Last time I wrote about the problems with revenue sharing as a compensation model. Rev-shares over-compensate SEM firms for sales on the retailer’s trademark — which can be huge — and create disincentives for going after anything but the lowest hanging fruit.

Making the most out of search requires climbing the tree to compete for the incremental sales.

A better compensation model is to pay your SEM based on a fraction of the advertising dollars they spend on your behalf. Advertising the retailer’s brand name “generates” a ton of sales at minimal expense. An agency compensated on sales makes half of their money on the first 5 minutes worth of work they do for the client – that doesn’t make sense. An agency compensated on ad spend gets very little reward for brand advertising, but that’s okay, there’s almost no work involved.

Under this model an SEM must be able to spend a large amount of advertising dollars on your behalf in order to generate a big fee. This gives them incentive to spend money. Watching the results carefully to make sure the ROI is what it needs to be is your guarantee that the money is well spent.

One caution: make sure you view the efficiency of the competitive search phrases separately from the results on your trademark. Less than ethical SEM firms will spend more of your money than they should by subsidizing a poor performing competitive search program with search results on your brand. Make sure that the ROI makes sense on the competitive portfolio, as that’s where most of the ad spend takes place and where all of the incremental sales originate.

There is a downside to compensating based on ad spend rather than revenue. Some multi-channel firms have recognized the power of search as a branding tool. The term “Widget” may not be very efficient, but if Acme.com wants everyone who buys widgets to think Acme first, paying to be at the top of the page may very well make sense for the Acme brand. The cost of this branding can be material, but is often a bargain compared to mass media campaigns.

Should the SEM firm collect big additional fees to make that happen? Probably not. Managing a branding portfolio separate from the direct-marketing portfolio does add some additional work, but make sure the compensation for this extra work is sensible.

A pure rev-share is a disaster. A pure cost percentage model is better, but a cost model carefully watched for competitive efficiency with reasonable caps in place for branding budgets provides the best incentives for an SEM to work hard for its clients.

Next: SEM Pricing: Bundled Services or A La Carte?

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