Marketing Math Blog

May 30
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Why Agency Overhead Matters

By Advertisers, Advertising Agencies, Agency Compensation No Comments

overheadAt the ANA’s 2013 “Advertising Agency Financial Management” conference I attended an interesting session surrounding perceived misconceptions about the role of agency overhead rates in assessing the efficiency of an agency.   

My takeaway was twofold.  One, I agree with the premise of the speaker’s presentation that “overhead rates are not efficiency metrics.”  And secondly, overhead rates are both an important and often little understood component of any agency remuneration program.  Ironically, many advertisers spend little time in familiarizing themselves with the various components that make up agency overhead.  Further, most client-agency agreements are weak with regard to defining the composition of the overhead rate which gets applied as part of the compensation calculation.   

To be fair, this is an area where often time advertisers and agencies can “agree to disagree.”  In 2006, the ad industry’s two leading advocacy groups the Association of American Advertising Agencies (4A’s) and the Association of National Advertisers (ANA) jointly published a “Compensation Guide” that delved into this very topic.   

Let’s start with why agency overhead matters.  In short, it is a primary component of the multiplier utilized in marking-up agency costs to arrive at a total compensation rate in a “Cost-Plus” or “Labor-Based” fee arrangement.  Therefore, determining what is included in or excluded from overhead rate calculations has a direct impact on the fees paid by the advertiser to the agency.  Detailing these inclusions and exclusions within the agency Agreement is of utmost importance to promote clarity.  It should be noted that these are not static measurements; overhead rates vary within holding companies, from one agency brand to another and across geographic locations.  For advertisers utilizing services in numerous offices across an agency network, this can be an important consideration. 

The basic approach in the application of overhead is to base the allocation on the client’s  pro-rata share of the agency’s direct-labor costs.  However, sophisticated advertisers can and do negotiate overhead rates utilizing custom methodologies.   

It is in the advertiser’s best interest to understand the individual components included in the aforementioned categories prior to negotiating overhead rates.  Does “Indirect Labor” include agency personnel time invested in new business development?  Are other non-billable new business costs embedded in “Corporate “Expense?”  What parent and or holding company costs are assigned to the “Space & Facilities” and or “Corporate Expense” categories.  Transparency into this area is vital for advertisers to begin to understand the differences in overhead rates across agencies and geographies and will result in a much greater level of comfort when discussing this topic with their agency partners.  As well, costs that the agency is including into the overhead pool should be verifiable, and the client’s allocated portion should be recalculatable.  Such that the agency is not covering their overhead costs more than 1x across the client base.  Lack of transparency in this area can lead to abuse opportunity and inflated fees. 

Just as important as defining “what” is included in overhead and negotiating the overhead rate, is monitoring what this rate and or the resulting multiplier (i.e. direct-labor costs% +  overhead allocation% + profit rate%) is applied to.   

As an example, are there hours from individuals at the agency incorporated into direct-labor costs that should not be?  For instance, freelancers, independent contractors and or consultant time investment should not have overhead applied and therefore not be allocated to agency direct-labor costs.  The expense for these individuals’ involvement on client business should be handled on a pass-through cost basis and billed to the client with no mark-up.  The subject of part-time and or temporary W-2 employees is a topic for conversation between the advertiser and their agency.   

So while, overhead rates may provide limited insight into agency efficiency, they do have a significant impact on an advertiser’s agency fee investment and therefore the components of overhead need to be understood, discussed, defined and tracked. 

Interested in finding out how an advertiser can verify whether its agency is adhering to what has been mutually agreed to be included in overhead?  To learn more about advertising agency overhead and or agency remuneration practices, contact Cliff Campeau, Principal at Advertising Audit & Risk Management at ccampeau@aarmusa.com for a complimentary consultation.

May 17
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Moving Toward Strategic Sourcing

By Contract Compliance Auditing, Marketing Procurement No Comments

Advertisers strategic sourcinghave come a long way in forging stronger ties between their marketing and procurement teams.  Yet, there is much more to be done as organizations look for ways to improve their return on marketing investment (ROMI).  After all, while important, expense reduction is only part of the ROMI equation and some would argue a secondary consideration when contrasted with marketing’s role in demand generation.

The Association of National Advertisers (ANA) released the results of a recent survey of procurement professionals fielded earlier this year.  Not surprisingly, survey participants indicated that “cost reduction” and “cost avoidance” were the top two metrics by which their efforts were judged within their respective organizations.  No problem.  These are important financial goals for any enterprise.

