Commentary

The Wolf Of Madison Ave.

Moneyball: the agency industry isn’t as profitable as it used to be.

Last week I talked about how agencies perhaps need to radically reinvent themselves. I made that recommendation on the basis of studies from both the U.S. and the U.K. by the ANA and the IPA respectively, which showed that the marketer-agency relationship is so broken, it may be time to call it quits on the current model.

The day after my post, Gord Hotchkiss added additional food for thought by delivering a sharp analysis of the problem, concluding: “What was once an agency’s strength -- its position as a bridge between existing networks -- has turned into its greatest vulnerability. Technology has essentially removed the gaps in the market itself, allowing clients to become more effectively linked to natural customer networks through emerging channels also increasingly mediated by technology. Middlemen are no longer needed.”

And now we throw more oil on the flames, thanks to an insightful report from U.K.-based independent accountant Kingston Smith W1 analyzing the financial performance of Top 50 agencies across a number of different agency categories.

Apparently Kingston Smith has been doing this analysis since at least 2008. I know this because the company reports, quite shockingly, that operating profit margins for all agency types are at their lowest level since 2008. The average operating profit margin for the industry is now 10.6%, while the target is 15%. (It certainly was 15% when I worked in the agency business, but that was shortly after the invention of the wheel.)

For the agency industry to slip steadily toward single digits of profit is quite astonishing. Here is how the different sub-segments of the agency world performed, from highest operating profit margin to lowest:

-- Media at 15.5%
-- Branding and design at 11.8%
-- Direct marketing and sales promotion at 10.2%
-- Digital at 8.9%

All sectors are down versus the prior year, with the exception of branding and design, which crept up a paltry 0.8%. But at least it went up. With these numbers, you can see the really quite challenging agency conundrum in a nutshell: Marketers are buying less and less brand and design work as they move away from traditional media, where the most expensive branding and design content was traditionally placed. Instead, they are spending more and more on creating and placing digital media, which costs less to make and place. So as an industry, agency groups are facing a decrease in marketing dollars in their two most profitable sectors, and an increase in their least profitable sector. That’s gotta hurt.

Which might in turn explain agencies’ interest in supplementing their revenue and profit losses by other means. And by “other means,” I refer of course to less-transparent and in some cases, downright deceitful practices like agency volume media deals, digital hocus-pocus (viewability! bot views!) and so on. It also explains why agencies are so keen on implementing automation like programmatic, since that has the potential for eliminating, or at least decreasing, their highest cost: people.

The problem with this situation is that it is clearly not in agencies’ interest to truly address marketers’ unhappiness with the invisible and perhaps sometimes even dodgy new agency revenue sources. Because that would exacerbate the problem  — and Wall Street does not look kindly on decreases in profit margin and share.

5 comments about "The Wolf Of Madison Ave.".
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  1. Ed Papazian from Media Dynamics Inc, August 10, 2015 at 1:30 p.m.

    Having had direct access to major agency "gross profit" data at a time when the major shops were all operating at about an average 10% fee level and hadn't spin out their media operations into major buying conglomerates, it seems, at first glance, as if little has changed. It was taken for granted that you had to equate profitability with dollar volume. My old shop, BBDO, was one of those that led the way, offering to take still lower fees in exchange for handling more of a client's brands and, thereby, building volume. As I recall, a 10-12% gross profit was quite acceptable when all services were lumped together; in some cases, 8-10% was OK, provided it yielded enough dollars.

    But things have changed. These days, we are no longer dealing with fully integrated, client-centric ad agencies. Rather, we are seeing a major effort to make money via media buying----something that was virtually unheard of in my day, and, as Maarten has noted, this is leading the agency media moguls into murky and uncharted waters. This is evident in the rush to adopt "programmatic" buying for digital media and the ways that agencies wheel and deal with the networks and major cable players in the TV upfront. To be fair, in the latter case, advertisers need to realize that agency "volum" deals with the sellers can actually benefit them, due to the combined weight of all of an agency"s clients, and once the machinations of this system are fully understood by both sides, some fair balance in terms of added agency profits----one might say, "incentive"--- and cost savings to the client needs to be negotiated. As many have said, and I agree, this requires total transparancy on the agency side.

  2. Martin Albrecht from CROSSMEDIA, August 11, 2015 at 9:58 a.m.

    Hi there Maarten - thank you for your inspiring and bold thoughts on the state of the industry. Having pioneered a completely different model ourselves for the last 7 years (self-imposed, third-party audited transparency) I know that profitability can be a struggle competing for talent, technology and of course winning clients in the first place. Do you think that clients are as open towards new models as they should be? Sometimes I wish they would whine less about the status quo and instead insist on / incentivize the new.

    Thanks!

    Martin

  3. B Sass from U of C, August 11, 2015 at 10:55 a.m.

    Sorry to be dense, but why does the article site "digital" as the lowest operating profit unit when the agency holding companies tout this as the highest margin growth driver and Wall Street cites that agencies take 20-30% of the average digital media budget compared to just 10% of traditional media budgets. thanks for explaining. Great article. Very illuminating. 

  4. Maarten Albarda from Flock Associates (USA), August 11, 2015 at 7:06 p.m.

    Hey everyone: the full report I took the numbers from can be found here: http://www.kingstonsmith.co.uk/sw1/wp-content/uploads/sites/12/2015/07/MarketingMonitorSummer2015.pdf.

    B Sch: I do think that agencies, just like any other business, typically try and highlight numbers that work well for them and try and gloss over other numbers. The report from Kingston Smith also highlights that certain individual agencies or groups are doing better than average.

  5. B Sass from U of C, August 12, 2015 at 7:33 p.m.

    Thank you! 

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