• by Brian Wieser , June 7, 2016

“A prince who is not himself wise cannot wisely be advised,” wrote Machiavelli many years ago. As marketers’ jobs have become more complicated, it has been difficult for many of them to know as much as they would like about the ecosystem they participate in, especially in the important fields of media planning and buying. With the release of a long-awaited report related to media transparency from K2 (commissioned by marketer trade group the ANA), we expect that marketers will be made much more wise about the ways media agencies generate revenue. As marketers become better informed, they will probably become more aggressive in their efforts to eliminate or curb many practices that agencies have pursued to generate revenues in the fast growing / high-margin media agency business.

While the report did not contain any shocking revelations, the documentation contained in the report will resonate within the industry for many more years to come. Overall, the findings are generally damning of the whole industry – even if problematic practices described in the report are not undertaken by all holding companies – which will likely contribute towards negative sentiment towards the whole agency sector.

For background, In October of last year, K2 was appointed by the ANA to explore the topic of rebates and non-transparent practices in the media agency industry, following on several years of other work by the ANA. The survey released today was “based on information compiled from interviews with 150 individual sources. Those interviewed included marketers, media suppliers, ad tech vendors, current and former advertising and media agency professionals, trade association executives, industry consultants, attorneys, barter company employees, and post-production professionals.” “Five of the six major agency holding companies and their affiliated companies declined formal requests to make any of their current executives available to be interviewed.” However, sources interviewed included “38 agency professionals, both current and former, including representatives of all agency holding companies”

While agency holding companies will understandably protest the absence of identification of specific holding companies in the report, let alone separation of good from bad agencies, the report nonetheless represents the views (perceptions of fact, at minimum) of many of their largest clients. As noted in the past, the low (and worsening) levels of trust between marketers and agencies likely contribute towards more aggressive fee-squeezing efforts between marketers and agencies.

Non-transparent practices described include:

• Rebates in cash and free media • Rebates structured as service agreements (whereby an agency provides token work for the media owner, such as consulting, research reports or other limited value activity in exchange for significant spending by the media owner to the agency).

• The collection of rebates by affiliates (domestic and international) of a marketer’s primary agency.

• Agencies using opt-in principal trading services where negotiating clout of all clients (those opting in and those not) affects underlying media costs for media an agency resells as principals.

• Directing of spend towards media owners (primarily ad tech companies) in which agencies have equity or contingent equity.

Key findings from the report include:

• Cash rebates are pervasive. “K2 identified evidence of several methods by which rebate deals are structured, including financial incentives in the form of cash or free media. Other sources noted that rebates are often structured as service agreements whereby the fees for the services – usually described as consulting or research – are tied to the volume of agency spend. Moreover, these services were either of minimal utility, significantly overpriced, or not provided at all.”

• Rebates are not necessarily disclosed or passed along to advertisers. “41 sources…reported that media rebate deals occur in the U.S. market. Of those 41 sources, 34 reported indicated that the rebates were not disclosed to advertisers, were not passed through to advertisers, and/or were demanded by agencies “

• The agent-principal relationship was described in a broken state. There is “evidence of a fundamental disconnect in the advertising industry regarding the basic nature of the advertiser-agency relationship.” “In general, advertisers expressed a belief that their agencies were duty bound to act in their best interest. Meanwhile, many agency executives interviewed said their relationship to advertisers was solely defined by the contract between the two parties.”

• Many media types – not just digital advertising – are involved. “K2 found evidence of non-transparent business practices across digital, OOH, print, and television media.”

• The problems involve higher level agency employees. “K2 found evidence that senior executives at agencies and Agency Holding Companies were aware of and even mandated some non-transparent business practices, suggesting high-level buy-in.”

• Audit rights are commonly limited. “Some advertisers have limited audit rights that are insufficient to detect the kinds of non-transparent business practices described above, do not fully exercise their audit rights, and/or are not aware of what audit rights their agency contracts permit.”

• Marketers may not fully understand their agreements with agencies. “One former Agency Group executive told K2 that agency addendums to client contracts permitted practices that, in his opinion, most clients did not anticipate.” “in many cases, advertisers were unaware of details in their agency contracts that addressed the issue of transparency.”

• Some media owners encourage these practices. “A senior executive at a magazine publisher reported that he was engaged in negotiations with an Agency Group to finalize a similar rebate deal, which would provide the Agency Group with free media linked to spend at a certain monetary threshold. The executive reported that, “if you’re trying to turn around an aging [media] property, these [rebate] deals are beneficial.” He noted that his company was “scraping and clawing for every dollar we can” and that he felt no pressure from agencies to enter into rebate deals. “The pressure was from me,” he said.