However, the key to evolving the collaboration between marketing and procurement is to evolve their focus to include various means of boosting supplier performance.  The potential strategic value related to improvements in; agency relationship management processes, resource allocation decision making, supplier innovation and client/ agency engagement can have a meaningful impact on the bottom line.  On this topic, the aforementioned ANA survey would suggest that marketing and procurement have made significant progress, at least philosophically.

So what are the impediments to strategic sourcing playing a more meaningful role in marketing procurement and supplier relationship management?  Many in the marketing and advertising industry would suggest that “experience” is the principal challenge facing procurement professionals when it comes to the marketing services arena.  To be fair, this is not a procurement issue, this is an organizational issue. Recruiting sourcing talent with marketing experience, educating and training procurement professionals on the nuances of professional services sourcing and creating a culture which embraces accountability and transparency across the organization are key issues to be addressed.

In our opinion, marketing has a significant opportunity to shape the organization’s efforts in building the proficiency of the procurement team.  Work begins with, but clearly is not limited to, assisting HR to identify sourcing professionals with marketing experience, assisting in the crafting of job descriptions, educating and informing their procurement peers on differences between marketing services and other direct or indirect procurement categories, and working diligently to articulate their supplier optimization initiatives as the basis for driving goal alignment between marketing and strategic sourcing.

Unfortunately, in some organizations, rather than assist in developing procurement’s skill set and resource offering, marketers take advantage of the procurement team’s lack of category experience to stave off or minimize their involvement within the marketing services realm.  Given the significant level of marketing investment advertisers are making this is clearly not a desirable outcome; either as it relates to ROMI or relates to mitigating financial and legal risks inherent across the marketing services supplier network.

Unlike George Carlin’s “seven dirty words” which were once “forbidden” by the broadcast industry; accountability, audit, collaboration, cost containment, expense reduction, risk management and transparency are not taboo.  Rather, these activities should be considered necessary ingredients in any strategic supplier management initiative.   It remains a mystery as to why this perspective has been slower to take seed in the U.S. advertising marketplace than it has in the U.K. and Western Europe, but it is an issue that will need to be addressed for any real progress to occur.

Interested in learning more about constructive marketing procurement programs? Contact Cliff Campeau, Principal at Advertising Audit & Risk Management at ccampeau@aarmusa.com for a complimentary consultation.

Apr 26
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Take Stock of Your Marketing Supplier Network

By Advertising Agencies, Client Agency Relationship Management, Contract Compliance Auditing, Marketing Agencies, Marketing Agency Network No Comments

marketing agency networkWhether viewed in the context of the marketing dollars that flow through an advertiser’s marketing services agencies or their respective roles in building an organization’s brands and driving revenue, a marketing supplier network is a valuable corporate asset.  So how much do you know about the agencies which comprise that network?

Boosting supplier visibility within the C-suite of an organization can yield significant strategic and economic benefits.  The process begins with taking an inventory of those suppliers, their corporate lineage, resource offering, skills, pricing and historical performance on behalf of the company.  Without this knowledge it will be a challenge to optimize the investment made in maintaining this network.  Constructing a database with pertinent details on your supplier organizations is a pre-cursor to assigning roles and responsibilities across an advertiser’s agency base and for determining internal oversight responsibilities.

If this is an activity the organization has yet to undertake, there is a high likelihood that there is a significant degree of overlap across the supplier base and a less than optimal utilization level within a select group of marketing agencies.  Why should an advertiser care?  Because there is an attendant cost to contracting with marketing agencies and to retaining them on the advertisers agency roster… whether those agencies are being effectively utilized or not. 

Additionally, it is quite likely that the controls that are in place vary greatly from one supplier to the next.  This begins with the master services agreement (MSA) that is in place, whether or not such contracts have been executed and or kept current and extends to the resulting statements-of-work (SOW), agency staffing plans and remuneration programs.  While there is an obvious need for customizing MSAs and SOWs by agency type, there are certain terms and conditions ranging from “non-disclosure” and “non-compete clauses” to “right to audit” clauses, “document retention” policies and “intellectual property rights” assertions which provide critical controls that should be present in each MSA.  The question is; “Are they?” Further, once an MSA and or an SOW has been reviewed, updated and executed these documents should be retained in a central database for “ready access” by authorized representatives from Marketing, Procurement, Legal, Finance and Internal Audit.

