Are Good Ideas Getting Harder to Find?

Peak Ideas

Economist Michael Webb was a guest on the excellent Rationally Speaking podcast, discussing a paper he co-authored entitled “Are ideas getting harder to find?”

It’s an economics paper so it uses formulae and data sets to explore what is a recognized modern phenomenon across advanced economies: the productivity slowdown.

Webb uses some standard growth accounting economagic to establish a basic observation:

In many models, economic growth arises from people creating ideas, and the long-run growth rate is the product of two terms: the effective number of researchers and their research productivity. We present a wide range of evidence from various industries, products, and firms showing that research effort is rising substantially while research productivity is declining sharply.

It uses the equation below to work out the productivity per researcher as it contributes to economic growth.

Harder to Find

Moore’s Law is one of the most famous measures of sustained exponential growth and one of the key drivers of economic growth since the invention of the integrated circuit.

Coined by one of the founders of Intel, it states that the number of transistors we can squeeze onto a chip [a proxy for computing power generally] doubles every 18 months while the cost of production halves.

Sounds great doesn’t it? Twice as fast, twice as cheap, every 18 months.

Unfortunately, it doesn’t include all the costs of research and development:

Such doubling corresponds to a constant exponential growth rate of around 35% per year, a rate that has been remarkably steady for nearly half a century.
As we show in detail below, this growth has been achieved by engaging an ever-growing number of researchers to push Moore’s Law forward.
In particular, the number of researchers required to double chip density today is more than 18 times larger than the number required in the early 1970s. At least as far as semiconductors are concerned, ideas are getting harder and harder to find.

The amount of research funding has to double every year to sustain Moore’s Law.

The same patterns repeats with seed yields, which have been growing fast in order to keep the world fed but require more and more researchers and money to maintain the same rates of growth. Research productivity is declining.

The paper then looks at US healthcare and shows that despite spending ever increasing amounts of money on it, now totaling 20 % of GDP, of the world’s largest economy and spending five times the amount per capita compare to the UK, where no one goes bankrupt because they got sick, success measures like mortality rates are actually declining. The US healthcare market is incredibly inefficient and gets ever worse because it is the worst of both worlds: a profit driven industry that lacks all the things that makes markets efficient: price, true competition, agency and negotiating power.

Diminishing Marginal Returns

One obvious challenge to the thesis is that every new technology [and pretty much everything else] falls foul of the law of diminishing marginal returns.

Once a breakthrough happens, things move fast until all the easy value has been extracted and subsequently each new unit of growth becomes more and more expensive.

What if there is sharply declining research productivity within each product line, but the main way that growth proceeds is by developing ever-better new product lines?
First there was steam power, then electric power, then the internal combustion engine, then the semiconductor, then gene editing, and so on.
Maybe there is limited opportunity within each area for productivity improvement and long-run growth occurs through the invention of entirely new areas.
Maybe research productivity is declining within every product line, but still not declining for the economy as a whole because we keep inventing new products.

So we need to take an aggregate view of the whole economy and see if new products are replacing the more costly ideas and innovations that we are exploiting.

The authors of the paper did and the same pattern holds;

For the U.S. economy as a whole, exponential growth rates in GDP per person since 1870 or in total factor productivity since the 1930s are relatively stable or even declining. But measures of research effort — the right side of the equation — have grown tremendously.

We can see this really easily. GDP growth has been flat to declining

But it takes more and more researchers to maintain this level of growth — which is to say that research productivity is not constant over time.

Taking the U.S. aggregate number as representative, research productivity falls in half every 13 years. Ideas are getting harder and harder to find over time.

Put differently, just to sustain low constant growth in GDP, the U.S. must double the amount of research effort searching for new ideas every 13 years to offset the increased difficulty of finding these new, economically productive, ideas.

Amazon nows spends more on R&D than any company in the USA.

R&D spending is important not only as it contributes to a company’s own innovation and dominance, but also for its contribution to national productivity, accounting for about 3 percent of the GDP.
Productivity — which in addition to R&D includes other measures like wages and hours worked — has remained mysteriously slow the last few years despite low unemployment and higher profits from major U.S. companies.

