August 10, 2017

By Brian Wieser / Pivotal Research Group

BOTTOM LINE: Marketer trade group the ANA has released a detailed report on fee transparency issues in the commercial production ecosystem, which is the focus of a Department of Justice probe. While the report does not detail any specific agency or holding company’s wrong-doing, the description of practices and recommendations to marketers may add to the scrutiny marketers are increasingly applying to their agency and holding company contracts.

The Production Transparency Task Force of the ANA (the Association of National Advertisers, the primary trade group for large marketers in the United States) released a report today detailing fee transparency issues that exist within the commercial production ecosystem. Commercial production is a key function of creative agency business units, especially for the industry’s largest ones which are mostly owned by holding companies. Bid-rigging associated with commercial production has been the subject of a Department of Justice investigation, which has in turn led to subpoenas at business units owned by each of Interpublic, MDC Partners, Omnicom, Publicis and WPP. The DOJ has not yet announced any conclusions from its investigation, and the ANA does not identify wrong-doing by any specific agency or holding company. However, the ANA study does detail business practices which are not transparent to advertisers, and states that “eleven of twelve subject matter experts” agree such practices occur at multiple agencies and holding companies. Related activities may cause advertisers to effectively pay more than they think they need to for the services provided by their creative agencies’ production units or corporate siblings. Beyond detailing the practices in question, the report provides a series of recommendations for advertisers around these issues, including questions they should be asking of their agencies (but which they may not have known they needed to).

The most important take-away for investors is that this study, like the media transparency report released in June of last year, could serve as a catalyst for advertisers to more aggressively scrutinize the contracts they have with their creative and production agencies. In some instances, it may even encourage marketers to develop or expand in-house studios, or otherwise oversee more of the bidding processes related to commercial production themselves, reducing agencies’ roles in this process. Quantifying the impact is next-to-impossible, but presumably the general outcome will be incrementally greater fee pressure and slightly curtailed growth.

We believe that most agencies’ contracts with most marketers include language that allows agencies to operate as they presently do. However, on multiple instances over the past three years we have come across marketers who were unaware of the ways in which agencies generated revenue which was not contractually prohibited. In many instances, a marketer who is sufficiently well informed would eliminate these practices. Our guess is that at least some (although certainly not all) of the deceleration in growth that we have seen from agency holding companies over the past year occurred because many marketers began to tighten up their contracts with media agencies in response to their increased awareness of non-transparent revenue generating practices.

Overall, we wouldn’t want to overstate the impact of the report on financial outcomes, at least not yet: the scale of activity described relates to a smaller and generally less profitable part of the industry than the part in which media agencies operate, and presumably any impact from this report will be less significant. Still, the ANA’s findings and recommendations won’t help holding companies resume historical growth rates any time soon, and they probably won’t help much with agency-marketer trust either.

VALUATION. We value companies on a DCF basis. Key variables driving valuations across the agencies include long-term costs of capital ranging from 11.5% to 12.0% (WPP on the low end and IPG, OMC and PUB on the high end) and long-term growth rates ranging from 3.0% for OMC to 5.75% for WPP.

RISKS. Agency risks relate to squeezing fees from clients, competition from adjacent industries, reduced competition between marketers and demand for advertising services.



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