How is digital disruption hurting advertising agencies?

This blogpost examines if, and how, digital disruption is hurting ad agencies.

September 18, 2017
• by
Vivek Sharma

Last month, The Wall Street Journal reported that "shares in the world’s largest advertising company, London-based WPP PLC, [owns agencies such as J. Walter Thompson, Young & Rubicam and Ogilvy & Mather] fell nearly 11%... after it reported a steeper-than-expected slowdown in global ad buying, particularly from consumer-goods companies. It was the stock’s biggest one-day drop in more than 18 years… The penny pinching has been widely telegraphed, but the sharp declines at WPP shocked investors.”

This phenomenon is not limited to WPP. The other three leading ad agencies in the Madison Avenue Big Four – Publicis, Interpublic, and Omincom – have also seen similar growth challenges. Michael Farmer, an advertising industry veteran and author of Madison Avenue Manslaughter, states in his book, "what was once one of the most fulfilling and glamorous of industries [personified, in my view, best by Don Draper in Mad Men] has become a grim sweatshop for the people who do the work.”  While that feels like an extreme characterization, this blogpost examines if, and how, digital disruption is hurting ad agencies.

Ad agencies provide a broad spectrum of services for their clients, including creative content development, media buying, and public relations. Typically, their revenue comes through a markup on labor and overhead costs for content, strategy, and creative development, and/or a commission (typically 15% of clients’ media dollars) for media buying across different formats like print, radio, TV, digital, cinema, etc. The worldwide advertising industry has grown from $493 billion in 2012 to (projected) $505 billion in 2017. During this period, traditional media (TV, radio, print, out of home) spend fell by $105 billion (from $405 billion to $300 billion), while digital media (display, search, video, social) grew by $117 billion from $88 billion to $205 billion. 

Ad agencies (historically) manage different media for their clients, and pool their clients’ money to get the best prices for them. With that ‘network effect’ advantage, an additional fast-growing ad format like digital should have been a welcome business opportunity. However, the reality is quite the opposite, and is driven by two key factors: 1) disintermediation by digital ad platforms and 2) agencies’ inability to respond to data based conversion quantification. 

While digital advertising has grown at an impressive 20% CAGR over last 5 years, over 60% of that growth was captured by just two companies –  Google and Facebook. Like other ad formats, sizeable digital advertising from brands continues to go through the money pool given to their ad agency – for example, in 2016 WPP spent $5 billion of their clients’ money with Google and $1.7 billion with Facebook. However, a rapidly increasing portion is going direct, as Google and Facebook have made it convenient for advertisers and publishers to interact over advertising marketplaces.

Google started the disintermediation by first building the Doubleclick marketplace to help buy and sell display advertising, followed by the Admob platform to help mobile app developers monetize their apps through in-app ads. They further invested in programmatic advertising on both the supply side and the demand side – Double click bid manager for advertisers to find the right audience, and Double click for publishers for publishers to find advertisers across all screens.  Facebook has built Facebook Audience Network (FAN) to help brands take native ads to 3rd party publishers, leveraging the same targeting data that they use on Facebook or Instagram. These platforms provide agency-like functionality and an increasing number of brands are putting their agency contracts up for review, while also building in-house “trading desks,” thus, disintermediating ad agencies and their 15% commission on media buy. Mike Shields illustrates this in “The Future of ad agencies has never been more in doubt

“A few years ago, Booking.com, a hotel e-commerce site owned by Priceline, worked closely with a media-buying agency to figure out where to allocate its ad budgets. "We’d have meetings where we’d sit down and say, 'We should put this much on YouTube, this much on other sites,' etcetera," …. But Booking.com is about to cut out that middleman, and it could have big implications for the advertising industry. In recent months, Booking.com has hired data scientists and researchers and other digital-media-buying experts. By the end of the year, all Booking.com’s digital-media buying will be done in-house.”

Brands today are also keen on data-based conversion quantification. In the past, an ad campaign was deemed “good” either if a key client executive, or executives, liked it, or if it was successful with a focus group. The key criterion was likability, and not necessarily the effectiveness of the campaign. Google, with its CPC (cost per click) search ads, helped start a mindset change on marketing ROI quantification. This was exacerbated by brands building direct connections with users and getting better access to data than agencies – all while agencies continued to primarily have a creative and campaign mindset. As Penry Price proposes in AdAge, ad agencies urgently need to act more like technology companies

As marketing becomes increasingly driven by data and technology, ad agencies are having to compete for business against a newfound rival: consulting firms like Accenture and Deloitte… Deloitte has acquired a dozen creative agencies, while Accenture Digital last year was named the largest and fastest-growing digital agency network... Omnicom, for example, created Hearts & Science, an integrated digital agency that uses technology to scale customer relationships. As ad spend continues to shift from TV to digital, agencies will need to hire software engineers, designers and analysts that can quickly build tools and drive the customer experience their clients are looking for. The year 2017 will be a turning point for agencies. Those that aren't singularly focused on technology to scale the customer experience may find themselves up for review.

Are these challenges insurmountable for ad agencies? One could argue that the days of full-service ad agencies are gone, and potentially replaced by ad agencies focused on niche areas like creative, search, mobile, and social. Having said that, in the past, ad agencies have shown remarkable agility and adaptability in their work. With digital technology becoming core to advertising, they will have to demonstrate that once again.