The writing on the wall

HEADNOTE

Kieron Franks of Euler Hermes looks at the Advertising sector, and in particular the impact of New Media.

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The

health of the advertising sector is inextricably linked to general trends in economic activity. A business' confidence and stability is directly related to its enthusiasm to promote itself and, rightly or wrongly, it is well known that if a company is in trouble, the first thing to be cut is its marketing budget. This has a knock-on effect for both advertising and media agencies, the most susceptible of which are those that rely on one or a few major clients for their income.

The dotcom boom of the late 905, for example, followed by its crash in the early 20005, produced an upturn followed by a sharp downturn in the performance of advertising agencies, as their clients first flooded money into their advertising budgets (they were urged to spend 70% of the venture capital funding on promotion) and then retrenched dramatically.

Between 2000 and 2003, marketing budgets decreased and many agencies, such as Cordiant Communications for example, were badly hit. Companies created and booked less advertising and there were lay-offs among staff employed in the sector. Shockwaves continue to be felt but 2004 showed a light at the end of the tunnel once more.

According to the DTI, quoted in the Barclays Business Services Review 2005, the number of VAT registered advertising agencies operating in the UK has decreased in 2005 for the third successive year. The total stood at 11,660 at the beginning of 2004, compared to 11,945 in 2003 and a peak of 12,300 in 2001.

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UK Advertising Expenditure 1999 - 2004 according to the Advertising Association's Advertising Statistics Yearbook 2005

Expenditure

Advertising is a very cyclical sector. Broadcast media is the area which traditionally commands the largest share of the marketing 'wallet', and 2004 saw an increase in almost all advertising expenditure. A report by Key Note (2005) on the Advertising sector estimates an overall increase of 5.8% for 2004 compared to 2003. Advertising expenditure in the UK totalled 3,993 million in the first quarter of 2005 (representing a year on year increase of 5.3%) according to the Quarterly Survey of Advertising Expenditure by the Advertising Association (AA). Annual growth rates however are still well below those of the 90s, but with UK ad spend hitting 18.4 billion last year - the highest level since 2000 - and Advertising Association forecasts predicting further growth of between four and five per cent this year, a welcome optimism is returning to the industry. Internet advertising spend continued to grow at a higher rate than all other media expenditure, but this still accounts for only less than 5% of the total.

It is important to recognise that world-scale events can also act as catalysts to boost advertising activity. Recent milestones, such as the US presidential election; the Olympics in Athens; and European Football championships have all attracted significant activity in terms of media spend and sponsorship. In 2005, however, there are no major sporting or political events which may lead to a downturn in overall spending by the end of the year.

External events and macro-economic factors are a strong influencer on the health of the sector, but so too are 'internal' developments in terms of new technologies and trends affecting different media and the way they are used by brands and consumed by their audience.

Notable failures

Arguably, the most recent recession was not as devastating as previous advertising downturns but it was more enduring, was industry-wide and claimed some high-profile casualties such as Bates.

Some large media planning and buying agencies such as Interpublic are struggling and are at risk following acquisitions in the 90s which leveraged the company too much, coupled with accounting irregularities which arguably has led to a loss of key accounts in the public eye.

Recent failures at the end of 2004 and early 2005 among smaller agencies can be laid at the feet of the loss of one big client on which the billings relied. Link ICA, for example, was declared insolvent in January this year having lost its major client P&O. KA Advertising similarly lost Dixon Motor Group and Radar Media was another one to suffer.

Not all agencies will be able to make the most of the recovery currently underway. Some which have been weakened may not have regained strength. With limited resources, it's likely that some will be unable to catch up and so even now there will be agencies finding things difficult and perhaps close to collapse. The UK subsidiaries of international groups seem to have been particularly badly affected, largely due to their networks that are operating in areas of the world that are still in recession.

Another key area is talent. Too many middle-ranking staff were casualties of the recession as agencies strove to appear more efficient, and this is something that the industry might regret.

The need to diversify

As a general rule, both advertising and media agencies tend to be profitable and cash positive but historically have taken a significant proportion of profits out of the business in terms of salaries and dividends.

Agencies have stripped costs out of their businesses and, over the past four years, been forced to undergo some painful correction following the excesses of the 90s. During this time, the structure of advertising spend also changed and, as discussed previously, there has been a shift away from traditional above-the-line spend into direct marketing, online and interactive advertising.

As quoted in Campaign 'Top 300 Agencies' 2005, Stephen Woodford, a founding partner of leading agency WCRS, says: "Agencies can't expect to continue what they've been doing for the past five or six years. The rapidly changing media environment and regulatory pressures on advertisers mean agencies will have to become more fluid. However, if they are set up correctly, agencies are in an excellent position, because the expertise to create ideas across channels will be at a premium."

Again, agencies that are poised to make the most out of the rebirth of digital media and other non-traditional communications channels, such as branded content, seem to be best placed for the future.

Conclusion

Mark Lund, chief executive, Delaney Lund Knox Warren & Partners, summarises: "Historically, the industry has been boom and bust, and it piles people and cost on in the good times and then has trouble downsizing when things go bad. This has damaged the reputation and growth of the business. Agencies need to start thinking ten years ahead and about how communications will be different."

It is no secret that advertising is a cyclical industry. The article entitled 'Diversify or die' (Campaign, 25 Feb 2005) discusses the fact that recently, agencies have been investing heavily to broaden their offerings and keep up with where they think clients will spend their money. It goes on: "There is more pressure than ever on agencies to change or risk appearing hopelessly out of date. According to last month's IPA Bellwether Report, an even bigger slice of clients' budgets will be spent below the line and online at the expense of traditional advertising." Going forward, the traditional fears of slashed spend and the loss of key accounts will be joined by this more far-reaching threat - keeping up. Those agencies which remain blindly faithful to the 'old agency model' will ultimately be exposed.

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