Cataloging agency costs is another important step in constructing a marketing supplier database.  Armed with a deeper understanding of agency bill rates, overhead rates, direct and indirect expenses and multipliers an organization will be able to construct agency remuneration packages that are fair to the agencies and which generate savings for the advertiser.  One of the important bi-products of this information is the ability to benchmark supplier costs across agencies and makes for some interesting comparisons for those advertisers working with multiple agencies owned by the same holding company.

Implementing a systematic marketing supplier performance review program to be followed by the advertiser’s marketing department and marketing suppliers will provide a layer of qualitative data to further assess the effectiveness of each agency and to proactively identify potential weak links within the network.  Laggards can be targeted for performance improvement actions and or replaced in the event of continued sub-par results.

Ironically, the most valuable benefit of a marketing supplier database is the role it can play in advancing an organization’s collaborative supplier management (CSM) initiatives.  Aside from boosting agency performance and marketing ROI a well-orchestrated CSM program will enhance supplier satisfaction, longevity and fuel supplier motivation to invest in the client-relationship.  In the words of former Federal Reserve Chairman, Alan Greenspan;

“I have found no greater satisfaction than achieving success through honest dealing and strict adherence to the view that, for you to gain, those you deal with should gain as well.”

Interested in learning more about supplier visibility systems?  Contact Cliff Campeau, Principal at Advertising Audit & Risk Management at ccampeau@aarmusa.com for a complimentary consultation. 

 

Apr 17
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What is the Future of Agency Trading Desks?

By Programmatic Buying, Trading Desk No Comments

crystal ballIt was recently reported in Adweek that IPG was re-organizing its trading desk operation, Cadreon.  Representatives from IPG cited the costs and conflicts across its agency brands and offices stemming from having a centralized, autonomous trading desk with its own P&L.

This is a timely issue as publishers, agencies and advertisers brace for a pronounced increase in the role of programmatic buying.  Internal squabbles aside, the reason why some agencies aren’t totally on board with holding company trading desks comes down to one item… their own bottom line.  While agency holding companies could easily address this dilemma via a revenue sharing model between their entities that is not the seminal issue with trading desks.

The primary consideration in our opinion should be focused on an agency’s role in serving the advertiser and whether or not that obligation can be fulfilled when they’re acting as a re-seller of media where the original inventory cost is not disclosed.  Secondly, while the agencies and the ad networks have figured out how to make money moving digital inventory, publishers and advertisers are now evaluating the financial impact of programmatic buying and assessing alternatives which drive both efficiencies and performance for their respective organizations.

What are the financial implications?  The aforementioned Adweek article cited “agency insiders” who indicated that trading desks generated “high profit margins” in the “40% to 50% range” (hence the internal conflict).  Easy to see why advertisers would forgo the arbitrage model and opt for having their media AOR handle the digital media buying, on a fully-disclosed basis, within the context of their letter of agreement and the remuneration program that has been established.  Throw in the desire for advertisers to understand more about the quality of their digital ad placements and the environment is ripe for change.

Does this spell the end for trading desks?  Not at all.  Change and refinement are to be expected for a business model that only came into being within the last several years.  The technological capabilities that trading desks possess to manage reams of client data to effectively match advertisers with relevant inventory/audiences on a real-time basis is incredibly valuable.  This is particularly compelling as a higher percentage of an advertiser’s budget is shifted to digital media and programmatic buying.  Having said that, most advertisers are simply not willing to accept the level of opacity and the resultant hidden learning’s, which reside within their agency’s trading desk operation.

While media has evolved through the decades, the formula that has governed the media marketplace should remain constant; publishers sell inventory and advertisers buy inventory through their ad agency partners… not from them.  In the words of the noted American author Wendell Berry:

“The past is our definition.  We may strive, with good reason, to escape it, or to escape what is bad in it, but we will escape it only by adding something better to it.”

Apr 01
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Scam Ads? You’ve Got to Be Kidding.

By Advertisers, Advertising Agencies, Contract Compliance Auditing No Comments

scam adsMany of you are by now familiar with the recent scandal which has embroiled Ford and JWT India with regard to a series of “Scam Ads” for the Ford Figo.  The ads were created for entry into an awards show and were accompanied by tear sheets and a client letter allegedly vouching for their authenticity.  Much has been made about the actions taken by Ford which led to the dismissal of two JWT creative representatives and a member of the client’s marketing team for the offensive nature of the scam ads.