Paradigm Shifts

One way of perhaps explaining both these points is that we are at the tail end of an S curve. As the authors point out, each new technology wave brings tremendous growth that petters out. However, if there are significant discontinuities in paradigms, there will be a productivity declines, or gaps, until a new breakthrough happens and gets to a level of maturity that can contribute meaningfully to economic growth.

McKinsey thinks that’s partly the problem, the other part being the ongoing economic impact of the financial crisis, which means people don’t have money to spend on things, which flattens demand.

Productivity growth in the United States was 3.8 percentage points lower in the period from 2010 to 2014 compared with the 2000–2004 period.
Part of that, McKinsey found, was a result of the information technology boom of the 1990s — which paid continuing productivity dividends into the first years of the 21st century — having run its course.
But 1.1 percentage points of the drop was due, in its analysis, to aftereffects of the financial crisis. Those effects sapped even more productivity growth, 1.3 percentage points, from the British economy.

Either way, within the current paradigm, ideas are harder to find.

Borrowing [again] from the metaphor of Peak Oil, we can say we have reached a point of Peak Ideas [within the current paradigm]where it costs increasing amounts of money/effort to get to every new economically valuable idea.

Ideas That Grow Advertising

Every sector the economists analyzed seemed to be suffering the same decline in productivity but of course there are all technology and product based. What about advertising?

Growth in advertising has plateaued globally at about 4%.

Ad Spend Growth Worldwide

But as per the paradigm shift hypothesis, these numbers are not the whole story. Rather, declines in some traditional media spend have been shored up by huge growth in digital spend.

“Back in the 1990s, TV and newspaper ad spending were leading the pack. Since then, thanks to the rise of the internet and web advertising, newspaper ad sales have plummeted and TV ads have stagnated.”

ADVERTISING R&D

“The advertising-agency industry is one which does not have R&D built in as a line item in the budget.” Dr. Len Ellis, former executive vice president of strategy at WCJ

Growth rates are only half of the equation and advertising agencies don’t have a research and development budget.

There are various structural reasons for this, according to Ellis:

1. The Deliverable. Advertising agencies produce content for a living; specifically, memorable stories in print ads and broadcast spots. Moreover, these stories are to be one-of-a-kind. Storytelling does not require R&D, nor does originality in storytelling.
2. The Value Proposition. Like all professional-services firms, agencies sell expertise, which by definition reflects what has worked in the past. R&D reflects an intention to try what hasn’t been tried before.
3. The Culture. Like all vendors, ad agencies are risk-averse. Proposing the untried to results-oriented clients is a risk with long odds, an unknowable payoff and a steep downside.
4. The Ownership. The big agencies that have the requisite resources are all publicly owned these days and Wall Street has little patience with company spending that cannot be tied to short-term results.

That last one is clearly specific to our sector, since Wall Street seems to welcome Amazon’s incredible R&D spend.

There are a few advertising innovation labs still standing, such as BBH Labs, which continues to produce excellent thought leadership, but it isn’t creating new products and services that might enable exponential growth. Large global agencies have shuttered their innovations labs because in times of declining margins it’s hard to fund line items that are not immediately remunerative.

Some of the holding companies and agencies such as RGA have investment arms, buying into and supporting start-ups, which is another route to innovation, but isn’t R&D.

In the absence of R&D spend, it’s hard to explore whether advertising ideas are harder to come by now. However, one proxy we can use for R&D in agencies is pitches.

Pitches are where agencies throw all their best people and thinking and where the most interesting, most innovative ideas are presented in order to woo prospective new clients. Since advertising growth is flat, an increase in pitches would suggest declining creative productivity.

The number of pitches is on the rise as the default AOR relationship with clients break down and increased competition in the market creates more pressure on agencies, who are thus more willing to invest speculatively in the nominal soft cost of pitches.

