State of Advertising Agencies: Redistribution of Value

LinkedIn Article by Tim Williams 
March 25, 2014

This post is part of a series in which LinkedIn Influencers analyze the state and future of their industry. Read all the posts here.

Today’s advertising agencies might be surprised to hear that there is just as much money being spent in marketing today as there ever was (as a percent of sales). In some categories, marketing spending has actually accelerated. It’s just that less and less of this marketing spend is making its way into the coffers of advertising agencies.

A redistribution of value

The fact is the advertising agency industry is experiencing a massive redistribution of value. There are at least five major factors underlying this change:

  1. The decline of the “agent” in a disintermediated marketing environment

  2. Other suppliers of marketing-related services getting into the agency business

  3. The declining effectiveness of traditional media (which is what most agencies know best)

  4. The perceived commoditization of some advertising services

  5. The failure of agencies to address the other “P’s” of marketing beyond “promotion”

No more middleman

Media companies (publishers and broadcasters) are forming their own agencies, going directly to marketers to sell not only advertising space and time, but also advertising creation and development. In the past, these companies were largely dependent on agencies for their revenues. Now, digital media companies like Google and Facebook can survive quite nicely without them. So much of the revenue that used to show up on agency income statements now flows directly to the media companies.

Former business partners as competitors

Production companies that were once dependent on assignments from advertising agencies are now dressed up very much like agencies themselves, offering complete creative development services directly to marketers. So again, some of the revenues that used to be earned by agencies now go directly to their increasingly competitive business partners.

The decline of mass media

Thanks to all of the ways consumers now have to avoid it, mass media advertising has been losing ground to online media, social media, experiential marketing, and other approaches that reach prospective customers in more authentic and effective ways. This phenomenon is actually at the heart of the financial difficulties faced by most agencies, because mass media advertising is still their essential skill set.

Supply and demand of advertising services

Most agencies derive the majority of their revenues not from ideation, but rather from execution. And it’s these production-related services that are under the most intense pricing pressure because they are increasingly seen by marketers as commodity services. Because advertising production services are so widely available from so many low-cost providers, it becomes harder and harder for creative agencies to derive a profit from this part of the business.

The missing P’s of marketing

Back in the days of Mad Men’s Don Draper, agencies were deeply involved in the business of their clients -- not just promotion, but also the other three P’s of marketing, which are product, price and place. Agencies had a vested interest in this level of
involvement because their compensation was tied directly to the brand’s success (the stronger the sales, the higher the advertising budgets, the more money the agency made in media commissions). But starting in the late 1980s, the advertising agency industry unbundled itself (creative, media, direct, etc.) and these business units adopted the repressive “hourly rate” system, which gave clients a big disincentive to assign anything but “advertising” responsibilities to their agencies. So in the ensuing decades, agencies became less and less involved in the big picture of brand marketing and instead became know as “the advertising guys.”

Especially in the last 10 years, all of these disruptive forces have all combined to extract considerable value from the advertising agency value chain. The fact that agencies are getting a smaller and smaller piece of the marketing pie is not because they fail at negotiating with procurement. Agencies must understand that in order to capture more value, they must first create more value.

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