The recently-failed Publicis-Omnicom merger was positioned as a scale-creating establishment that could squeeze out $500 million of unnecessary costs. The benefits, it was assumed, would be retained by shareholders. Holding company profit margins would rise, as would share price.
This was surely flawed thinking – client procurement departments would have been the first in line to secure and enjoy any cost such cost savings. Shareholders would have never seen a dime of the benefits.
Now we hear Paul Elliott Singer, hedge-fund billionaire, with a 6.7% stake in Interpublic, beating the drum for “media consolidation” and promoting the sale of Interpublic within the industry as a remedy for IPG’s profit “underperformance.”
What’s similar in his argument for IPG – as was previously argued for Publicis-Omnicom – is the erroneous assumption that cost management is the strategic problem, and that increased scale or consolidation is the solution.
Agencies have very real profit problems, to be sure. Ask any finance director how easy it is to meet holding company margin targets of 15% per year. But agency profit problems are the result of pricing problems, not of cost problems. Agencies have successfully attacked their costs for more than 20 years, downsizing their headcounts, holding the line on salaries and bonuses and reducing overheads. They are genuinely expert at downsizing and economizing, trying to get ahead of relentlessly falling prices for their services. Remuneration in the industry is scandalously low; new agency hires out of university are given salaries that are less than 50% the rate offered by the major consulting firms or investment banks. Agency salaries do not attract the best and the brightest.
Price in this case is simply agency fees divided by agency workloads. Fees have been under downwards pressure from client procurement departments, while workloads have been growing relentlessly as a result of increased client experimentation with new forms of advertising. Workloads are not negotiated effectively by agencies; they accept fixed retainers and then do whatever work their clients want done. Ergo, prices for their services have been in free-fall since 1990. I’ve calculated that agency prices are down by 2/3rds over the past 20 years if inflation is removed.
Those who simplistically propose ‘consolidation’ and promote more aggressive cost reduction are merely helping agencies dig their own graves. Increased workloads cannot be handled year after year by fewer, more junior, less-well-paid agency people. Creative quality is the first casualty, and there is already plenty of evidence that poor quality is an issue. Client relationships turn over rapidly; the average duration is now less than 4 years.
Is the industry below scale? Not at all. Are agencies guilty of under-managing their costs? Not in the least. Are agencies suffering from declining prices due to poor contract and client relationship practices? Absolutely. Agency workloads are neither documented, tracked, nor negotiated with any consistency or professionalism. The price decline has been authored by inadequate agency management and operational practices. Falling prices are a self-inflicted wound.
Agencies need to negotiate better terms with their clients and ensure that they are paid for all the work they do rather than accept declining retainers and do whatever work their clients dream up during the fiscal year. Downsizing at the end of the year to generate required profit margins is stupid and suicidal.
Michael Roth of IPG is right to resist Elliott Management’s siren call to find a holding company acquirer. Roth is wrong, though, if he redoubles his efforts to accelerate IPG’s cost reduction programs within the portfolio of ad agencies. Roth should focus on IPG's weak prices from its clients rather than on agency costs if he is genuinely interested in restoring IPG’s profitability to appropriate levels.
Improved prices for growing agency work is the strategic need, not lower costs. And let’s drop the talk about ‘scale’ within the industry. This is not an under-scale industry. Reducing the number of holding companies through a mega-merger is hardly a serious route to sustainable and improved agency profit performance.