Kickbacks are nothing new. They've been going on for centuries and no industry is immune. Normally "you scratch my back, I'll scratch yours" is innocuous, but when kickbacks cross the line into criminal territory, the ramifications can be severe.
The Association of National Advertisers (ANA) recently released an explosive 58-page report on kickbacks happening in the ad industry. The report claims U.S. ad agencies unethically padded their profits with secret rebate schemes, and that's just the tip of the iceberg.
Here is what you need to know.
How ad agency kickbacks work
For most ad agencies, the media buying process starts off legitimate. It's the latter half that gets murky, potentially crossing the line into criminal territory. Here is how it works:
- Ad agency is paid by the client to purchase media. (Good)
- Ad agency is then paid from incentives by the vendor who supplies the media. (Bad)
Incentives can be anything from discounts to consulting fees to volume deals. To achieve those incentives, ad agencies will recommend or implement media that is off-strategy to their clients.
Oftentimes clients have no clue because ad agencies aren't being transparent in their actions.
Why kickbacks are a serious problem
Historically, transparency in advertising has always been an issue. Dating back to the days of Volney Palmer -- the first advertising "agent" -- there has always been a veil of mystery surrounding ad practices. What happens to the ad copy when it leaves the seller's hands and goes to the buyer was pretty much unknown until now.
Shedding a light into the darkness is Jon Mandel -- former CEO of WPP media agency MediaCom. Mandel recently opened up to the media, explaining why he left the industry. The rampant use of agency kickbacks left a sour taste in his mouth.
Mandel warns agencies who use shady practices to make hidden margins are playing with fire. And this time around, it won't be the first time an agency has been burned.
In 2005, Ogilvy & Mather's chief Shona Seifert and CFO Tom Early were charged with overbilling the White House anti-drug account. Seifert was sentenced to 18 months and Early to 14 months in federal prison. And that's just one of many prominent cases. Now it looks like history is set to repeat itself.
What the ANA's report reveals
After a 2012 report went disregarded, the ANA hired two firms in 2015 -- K2 Intelligence and Ebiquity -- to investigate media rebates and transparency. The report is the culmination of seven months' worth of investigation. Initially it was anticipated the report would address two major questions:
- Did U.S. ad agencies accept rebates from the media?
- If they did, were those agencies transparent about disclosing them to their clients?
But what the report found, was even more explosive than originally anticipated.
On June 7, the ANA released its full K2 report, sending shockwaves through the industry. The study revealed not only several non-transparent practices, but also cash rebates to agencies.
The data was collected by K2 Intelligence, who requested interviews with 281 sources. Of the 281, they were able to conduct 143 interviews with 150 individual sources. All of the participants' identities remain confidential.
Of the 150 sources, 117 were directly involved in media buying. Of those 117, 59 had direct experience with non-transparent practices, and 34 included rebates. K2 also discovered executives were well aware, and leveraging a variety of deceptive practices. In fact, a former exec at an OOH agency owned by an Agency Holding Company reveals their approach was to set aside funds in escrow and pay back clients if they got caught.
What types of deceptive practices
The lengths to which ad agencies would go to make a buck were eye-opening. Common practices included:
Many agencies use the tactic of purchasing digital media in advance of an advertiser's need for media. Purchasing in advance typically garnered an additional discount from the media supplier, increasing revenue and margins for the agency.
As agency holding groups were buying media ahead of time, in turn, they would sell the media back to clients but not at the original price. Often the media was marked up anywhere from 30 to 90 percent. Naturally the agency pocketed the difference.
Here's an example of a typical markup.
Source: K2 report
Trading arrangements or barter deals help agencies acquire media for principal deals. One scenario involved a media supplier striking a deal with a barter company (agency). The barter company agreed to buy $1 million of media, helping the media supplier with revenue for the quarter. Then the barter company received a discounted rate for a larger purchase of media to the tune of $5 million for the next quarter.
Cash or credit rebates
Cash rebates are based on the amount spent on media, or in the form of free media inventory credits. For many execs, finding ways to keep rebates literally became like "playing a game."
Incentivized media buyers would direct client spend to highest-margin even if it wasn't in the client's best interest.
Programmatic media transactions
Several agencies treat programmatic buying as a principal transaction. Often an agency would use an ATD to acquire media, transfer the same media to another entity within the Agency Holding Company, and transfer it yet again to another entity within the Agency Holding. And no surprise, with each transfer, the agency would take another markup.
Where does the industry go from here
Prior to the announcement, advertising companies like Publicis and WPP were already feeling the monetary ramifications of stock prices falling when the ANA announced they had hired K2 and Ebiquity.
In the days and months to come, one senior media executive at a large brand thinks some clients may start asking to see the contracts that agencies have with their media vendors. There's also the possibility a brand could sue the agency if found in breach of contract. And like before with similar kickback situations, some ad execs could even be looking at jail time.
Stay tuned to see what evolves as the industry continues to digest the magnitude of the report's findings.