Ad Agencies are Complex Businesses. New Metrics are Needed for Improved Management

Advertising agencies are exceptionally complex businesses, driven by digital / social media innovations, large and fragmented scopes of work, procurement-led fee reductions, holding company-led downsizings, and client pressures to get brands moving again. Agencies have developed hyper-targeted digital executions and ROI tracking tools to help their clients. What they have not done is develop new and better metrics for managing their own businesses.

 

The shoemaker’s children always go barefoot, goes the proverb. Client-focused businesses, like advertising agencies, focus on their clients’ needs and often ignore their own.

When an industry goes from simple to complex, and from rich to poor, the past prevails over the present, and outdated metrics, designed for long-gone periods of simplicity and richness continue to be used.

Advertising was a simple TV, radio, and print business prior to 1994. Creative and media agencies were paid healthy commissions for their work; agencies were well-staffed; and there was a significant history of expertise to guide creative development, media planning and media buying efforts.

Since 1994, creativity and media have changed enormously in character, and agencies have had to deal with dramatic increases in complexity for which their past experience or metrics did not provide relevant guidance.

•     1994 First banner ads
•     1994 Amazon
•     1996 Improvements in ROI tracking tools
•     1998 Google
•     1999-2002 Development of paid search and pay-per-click
•     2004 Facebook
•     2005 YouTube
•     2006 Twitter
•     2006 Development of hyper-targeted digital ads
•     2008 Global financial crisis, affecting client brand growth and profitability. Dramatic procurement-led fee cuts and marketing-led Scope of Work (SOW) increases
•     2019 Digital advertising overtakes traditional advertising spend

Throughout this period, agencies have measured their business operations by staff-cost ratios and operating margins.

Staff-cost ratios simply measure the percentage of staff costs versus income. An agency might set a staff-cost ratio target of 50%, saying “Our total staff costs cannot exceed 50% (or some other percentage) of income.” Operating margin is simply income less operating costs — a similar metric.

The problem with staff-cost ratios and operating margins, of course, is that procurement-led fee reductions must always lead to agency staff reductions in order to hit the metrics, even if agency workloads are growing. WPP, under Sir Martin Sorrell, was an aggressive staff-cost measurer, and WPP’s staff-cost reductions drove WPP’s spectacular 30-year share price growth through 2016, when it hit $118 per share. This game got played out. The stock is trading at about $40 today.

Agencies need a better suite of metrics, and they must include “workload metrics” that measure the amount of work in client SOWs — a particular need in this era of large and fragmented SOWs.

For creative agencies, this simply means counting and categorizing their creative and strategic deliverables, and negotiating fees based on an agreed workload. In our consulting practice, we developed a standardized unit of work called the ScopeMetric® Unit (SMU), which is roughly the size of a TV origination spot. All the deliverables in a creative SOW can be converted into SMUs (or TV equivalents) to measure the size of a total SOW. A typical creative agency team of account executives, creatives, strategic planners, and production people can complete roughly two SMUs per FTE per year — a more useful way of thinking about staffing than the staff-cost ratio, which ignores workload.

For media agencies, which have a mix of planning, buying, analytical and reporting activities across a large number of media channels, SOW measurement is more complicated, but it is possible. Here, we use the Media ScopeMetric® Unit (MSMU), which is the same size as the creative ScopeMetric® Unit (SMU) but it is driven not by deliverables but instead by media spend, media fragmentation across channels and the complexity of relationship processes, which can all be measured.

The use of workload measurement gives rise to the following enhanced metrics:

•     Price. Price is simply fee divided by the number of SMUs or MSMUs. It is a measure of the price per unit of work. Every industry in the world measures price; ad agencies need to do the same, particularly to put a floor under declining prices, which are today down by 2/3rds since the dawn of the first banner ad in 1994.
•     Productivity. Productivity is output per head, or SMUs (or MSMUs) per FTE. A reasonable benchmark is 0 SMUs or MSMUs per head per year. Understaffed relationships have higher numbers than this; overstaffed relationships have lower numbers than this. Productivity is a normal business metric that needs to be measured to ensure proper staffing. Agencies need to understand and negotiate productivity levels with clients.
•     Media Workload Intensity (WI). For media agencies, the number of MSMUs per $ million of media spend is a useful complexity metric. Relationships with a high workload intensity (1.0 to 1.5 MSMUs per million of spend) are highly complex relationships that are difficult to manage. Process efficiency is critical. Low workload intensity is in the range of 0.3 to 0.5 MSMUs per million of spend, and these relationships are much easier to manage. Agencies and their clients need to share an understanding of relationship complexity and process efficiency.

Metric enhancement begins with workload documentation and measurement. Once enhanced metrics are in place, agencies can review each of their client relationships and categorize the health of each of their relationships, using Price, Productivity and Workload Intensity metrics.

The shoemaker’s children need shoes during this complicated era — they’ve gone without for much too long.

Agency CEOs need to commit themselves to the development of enhanced metrics for improved agency management.

About Author

Michael Farmer is the author of Madison Avenue Manslaughter: An Inside View of Fee-Cutting Clients, Profit-Hungry Owners and Declining Ad Agencies (Third Edition, 2019), which won four publishers’ awards for excellence in marketing.

First appeared in Media Village