Feature

Why transparency is good for business

If agencies want to be seen as business partners instead of suppliers, they need to abandon unprofessional practices such as over-riders, Chris Ingram writes.

Interpublic Group's decision to include hidden media discounts as part of its restatement of accounts finally uncovered what has been an unspoken practice for many years, and it is high time the issue was debated properly.

Over-riders, volume deals, trade discounts, other media income, surcommissions and kickbacks are just some of the words we use when discussing this practice.

But, however it is described, what we mean is an extra payment from the media owner to the agency, over and above the standard published agency commission.

This extra commission goes to the agency on achieving an agreed total volume of expenditure: it is not client-specific. In some countries, this practice has become more "sophisticated" over the years (if that's the right word) and can include market-share targets required by the media owner, or varying levels of discount depending on the seasonality of monies deployed. The discount is nearly always a payment to the agency at the end of the year or agreed period, but sometimes it can be given as bonus space or spots instead of money.

In my experience, these rebates invariably go to the company and not to the individual. This is why I think the descriptor "kickback" is wrong and dangerous - it implies corruption where there isn't any. In fact, the advertising and media business is an amazingly clean one and it would be very sad if the net result were for the industry to be labelled corrupt.

In all my 40 years in the media business and having spent many billions of pounds, only twice was I offered a bribe and both of those were pathetic attempts made early on in my career by rogue directory companies.

Historically, the practice of media over-riders in the UK and US has been less prevalent than almost anywhere else. In France, the level of these discounts (known as "surcommission") was once so huge and distorting that legislation was passed (the Loi Sapin) that significantly limited the practice.

Note that the US, the UK and France are the head offices of all the big multi-national agency groups. Historically, this has allowed a head-in-the-sand attitude among agency chiefs of "I wouldn't know what goes on over there".

That excuse isn't going to work any longer.

But are such discounts illegal? On the Biblical principle of "render unto Caesar the things which are Caesar's", one has to start with the question: whose discount is this and, therefore, whose money is it?

Some clients will argue that they contributed to the volume and so they deserve a share of the discount. It doesn't work that way in other markets and anyway, unless the contract between client and agency has been written in such a way that stipulates the client should be rebated its share of the agency's volume discount, there is nothing illegal about it.

The issue is more complex than that. After all, if it were illegal you could bang a couple of people in jail to set an example, everyone would be terrified and that would be the end of it.

Some might say the practice is unethical, but I'm glad to see that not many clients are getting moralistic about this debate. Over-riders have been demanded by retailers from manufacturers since well before the Second World War, and the variations on that system now would fill a book. Look up "baker's dozen" in the Oxford English Dictionary and it says: "From the bakers' custom of adding an extra loaf to a dozen sold to a retailer, this constituting the latter's profit."

These discounts too were and are opaque, and the ultimate client (the shopper) knows nothing about them. Neither is there any intention of telling the customer what the real cost of the goods is, or which are the most profitable lines.

At the other extreme, if you get an interior designer to refurbish your house, they charge a fee, but also receive trade terms on nearly everything they buy on your behalf. Do you lie awake at night wondering if all these discounts are being passed on to you?

Certainly, one could ask whether the ad industry's practices are unprofessional, even if not unethical, but that depends on where you are sitting - with the clients, the agencies or the media owners.

The media owners aren't often mentioned, but this is the logical place to start. The media created agencies in the first place by giving them sales commissions. We are left with this anachronism even though fees are increasingly used and a lot of commission ends up going back to the client, particularly on bigger accounts.

Hence the mumbling you hear among media owners from time to time as to whether the agencies are earning their commission. Not surprisingly, a large proportion of media owners are therefore entirely comfortable with the idea of paying a percentage point or two more to ensure that certain volumes are delivered.

Others regard this as a dangerous precedent: a few for ethical reasons, but many more because they see it as a slippery slope towards ever-increasing commissions paid to agencies.

If you look at the economics from a media owner's perspective, paying over-riders can be very attractive - when a media company makes a good margin of, say, 25 per cent, it means it makes £25 for every £100 of turnover.

When a media agency talks of a 25 per cent margin, it refers to 25 per cent of the income, not turnover, going through its books. To simplify: a 25 per cent margin on income equating to 4 per cent of company turnover means that an agency is only making 1 percentage point on turnover. So an extra point is hugely significant to the media agency: it doubles its profit.

This is potentially very significant leverage for a media owner. Google's recent decision to replace agency commission with "best-practice funding" looks as if it is primarily a volume rebate. This may be the dangerous precedent that people fear, but at least it is transparent.

