Agencies may bemoan the demise of 15 percent media commissions, but they're hardly headed for the poorhouse.
According to data compiled by Morgan Anderson Consulting, this is particularly true at shops with more than $75 million in annual revenue. Last year, a sample of about a dozen such shops revealed an estimated average profit margin of 19 percent, the data shows.
Morgan Anderson, which tracks agency compensation on behalf of marketers that spend an average of $100 million a year in measured media, reports that the figure is up from 18 percent in 1998 but down slightly from 19.3 percent in 1997. Moreover, 1999 capped a five-year period that produced an average annual profit of 18.2 percent.
And the bounty isn't limited to the big guys.
Between 1995 and 1999, a like number of midsize shops, with annual revenue of $30-75 million, produced an average annual profit of 12.5 percent—ranging from a low of 9.8 percent in 1996 to an estimated high of 15.5 percent in 1999, according to Morgan Anderson.
And the picture remains rosy when the figures for large and mid-size shops are combined: a five-year average annual profit of 15.3 percent, with a high-water mark in 1999 at an estimated 17.3 percent.
The high-teens margins seem even bolder in comparison to the recessionary days of the early 1990s, when the combined average was 10 percent. Back then, the behemoths fared better than their smaller counterparts, with an average annual profit of 11.2 percent between 1990 and 1994, compared to 8.8 percent for midsizers during the same period, the data shows.
Morgan Anderson, which has been comparing client bills to agency costs for 15 years, concludes that the ad business is as profitable as ever. That's due, in part, to creative billing techniques, but also because agencies have expanded their scope of work beyond traditional advertising.
Some observers also say the higher profit margins are a sign that shops have found ways to operate more efficiently, particularly when servicing king-size accounts. What's more, a longtime client that's pleased with its agency generally won't question profit margins, says consultancy managing principal Arthur Anderson.
Still, Anderson warns that without "transparency," or a complete breakdown of an agency's actual costs, a client has no true accounting of where its money is going. And as profits soar, agencies may lose focus and become more concerned with making money than great ads, says Anderson. He adds: "There's no direct correlation between profit margin and quality of work."
While acknowledging that profit margins have risen in recent years, a handful of CFOs say Morgan Anderson's numbers seem high.
"The last five years were much better than the five years before that. Virtually everyone would agree to that," says a CFO at a large New York-based agency. But, he adds, "I know of only one big agency network that has the type of margin you're talking about—McCann."
Adds Randy Weisenburger, CFO at Omnicom Group: "[The numbers] seem pretty out of whack. We had the highest margins in the industry last year, at 14.1 percent."
The data comes from the fact finding that occurs when clients, for various reasons, hire Morgan Anderson to conduct a cost analysis. At the request of the marketers, agencies provide information about labor and overhead costs. Often, it's done during a contract renewal period and leads to a new deal for the incumbent agency. Other times, it comes at the completion of a review, when agency contenders submit estimates of how much it would cost to service a particular account.
The $75 million-plus revenue crowd is a "Who's Who" among "top 20" agencies—about 12 to 15 a year, according to Anderson. Although he declines to identify agencies, the group is likely to include Young & Rubicam, BBDO, Ogilvy & Mather, TBWA\Chiat\Day, J. Walter Thompson, DDB, McCann-Erickson and FCB. And the lineup changes little from year to year.
The clients come from all walks of business life—packaged goods, financial services and retail to telecommunications, aviation and automotive—"top 200 in terms of spending," Anderson says. He would not reveal names, but the firm has worked for the likes of McDonald's, AT&T, Coca-Cola, Compaq, BMW, Delta, Sears, Apple, Nabisco American Express and IBM.
Why, in an era that espouses pay-for-performance standards, is the ad business so profitable? Experts point to four factors.
There are more clients today, thanks mainly to explosive growth in the e-commerce sector but also due to new technology and changes in the marketplace, particularly in telecommunications. Where once there was Ma Bell, now there are scores of telcos, providing everything from basic phone service to Internet access and wireless communications.
Clients also have become more peripatetic. That, in turn, has prompted agencies to maximize profits up front, knowing that what's here today could be gone tomorrow. This is particularly true with dot-coms. "Agencies are simply demanding to be paid more fairly," says Robb High, chief financial officer at Kirshenbaum Bond & Partners in New York. Along the way, agency executives have sharpened their negotiating skills.
In addition, fee-based agreements—particularly those laced with performance incentives—can produce greater rewards, since they take into account a multitude of factors, including salaries, staff hours and overhead. "It's based on an agency's activity, productivity and negotiating prowess," Anderson says. Under the old commission system, a flat percentage and media dollars were the sole variables.
Finally, agencies increasingly provide more than just ads through a bevy of below-the-line companies that are now part of the fabric of Omnicom, WPP Group, Interpublic Group and Publicis Groupe, among other holding companies. Margins on those services, such as direct marketing and interactive, are generally higher, partly because the overhead is lower.
In fact, as agencies nurture clients that first walked in the door a few years ago, the cost of servicing them generally does not rise at the same pace.
Once the infrastructure is in place, overhead costs are likely to diminish, thereby increasing profit. "The last money that comes in is immensely profitable," says Alan Gottesman, an Adweek contributing editor and principal of West End Consulting in New York.
Profits have been the talk of the industry recently, following the revelation that True North's margin on its Chrysler business at FCB was as high as 25-30 percent. And even though Omnicom will take on additional salaries to absorb the estimated $1 billion, CEO John Wren is betting the investment will pay off eventually. With Morgan Anderson's data as a guide, that could be sooner rather than later. TMC/PICTURE QUEST