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Agency Survey 2005: Coming of age for digital agencies

Most babies grow up eventually, and the same can be said of the digital media sector. Still, the adolescent years can prove a bumpy ride for both. During the digital baby boom, many newborn businesses were spoilt with vast cash gifts, often from private equity funds and venture capitalists.

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They had fun spending the money but never learned the need for disciplined housekeeping.

Other fledgling businesses had very little money, but plenty of talent, energy and enthusiasm. They enjoyed the freedom of being the new guys on the block during the dotcom boom, but lacked commercial experience and often ignored the advice of their elders. "It was like selling shovels in the gold rush," recalls glue London's commercial director James Sanderson.

Flaky beginnings

"There was a sense of unreality," adds dare's managing director Mark Collier. "Dotcom companies were being put together on the back of an envelope and getting floated on the stock market. Agencies made bullish assumptions about growth and over-recruited, only to find the revenues and cash flow were not there. There were few processes in place and little planning." Nobody seemed to worry about the optimum project size or the need to monitor and manage the cost of time spent on those projects, both critical to making a profit.

Collier contrasts the flakier of the young agencies with companies like AKQA, which enjoyed more robust relationships with heavyweight clients: "There was pressure on us to take on dotcom businesses," admits AKQA's founder, Ajaz Ahmed, "but we stayed loyal to existing clients." One of the pay-offs was the opportunity to build the agency internationally on the back of blue-chip clients.

In a nutshell, the interactive age initially lacked adequate commercial sense and financial discipline. Little was done to demonstrate the effectiveness (or lack of effectiveness) of work for clients, and over-optimism reigned supreme.

Now the sector is growing up and has learned a series of lessons - sometimes the hard way. The first financial review, published by New Media Agencies Financial Intelligence in 2002, showed that, in the year 2000, the 20 largest agencies did little better than break even and 35 per cent of them made a loss. By the next year, the top 25 agencies had lost £62 million.

Of the 20 companies featured in that first financial survey, only seven remain in business under the same ownership today. Many of the casualties were those built on a technology consulting foundation - like Entranet, Hyperlink Interactive and Quidnunc - proving that agencies cannot survive on technology alone. Instead, they need to understand the business needs of their clients' markets, and have the creative skills to communicate effectively with them.

"The IT consultancies' business model was quite risky," says glue's Sanderson.

"It needed a lot of very expensive technicians and assumed break-even could wait for three or four years." As demand evaporated, so did the support backers. "It is important to focus on being good rather than being big," adds AKQA's Ahmed.

From a financial perspective, it now seems incredible that, by 2001, several companies were shelling out more on their payrolls than they were billing to their clients. That may have been an acceptable policy for the first six months or so in business, but not for several years. The problem was not caused by over-recruitment alone. Some consultancies were paying generous salaries at rates that were never recovered from client projects - either because clients did not recognise the commercial value of the work, or because the consultancies did not charge enough.

Then, as the initial growth in demand waned when the dotcom bubble burst, agencies large and small started scrabbling around for any business they could find. Small projects that could not have been managed at a profit, or have made a positive contribution to overheads, were accepted.The circumstances were not helped by inexperienced clients being unable to measure value, not least when agencies failed to provide it.

But now the sector has begun to show signs of a recovery. Output and revenue per head are improving. Average staff costs have been curtailed, helped by the exodus of higher paid IT consultants from the sector. Operating profit margins on gross income have also begun to climb ('gross income' being the amounts billed to clients less the cost of bought-in direct costs), although only one-sixth of the agencies in this year's survey beat the benchmark of 15 per cent.

Better understanding

Ensuring further recovery is not just a matter of increasing revenue.

Even more important is the need for a better understanding among clients of how interactive channels might be used to best effect. It has been a steep learning curve for clients and agencies alike, but one that has now produced a clearer picture of the exciting commercial opportunities to be seized as well as the many black holes to be avoided. The shape of the new media agency sector is changing as a result.

The future for serious digital agencies depends not, for example, on their ability to create ordinary campaigns or even the most user-friendly campaigns. Typically these assignments will always be modest budget affairs with little scope for adding value. The real success stories will come from agencies that can marry top quality marketing skills - including exceptional but appropriate creative output, proper research and meticulous planning - with efficient and inventive technology so as to offer an all-embracing commercially effective solution to client needs. That's a mouthful and a lot to deliver under one roof. It calls for exceptional management, plus a wide range of solid skills.

