optimise for metrics that benefit the agency, not your business. “
Their culture celebrates budget growth, not efficiency. Their training develops skills for expanding spend, not controlling it.
Munger’s principle holds. The incentive determines the outcome. Pay an agency to grow your spend, and your spend will grow. Whether your results grow alongside it is secondary.
The question isn’t whether your agency is gaming the system. It’s whether you want to keep paying them to do so.
