Why agency CEOs are giving away their profits

advertising agency pitches

I remember very clearly the look on the marketer’s face when we benchmarked the proposed scope of work and had received the financial proposals from the three shortlisted agencies. Two of the agencies were within 10% of the benchmarks, but the incumbent agency was proposing a fee 55% below benchmark.

The procurement team were questioning our benchmarking. But it was clear to us that the incumbent agency was trying to buy the retention of the account. “Why would they do that?”, queried the marketer. The answer to that is complex. But let me take you into the mind of an agency CEO.

Ultimately, it comes down to the fact that for many agency CEOs they find themselves in a quandary. While they should be acting in the best interest of their clients, in fact they are incentivised and encouraged to act in the best interests of the agency owners. Increasingly these interests are no longer aligned, as I will explain.

Facing the loss of a client

For the CEO of an agency, facing the loss of a client is a critical time. Retaining the business is paramount, even in the face of certain loss. We have written previously on the difficulties of being an incumbent in a pitch.

Yet many marketers wrongly insist on including the incumbent even if they have no intention of appointing them again. This creates an expectation and an opportunity for the incumbent agency CEO to pull out all stops to avoid losing the account. But at what cost to the agency and to the advertiser’s business?

The personal consequences

It is difficult to separate these, but the fact is that senior management in multinational agencies at a local, regional and global level are increasingly incentivised to grow revenue. These incentives mean that they face a personal financial loss if they do not meet their targets. On the flip side they will also be replaced if they underperform and the loss of the account could be fatal to their career.

On a local market level, there is also the personal cost of firing staff following the loss of an account to maintain head count to billing ratios set down by the company. This is not a task anyone wants to face.

The business consequences

The business consequences are similar to the personal ones, except wider reaching. In losing an account the agency has to make up the revenue either by winning new business (hard and potentially costly) or increasing billings from existing clients (usually at the expense of other agencies on the roster).

The agency also faces challenges with the salary bill because while they will need to balance the salary cost to revenue by laying staff off, they may be also under pressure to make further cuts meaning they will have little leeway to increase salaries to keep desirable staff.

Also, they will be managing office morale and the loss of a client will mean that unless the agency has a win, staff will potentially begin to feel the agency momentum is slowing or even going backwards. This can lead to key valuable staff leaving, especially if they do not get the pay rises they expected.

The best worse case scenario

It is far better for an agency to keep an existing client, even for a lower fee, than to lose the client completely. While a lower fee may mean lower profit margins, they will take a smaller hit on the revenue than if they lost the whole account. Besides, it is only the agency fee or retainer. It could still be possible to make up much of the shortfall in production charges over the next 12 months because as we have highlighted, these have less cost management rigour.

The agency CEO will also be able to manipulate the seniority and quality of the personnel and therefore the cost of the people on the account and they can also spread the loss of staff across multiple accounts to lessen the impact of running your account short staffed.

To illustrate:

If the account being tendered is $5 million in agency fees and retainers across 12 FTEs, and an additional $9 million in production costs, then the incumbent can take a $2 million cut in the fee and downgrade the FTE cost and take a hit on the overhead and profit multiple knowing they could make up the difference with just 10% extra revenue extraction on the production budget.

The procurement team and marketer report they have achieved a 40% decrease in agency fees, but end up with more junior staff working on their account and paying more for their production.

The agency will effectively only take a small hit on the revenue and in fact make much of this up over the year, compared to losing the whole account, and even adjust their FTE salary cost by reducing the seniority and quality of the staff on the business.

Of course one of the new agencies participating in the tender is not facing this loss and so are less incentivised to play this game as they would be effectively giving up revenue they as yet do not have. They are also unable to determine the services expectations of the marketer and so cannot assess how low they can drop the quality of their staff to increase margin so they are hesitant to potentially kick off a new relationship on the wrong foot.

Therefore this strategy works for the incumbent to maintain the status quo but makes it increasingly difficult to be able to select a new agency, even if the incumbent relationship is hugely dysfunctional.

A principle is only a principle when it costs you money

While increasingly agency CEOs have been complaining about the race to zero, or alternatively trying to talk up the value of their services, these strategies to maintain accounts at any cost impact the market value of agency services.

While the trend in marketing procurement is to talk about value, hearing stories from colleagues of how they were able to reduce the incumbent agency fee by 40% through a tender still stimulates the need to drive savings in the marketing budget.

But this means we will continue to see the race to zero in agency fees as long as marketing procurement use tenders as a way of driving savings on agency fees and agency CEOs are more afraid of losing revenue than making profits.

Interestingly the only one worse off in all this is the advertiser and marketer. They end up with the incumbent they wanted to replace at a lower cost with less or lower quality agency staff and paying more for their production.

Otherwise it works perfectly well for everyone else.


To find our how TrinityP3 Marketing Management Consultants can help you further with this, click here.