What is interesting are the revelations which have come to light regarding these faux ads and the extent to which agencies around the globe invest the time and money in creating these ads for the sole purpose of demonstrating their creative prowess.  One might ask; “Are awards really that important to the agency community?”  So much so that their actual work on a client’s behalf is deemed to be too pedestrian to be entered into competition?  In commenting on this practice to Ad Age, Susan Credle, Chief Creative Officer of Leo Burnett observed; “Sometimes, we (the industry) are so consumed with winning awards that we forget how public our work is.”

Much of the feedback has rightly been on the potential negative impact these ads can have on a brand when they inadvertently become public, as in the case of Ford.  But there is another aspect to this practice beyond who bears the risk and it is related to the issue of who bears the expense of this non-sensical pursuit of creative recognition.   The answer to this question should come as no surprise to anyone… the advertiser.  Interestingly, according to Nancy Hill, President and CEO of the 4A’s; “Clients don’t know that this happening.”

Not only is there the time-of-staff spent on creating these ads, the production costs and potentially the award show entry fees and even travel to awards shows such as Cannes (if not in direct expenses, overhead allocation) but the opportunity cost related to the diversion of client-paid agency resources being diverted away from brand building and demand generation advertising support. 

Given all of the good work done by agencies and advertisers alike, it is a shame that a sophomoric practice such as the creation of “scam ads” exists and serves to detract from the perceived level of professionalism attributed to the entire advertising industry. As the old proverb goes;

“Don’t do what you’ll have to find an excuse for.”  

What can be done?  The Ford – JWT firings of those responsible for the Figo ads are one thing, others have advocated for creative award show reforms such as banning faux ads from entry combined with a more thorough vetting process.  From our experience, advertisers who employ contract compliance auditing, with detailed fee/ time-of-staff monitoring and expense reconciliation can further enhance the controls necessary to insure that agency behavior and financial stewardship decisions are consistent with expectations. 

Mar 18
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Transparency Rules: Not So Clear

By Digital Media, Digital Trading Desk No Comments

digital trading deskThe hot topic thus far at the American Association of Advertising Agencies (4As) “Transformation” conference in New Orleans has been in and around agency charging practices for their digital trading desk operations.

It would appear as though the panel of agency digital media experts fell into one of two camps:

1) Arbitrage and profiting on the spread between actual inventory cost and client authorized plan costs is an acceptable way for agencies to recoup the investment they make in digital technology support and there is no obligation to share true cost data with clients.

2) Agencies should fully disclose the cost of the original inventory and any fees or commissions charged to clients in association with an agency’s procurement of that media.

Over the course of the last three to five years, virtually every agency holding company has launched a digital media “trading desk” operation focused on the procurement and in some instances re-selling (arbitrage) of online advertising inventory.  Evolved from the early days of demand side platforms, agencies have layered on significant data analytics capabilities that allow the trading desks to select the most appropriate inventory/ audiences for their clients in a real-time-bidding (RTB) auction environment.  No one disputes the value of that capability and its role in securing optimized inventory at the right price.  The questions surface around the transparency into the true cost of that inventory and whether it’s purchased for all the right reasons.

Theoretically, agency holding companies present their trading desk clients with agreements that specify the type of buying practices employed by the trading desk operation and the fees associated with that service.  Practically speaking, in our agency contract compliance audit practice, seldom have we seen separate agreements executed for this service nor have existing letters-of-agreement (LOA) been modified to reflect the terms of engagement for this aspect of an agency’s media buying offering.

Separate from the 4A’s conference, Rob Norman, Global Digital Chief of GroupM presented an interesting perspective in an interview with Ad Age when he referred to their policy on trading desk charging practices as “transparent, but not disclosed.”  In the end, this may be the most practical approach to the debate on this topic.

For savvy advertisers who seek full-disclosure on all aspects of the relationship with their agency partners and 3rd party vendors this is a discussion that they need to have prior to authorizing the agency to engage their trading desk on their behalf.  On the other hand, for advertisers who believe that they are receiving superior online ad inventory pricing and that the results of the effort are consistent with expectations, they may be comfortable forgoing insight into the cost of the original inventory.  The point is, that these are conversations that should be had upfront between the advertiser, agency and trading desk.  Any decisions made with regard to agency/trading desk remuneration, 3rd party vendor disclosures and transparency requirements on behalf of the digital trading desk process and performance should then be incorporated into the LOA.

