Inflation, escalating talent and rental costs, increased investments in tools and research, declining client fees and commissions—all these are playing their part in squeezing the profits of ad agencies. Revenue growth of most of the big agencies is hovering at 15%. For big networks, profit margins have dipped from 30% a decade ago to 15-20%. For small agencies, the margins range between 10% and 50%, say the CEOs of some ad agencies.
Mint spoke to several senior advertising executives on whether agencies are facing pressure on profits.
M.G. Parameswaran, Executive director and CEO, DraftFCB+Ulka
Where agencies’ profit margins are going
Indian advertising agencies have been profitable, well run, locally managed affairs for a long time, unlike some other countries in the Asia-Pacific region. Due to the abundance of local talent, India has been a net exporter of talent to the region. The talent surplus also meant that we had good margins on our operations, till a decade ago. But over the last five years, we have seen agencies (and margins) coming under increasing pressure to operate with lower levels of compensation. This has come at a time when talent from Indian agencies is in great demand not only in the region, but also in the new sectors that are opening up, such as media, financial services, retail and even infrastructure.
The increase in talent costs, rentals and technology upgrades has had a negative impact on margins. Agency margins are under pressure due to several reasons, which go beyond undercutting. In fact, with Advertising Agencies Association of India becoming more active, we see some discussions on this. The key question is, do agencies see themselves as suppliers of creative materials, or as strategic partners in brand value building? Fortunately, there are still many in the advertising business and client organizations who subscribe to the second belief.
Worldwide, talent cost and rentals are the two big cost elements in agency operations. We see increasing pressure on both these fronts in India as well. Unbundling of agency services (separation of media and creative) does not always result in reduction of costs to the client. Costs often go up. Several clients are today seeing the merit in keeping many services under one roof.
Possibly, smaller agencies are under increasing pressure, but we are seeing some level of entrepreneurial activity in the advertising space, and this is a good thing for the industry. The better-run small agencies are able to operate with margins that are much better than those of big agencies. However, the small shops are very dependent on one or two critical persons. We need to see if they can leverage that skill to become big in the coming years. If they can scale up, remain profitable and retain clients, they will be attractive acquisition targets in the future.
Suggestions: Agency margins will have to go up because that is what will help agencies invest in talent, research and development (consumer tracking studies, creative experimentation and technology upgrades, etc). So, better margins are not just better for agencies, but in the long run will be better for clients as well.
I think it was Robert Townsend, the legendary CEO of Avis (author of the book Up the Organization), who said that wise clients make sure that their account is one of the most profitable for their ad agency; that way they get the best talent in the agency working on their problems.
Agencies cannot increase their profitability only through better compensation from clients, though it is an important part. Areas such as talent attraction, growing own talent, training, operational processes and new ways of working seamlessly across disciplines would help agencies protect their margins.
Santosh Desai, CEO and MD, Future Brands Ltd, and former president, McCann Erickson India
Where margins are going
There was a time when the advertising business was under significant strain and margins were dropping due to lower remuneration systems, rising costs of talent and other input costs. But the previous year saw profits becoming healthier for most agencies due to better client spends, economy, etc.
Agencies are historically top-line driven. There was a time when remuneration was down, but input costs were on the rise. Agencies were being squeezed from both sides. Agencies are seeing price stability today. There is an absence of strong downward pressure in terms of fees. There is no further decline in fees. There is growth in business and hence better top-lines.
Next year, the overall economy story could reflect the caution that’s crept into the worldwide scene. Cutting costs is definitely not an option (neither today or in the future) since most of the costs that agencies incur is on talent. I think that the growth story for the next year will not live up to what we see this year. There will be lower profits for agencies because the advertising business is led by global multinationals and we are connected to global systems and economies.
Suggestions: One big constraint in the agency model is that the existing compensation system is too top-line driven. Agencies could focus on new sources of revenue and new areas of businesses such as digital, consultancy space or entertainment. Consultancy, specially, is an area where agencies don’t have too many capabilities.
Colvyn Harris, CEO, JWT India
Where margins are going Most agencies are profitable and margins are going up because this is a high growth market. With recession in the West, global clients would make sure that they do not cut off fuel supply to India and China, where there is maximum growth.
Costs to get and retain talent have definitely increased for most agencies. Half of the investment from the agency’s side is in the area of talent.
Margins are under pressure for most agencies due to cost of operations such as new business areas, technology, opening of new offices, etc, though there’s corresponding growth in business from existing and new clients and newer revenue streams.
Suggestions: Smaller agencies definitely need to improve bandwidth (resources) in terms of what they deliver. Agencies can focus on new areas within client businesses such as (direct-to-home) to sustain growth, continue investing in talent and in good creative work.
Pranesh Misra, Global director, marketing accountability, Lowe India
Where margins are going
Profits are back on track. In the early years of this decade, when several large clients were either moving to fee-based remuneration or were renegotiating agency remuneration, there was some dent in the profitability of agencies. But over the past three years, these pressures have eased a bit, and agencies have also got used to a bit of belt tightening.
Smaller agencies, however, continue to suffer more acutely versus larger ones, because overheads keep rising without commensurate growth in revenue. Small agencies also don’t enjoy economies of scale that larger agencies have. Even within large and medium-sized agencies, there are those who have profit pressure, because they have not figured out how to make a fee system work in their favour. They estimate fees on a marginal cost basis, without accounting for the overheads. That means that they are making a loss even before they start servicing the account.
Larger agencies will continue to flourish. Medium-sized and smaller agencies will continue to feel the heat. The small boutique agencies (if they come to India) will do well in terms of profitability.
As told to Marion Arathoon and Anushree Chandran