"Marketing directors want the very best specialist for each marketing discipline," says Ahmed. "Digital has become a discipline in itself that has gone way beyond initial expectations. So digital agencies must improve the range and depth of their digital offers. There is no question that in two to five years the digital medium will be more important to clients than TV or press ever was."

"The challenge is to become excellent in every area," says dare's Collier.

"Agencies that traditionally have done well are those that have a clear focus."

Anxieties remain about whether digital agencies should seek to link back-end e-commerce technology with front-end marketing expertise. "There is a logic in doing both marketing campaigns and the fulfilment," says Collier, "but not if it is at the expense of quality."

Sanderson doesn't believe agencies are able to compete with the technical expertise of consultancies like CAP Gemini, Accenture and Pac. In his view some were tempted to invest in technology but have since refocused on client marketing. As a result, he doesn't expect glue to develop much of a back-end capacity in the short term. Instead, the agency has invested sub-stantially in building a six-person planning capability. Dare has taken a similar approach.

Another question that needs answering relates to the ownership of digital expertise. Will clients be best served by the big marketing services groups offering a so-called 'integrated digital competence' alongside traditional marketing disciplines, such as is offered by Tribal DDB? Or is the breadth and depth of digital expertise - not to mention the number of channels to market- becoming so significant that dedicated independent specialist agencies will achieve better results?

Digital ownership

Collier sees the emergence of broadband as adding further impetus to the digital market, bringing a degree of convergence between the types of advertising used on TV and mobiles. But whether that will strengthen the prospects for independent specialists, or lead to a future rehabilitation of digital agencies within major marketing groups, remains uncertain.

Those with long memories will recall the previous industry rev-olution, when media buyers declared independence and walked out of full service agencies. Twenty-five years later, the importance of media buying and planning agencies remains as potent as ever, and for that very reason most have been reacquired by the global conglomerates.

While on the subject of the traditional media-buying houses, Ahmed wonders whether they have yet fully accepted the importance of new channels within an integrated marketing campaign. "Traditional agencies have traditional mindsets," he says. "But media is becoming so fragmented, and the consumer so tough to reach, that it requires new solutions."

It is not enough to be a "distributor" of creative output around the world - brilliant digital ideas are needed too. Ahmed sees the work done by digital media agency i-level as going beyond the commodity purchase environment that has dominated traditional media buying. "They have created real value," he says. I-level's founding partner, Andrew Walmsley, comments:"The big networks have not invested adequately in creative and planning. There's a tendency to wait for clients to pay before producing innovative services."

The digital top dog will be the agency that leads the charge to the market.

It will not just be a subcontractor to direct marketing or advertising agencies or media buyers. It will not just fix the e-commerce technology for retailers. It will harness all these skills in a co-ordinated - and commercial - way for the benefit of the client.

The winners will be agencies that can deliver the added value of a comprehensive digital offer to their clients, and command adequate rewards for their efforts. In doing so they will show that the digital space is not to be occupied discretely by graphic designers, IT boffins, or traditional marketing disciplines that attempt to bolt on some sort of digital competence.

Managing risks

In such an environment the opportunities to screw up will be far greater than in a traditional, single discipline business, like a direct marketing agency or IT consultancy.

Risk management will be all-important. If the industry has really grown up, it will understand that risks need to be identified in advance, then measured and monitored, but not avoided altogether. Entrepreneurs hopefully will have learned not to allow new developments to jeopardise the established core business. A strong capital base will be crucial, as well as satisfactory answers to the following questions: could the agency pay all its regular costs for six months without earning any income at all?

Could the worst case financial outlay on acquiring new skills or businesses wipe out more than half the agency's existing capital base? Can expansion be managed by competent people without depriving the existing business of critically important management or creative resources? Will the outcome enhance the agency's competitive advantage in a commercially beneficial manner, rather than simply achieve market differentiation just for the sake of it?

Fortunately, for those who cannot answer those questions with confidence, or who favour a narrower focus, there will always be room for some top quality technology shops and digital creative agencies, simply because of their proven competence and single-minded dedication.

Of two things we can be sure: that digital channels are not going away and, as the digital agency sector begins to enjoy more financial stability, the prizes will go to those who put the clients and the work first. There's nothing new about that.

- Bob Willott is editor of New Media Agencies Financial Intelligence (www.fintellect.com) and a special professor at the University of Nottingham Business School.

This article was first published on marketingmagazine.co.uk

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