While it would be convenient if there were published industry guidelines on this issue and others related to contract and compensation topics ranging from the composition of agency overhead rates to standard ranges for fee multipliers and full-time equivalent definitions, the fact is there are no standards.  Thus, advertisers must enter into all agency agreements with their “eyes wide open.”  Caveat emptor.

An agency can best serve the needs of their clients and their proprietary interest by initiating these conversations, sharing the agency’s philosophy on the practice in question and discussing options that are available to the advertiser within the context of that agency offering.  There is nothing to be gained by suppressing dialog on topics such as trading desk charging practices and transparency.  In fact, having these conversations surface after work has been begun can call into question the agency’s trustworthiness and or loyalty.

So if you’re an advertiser that has engaged your agency partner’s expanded service offering whether in the form of digital trading desks, in-house studios, programming procurement or production, poster specialists and or barter, check to make sure that you have a current binding agreement in place that affords you the desired level of protection, control and transparency.

If you would like a complimentary consultation to discuss agency contract “Best Practices,” contact Cliff Campeau, Principal at Advertising Audit & Risk Management at ccampeau@aarmusa.com.

Mar 11
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The Value of Consistency in Building Brands

By Advertisers, Advertising Agencies, Client Agency Relationship Management No Comments

brandingMarketing pundits the world over have long championed the role of consistency when it comes to building great brands.  When citing examples, we frequently here about creative expressions of that consistency ranging from Budweiser and the Clydesdales to Nike and their “Just Do It” slogan to McDonald’s and their “Golden Arches” or Coca Cola’s iconic red can. 

Rarely do we tout the generation’s long relationships between advertiser and agency which have contributed mightily to building so many of today’s top brands.  Chevrolet and Campbell-Ewald, Ford and J. Walter Thompson, Exxon Oil and McCann, Kellogg’s and Leo Burnett, Met Life and Young & Rubicam or Unilever and Lowe + Partners are but some of the examples of long-term collaborations.  And yet, sadly, even some of these unions are no more.

Great advertising is the result of proven methodologies and sound processes, which guide talented professionals steeped in brand knowledge and keenly aware of the needs and desires of the brand’s target audience to produce compelling work.  This doesn’t happen overnight.  Great advertising requires a commitment between an advertiser and their agency partners, a culture which values brand building and the vision to be able to balance that with the need to generate sales and build share today.  Importantly, it requires a resource investment on the part of both client and agency and a deep level of respect between those organizations which allows for a robust, long-term relationship in which both parties can challenge and feed off of one another.

So why then has the length of Client/ Agency relationships shrunk so dramatically over the course of the last thirty-years?  Why does it seem that when an advertiser changes CMO’s that an agency review is but a few short months behind?  Why do so few corporate CEO’s take the time to get to know their organization’s advertising agency partners? 

An advertiser’s agency network, which can number dozens of agencies across disciplines, geographies and brands, is a corporate asset which is at the heart of the organization’s ability to create near-term demand generation and long-term brand value.  Thus, the agencies which comprise this network should be afforded the requisite level of respect and attention which a valued strategic partner would warrant. 

Advertising agencies are not the property of, nor the sole purview of a CMO.  This is not to diminish the importance of a CMO’s agency stewardship responsibilities or their contribution to deftly managing the outputs of an organization’s agency network.  It is the realization that enduring, effective collaborations must be anchored in a culture that values long-term relationships.

At its low in 2006, the average time-in-position of a CMO was 23.2 months according to research conducted by executive recruiting firm Spencer Stuart.  The good news is that CMO tenure has climbed to 43.0 months in 2011.  However, 3 ½ years is but a blink of an eye in the context of some of the Client/ Agency relationships referenced earlier.

It is a truism that “great clients, get great work” when it comes to advertising.  So what makes a “great” client?  It begins with an organization that respects their ad agency and the agency personnel which work on their business and values the work that is done on behalf of their brands.  This is augmented by the willingness to integrate the agency into the broader marketing team and to work seamlessly as one unit, while understanding the division of roles and responsibilities.  Importantly, it involves a commitment to the relationship.  Agency CEO’s are much more willing to invest in adding resources, developing personnel and building infrastructure to elevate the caliber of work on a client business when they can do so with a long-term perspective and the opportunity for a return.

