Deflation, Agency Margins and the Way Out
Cultures vary from country to country. Business practices vary from country to country. And even agency compensation plans vary from country to country. But the one thing advertising agencies worldwide now have in common, regardless of language and how they’re paid, is that profit margins for most agencies just plain suck. Why is this?
Most economists and pundits see inflation on the horizon; we see deflation. Deflation can basically be described as the economic point whereby you almost can’t give stuff away because consumers become increasingly shy to buy anything so businesses keep lowering and lowering prices in order to try to get consumers to buy.
Ever since the global economic crisis of 2008-2010, consumer businesses have been consistently lowering their prices in order to regain gross revenue and maintain market share. This was especially true during last year’s Christmas/holiday season. For instance, flat-screen TVs were at their cheapest prices ever in December 2011. So while corporate revenues, earnings and profits have rebounded somewhat, consumer brands are still doing everything in their power to control costs and continue to discount product in order to maintain sales because of their collective uncertainty of what lies ahead. As this trend continues, you very quickly reach the point of diminishing returns: you sell more things but lose money doing it. Ultimately, as we are now starting to see, this deflationary chain reaction works backwards from the consumer, to the retailer, on to the manufacturer, and then on to the supplier. And it has now found its way back to advertising agencies.
Many businesses are essentially saying to agencies, ‘We can’t afford to pay full faire anymore because our cost of goods are going up but we can’t charge more for our products so our margins are down… and, by the way, we need a whole bunch of different kinds of communication services just to sell all our stuff so we expect you guys to give us more for less, too.’ As such, marketing directors and procurement departments are putting the squeeze on agencies like never before. This agency profit-margin squeeze comes at a particularly bad time since agencies are having to offer an unparalleled cadre of services, such as social media, digital, PR, advertising, direct marketing/dialogue, event marketing, etc., just to satisfy clients.
The problem is that not all of these services are needed on a regular basis across all clients and thus don’t provide the consistent workload and revenue to justify fully staffing them. This, coupled with the lack of annual client plans, keeps agencies guessing – almost on a weekly basis – what is going to be needed and when. But if an agency doesn’t have the full slate of services, most companies won’t hire them to do their advertising. So agencies try to staff up and add new services, but they can’t afford to do so because their profit margins are so reduced that they are having trouble financing their own growth. So what’s an agency to do?
Here are some possible options to consider:
- Be The Expert – Specialize in a certain industry so that your agency becomes an expert in that industry and staff the agency horizontally across the communication services most in demand for that industry. The agency becomes an expert, destination brand and thus has a better chance of protecting its margins.
- Executive Producer Model – Focus on the core communication disciplines that your agency does best and subcontract out the ancillary/less frequently needed communication services. Client companies are usually OK with subcontracted work since they’re doing more and more of it themselves for just the same reasons agencies are.
- Join a Network – If you’re an owner/operated agency, join an international agency network of independent agencies so that you have a known base of geographic outreach and communication disciplines at your disposal that you know and trust. (No, this is not a plug for Worldwide Partners; just something indie agencies may need to consider in order to compete and win against larger, better resourced competitors.)
- Equity Investment – If you want to be a general, full-service agency, find an equity investor to help you add people and services. This could range from straight financial investors to other specialty agencies to merge with that need the services your agency provides just as much as you need their services.
- Form a Holding Company – An additional take on the equity investment model is to form a holding company from among the individual agency owners with the individual agencies underneath. The agency principals then get revenue from both their individual agencies as well as from being part of the holding company. The shared profits from the holding company may help reduce some of the profit margin strain on each individual agency and thus allow it/them to better compete in a deflationary market. The holding company agencies can then be brought into play, or not, depending upon the clients’ needs.
- Be Choosy – Be more selective in your new-business efforts. Concede that this is going to be a tough stretch for agencies so focus on current clients to try to help them grow their businesses and thus your revenues and margins, and only dance with prospective clients that are willing to offer decent margins from the outset.
- Incentive Compensation – Consider incentive compensation plans with clients, whereby the agency’s desired profit margins are met per the agency helping the client reach their goals. Yes, this has been tried with mixed results over the years. But if you’re a specialty agency, be it by industry or communication discipline, you have a better chance of establishing, agreeing to and achieving stated client goals because you know their industry better or because the client goals can be focused more specifically on the particular communication discipline your agency provides.
Do we have all the answers or even the right answer? Not necessarily. But we are hopeful that by even raising this topic it gives us all pause to think what is really going on and how it impacts the agency business. At any rate, at least you can go buy a bunch of fancy new monitors, TVs and presentation equipment on the cheap to impress your clients and new-business prospects!
Al Moffatt | President & CEO