Is The Current Ad Agency New Business Model Sustainable?

Unsustainable

Stan Rapp refers to the current upheaval in both the economy and the advertising/marketing world as “The Great Disruption”. In his opinion, what we are experiencing is not just a phase in time that will pass, but rather a permanent shake up that will forever change the world as we know it. I agree with him and believe that it will have a particularly strong impact on the current ad agency new business model.

 

The agency world in essence created its own monster. For years agencies have freely invested many millions of dollars on speculative pitch work, and the client has benefited from paying for only the work they consider to be the best. Can you imagine any other profession such as architects or engineers accepting the same terms? All based on a subjective decision with no mutually agreed criteria?

This age-old “Pitchworld” chaos is being further exacerbated by:

  • The increasing complexity and integration of marketing communications media and channels.
  • Ad agencies trying to become more digital and take a greater share of digital opportunities.
  • Digital shops trying to be more full-service oriented and look more like agencies, so as to try and win a larger share of the traditional media spend.
  • Technology providers going directly to the client and cutting out the agency.  

One digital shop has even resorted to acquiring an existing ad agency. To my knowledge this is the first time ever that this has happened!

All this effort for an ever decreasing profit margin? Agency profit margins continue to be subject to serious downward pressure as clients expect increased value for a lower fee. A great example of this was recently reported in the trade press.  Interpublic Groups’ CEO Michael Roth announced on July 28, 2009 that he expected IPG’s operating profit margin to around 7-7.5 percent for the current year. A very slim margin when you consider it from a return on risk perspective.

Something has to break. I just don’t see the industry being able to continue as it is. Consider the incredible amounts of money invested by agencies on speculative pitches with extremely low odds of success. In many instances the odds against the agency can start out being as high as 30:1 and, at best, be expected to finish somewhere around 4:1.

Successful agencies can achieve a 70% or higher success rate for a limited period of time. However, I would estimate the industry average as probably being closer to 25-30%. All of these pitches cost time and money. These costs either have to be paid for through reduced agency operating margins or alternatively, the three clients who actually picked the agency have to help fund the cost of the other seven unsuccessful pitches. Somebody has to pick up the tab for it all at the end of the day.

So my question is, how long will both private and public investors continue to put money into a company/industry that continues to experience declining operating margins with increased business risk? When is enough, enough?

I guess that’s the million dollar question we all keep asking ourselves.

 

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3 Responses to Is The Current Ad Agency New Business Model Sustainable?

  1. Ed says:

    Great read and great job putting into words what I think everyone has to be thinlking about. Sometimes we work so hard just to get in the door that we’ve somehow lost sight of the true nature of the business. We’ve gone away from what we know works, and is substantially more profitable, to a quick and easy platform that kills profit margins.

    So if we know the problem, how do we fix it?

  2. Steve Patti says:

    Clive/all – I think the bigger question to ask is whether the traditional “ad agency” is relevant anymore. CFO’s are now driving more marketing decisions than CMOs, as most CMO’s have squandered their political capital by demonstrating they have few/no metrics by which to make objective spending decisions.

    I mean seriously, a 1% open rate on direct mail that leads to a fraction of 1% conversion rate? A 1% conversion rate means a 99% failure rate — in what other industry do people keep their jobs when blowing 99 cents on each dollar given to them?

    Ad agencies (and many so-called “digital agencies”) are all about creating imagery and placing it in front of aggregated eyeballs — however, this simply creates “Awareness” for a brand or product (remember the Sales Funnel? — Awareness, Consideration, Purchase).

    Where the agencies are woefully inadequate is converting Awareness into Consideration — and this is because the traditional approach to Awareness is interruption and people today (particularly with social media) want to be engaged. So the engagement with the prospect breaks down and ultimately conversion to the Purchase stage is even worse.

    So the agencies are great at spending client money (protected by retainers and exclusive contracts from accountability) and now that the CFO is the new sheriff and is asking tough questions about ROI, customer LTV, etc. — the creative types in the agencies are at a loss how to respond.

    Check the Linked In profile of most AE or AD types and then you’ll see why CFO’s in America should be concerned — most of these people being paid high hourly rates to “advise” as to lead generation (via ads) and conversion have never really managed a product, brand, or channel — so where’s the experience (thus, credibility) in the recommendations?

    You might like two blog posts on this topic :)

    http://polarityinc.com/2009/03/are-ad-agencies-relevant-anymore/
    http://polarityinc.com/2009/09/how-to-rate-select-an-ad-agency/

    • clivemaclean says:

      Thank you for taking the time to post a comment. There is undoubtedly a very real shift to accountability and ROI that will continue to gain momentum. With it will come a new breed of agency professional very much in-line with your comments. Happy holidays to you.

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