By Michael Farmer
What are the steps that creative ad agencies can take to rekindle revenue growth? We recall that agency fees have been under downwards pressure for quite some time due to brand globalization, client obsession with "shareholder value," the rise of procurement, the fragmentation of media, the scrapping of AOR relationships and the stagnation of brand growth. These factors have driven fees downwards and reduced the length of client relationships. The agency scramble for new business has pitted agency against agency in an industry price war. Where is this headed? Can any agency "break out" of this deadly cycle and join the Madison Avenue Makeover Club? Is there a way to restore ad agency revenue growth?
How big is the problem? According to my research, 2004 was the last year that creative agencies were paid fairly by their clients for the amount of work in their Scopes of Work (SOW) and for the number of Creative, Production, Client Service and Strategic Planning people required to do the work at an acceptable level of quality.
Since 2004, industry fee levels have declined by 26%, in constant dollars, and Scopes of Work have grown by 34% (as measured in ScopeMetric® Units, or SMUs, which harmonize the sizes of the different types of deliverables in a SOW). These are average industry figures derived from my consulting experience and research.
The combination of declining fees and growing SOWs has been a deadly one. Price, which is mathematically income divided by workload, has declined by an alarming 45% since 2004 (in constant dollars). Put another way, the price for agency services is only 55% of what it was in 2004. The gap between workloads and fees is enormous.
Agencies, of course, have dealt with this by holding back on salaries and headcount growth. The most telling fact is that agency creative headcounts have grown, on average, by only 11% despite the 34% increase in SOW workloads. This means that the average creative is more junior and very stretched in 2017, and this cannot be a good thing for agency creativity or quality. It has certainly accelerated employee turnover in the creative department.
Holding companies should note these figures and reconsider their strategies. Holding company profit growth cannot be maintained by continuing to squeeze agencies for lower costs. Muscle, rather than fat, has been squeezed out for the past 13 years. Further reductions of agency operations will only enfeeble agencies and encourage clients to invest further in their inhouse agencies.
How, then, does any agency CEO turn this around, put a floor under prices, and rekindle agency growth? The most obvious step is to rethink remuneration and agency contracts (especially for new clients) to assure that agencies are paid for the work they do rather than for some client guesstimate of agency manhours. Is this an astonishing concept? Forget about "value pricing" or other sophisticated remuneration schemes. Get paid for the work! That would be a good start.
If "being paid for the work" had been the policy from 2004 to the present, agencies would have seen fees that grew in proportion to workloads, less any "discounts" that may have been provided to meet competitive pressures. If workloads were growing at 2.3% per year (according to my research) but agencies had to discount their prices by as much as 1% per year, they would have grown their fees by 18% (in constant dollars). On an annual basis that amounts to 1.3% compounded annual growth in constant dollars, or at least 2-4% per year in current dollars. This would have permitted investments in additional headcounts.
What is required as a first step is for agency CEOs to say, "We can't ignore our growing workloads any longer. Across our agency, as a matter of policy, we will document, measure and negotiate our SOW workloads in a uniform way as the basis for our fees. Account Heads will be responsible and accountable for this; their performance will be transparent and reviewed, and corrective action plans will be put in place where workloads exceed fees." CEOs need to establish this agency policy and roll out an off-the-shelf SOW management system with an SOW metric like the SMU.
The benefits of this should be obvious. First, agencies will be tying their remuneration to growing workloads and putting a halt to declining prices and headcounts. Second, agencies will develop a heightened awareness of what is actually in their Scopes of Work and, it is hoped, begin to recommend SOWs that have a high probability of delivering improved brand results. Third, account heads will become more accountable and motivated to run their clients in a responsible way. This is sorely needed; there has been too much scope creep and unpaid out-of-scope work over the past decade or two.
Every journey begins with a single step. Agencies embarking on the makeover path need to begin by documenting, measuring and negotiating SOW workloads in a uniform way as the basis for fees. That's the first and most logical step to rekindle revenue growth and halt the erosion in agency capabilities.
Michael Farmer is the author of Madison Avenue Manslaughter: an inside view of fee-cutting clients, profit-hungry owners and declining ad agencies, winner of four publishers’ awards for the best Marketing/ Advertising book of 2016 and 2017.
Appeared first in Media Village