In building the world's largest advertising company over the past 30 years, Sir Martin Sorrell, chief executive of WPP, has weathered two recessions and survived a global financial crisis. His firm nearly went bankrupt in the early 1990s. Now he must make his hardest advertising pitch yet, to convince the corporate world that image-making agencies like his are not dinosaurs on the brink of extinction.
Advertising agencies grapple with changes driven by Google and Facebook
With pressure on all sides, big agencies must sell idea of their own survival.
By Economist
April 2, 2018 at 9:02PM
The world's advertising giants are struggling to adapt to a landscape suddenly dominated by the duopoly of Google and Facebook. Some of their biggest clients, such as Procter & Gamble (P&G) and Unilever, are also being disrupted, in their case by smaller online brands and by Amazon. They are cutting spending on advertising services, and also building more capabilities in-house. Consultancies with digital expertise such as Deloitte and Accenture are competing with agencies, arguing that they know how to connect with consumers better, and more cheaply, using data, machine learning and app design.
Investors losing faith
The resulting picture is an industry under siege.
WPP just had its worst year since the financial crisis, with declining revenue from like-for-like operations (which strips out revenue from acquired businesses) and a slightly reduced profit margin. This year the company projects that organic growth will be flat, compared with 5 percent or so in better times. Its big rivals, including Interpublic Group and Omnicom Group in the U.S. and Publicis Groupe in France, have registered anemic growth. Publicis posted 0.8 percent growth in its like-for-like operations in 2017.
Investors are losing faith — none more so than WPP's, who have driven the company's shares down by 23 percent since mid-February.
The ad giants have conventionally made much of their money from huge fixed contracts with clients, which lock in long-term relationships with multiple agencies. Their holding-company structures include famous creative firms that design and make ads for TV and other media, but also a host of other businesses that bring in the bulk of their revenue, such as media-buying operations, digital services, brand consulting and public relations.
Last month, Marc Pritchard, chief brand officer of P&G, criticized their model as a "Mad Men" operation that is "archaic" and overly complex in an era when campaigns and ads need to be designed and refined quickly across lots of platforms.
Technological forces are buffeting this model. The first big challenge is disintermediation. Despite the growing backlash against the tech giants, Google and Facebook make it easy for firms big and small to advertise on their platforms and across the internet via their powerful ad networks.
The U.S. advertising market grew by around 3 percent last year, to $196 billion, but only because of the tech giants. MoffettNathanson, a research firm, estimates that Google and Facebook each accounted for more than $5 billion of growth in advertising spend, and for almost 90 percent of online ad growth. All forms of conventional advertising, apart from outdoor, shrank.
The second headache is the rise of ad-free content for consumers, especially on Netflix, and the corresponding disruption of ad-supported television, which has declining viewership globally. This hurts agencies because their biggest clients, including the manufacturers of consumer goods, beverages and pharmaceuticals, use television the most. Planning campaigns and creating 30-second spots for television is a people-heavy, high-margin business that the agencies dominate. In the U.S., TV advertising sales fell by $4.9 billion in 2017, or 7.3 percent, to $62.1 billion, said Magna Global, which is owned by Interpublic. That is the biggest such drop in a nonrecession year in two decades.
Third, Amazon's e-commerce might, and the growing clout of internet-era direct-to-consumer upstarts, have weakened the distribution muscle and pricing power of the advertising giants' biggest clients. Consumer-goods companies are responding to such margin pressure by cutting spending on agencies; P&G has cut agency fees and production costs by $750 million in three years, and expects to cut at least another $400 million.
Such cost discipline among clients is driven partly by the influence of thrifty private-equity investors like 3G, the Brazilian owner of AB InBev, the world's largest brewer. It also stems from a perception that the ad agencies have exploited their complexity to boost billings.
In 2016 an advertiser trade association issued a report accusing the agencies of using opaque practices, including in digital-ad placement, to extract higher margins. The holding firms strongly disputed the findings, but the report prompted many clients to review their contracts with agencies and insist on more transparency.
'We're cockroaches'
Nonetheless, some of the advertising holding companies' woes may prove less threatening than feared. And the advertising firms are gradually changing how they make money. Their plans mostly boil down to two things: investing in digital services and consolidating their collections of businesses so that they can provide a range of services to one client more cheaply under one account.
That should be more than enough to keep them alive. "Everybody says that we're dinosaurs but we're not. We're cockroaches," said Rishad Tobaccowala, chief growth officer for Publicis. "We know how to scurry around. We hide out in the corner. We figure out where the food is. We reconstitute ourselves."
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