Close-Up: Are agency profit margins too high?

An ISBA report shows clients appear to be resentful of agency profits. Is that fair, Alasdair Reid asks.

So it's true. Sometimes that light at the end of the tunnel really is an oncoming train. A year of blood, sweat, tears, redundancies and general fear and trembling in the agency sector - and what do they get? Just when things begin showing signs of picking up, they get a report from ISBA suggesting, in part, that their clients still think they're having a laugh.

Paying For Advertising, ISBA's triennial examination of the relationship between agencies and advertisers, focusing particularly on remuneration, was published this week. The good news is that agency profit margins remain "remarkably resilient". The bad news is that advertisers seem to resent this fact.

The report reveals the highestever recorded levels of "dissatisfaction with creative agency cost transparency and profit aspirations". And, it adds: "Advertisers take the running of commercial relationships with their agencies much more seriously than ever before and it is certain that the relentless search for even greater understanding, control, management and value will continue - this report reflects reality, however unpalatable in some cases."

But Debbie Morrison, the director of consultancy and best practice at ISBA, cautions against focusing on the report's most negative aspects. "If you look further into the report, you'll see that advertisers approve of the way that agencies manage their accounts more cleverly," she maintains. "Advertisers want to have smarter conversations about how their agency partners run their businesses."

And, indeed, there are cheery nuggets to be found here. The report notes, for example, that the average net rate paid to mainstream media agencies has been rising - this is, it goes on to speculate, perhaps down to the fact that they've been taking control of the more highly rewarded digital work, previously the domain of specialist digital agencies.

But it underlines a trend that the industry knows too well: the average net rate paid to creative agencies is down. And this is perhaps not entirely unrelated to another trend noted in passing: procurement people have more involvement in agency negotiations.

This was a theme that Mark Hunter, the ISBA president and chief executive of Molson Coors, touched on in his speech last month to an IPA gathering, when he acknowledged that agencies were often "caught in the cross-fire" between client procurement and marketing departments.

He stopped short of out-and-out sympathy, though - he was actually arguing that mainstream agencies are slow to react and should do more to emulate the costing methods pioneered by a new generation of more "nimble" niche agencies.

Agency bosses are, of course, too polite to suggest that this is all a bit rich. Or to point out that there's a certain amount of nimbleness required to keep profit margins "remarkably resilient" when revenues are falling off a cliff.

Interestingly, though, the report notes that curmudgeonly client attitudes aren't necessarily a product of the downturn. In other words, the golden age, when agency life was relatively easy, may never return - and that's a rather sobering conclusion.

As the report's preface states: "The recent harsh economic climate in which the research was conducted has revealed some interesting data - but this is no blip year. Rather the results indicate a continuation, or possibly an acceleration, of some long-term trends identified in previous reports."

CREATIVE AGENCY HEAD - Richard Exon, chief executive, Rainey Kelly Campbell Roalfe/Y&R

"A thriving and dynamic UK advertising sector is good business for brand owners everywhere. High-value creative ideas brilliantly executed can achieve telling competitive advantage, and to do this there has to be a sense of shared endeavour between client and agency. Not just culturally, but commercially too.

"The agency must recognise the prime importance of demonstrating value for money, and the client needs to believe, and witness, that a profitable, successful agency can attract and retain the best people, invest in changing skills and technology, and create a working environment that enables the best work."

FINANCE EXPERT - Alex Hunter, finance director, IPA

"Although the headline coverage was about agencies making too great a profit, ISBA's report is based on 26 clients thinking margins may have moved from 14 per cent to 15 per cent - and a lower proportion of clients now think they pay too much.

"The accountancy firm Kingston Smith W1 takes the view that the benchmark target for gross income per employee should be in excess of £100,000 to cover costs. Its survey shows 42 per cent of the top agencies didn't achieve that benchmark in 2008. 2009's figures can only be worse. ISBA confirms lower remuneration levels - agencies know margins have been squeezed too."

INDUSTRY BODY HEAD - Debbie Morrison, director of consultancy and best practice, ISBA

"Our members want healthy agencies, ones that have good business models and are in a position to grow and attract the best talent. That will allow them to attract new clients. It's a virtuous cycle. Yes, advertisers will always have a moan about money - but they generally want to work with well-run agencies.

"Procurement people acknowledge there comes a point when you can't push any further - and some form of payment by results is increasingly common. I think people are acknowledging that it's time for a different type of dialogue."

MEDIA AGENCY HEAD - Lindsay Weedon, chief executive, Maxus UK

"I'm surprised at the conclusion about profitability. I think it's pretty well known that media agency profits continue to be squeezed - though it's also true that the industry is working towards different models of remuneration.

"Increasingly, clients pay fees - and commission is being taken out of the equation. When that happens, we move more closely into line with the way that consultants work. I think sensible clients see what's happening in the industry and understand the pressures there are - and there are those, not least on the procurement side, who are increasingly looking to reach win-win solutions.

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