Advertisers find themselves in a strange position, because they have played a significant role in causing something to happen that is not in their interest. On the one hand, they operate in a global world in which there is intense competition, particularly price competition, from all directions. Whether local or global, the digital world we all increasingly inhabit is one of inexorable transparency, where the customer is better informed and more quickly aware than ever before. Price comparison is now an easy game that everyone can play. The rise and rise of the procurement department is no surprise in such a tough climate where cost reductions and efficiency improvements have to be constantly sought, year in year out.

Very often, the agencies and their parent holding companies have been unable to fight against this downward cost pressure from clients. This has made it extremely difficult to offer the quality of strategic advice clients say they want, thereby forcing agencies into an implementational (and often reactionary) role.

This has resulted in increasingly frustrated public statements from big advertisers - Unilever, Gillette, Coca-Cola, Procter & Gamble - about the agency world's inability to meet their changing needs. Apparently, they want innovative strategic thinking and objectivity, coming from a really transparent organisation. But the evidence suggests few are willing to pay their agencies for it.

When I was the chairman of the publicly quoted Tempus Group, if a major global advertiser was moaning about the problem of hidden commissions, I would reach for my latest annual report and turn to the summary sheet.

"Look," I'd say. "Here is our income and here is our turnover: they are properly audited figures, so there is zero scope for playing games, unlike with billing figures. You can see our average 'yield' from media turnover is 3.7 per cent and, since our margin is 16 per cent, it costs us 3.3 per cent to service the typical client.

You are getting a sophisticated service from us in lots of small countries for (say) 1.8 per cent. You know we are not a charity - where do you think the rest of the money is coming from?"

Most advertisers couldn't cope with that. They wanted transparency, and so did I, but they knew they couldn't politically push through the apparent price increase, even though I'd have gladly given them back the over-riders.

This was a huge frustration for me as, at that stage, with an international organisation driven by entrepreneurs all pulling together, I was in a position to guarantee total transparency in all markets, subject to the client giving a fair price in all markets. I wanted to be able to demonstrate true objectivity without any risk of bias on the basis that some media were more profitable than others, but I didn't find a client who could or would deliver it when it came to the crunch.

In one case, I was looking for 2.75 per cent on a huge volume of business providing a very sophisticated (for the time) media service closely integrated into the marketing department.

At the centre, the brand champions and media chief were excited and could see it was well worth paying the premium, but in some countries the local client (often the chief executive) was used to paying less than 1 per cent commission: there was no way they would consider paying extra even with the much bigger rebate the client company would get back.

I had come face to face with commercial reality: if the local chief executive remains profit-responsible, he or she is going to call the shots over any central function. That is just a fact of corporate power and politics.

So, unless things have changed dramatically in the past five years, there are many client companies where the structure prevents sensible decisions being made. Marketing people often do not have the clout in their companies they should and so, behind all the huffing and puffing, things are not going to change quickly. Besides, the agencies' clients are preoccupied with other things, such as having to work on ever-shorter time scales, and so leave agency fees and contracts increasingly to their head of procurement.

But, arguably, it is not advertisers who have the biggest incentive to change things - it is the agencies that are between a rock and a hard place. At the client level agencies typically operate on, the preoccupation is with implementation, not strategy. Clients want something, agencies deliver and that is where the big money is spent. So, not surprisingly, it is overwhelmingly how agencies make their money and media over-riders are merely a byproduct of big volume spending.

However, agencies can't take extra, hidden discounts from media suppliers and expect those clients to fully respect their advice and pay properly for it. If they want to be at the top table along with the other professions, then they have to give up those discounts. There's no denying this would hurt financially - at least in the short term.

It depends how much agencies want to get back to being trusted business partners instead of being regarded as suppliers. Many senior executives at the big agencies hate the idea of being suppliers and the increasing involvement of the procurement department.

When you hear from the IPA about the blue-chip client who asked all the agencies pitching for its account to sign over the copyright for their work (ie. the intellectual property) for £1, one can understand their frustration, even if that is an extreme case.

Agencies have to accept there is a trade-off: no-one pays their supplier for high-quality, objective advice. They are happy to listen to free advice but have an underlying worry that this advice might be biased and also probably not quite "top drawer". Just take the parallel of financial services and the changes the Financial Services Authority forced upon the market. Hidden commissions and objective, high-level advice just don't mix.

When we started Ingram two-and-a-bit years ago, we accepted that trade-off. We consciously decided not to offer implementation to clients. The net result is we captured "business partner" status, but the price is that we will never be a big, scaleable business.

Over-riders are rarely illegal, only occasionally unethical, but very often unprofessional. And for an industry that wants to be thought of as a profession, in a world where transparency is inexorable, that's no place to be.

- Chris Ingram is the founding partner of the strategic consultancy Ingram.

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