Why do so many agencies take on revenue at the expense of profit?

This post is by Nick Hand a Senior Consultant at TrinityP3. Nick has over 15 years experience in advertising agency finance and operations. His expertise and knowledge covers the spectrum from large multi-national operations down to the boutique creative shop.

A couple of weeks ago I was reading an article about why Apple decided not to enter the ‘Netbook’ market; you know – those tiny, ultra portable and inexpensive laptops that threatened to take over the personal computing universe, but ultimately disappeared before they barely got started once the iPad and its like entered the market.

It turns out that Apple had already committed to the iPad, but more pertinently, Apple prefers profit over revenue. Through fierce competition, the profit margin on netbooks became so low, that Apple would have to have played the market share game along with every other manufacturer.

But that is something Apple doesn’t do. They are a company that would rather make $10bn from 10% of the market, than make $1bn from having 90% of the market.

So that got me thinking; why do so many agencies prefer revenue over profits?

Revenue at the expense of profit

Nothing Breeds Success Like Success

With a few exceptions, most large advertisers like to be serviced by agencies that service other, similarly large sized advertisers.

New business success in a competitive pitch depends on many factors, but price will be the biggest determinant if capability and fit considerations are equal or thereabouts.

Agencies “buying” a high profile client has been going on since deregulation. Not saying it happens in all cases, but it never ceases to amaze me the number of quick fire wins in succession agencies often experience after news of that initial big win hits the trade forums.

Improve Staff Morale/Agency Reputation

If it is true that success breeds success, so it is also true that a couple of quick client losses in succession can see remaining clients become nervous, and staff become worried.

I defy any agency to come out and say they have never dropped their pants to buy a client to try and stem the tide when faced with this scenario.

Short Term Business View/Focus

One of the great dichotomies of the modern business world is that investors are advised to think long term, but business managers generally think in the short term.

Global Agency management tends to ask for around 20% growth year on year – whether market conditions warrant that or not. In emerging markets this might be fine, but in mature markets like Australia, or North America, or Western Europe this can be a tough ask. The rise of digital media has largely been at the expense of traditional channels, and for an Agency to “sell more widgets” under most current remuneration structures requires more people, and therefore more clients – there are few economies of scale to be had.

More clients generally mean pinching them from someone else, i.e. increasing market share in a market that is barely (if at all) growing. So, the Agency (again) often buys clients cheaply, which for a while fulfils the parent company’s expectations. Then, when things sour (usually the profitable clients scaling back activity & spend and the ‘bought’ – and so unprofitable  – clients scaling up) growth slows or goes backwards, and the incumbent agency management get shown the door. New management comes in, waste 12 months spending money and shaping things the way they want them, and the whole process starts again, all from the same perilous base.

Overheads Become Too Excessive

Many friends come to me for advice on how to budget better. They tell me: “My first job out of Uni paid $30,000 a year, and I had more money left over at the end of the month than I do now, earning 5, 6 or 7 times that!” It’s true – over the years, not withstanding the mortgage and kids, we tend to raise our lifestyle to match our increase in income. It’s also too easy for business to fall into the same trap: a couple of extra Account Directors who only get ¾ utilised; a hip and trendy (read: expensive) new office fit-out to attract the good talent; an investment in two new (senior) digital people of whom “we’re not quite sure yet how to monetise what they offer, but it’s bound to be a goldmine when we do”. And the list goes on.

The bottom line (pardon the pun) is that the beast needs feeding, and chasing cheap revenue is often the only way to stop going backwards.

Improve Standing in The “League Tables” in Various Industry Journals

An agency’s ranking in these probably depends more on the agency CEO having a good PR machine, or a regular golf outing with the editor of said publication. But I imagine there do need to be some revenue wins along the way to lend the whole thing some modicum of credibility – and the bigger the better I guess!!

Unfortunately though, in the long run, agencies and advertisers alike suffer when these scenarios play out. And I know there are more reasons – I just didn’t have time to write them all down!!

I’d be interested to hear why you think agencies go down this path, and what can be done to fix the problem?

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About Nick Hand

Nick is a commercial specialist accomplished in client/agency remuneration & contract negotiation, business process change, financial information systems & IT, M&A, business strategy, and key financial indicator reporting and analysis. Read Nick's bio here or email nick@trinityp3.com
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8 Responses to Why do so many agencies take on revenue at the expense of profit?

  1. Michael Duda says:

    I generally agree, though taking on a brand that might be considered a loss leader could be a smart business move over the long term if it gives the Agency business advantages (e.g. Experience in key category, excellent creative, etc.) Managed well, it could be smart for the longer haul.

    • TrinityP3 says:

      Hi Michael, yes it is true that you could see the cost of serving the clients business as an investment in developing expertise and experience. Unfortunately I am not seeing this in most of the cases we are reviewing. In most cases the client was effectively bought with low fees to add to revenue with a vague hope of being able to increase the revenue over time. What do you think Nick?

      • Nick Hand says:

        Hi Michael,
        Darren is right; it's almost a case of the agency thinking "let's just get the win, and we'll deal with the revenue shortfall later". Usually though, once that precedent is set, it's hard to claw back.
        I do agree with you there can be an excellent business case for taking on a loss leader client. The downside is you end up with a whole agency of loss leader clients by treating every new opportunity in that manner (like a shiny new toy), and not knowing when to to say enough is enough.

  2. Rebecca says:

    Surely there is an element to revised remuneration models also being needed? Sure, 'buy' the big name accounts to begin with, but if we're doing our jobs well then we'll be growing their business as well as ours over time and should use this as a win-win opportunity.
    Perhaps the first year's remuneration = breaking even (or making a loss), but subsequent years remunerations = breaking even + performance based incentives partially linked to the agency 'success' (meeting client KPIs) and partially linked to client success (business growth)..
    I know this already happens in some cases but could be much more widespread.

    • TrinityP3 says:

      Hi Rebecca, the point is that often the marketers do not realise the agency is making a loss. They believe that the agency would only be accepting or proposing the level of remuneration if they were still making profit. This is what is driving down the perceived cost of advertising.

  3. Darryl says:

    Hi. Generally the reason agencies may drop their pants is:
    1. They fail to do due diligence on a client and get wrapped up in the pitch process, and the 'win'.
    2. They fail to understand their own costs of business, or fail to manage them appropriately, according to the needs of clients on various budgets
    3. They think a 'good brand name' client might attract other clients.
    4. The need to report to head office they are 'winning' business, and report on increasing revenues, forgetting about profit.
    5. The assume existing staff will just work longer hours to fill the void, and therefore 'profit' comes through double-dipping into ancillary head hours rather than into already allocated working hours.
    6. Agencies may take on a client if they give them the creative flexibility to showcase their ideas, and win awards.
    Flexible business arrangements, such as agency profit incentives for client business growth, is a way to take on a low budget client, which may be win-win. Clients however, usually baulk at such arrangements, worried that they may have to share success.

    • TrinityP3 says:

      All very good points Daryl. Thanks for the contribution. Nick, what do you think?

      • Nick Hand says:

        Daryl, I think you're spot on, particularly your last point around clients concerned about sharing success and where the incentive payments might be found in their budgets. Advertising & Marketing should not be considered an overhead cost with a fixed budget, but rather a cost of sales, can vary as sales vary.

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