David Ogilvy once shared his perspective on the role of his agency and the investment required to implement his vision in a memo to his board of directors in 1978:

“I have a new metaphor. Great hospitals do two things: they look after patients, and they teach young doctors.  Ogilvy & Mather does two things: we look after clients, and we teach young advertising people.  Ogilvy & Mather is the teaching hospital of the advertising world.  And, as such, to be respected above all other agencies.”

Needless to say there are a myriad of processes, controls and performance monitoring tools which come in to play to maintain focus and to incent all parties to engage in the proper behavior and motivate each member of the team to achieving in-market success.  These include everything from a properly structured letter-of-agreement, a fair remuneration system which rewards superior performance, annual 360° relationship reviews, proper client briefing processes, independent performance assessments and access to key decision makers within both the Client and Agency organizations.

It is safe to say that with the passage of time and repetition, the ability to improve these processes and tools… and their outputs, becomes infinitely more doable than when changing agencies every few years.  Perhaps Leo Burnett had it right when he intoned:

 “I have learned that you can’t have good advertising without a good client, that you can’t keep a good client without good advertising, and no client will ever buy better advertising than he understands or has an appetite for.”

Mar 04
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Are Advertising Agency Performance Assessments Disruptive?

By Client Agency Relationship Management, Contract Compliance Auditing, Marketing Accountability No Comments

disruptionThe answer to this question will be as diverse as the background and experience readers have with corporate accountability initiatives in general and marketing services agency audits in particular.  However, the question shouldn’t be whether or not these assessments of contract compliance or performance are disruptive but; “are they beneficial?” 

As a former agency account director and client side marketing executive, I have had the benefit of seeing the marketing accountability process from both perspectives.   As such, in my humble opinion, performance assessments and contract compliance audits are neither disruptive to the advertiser’s or the agency’s workflow, nor do they place any undue strain on the relationship.  Quite the contrary, in my experience performance monitoring and compliance testing serve to better align advertisers and agencies and more often than not lead to process improvements which are beneficial to both parties.

What is puzzling is that there are individuals on both the client and agency side that continue to rebel against the prospect of a comprehensive, independent assessment of their collective performance and adherence to the terms of the relationship.  After all, both parties were actively involved in negotiating their letter-of-agreement (LOA), which most likely contains a statement of work, an agency staffing plan, a schedule of charging practices, 3rd party vendor management parameters and a clause detailing the advertisers “Right to Audit.”   It occurs to me that accepting independent assessments is much akin to accepting the truth.  In the words of the 19th century German philosopher Arthur Schopenhauer :

“Every truth passes through three stages before it is recognized. In the first, it is ridiculed, in the second it is opposed, in the third it is regarded as self-evident.”

More importantly, there isn’t a member of the C-Suite in any client organization who is not wholly on board with the notion of accountability.  While not initially the case in the context of marketing, those days are clearly in the rearview mirror.  It is not uncommon for corporations to spend between 1.5% and 5.0% of their revenue on marketing.  Whether the goal is to build brands, create short-term demand and or to grow market share, marketing is an important component in the success of an organization.  Thus, it is imperative that executives have confidence that their staff, their partners and their 3rd party vendors are making good resource allocation decisions with the company’s marketing investment. 

Performance reviews and compliance audits provide a measure of control to an advertiser to ensure that there is transparency into the decisions being made with regard to their marketing investment.  These initiatives have the added benefit of providing a mechanism to review personnel, processes and resource investment on the part of the agencies so that adjustments can be made along the way to improving their return on marketing investment (ROMI).   Independent audits also yield an excellent opportunity for client and agency to engage in a candid, comprehensive dialog regarding the audit findings and recommendations which frequently contain normative benchmarks or industry “Best Practice” insights.  This type of approach fosters partnership and strengthens relationships.  Everything is on the table, no surprises, with the simple goal of identifying various means of improving performance.

From a workflow perspective, audits should not disrupt an agency’s critical role in the demand generation process.  Is there a modicum of time required of the account team and or the subject matter experts on the agency side?  Most definitely, but not at an onerous level.  Further, this can be an incredibly worthwhile investment of time if the agency is willing to provide feedback and share insights into the relationship and thoughts that they might have on changes that can be made to strengthen that relationship and in turn boost performance.  Other than those qualitative interviews, it is the agency financial team that is typically “on point” for providing the requisite data and or reports required to support the audit.  The nature of the information request is straightforward is typically detailed within the LOA and can be readily accessed from the agency’s financial system, thus requiring little administrative time… unless of course the agency has neglected their “housekeeping” duties along the way (i.e. lax time-of-staff controls, failure to reconcile fees, delays in reconciling 3rd party vendor fees, etc…). 

