Recently, both P&G as well as Mondelez announced they were seeking significant increases on the payment terms they require from their media agencies. Mondelez International is going the way of AB-InBev with 120 days payments terms, while P&G are going with 75 days. This means advertisers are asking their media agencies to bankroll the advertiser’s media costs and fees for a longer period of time (up to 120 days).
Note: a few of the paragraphs that follow were written by me for the book “Z.E.R.O., zero paid media as the new marketing model” (with co-author Joseph Jaffe). Z.E.R.O. is on pre-order on Kickstarter through June 26, 2013. If you haven’t pre-ordered yet, and it isn’t June 26 yet, then you still have time.
Let me bore you with a history lesson first.
A long time ago in a universe far, far away, advertising agencies created TV ads, bought the media space for these ads and pocketed 15% commission on each placement. It was a peaceful and gentle world, where the focus was typically on the creative execution (TV) and less on the agency’s bottom line. OK, perhaps it was not that tranquil… if we can believe the exploits of the Mad Men.
No longer. Initially, agencies evolved their approach to a payment system whereby clients paid for the number of hours that people worked on a given business (fee system). This worked well initially, and created a more fair model of actual cost of doing business for an agency on a given client assignment. After all, it meant that a complete rethink of the brands’ strategy and campaign earned the agency more than the development of a simple shelf wobbler. It certainly saved clients with major media (TV) budgets some money.
But as time moved on the media world became more complex, media agencies separated from creative agencies, as a result of which the amount of fees increased while at the same time budgets became tighter, so clients started to “shave” the cost of planning and buying. This has led to some clients today paying less than 2% (sometimes less than 1%) of their total media spend towards the complete bundle of strategy development, planning, buying, execution, optimization and post-buy of each plan. Media agencies were born to deliver these specialized media products to advertisers worldwide, and to benefit from the economies of scale to develop high-end back-office systems and resources. But at <2% any business will struggle to make ends meet.
As a result, media agencies were forced to become more and more creative and less and less transparent towards their clients as to how they made ends meet. They now need to straddle how they can deliver on the clients’ expectation of paying 1 – 2%, while at the same time delivering a more and more sophisticated product tailored to the ever expanding fragmentation of today’s media world, and delivering anywhere between 15%+ profit margin to a hungry Agency Group CEO (e.g. Sir Martin Sorrell, Maurice Levy or any of the other advertising barons) who are themselves are under pressure to deliver to the street.
The squeeze and “creative sourcing of income” exacerbated some bad practices already in place, and in many markets there were legislative or industry efforts to prevent some of the excesses. It started with La Loi Sapin in the early 1990’s in France, which was supposed to make the advertising business more transparent, and for media agencies specifically to root out so called media surcommissions or bonifications.
For those of you who don’t know what that is, it basically means that agencies or agency groups negotiate an additional volume bonus across all of its client billings with a media owner or other partners/suppliers such as production houses, print companies, etc.
Let’s say I have three clients: Client A with a budget of $30, Client B has $20 and C represents $50. As an agency I am obviously negotiating on behalf of each of my clients relative to their volume and client C should get a better deal than client A or B. But agencies or agency groups now also negotiate an additional % for placing the total volume with a media owner, which goes back to the agency in cash or media space. Advertisers (and for instance La Loi Sapin) content that each client should (must) get their fair share of these additional benefits.
The reality is very different and murky.
For instance: what if the media space ends up on clients’ media schedule and the client is charged for it as if it were “normal” media space at client cost? It is invoiced as such and thus creates an additional income for the agency.
Obviously, if the bonifications are received in cash, it requires some risky “creative” bookkeeping on the agency side.
Since La Loi Sapin was introduced and subsequent laws and increased self-regulation happened in many other markets, as well as the advent of independent media auditing and smarter clients in general, there have been a few scandals that have hit the headlines. Most global companies doing business in the US must now be compliant with SOX, a.k.a. Sarbanes Oxley, the famous Sarbanes Oxley law in the US. The picture below shows George W. Bush signing the final version of the law named for Paul Sarbanes (a democratic senator from Maryland) and Michael Oxley (Republican representative from Ohio).
One such scandal was the McCann-Erickson debacle which came to a head in 2005 and which resulted in a $550 million restatement for parent holding company Interpublic Group (IPG), where about $60 million was directly due to media agency volume bonifications not being shared with clients.
There was the case of Carat in Germany, where bonifications led to the fall of CEO Alexander Ruzicka. He ended up with an 11 year prison sentence in 2009 after being found guilty on 86 counts of fraud, and Carat had to completely open its books to client Danone to showcase how much money the agency had made on the back of the client’s budgets. In this case individuals enriched themselves on top of enriching their businesses. It also cost Carat their VW account.
Given how small the number of public scandals is, one can only assume there must be a lot more to discover, as well as many cases that were settled quietly.
Why does it happen? Because many advertisers are wanting to have it both ways. As explained, they demand that their agency offers the best people, the smartest tools and systems, the most complete data, and the ability to magically deliver things well past official deadlines. And all of this at the absolute lowest cost, e.g. less than perhaps 1% of the media billings and a profit margin of close to “0” (this is not the ZERO we are advocating in our book!).
Why is this bad? I am sure you can think of many reasons yourself, but it obviously hampers the agency’s ability to deliver impartial advice. Because the bonifications come with commitments to the seller, and so if the agency can score a bonus by hitting or over-shooting their commitment, there will be pressure on its planners to ensure the seller is well represented in the proposals for their advertisers.
There aren’t many reasons to feel sorry for Sir Martin Sorrell from WPP or Maurice Levy from Publicis Groupe (have you seen the pay packages of Sir Martin and Monsieur Levy?), but this business conundrum is one that is truly a very tough challenge. I have been in a position where I had to negotiate a deal with an agency where I was uncomfortable with what we were trying to accomplish. Yes, our cost would go down… but would it end up being reflected in either the quality of the work, or in encouraging the agency to be “creative” in finding alternate sources of income? Have you ever been in a pitch where the outcome was a higher agency cost versus what you were paying the incumbent?
There are Agency Group CEO’s who have simply said “NO” and walked away from the billings. This is an acceptable strategy as long as there are enough advertisers who still pay by using more commonly accepted payment terms like 30 to 45 days. But I am sure many more advertiser CFO’s and Heads of Procurement are getting together to compare their current payment terms vs. P&G/Mondelez/AB-InBev.
At the same time, there are plenty of major agencies that already have said “OK” to the demands of the clients asking for more and somehow make it work. This fact should actually worry advertisers. If an agency is capable of bankrolling P&G’s media dollars for 75 days, or Mondelez’s for 120 then clearly money is being made somewhere and somehow to allow for that to be a good business decision. The question is if that money is being made to ensure they can operate a viable business, or is it adding to the agency groups’ financial riches?
So what is Chicken and what is Egg in this scenario? Are advertisers rightly increasing their payment terms because the agency groups are enriching themselves via murky media deals which are difficult to trace and only partially passed back to the clients. Or are agency groups forced to do such deals because advertisers keep squeezing their margins while increasing their demands?
The answer is probably “yes”. The real issue is that none of this helps the industry in terms of trust, respect, transparency and partnership. I think the real winners are, for now, the shareholders of both advertisers and agencies.