In agencies’ defense, we took away several important considerations:

• Marketers’ efforts to reduce agency fees have contributed to the current state of affairs. “Advertisers and their procurement departments drive down agency fees and seek extended payment terms, thereby causing agencies to seek additional sources of revenue.”

• Clients can be complicit in non-transparent activities. “A former chief marketing officer at a global advertiser reported that he signed a contract addendum to (a Master Service Agreement) that permitted his agency to engage in non-disclosed buying. The source indicated that he agreed to the addendum with a sense of unease over the lack of transparency with regard to underlying media costs, but that he did so because the addendum promised – and delivered – lower rates for media.”

• Some of the activities described may originate from mis-understandings. “a former media executive at another U.S.-based advertiser told K2 that it was indeed possible that his agency was returning rebates without him or his team knowing. “The number of transactions and invoices is breathtaking,” he said. “Given the complexities, it's likely that they were returned and we were unaware.””

As I have written in the past, assessing the financial impact to agencies from such revelations is difficult. I believe the most significant consideration is that marketers who are better armed with more knowledge may apply more pressure to the conventional fees they pay. However, they will also likely recognize that the quality or volume of services they receive would likely go down if they squeeze too hard. As well, agency holding companies are entrepreneurial environments, where new types of services emerge over time (i.e. marketing technology consulting) that replace some of the lost revenues.

A bigger potential risk that may remain outstanding from a report such as this one is whether or not there are legal consequences or clawbacks to follow. While the report notably did not use the words “fraud” or “illegal” anywhere, one anecdote described in the report suggested approaches that some marketers might pursue, especially if audit rights become more expansive in the future for more marketers.

A former head of global media for an international advertiser said that he helped negotiate broad audit rights with the firm’s agencies that extended up to the holding company level and included any affiliate organizations of the Agency Holding Company. “We had the right to audit the books of every affiliated organization in every country for all our agencies,” he told K2. However, in his experience, the firm only commissioned audits on Agency Group operations at a country level, never on the agency’s global holding company. He recalled one occasion when his firm sought to activate its full audits rights but the agency “flatly refused to allow us anywhere near the holding company-level accounts or numbers, so technically they were in breach of contract.” The source said his firm considered taking legal action but decided against it because it feared a lawsuit could damage its continuing working relationship with the agency. The source, who has former agency experience, added that even if his firm were to obtain full audit access in order to uncover any non-disclosed sources of agency revenue, “it would be an enormous task to unpick the various stitches in the tapestry to find out where the gold is buried.”

In general, I think that the findings are generally damning of the whole industry, which will likely contribute towards negative sentiment towards the whole group as investors learn more about the report and what it reflects around their largest clients’ perceptions.

What should happen next? Trust was generally poor between agencies and marketers before the presentations on transparency at an ANA event in March of 2015 that ignited focus on the topic. It became much worse afterwards, and will likely worsen further as more marketers explore the details contained in K2’s report.

The approach the industry has taken to date – mostly denying the existence of rebates – does nothing to help. Certainly, agency trade group the 4As exacerbated the problem with the release of its own “Transparency Guiding Principles of Conduct” document earlier this year, which seemingly ignored some of the obvious concerns. (It also irritated the ANA and many of its members with the implication that ANA members were supportive of that document.)

A statement from Publicis that was released shortly after the K2 report release this morning – which says that “the ANA has failed its members” can only be interpreted as unhelpful, if not damaging, not least as it seems to ignore the very real concerns of its members. We think it is important to recall that when agency holding companies express concerns that comments in the K2 report “(hide) behind suspicions and anonymity” it is important to note that marketers may have been expressly prohibited – by contract with their agencies – from sharing their contracts with K2. Marketers who “out” themselves may be taken to task by their own management for having allowed non-transparent activities to occur on their watch. Media owners who “out” themselves may find their relationships with holding companies worsen. Agency executives who identify themselves would likely be fired.

With luck (for the agencies) there will eventually be a recognition of the problems at hand. Accepting the presence of non-transparent revenue activities and actively talking with the industry about those activities is a good way to go. We think the approach that WPP’s GroupM has taken, openly engaging in a dialog with the industry about such activities, is the right one. Alternately, an agency group claiming complete transparency could offer audit rights at a global holding company level to any marketer willing to pay for the process, and with the auditor of their choosing. However, it may be a bumpy ride ahead, with ongoing education efforts from the ANA towards its members on the topic and the pending release of another report in several weeks’ time related to recommendations for marketers going forward.