Working Capital

If there's one thing the recession has taught ad agency management, it's that staffing costs determine profitability. Woe betide the shop or holding company that doesn't closely match head count and salaries to revenue from clients.That lesson was illustrated most starkly at WPP Group. In late 2008, with the collapse of Lehman Brothers and Bear Stearns triggering a death spiral on Wall Street, WPP CEO Martin Sorrell gave this warning at the UBS Global Media and Communications Conference in London: "In the first nine months of this year and through October and November, head count [at WPP] grew faster than revenue. In our business that always means trouble. In the developed areas of our business, the mature parts -- that's the polite phrase for them -- there will be pressure on head count. In other words, there will be cuts."Sorrell then axed some 14,000 jobs between the end of 2008 and the first quarter of 2009 from WPP's agencies across the globe, according to WPP's financial disclosures. In September 2009, he told Reuters he wasn't done cutting. WPP's big agencies, including JWT and Ogilvy & Mather, he said, all have their own back-office operations, a duplication of efforts that Sorrell called "ludicrous." In an interview with AdweekMedia, Sorrell says, "I don't think we've done enough in looking at that. If you take a bird's-eye view of these operations and look at these back offices ... there's a lot more we can do of that nature."The reason Sorrell was so focused on getting rid of staff is not just that organic revenue was dropping 8 percent and he wanted to keep costs in line. It's that most of the time he had nothing else to cut: On average, about 72 percent of an ad agency's entire operating expenses are made up of salaries and bonuses for staff, according to holding company financial disclosures. The rest goes to real estate and other overhead bills. When clients reduce their spending, it's a lot easier to get rid of bodies than it is to move to a cheaper part of town. (Ogilvy, however, did just that last year, leaving its skyline-defining Worldwide Plaza building in Manhattan for the remote address of 636 11th Ave., many blocks from the closest subway line.) "You can manage staff costs to revenues, but property costs are the second-biggest investment you can make," says Sorrell. "It's much more difficult to manage because once you lock yourself into a lease there's little you can do about it for, say, five or more years."Agency staffing costs, in fact, make the difference between whether an agency is profitable or not, and the stock price that rides on that.The agency holding companies aren't equal when it comes to operating costs. The most efficient large network is Publicis Groupe, which earns back $1.21 for every dollar spent on employees and other overhead, according to the company's 2009 annual report. Publicis has a systematic approach to staffing costs, and rewards agency managers for keeping them low. "All the bonus 'envelopes' are controlled at the group level, so basically each agency gets a specific envelope and has some criteria based on organic growth, cash and margins," says Publicis investor relations officer Capucine Boncenne. "The rest is based on overall group performance."The least efficient is MDC Partners, which generates only $1.04 for every dollar spent. That's how thin even good advertising margins can be: just cents on the dollar. (In the pharmaceutical business, by comparison, some companies get returns of up to $3 per dollar spent.)Five agency holding companies break out staffing costs in their financial disclosures, allowing us to compare how well their people earn revenue. In order of efficiency by staff costs alone, they are: WPP, Havas, Publicis, Interpublic Group and Omnicom Group.WPP earns $1.70 for every $1 the agency puts in staff wage packets. At Omnicom, however, the staff generates $1.39 from every dollar of their wages. Omnicom has a reputation for paying the most for staff. Last year, salaries made up 82 percent of the company's entire operating expenses -- 10 percentage points higher than the average for the five holding companies. But when you factor in overhead costs, the ranking changes. If you compare total operating expenses to revenue, not just salary to revenue, Omnicom is second in efficiency to Publicis and better than Havas, WPP, IPG and MDC, in that order.For its part, IPG points out that it has been wrestling with a years-long turnaround: "We have taken a company that was losing money and increased margins by over 1,000 basis points, with improvements spanning 10 quarters prior to last year's recession," explains an IPG representative. "As of the first quarter of this year, we believe we're once again on the path to aggressive margin expansion."Part of the differences have to do with the business mix of each company. Digital ad shops and networks that have large media-buying operations tend to generate more operating profit than companies with traditional agencies inside them, like WPP. ValueClick, for instance, earns $1.89 for each dollar spent on operating costs; the European media buyer Aegis gets $1.30 for its dollars.But it's also clear that some agencies are simply better at hiring and firing than others. "When I was a managing partner of Berlin Cameron, basically it was an agency that did not have middle management. So, the cost structure was unique to the industry," says Avi Dan, CEO of Avidan Strategies, an agency management consultancy. (He's also a former global executive director at Euro RSCG and CMO at Saatchi & Saatchi.)"We were able to deliver margins north of 30 percent because at the same time we were growing very fast," Dan says. "So, that really is the most extreme situation that I've seen. The reverse is that some of the bigger multinational agencies have a bloated middle-management structure. I don't mean just account management -- it can also be on the creative side." MDC CEO Miles Nadal says Sorrell is right to look at ways of reducing staff and compensation in the larger operations. Client compensation has fallen dramatically over the last few years, leaving overpaid staff looking, well, overpaid. "The legacy agencies are dealing with people who've been in the agency for 15 to 20 years," he says. "If you have a lot of legacy talent that's been there a long time, and you didn't cut the compensation of executives, then their compensation as a percent of fees all of a sudden becomes out of whack."That scenario appears to have happened at Publicis. At the beginning of the recession, CEO Maurice Levy (pictured) told London's Daily Telegraph that he did not foresee any layoffs -- the opposite of Sorrell's prediction at WPP. He later said the recession "excited" him because of the new opportunities it offered. Indeed, in first-quarter 2009, Publicis revenue was still growing. But by July, reality set in, and Levy told investors he found the recession "unexpectedly steep" and "increasingly extreme." He reversed his prediction that month and ultimately cut more than 2,900 staffers across the globe, Publicis Groupe CFO Jean-Michel Etienne told investors and analysts at the Dec. 8 UBS Media Conference in New York. Levy finished '09 by giving up his bonus in "solidarity" with his workforce.Publicis' Boncenne says the hiring freeze was enacted in third-quarter '08 and is still on. "It's [currently] being cancelled for each agency on a case-by-case basis," she says.For agency staffers, it's not all doom and gloom. Agency revenues are growing as clients increase budgets and create new business. Interpublic and WPP have both told analysts that they are hiring new staff to cope. With growth comes a competition for talent, which both increases the number of new staffers needed and the salary cost for each one, so, average salaries could go up this year."The two things you can influence are revenues and staff costs, and maintaining that balance is the critical thing. If revenues rise, you can invest further in staff and associated costs," says Sorrell. "Revenues rose in the first quarter and we have started to hire again."

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Working Capital

Jim Edwards

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Jim Edwards