The advertising agency business is in pretty big trouble.
I say this while keeping in mind all the ways this phrase has been meant during the recent past: the changing media landscape has forced change to a model that has persisted nearly unchanged since its inception in the 1840s, when one of the first media agencies -- a distinction frequently ascribed to Boston's Volney Palmer -- started charging a fee based on a percentage of the amount a client spent for advertising placement.
NW Ayer and J Walter Thompson began their practices at close enough to the same time to share the distinction of being the oldest formal, full-service advertising agencies, charging in the same fashion.
I say this keeping in mind that what agencies are now being asked to do is far outside their traditional purview, and they are tasked with everything from creating product and generating sales to producing global marketing strategies.
The part of the agency business that is in big trouble is the business part of the business. While related to the aforementioned, the business aspect of what it is that agencies do is tied closest to how it is that agencies are compensated for what they do for clients.
Advertising agencies have, for some time now, never really been very business minded. It isn't in their DNA to look at what they do from a business perspective. This is in part because rarely do those involved with creating a company's marketing and advertising plan have P&L responsibilities in that business; hence the longstanding tradition of resentment between corporate bean counters and marketing personnel.
But more than that, the vehicles for carrying marketing and advertising, and the use of those vehicles, have changed so dramatically at so many levels that the responsibilities agencies are being tasked with no longer jibe with how those agencies are being compensated.
Clients are demanding more sophisticated services, but they are doing it while insisting on lower rates of compensation.
Percentages
Don Schultz, professor emeritus of service at Northwestern University's Medill School, and an occasional speaker at the iMedia Summits, once said as an answer to a question I asked during the Q&A session following an address he’d given that the advertising industry was ruined near the beginning by a man named J Walter Thompson, who gave away his ideas to his clients for free, and only charged them for the media they'd buy.
This is a compensation structure that, while frequently rebuked, is still in play, if not formally, then as a guideline.
While agencies may no longer charge the old 15 percent of ad spend, and studies done by consultants based on surveying advertisers show that around 10 percent of the majors still do charge some percentage of spend, there's no telling what the small- to mid-sized shops are doing. And this doesn't address media-only activity.
That said, when a percentage is involved, that percentage has shrunk to low-single digits. This is why larger buying services have had to get larger, because the margins are so small they have to make up for it in volume in order to generate any real income. This is also why so many agencies participate in a practice that is one of the business' most well-known dirty secrets: hold invoices for so long past the due date in order to keep the client's money in escrow so as to earn some interest. It's commonly referred to as making money on the "float."
But as anyone who has worked day and night on a piece of business only to see the client never actually spend any money, or to spend so little as to become a money loser, can tell you, percentage of spend as a method for compensation -- no matter that percentage -- is a crappy way to do business.
Pay for performance
Tying compensation for agencies directly to "performance" is a path no agency should ultimately go down, in spite of its popularity with clients. This was the toast of the town a few years back, particularly for agencies working with consumer packaged goods clients.
Agencies are compensated based on the lift in sales their advertising can be shown to produce. Some advertisers have used "agency-specific" measurement criteria, such as lifts in brand awareness and various brand perceptions. The problem with this approach is that it puts absolutely no onus on the advertiser. Yes, good advertising should instigate action on the part of the audience exposed to it, but that action is highly dependent upon what is being advertised.
The advertising for a new candy bar with extra doses of arsenic might be excellent advertising, but the product leaves quite a bit to be desired. The agency can only be held responsible for bringing the audience to the Rubicon; the product or service being featured has to at least meet the audience on the banks of the river.
More often than not, pay-for-performance compensation is included as "incentive" compensation, and not the basis for how the agency is actually paid for the work it does.
Direct response shops will often tie their compensation to performance, in concert with other means of compensation, such as percentage of spending or fee for service.
Fee for service
Frequently, fee-based compensation derived from hourly rates is set to mirror a desired total compensation that itself reflects a percentage of spending.
This is really the fairest form of compensation for an agency, but also one that the client is nearly always most suspicious of. What if the work isn't very good? What if the number of hours isn't really what the agency estimates them to be? Why should I have to pay for something if my advertising plan doesn't end up being executed?
Because advertising product that cannot be seen, heard or touched (creative services rarely have the problem of getting compensated for work done), there is some form of psychological impediment to feeling comfortable with paying for work that is not tangible. And yet companies do it when it comes to lawyers and consultants all the time.
Agencies need to do a better job of presenting themselves as ideation centers and not executional functionaries.
In 2006, the top three holding companies (WPP, Omnicom and IPG) showed just over 7 percent profit margins, with IPG at only 1.3 percent. As it turns out, a seven percent profit margin is the average profit margin of the world's top 20 corporations.
However, for consulting firms, 20 percent profit margins are on the low end, with some of them yielding as much as 50 percent. If marketing services conglomerates could figure out how to position themselves as sources for ideas rather than factories for making advertising product, they could solve so many of their problems (higher profits leading to more employees and higher compensation leading to less burn out leading to happier employees leading to higher retention leading to people willing to work better and harder for your company to give you the best ideas).
Figuring out how best to make money is the key to every business, even the agency business. And without a better way of handling the business end of the agency business, there won't be much of a business.
Media Strategies Editor Jim Meskauskas is vice president and director of online media for ICON International, Inc., an Omnicom Company. Read full bio.
