Agencies: Catching Up On Key Industry Financial Trends

The advertising agency business has often been under-estimated, including by many of its practitioners. My experience in the industry has shown that its human elements – especially the need to develop and socialize ideas which help marketers solve problems that are either subjective at their core or which require specialist skills – allow it to constantly regenerate, and will allow it to do so even as AI tools become more widespread. Marketers may put pricing pressure on one part of the business, but this can have the effect of causing new ones to emerge as replacements.

Source: Madison and Wall, company reports. Note that organic growth refers to a composite of WPP, Publicis, Omnicom and Interpublic. All other figures include Dentsu’s international business (although headline margin % of revenue only includes Dentsu from 2014).

While I’ve kept on top of organic growth trends for the industry in recent years, I haven’t taken a deep dive on most of its financial attributes since I covered the sector as an analyst prior to 2019. Towards those ends, I’ve compiled a wide range of data on the advertising agency industry in recent weeks and while not all of it is surprising, many of these observations nonetheless help highlight important attributes of the industry.

Global agency business narrowly defined = ~$150 billion in annual revenue. Global agency business broadly defined = >$200 billion. The global industry for core agency services likely amounted to approximately $150 billion in net revenue during 2022, with the six biggest traditional agency holding companies (WPP, Publicis, Omnicom, Interpublic, Dentsu and Vivendi’s Havas) responsible for approximately $58 billion of that activity. Of course, it’s a much bigger industry if we include Accenture Song (formerly Accenture Interactive) and its most direct peers, although with little transparency into the various components of that business (which the company expected would generate $14 billion in revenue during its last fiscal year) it’s unclear how much direct overlap might come from those businesses and how much of it looks and feels like an agency rather than a professional service. Presumably on this broader definition the number would exceed $200 billion globally.

Media agencies now = 30% of global agency holding company revenue. Looking at WPP, Publicis, Omnicom, Interpublic and Dentsu’s International business (excluding Japan from the world for the moment, which has many unique elements in its agency industry and is often excluded from global estimates as a result) various recent disclosures allow me to estimate that this group of agencies had $54 billion in net revenue last year, of which $17 billion, or more than 30% of net revenue, was attributable to the media agencies within these holding companies, meaning GroupM, Publicis Media, OMG, Mediabrands and the media business within Dentsu International. Perhaps it should go without saying that media agencies have been responsible for much of the industry’s growth. On a comparable basis in 2012 I estimate that these same businesses generated only $8 billion in net revenue, or approximately 20% of the industry’s total at that time. Looking at it another way, we can say that media agencies were responsible for nearly 2/3rds of large agency group growth over the past decade.

Businesses housing traditional “creative” agencies are similar in size to media at the holding companies, but have evolved significantly in the face of tepid growth. While media agencies have clearly been a stand-out because of a range of secular factors (such as the complexity and labor intensity of digital media as well as the advantages of scale associated with managing global media planning and buying infrastructure) and there have been pockets of growth in some fields and with some individual businesses, it which has helped large media agencies take share from smaller which have , the largest agency groups have under-performed the overall industry. It’s likely the traditional creative agency brands which are responsible for this under-performance, as I estimate that on a basis which is comparable to the aforementioned $17 billion for media, I calculate $18 billion for creative agencies in 2022, up from around $14 billion ten years ago. Of course, these agencies have typically changed beyond recognition over that time, with significant M&A directly involving many of them, and so comparisons are difficult to make with precision. However, we know that this has been an area where marketers have been particularly aggressive in driving out costs, especially as most of these businesses were designed to make a small number of relatively expensive assets, while the world was clearly prioritizing other forms of messaging for their consumers.

Overall industry outperformed agency holding companies in the United States over the past decade. Interestingly, there did appear to be significant growth for a broader array of fragmented marketing services over the past decade. Looking at the most recent data from the US Census Bureau for the ten year period between 2011 and 2021, I calculate a nearly 5% CAGR – 61% in total – for all advertising, direct mail and PR agencies during this period, which compares with a 3% growth rate for the largest holding companies in the United States. Implicitly I think this could mean that there was a significant increase in spending on creative work from smaller marketers who don’t rely on large agency holding companies or from newer forms of marketing services. Alternately, we can argue that the industry has been favorable for entrepreneurs who have been able to consistently find new ways to service marketers, and this has led to outsized growth for those smaller agencies in aggregate.

Margins improve ~30bps each year with organic growth averaging 3% globally between 2012 and 2022. Back to the five main entities I’m focusing on here (WPP, Omnicom, Publicis, Interpublic and Dentsu International), I re-aggregated major components of each companies’ financial statements and attempted to make the data as like-for-like as possible, eliminating major dispositions from prior periods where sufficient disclosures were available, modifying historical data to conform to current accounting standards and further modifying KPIs across agency groups to make them more comparable to each other than might otherwise be the case. With these adjustments, I calculate that the headline operating income margins (typically EBIT with amortization of acquired intangibles and other unusual items added back) rose from 13.6% in 2012 to 17.0% in 2022. Margin improvement was relatively steady over the years, except in 2020 which saw a big pandemic-driven decline and 2021 which saw a big rebound. Put another way, over the past decade margins improved by around 30bps per year each year, and paired with an approximate 3% average rate of organic growth for the group over this time frame, it appears that a rule of thumb connecting those two metrics together has held up well over time.

Cash-based and accrual-based estimates of profit improvement show the same improving trend. Proving that profit gains aren’t solely the result of selective accounting choices, I estimate that cashflows from operations excluding changes in working capital produced margins which rose from 12.7% to 15.7% over this time (although there was a big jump in 2013 to 14.2% showing a slightly more gradual rate of improvement. For an interesting reference point, other data I have separately been gathering for hundreds of the world’s largest marketers show that EBIT margins improved to a similar degree, rising from 14.4% in 2013 to 16.2% in 2022.

The sector’s capacity to produce cash has improved, even as outflows have expanded. Cashflows from operations less changes in working capital, capital expenditures and acquisitions was understandably lower and more volatile, but rose from 5.2% in 2012 to 10.7% in 2022. This is probably the best single proxy for the group’s cash generating capacity that I could point to and highlights that the industry remains fully capable of producing returns, whether for return to shareholders or for further investment.

The industry has capacity to take on much more debt. The four biggest players produced $70 billion in cash from operations (excluding changes in working capital) over the past decade but interest expenses were under $7 billion over the same period, suggesting to me a high (or excessive?) aversion to debt. Indeed, this group of four only had net debt of $4.7 billion at the end of last year, down from a peak of $12.1 billion in 2016. While cash balances have built up, it’s notable that the group of four were still able to deploy $23 billion into acquisitions and $30 billion in returns to shareholders by way of dividends and share repurchases over the past decade.

Returns on equity remain high, and could go higher. I calculate that the four big agencies had around $21 billion of equity book value at the end of 2022. With net income at $4.4 billion for this group during 2022, and presuming higher levels during 2023, the return on equity for the group should easily exceed 20% this year. As intimated above, those returns could look even better if a modest share of the equity were replaced with debt.