In a recent “Recession Survey” from the Association of National Advertisers (ANA), 71% of client respondents are challenging agencies to reduce internal expenses and/or identify cost reductions. 56% are planning to reduce agency compensation (compared with 32% a year ago).

My friend Tom Finneran, Executive Vice President of the American Association of Advertising Agencies, says AAAA members are under tremendous pressure from clients on compensation. Current client tactics include:

• RFP’s that focus extensively on price.
• Procurement inviting more “competitors” to pitch and bid on projects.
• Unilateral procurement mandates to reduce fees with little to no reduction in scope of work.
• Procurement led processes that demand extensive agency “transparency” of agency labor costs, overheads, profit margins, hourly rates, etc.
• Clients being coy about revealing what they are budgeting for major marketing expenditure components.
• Procurement groups trying to use the recession to re-negotiate contracts and to edict extended payment terms.

Moving toward “perfect competition”?

It’s no wonder agencies are feeling more pressure on their margins than ever before.  Some parts of of the agency business are starting to match up with an economic theory called “perfect competition,” which is characterized by these conditions:

1. The customer is in control. (This is increasingly the case, evidenced by the rise of procurement.)

2. Excess supply. (There are 12,000 agencies in America vying for client business.)

3. Large numbers of small firms. (Most of these 12,000 are definitely small firms).

4. A homogeneous product. (While the quality and inventiveness of agency work certainly varies, increasingly clients view agency output as similar. When it comes to production, clients view these services as identical.)

5. Total access to information. (Clients demand — and mostly get — very detailed information about every dimension of the agency operations and cost structures.)

6. Low barriers to entry. (The belief that “anyone can start an agency” is largely true. It’s also true that small agencies come and go with great regularity.)

The above conditions are truer for the “tactical/manufacturing” side of our business than the “strategic/conceptual” side. Nonetheless, we’re on dangerous ground.

Magic and logic

The IPA (Britain’s version of the AAAA) has coined the terms “Magic” and “Logic” to describe what agencies do. The “Magic” is the high-value brand development, strategies, and concepting — things that clients generally can’t do for themselves (at least can’t do well, because the best talent in this area still goes to agencies). The “Logic” part of our business is the lower-value production and execution work — work that clients actually can do themselves (or at least believe they can).

The Project Lifeline

John Minty, CFO of Venables Bell & Partners, believes that every assignment has a “Project Lifeline.” On one side of the lifeline is the strategy/concept work that clients still value and are willing to pay for. On the other side of the lifeline is the increasingly-commoditized production/execution work that clients believe they can get cheaper down the street. The goal of VB&P is to maximize the value they provide to clients by emphasizing their abilities and services on the left side of the lifeline.

The agency business must begin charting a course away from commoditization if it is to remain relevant, valuable, and profitable. We must do that by developing and offering differentiated, high-value services. Particularly when it comes to dealing with procurement, we cannot negotiate our way out of pricing pressures; we can only differentiate our way to success.