“A massive 84% of agencies that participated in this year’s Brand Experience Report noted a rise in the number of pitches year-on-year, with a total of 1,220 pitches taking place last year.
“More work is going out to pitch — often because agencies are now competing against other disciplines and because it is procurement-led.”

There is also a phenomenon emerging where clients run pitches, and then don’t award anyone any work.

“Alarmingly, several agencies reported a rise in projects being cancelled. One agency said it had secured six ‘wins’ but the work was then put on hold or pulled.”

Pitching is expensive:

This year’s research also revealed that average new client pitch costs vary from £750 to £75,000. This compares with £2,000 and £65,000 in 2015. The highest cost incurred by an agency in 2016 came in at £150,000, reviving the debate over whether clients should pay agencies to pitch for marketing services.

It’s hard to know if these are soft or hard costs but that’s all the data we have.

So, if we take the median, an average pitch in the UK costs an agency £37,875 and there were 1220 that year = £46,207,500.

Therefore the UK advertising agency industry spent something in the order of £46M pitching in 2016. Total advertising spend in the 2016 was £21.4bn.

[If you’ve been paying attention, you might have noticed that the entire advertising expenditure of the UK, the fourth biggest ad market in the world, roughly equals Amazon’s R&D budget.]

The UK advertising industry is still growing in terms of spend, but growth slowed in 2016 -

and continues to decelerate.

Additionally, growth is almost entirely driven by digital advertising spend and a significant portion of that goes directly to adtech intermediaries and the duopoly of Facebook and Google, who spend a lot on R&D but mostly in non-advertising areas.

“TV as a whole saw a 0.8% decline, as did out-of-home, while spend on national news brands declined by 5.1% and magazine brands by 11.9%. Cinema ad spend dropped by 8.4% during the third quarter.” Marketing Week

Looking at agencies revenues, we can see the leaders in terms of billings remains AMV BBDO as it has been for as long as I can remember…

…but billings is a bizarre metric anyway, a relic of the old commission based renumeration model.

Revenue data for is often conflated with total spend on media, which isn’t helpful for our agency calculations.

Let’s say that agencies capture about 15% of spend, which used to be the standard commission on media buying.

15% of £21.4bn = £3,210,000,000

46,000,000 / 3,210,000,000 x 100 = 1.4%

So as an industry, considering we have no R&D budgets, we can say we invest 1.4% of revenue on R&D, which is less than half of the average in Europe across industries, which makes sense and seems to validate the methodology somewhat as at least being in the right ballpark.

R&D Spend by Region and Industry

A 1.4% R&D allocation puts advertising close to CPG / FMCG, because margins are slim in this sector and they tend to spend higher percentages of revenue on marketing.

If pitching is an agency’s R&D budget, award show entries are their marketing spend but that’s beyond the scope of this analysis.

R&D Spend by Region and Industry

Despite the increase in pitches, we also know that there has been and will continue to be decreased overall demand for traditional agency services for the near term future, the other main driver of diminished productivity according to McKinsey.

We know this because the largest advertisers in the world have greatly reduced their agency rosters.

“Procter & Gamble will cut its agency roster by 50% by the close of 2018, the latest act in a four-year cull witnessing some 4,700 firms axed from its books.”
Unilever: “We had too many agencies — 3,000. We are halving the number of agencies we work with and investing more with our strategic agencies.”

And because we are seeing it across our consulting engagements with brands, who are often asking how to restructure and streamline their rosters and actively reduce the amount they spend on “non working marketing spend” [which includes agency fees].

There are a number of significant competitive threats to the sector — in-housing, consultancies, influencers content supply chains — all of which are competing for the same budget.

So, we are spending more and more to get less and less growth. Ideas that generate returns for agencies are getting harder to find.

Obviously there are structural reasons impacting this analysis, but the point remains that as an industry advertising agencies are generating more ideas for more money and yet growth is slowing, which mirrors the trends from the economics paper.

So good, economically generative, advertising ideas are getting harder to find.

[I haven’t found data for USA, please let me know if you have any.]

THANKS FOR READING — A CLAP OR SHARE WOULD BE LOVELY.

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