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How Ad Agencies Can Avoid A Death Spiral

2014 May 7
Mad Men

Leo Burnett’s fledgling firm got off to an inauspicious start when it opened in 1935.  With one client account, a staff of eight and a bowl of apples in reception, cynics said that he would soon be selling those apples on the street.

Yet, even in the midst of the Great Depression, the firm survived and Burnett, along with other pioneers such as David Ogilvy and Bill Bernbach helped create the consumer culture that defined the post-war economy. Those halcyon days are now long gone.

As long time industry veteran John Winsor recently noted, advertising agencies are no longer the valued partners they once were.  In fact, he argues, brands don’t really even need agencies anymore.  He might actually be understating the case.  It’s not just their work that’s losing relevance, the ad agency business model itself may now be defunct.

The Age Of Consolidation

The agency business has changed a lot since the “Mad Men” days.  What used to be a diverse industry of creatively driven full-service shops has now consolidated into a handful of enormous holding companies like Publicis Omnicom, WPP and Interpublic.

These are monstrous organizations that manage a wide range of businesses including media and public relations agencies, digital shops, specialty players in areas like mobile and social marketing as well as marketing research companies.  Perhaps not surprisingly, now that just a handful of people manage the entire industry, differentiation has suffered.

The holding companies have largely centralized innovation efforts in order to make their investments more efficient, so improvements in services tend to be general and incremental rather than targeted and disruptive.  Hiring practices are somewhat incestous, with nearly all of the senior executives coming from within the industry.

The consequences of the present industry structure are clear:  Ad agencies offer very similar services carried out by very similar people.

The Race To The Bottom

Although the mammoth size of the holding companies might, in theory, increase pricing power and investment, the reality is just the opposite.  In fact, as consolidation breeds uniformity, pressure on margins increases, making any effect from gains in efficiency short lived.

Further, this constant pressure on margins has inhibited the industry’s ability to develop talent.  While other professional services firms in fields like finance, accounting and law put a heavy emphasis on training and upgrading skills, training in the agency world is almost non-existent.

The result is communication professionals who don’t write well, “data driven” analysts with little understanding of basic statistics and content strategists without content skills.  What passes for “thought leadership” is mostly confined to trade publications and industry conferences.  You can’t have a first rate industry with second rate capabilities.

In the past, the heavy consolidation and low differentiation would have been sustainable, but digital technology has made barriers across industries more permeable.  While ad agencies remain focused on competition within the industry, the real threats are coming from outside it.

Porter’s Five Forces Closing In

Probably the best way to understand the challenges that ad agencies face is through the lens of Porter’s five forces,  which illustrate the impact outside threats can have on an industry.
 
800px-Porters_five_forces
 
Once you take a broader view, it becomes clear that the agency business faces an existential strategic threat.  Bargaining power with suppliers and customers has always been a challenge, but now publishers are starting to offer marketing services and, as Winsor’s article pointed out, agency clients are doing more work themselves.

There are also new market entries on the high end, such as IBM, who have vastly more resources and capabilities than ad agencies (IBM’s market cap alone is larger than all the top marketing services companies combined).   New digitally enabled freelance services can do basic work, like producing a video or designing graphics, without agency overhead.

Agencies like to say that they provide strategic services, but that’s not really true.  Mostly, they offer planning related to their own work.  For any significant strategic challenges, clients usually prefer to go to a consulting firm like Bain or McKinsey, where strategic literacy is far higher.

A Classic Innovator’s Dilemma

Clearly ad agencies need to innovate their business model and redefine how they create, deliver and capture value.  In the meantime, however, they still need to keep their clients happy and the truth is that their clients don’t want them to change.  Ad agencies are, in fact, quite good at what they do—delivering large scale marketing solutions efficiently.

So there is no clear path forward.  Marketers pay agencies to do work that is contracted for and have no vested interest in the agency model.  There are, after all, no shortage of companies offering them services.  Within agencies themselves, executives are rewarded for winning and retaining business, not creating new capabilities.

Yet, the situation is by no means hopeless.  Open innovation strategies such as accelerator programs could spur innovation.  Training in crucial areas, such as coding and data skills, would help build capacity even if unrelated to day-to-day work.  Initiatives like these wouldn’t immediately increase margins, but they would improve future competitiveness.

Unfortunately, there is no easy solution to the industry’s woes.  No grand initiative, strategy wrapped in a bow or presentation deck that can bring back the glory days.   The reality is that in order to survive, ad agencies will have to learn to experiment, risk failure and pivot quickly.  In effect, they will have to stop thinking like ad agencies.

- Greg

 

3 Responses leave one →
  1. May 11, 2014

    As a veteran of the agency and client (and marketing consulting world) I couldn’t agree more. Here’s my five cents…

    1. Big holding companies increasingly are creating “vertically integrated teams” to get over the silos, barriers and “separation” of skills that exist behind different P&L’s in the traditional models.

    2. They still acquire many of the more entrepreneurial companies that gain footholds in the market, and unfortunately often eat them alive.

    3. I believe there is a renaissance in smaller agencies, whether born of “brand or digital” to realize they have to offer the full range of services a client needs and are also positioning themselves to be also execute everything a client needs from ads, to apps, to events and media including beefing up data and technology, fast and effectively. This is a good sign and demonstrates that with increasing maturation in digital understanding, smaller companies can indeed compete on a larger playing field – especially in the SMB space which is a huge pool.

    4. And I agree too that the number of other players who are starting to take bites out of marketing budgets is growing every day – with the advent of marketing clouds, increasingly smart automated services and smart applications that allow clients to bring certain capabilities in house.

    But old habits die hard, and agencies still struggle with the dramatic shift in clients needs.

    Today experienced systems-thinkers, capable of orchestrating complex non-linear solutions, should be as sought after, as those with deep vertical skills.

    Nice blog as always Greg.

    [Reply]

    Greg Reply:

    Very good points Janet. You do see a trend emerging where small boutique shops crop up at the beginning of a cycle (social, mobile, etc) and then get acquired when they scale. Margins then narrow and the cycle starts over again.

    Another thing I see a lot of is small, regional agencies who become trusted advisors on the basis of their founders. Their clients typically can’t afford to hire the Bains and McKinsey’s of the world and tend not to trust young MBA’s for advice. These types of agencies can do well, but lose a lot of their value when acquired.

    That leaves the big agencies often competing on the basis of “our 3rd party software vs. their 3rd party software.” I don’t see how that can ever be a great business.

    - Greg

    [Reply]

  2. May 12, 2014

    Douglas Adams was asked how he thought technological changes will affect the future of the music, publishing and broadcasting industries…

    “It’d be like a bunch of rivers, the Amazon and the Mississippi and the Congo asking how the Atlantic Ocean might affect them… and the answer is, of course, that they won’t be rivers anymore, just currents in the ocean.”

    Ad Agencies are just one of those currents.

    They survive only because clients haven’t realised this and still see them as important. But as those clients die off, Ad agencies will too. Because they don’t matter any more.
    Peter Johnston´s last blog post ..How do you Market Pizza?

    [Reply]

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