Ad agencies increase profit margins despite lower fees and higher staff costs

Many agencies have responded to a fierce competitive environment by discounts, but this is not sustainable in the long-terms, warns Kingston Smith partner Esther Carder.

Ad agencies increase profit margins despite lower fees and higher staff costs

The Top 50 advertising agencies managed to improve their average operating profit margins to 10.4% despite a decrease in fee income and continued staff cost pressures.

Fee income reported by the Top 50 advertising agencies declined slightly by 0.25% compared to their previous year’s results which is especially disappointing when compared with GDP growth of 2% for the UK in the same period and growth of over 15% reported for the top 30 digital agencies included within this survey. These statistics set the tone for the advertising sector this year which has found that budgets are being squeezed and delayed in response to an uncertain economy on top of the historic issue of being able to charge properly for the services delivered.

The operating profit per head for the Top 50 this year went down to £11,606

Encouragingly 28 of the Top 50 advertising agencies reported growth in fee income, with nine reporting increases of more than 15%. However, the significant growth reported by some was countered by some large decreases which meant an overall decrease.

As pitches become more competitive the pressure on fees within the advertising sector is fierce. Many agencies are agreeing to service more work for the same fee for existing clients and heavily discount rate cards for new ones. This behaviour isn’t sustainable in the long term and it’s those agencies that can separate themselves from the price competition that will deliver sustainable profits.

We suggest that a well run agency should aim to make an operating margin between 15% and 20% and the average operating profit margin of the Top 50 improved slightly from a low of 9.9% last year to 10.4%. This is some way off our target but encouragingly 17 agencies (13 last year) achieved our minimum target of 15%. The results were more polarised this year with a record number of standout performers but at the same time more loss making agencies. Eight agencies (four last year) reported operating profit margins over 20%. Interestingly these agencies ranged in size (as defined by their fee income) from £6 million to £95 million proving that premium margins are achievable across the board.

Across the Top 50 agencies the spend on employment costs as a proportion of revenue/fee income ratio worsened to 61.3% from 60.4% last year which is another record high for the sector. The pressure on staff costs is unlikely to relent in the short term as specialist digital skills are required at a premium and so it will be those agencies that can balance their costs with revenues that will deliver great results. Of course this 61.3% doesn’t include freelancer costs which are not reported in statutory accounts. Therefore once factored in the percentage spend on people costs is likely to be a lot more than our target of 60%, hence the low margins. 

Some 25 agencies cut their staff numbers whilst only 12 agencies increased staff count by more than 10%

Productivity as measured by fee income per head increased to £111,476 as staff numbers decreased ahead of revenues. This is in line with our target for advertising agencies of between £100,000 and £120,000 per head and some 28 agencies met the target of £100,000, with 15 exceeding the upper range of £120,000.

Operating profit per head however is arguably the most important performance indicator as it combines both the profitability and productivity measures of a business. The operating profit per head for the Top 50 this year went down to £11,606. Group agencies outperformed the independents here with an average of £12,980 per head against £9,153 for the independents.

Staff numbers across the Top 50 reduced very slightly by less than 1% after a few years of steady increases. Some 25 agencies cut their staff numbers whilst only 12 agencies increased staff count by more than 10%. A number of agencies reported restructures during the year and others will likely not have replaced leavers. Staff costs increased by 1.57% which was ahead of growth in fee income; the reason employment costs as a percentage of fee income deteriorated slightly.

As revenue growth opportunities become more pressured and talent is more expensive it is more difficult than ever to deliver good financials as our survey results confirm.

Unfortunately, 2018 looks to bring more of the same gloomy news for the advertising sector. With the majority of brands under pressure to deliver short-term financial performance, longer term relationships and retainer fee arrangements are becoming increasingly rare. The threat of consultancies is also very real as in some cases they are offering creative services and content marketing along with their strategic and data analytics solutions. At the same time the uncertainty around Brexit and the global economy are unlikely to help increase demand while adding pressure to staff costs. Those agencies that can adapt their offerings to combine creative excellence with strategic business solutions whilst managing their resources are the ones that will prosper. 

Top 50 advertising agencies (gross income)

Esther Carder is a partner at Kingston Smith