How Ad Agencies Can Avoid A Death Spiral

Apr 21 2014, 3:36pm CDT | by

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 keeping skills current, 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.
 

 
Once you take a broader view, it become 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 is higher 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.
 
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The Real-Life Mad Men (And Women) Of 2012

 
 
 

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