In our opinion, it makes sense for both parties to view the accountability process as a sound “preventative” care practice that can preserve the health of the client / agency relationship… not to disrupt it.  Marketers who invite an independent assessment of their performance and that of their agency network are embracing an excellent opportunity to showcase their commitment to corporate accountability and a desire to maximize ROMI.   

Interested in learning more about marketing accountability and how to implement the appropriate controls and transparency?  Please contact Cliff Campeau, Principal at Advertising Audit & Risk Management at ccampeau@aarmusa.com for a complimentary consultation on this topic.

Feb 13
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How Do Agencies Do It?

By Advertising Agencies, Agency Compensation No Comments

ad agency profitsEarlier this month the Japanese agency holding company Dentsu announced quarterly financial results.  For the nine-months ending December 31, 2012 revenues were up 4.5% and net income was up 48.1% year-over-year.  Impressive?  Certainly, but not inconsistent with other players in the ad sector; WPP achieved a 43.3% increase in net income on a 7.4% revenue gain and Omnicom Group reported a percentage net income increase which was twice that of its revenue growth. 

A healthy advertising sector represents good news for clients and agencies alike.  Growing, profitable advertising agencies are able to invest in; infrastructure, personnel and research which ultimately allows them to better serve their clients.

There are two interesting observations with regard to the aforementioned agency financial reporting; 1) the recent results fit a pattern of extraordinary net income growth for the category, relative to revenues. 2) In a professional services business, the ability to generate net income growth of 2X to 10X that of revenue can only be achieved through a combination of significant expense reductions and or dramatic increases in direct margin.

Let’s be clear.  Like most other professional service providers whether in the financial, legal or consulting sectors, payroll makes up a disproportionately high percentage of an advertising agency’s expense base.  The publicly traded agency holding companies break out salary expense within their financial reports, allowing for a review of this cost center.  In a 2010 review of agency expense structures, Adweek reported that for the top five agency holding companies, expenses represented between 83% and 94% of revenues.  Salary expenses ranged between 59% and 72% of revenues.  The difference between the two is largely made up of real-estate and overhead costs.

Thus it is unlikely that agencies are relying on expense reduction as the primary source of net income accretion.  This would have a dramatic, negative impact on the caliber of work, service levels and ultimately, client retention and would be unsustainable over any prolonged period of time. Therefore margin growth would appear to be the primary contributor to the extraordinary net income gains.  But how you ask?  After all, industry compensation surveys consistently report that the average agency profit level identified within client/ agency agreements is 15%.   

Unfortunately the answer is clear, while not altogether transparent to advertisers.  A portion of the improved margin is tied to the provisioning of agency-owned services such as in-house studios, trading desks, poster specialists, barter firms and production companies. These services have tremendous margin upside for an agency because there is limited disclosure to the advertiser of the rates paid to the ultimate media seller and or the fees earned by the agency in the form of incremental commissions, spread between planned and purchased costs or volume rebates paid by the media.  Then there are sources of agency revenue which are seldom discussed and rarely audited which contribute to an agency’s bottom line profits.  These include but are not limited to AVBs, interest income from float, earned but un-processed discounts, rebates and no-charge media weight.

These practices are neither good, nor bad they simply represent the nature, albeit murky, of the global advertising industry today.  In the end, knowledge is power.  For example, the agencies that have been smart enough to vertically integrate and to leverage non-transparent income “opportunities” have generated solid bottom line performance. 

For advertisers the answer is simple, extend your knowledge of what is clearly a dynamic and often opaque marketplace: 

  1. Revisit your agency contracts to make sure that the requisite legal and financial controls have been incorporated to protect your interest. 
  2. Make sure that your agency contract extends to the parent company and any sister divisions which may be engaged as part of your agency’s service offering.   
  3. Examine your agency performance evaluation process and remuneration methodology to ensure that you are incenting the behavior and outcomes which you desire.
  4. Engage an independent auditor to assess your marketing service agencies contract compliance and performance to make sure that the requisite level of transparency is always maintained.

In the words of Sir Edward Coke, the renowned seventeenth-century English jurist;

“Precaution is better than cure.”

If you’re interested in a second opinion of the soundness of your client/ agency agreement or would like to discuss the benefits of an agency contract compliance audit, contact Cliff Campeau, Principal at AARM via email at ccampeau@aarmusa.com.