The Agency Business Model is broken, but… How to fix it?

Freely reflecting on the communication business model without any pretense of being right, at a crossroads after 70 years.

Among the many stimuli that Caffeina gives me, there’s the chance to work in multiple different worlds: Integrated Marketing, Content, Digital Product, Digital Media and Strategy.

As a result, we have been working on Communication, Digital and Media projects for several years. I was “born” Digital, yet I was only introduced to the world of communication later on, which has very unique methods (which for example are often different for Digital Product projects).

It was around the fall of 2014, when I discovered that there was a TV series set inside a New York communications agency in the 1960s: Mad Men.

At that time I had only been “in the business” for 3 years, and after that initial period which focused mainly on digital activities (such as code development and UI Design), I started to approach various activities that had been the focus of my university studies, Marketing.

In fact, for those like me who study Marketing — made up of Product, Distribution, Promotion and Pricing, in other words, not purely Communication — there is a lack of background information when trying to understand this industry. 🤔

But how cool it must have been to work in an agency in the ’60s, ’70s and ’80s; of course, there must have been the negative effects of excessive smoking and drinking 🤓 but perhaps this also helped to create the myths and legends of advertisers, the so-called Mad Men. Oh, by the way, the name comes from Madison Avenue, the street in New York where the most important advertising agencies were based.

One thing that hasn’t changed, though, is how this industry does business.

Tenders. 😲

Let’s tell the (whole) truth about tenders.

When there’s a tender it’s an exhilarating time for a professional. If you love competition (like me), it gives you adrenaline and the opportunity to work with a team in order to beat everyone else, with the upmost focus on the result. Oh, and agencies are full of “race animals” who live for these moments, sometimes overshadowing ongoing activities.

But that’s not the entire truth.

Because if you’re a manager or an entrepreneur, you’re the one who pulls the strings and counts the returns and investments, reads contracts and clauses that are often imposed by large multinationals, makes negotiations “pressed” by buyers from Purchasing Offices that don’t always understand what you’re talking about, and must manage a high amount of tenders that are sometimes organized without criteria or substance.

For the sake of sharing here are some examples that have happened to me — we could even create a column, something like Horror Tenders:

• Exclusive contract against all direct and indirect competitors. But there is no list, rather to be judged from time to time by the brand’s international HQ. Therefore, waving goodbye to any chance of creating new business for the agency and to good old common sense.
• 1 Million Public Administration tender in 4 years. The reverse auction is not on the total value — which is not guaranteed anyway — but on a price list that is sometimes already ridiculously low but has to be decreased even further — this explains why PA very often operates in a C-list environment.
• Four-year contract with in-house team. But confirmed year after year. But with 30 days’ notice to terminate the contract at the client’s indisputable discretion.
• Omnichannel tender that lasted months, won. You enter into negotiations with the buying team. The strategy that we worked on with external/internal costs for research, consumer surveys, focus groups etc was part of the tender’s deliverables that the client chose. The buyer tried to argue that they would not pay us for the strategy, because it was effort included only in the tender and if we had lost it would have been a cost incurred anyway, so it was not to be recognized. It was only by threatening to reject the contract that we were able to defend this point.
• Tender invitation. There is no transparency on: budget range, agencies involved, average supporting investment, chosen timeframe, that there’s no reimbursement, complete deliverables for the strategy, campaign and content. Even if there is an exclusive media center, a supporting media plan is required.

Then the cherry on the cake is that when you refuse, you have to try to do so tactfully and make excuses that are sometimes untrue, because often clients can get offended if you don’t participate. 🤦‍♂️

I have a specific case of a client (beauty industry) in mind who wanted to invite us to take part in a tender for Social and Digital activities: Content, Community Management, live coverage at evening events and photo and video shooting for original content creation.

After asking if there was a brief (yes, there was no brief) to weigh up whether to participate or not, we asked for an idea of a budget range that we could allocate to the project. After a couple of weeks (just to be clear that no budget had even been set) we were given an estimate with a value of around -40% compared to what was needed for the requested activities. We explained that with this budget it was not possible to fulfill all of the required tasks, and that therefore we would not participate in the tender to avoid wasting anyone’s time, both client and agency.

The answer? Note: name the sin, not the sinner. 😁

“You can’t refuse an invitation to pitch to us, we are ThatMultinationCompanyWhichIsTheDreamOfAllAgencies”

What is the model of our market?

I certainly don’t consider myself a newcomer to our industry as I did a while ago, 😁 and I think I’ve understood something: our business model is a lot to support, and when negotiating, we are (all of us, more or less) on the weaker side.

Understanding how to innovate our industry’s business model is the challenge to ensure successful development in the medium-long term.

And it’s almost a game theory problem:

• Supply: extremely fragmented, in very high competition.
• Demand: extremely sparse, with few crossovers.

I tried to dig deep to find memories of microeconomic courses, market and competition models and a few of Michael Porter’s studies to analyze the market situation.

Among the market models theorized, the one that in my opinion is closest to ours is called Oligopsony. It is characterized by the presence of many sellers and few buyers.

I say that it is “close” because maybe there are not a few buyers at all: our market has thousands of companies buying marketing and communication services, but since we’re freely thinking here, let’s restrict our analysis to buyers who are large companies or multinationals, who have considerable budgets. The other factor that I consider is that bargaining power is still heavily unbalanced in favor of the client.

For this reason, I tried to create a value exercise by reading about our market situation with Porter’s 5 competitive forces model.

Michael Porter’s Five Forces.

The Communication Industry as seen by Porter.

(Or rather, interpreted through Porter’s eyes and without claiming to be the absolute truth.)

1. Threat of New Entries: HIGH
   We have an extremely open market. I discovered this myself with my partners, taking Caffeina from “nothing” to what it is today (I’m not trying to be arrogant but neither want to give false modesty) among the other agencies in our sector. If you’re good and smart you can enter without any problems. And if you’re very good and very smart (and a bit lucky) you can grow to a high level (this is a good thing). And if you are constant and trustworthy, you can keep on doing it. The market is open, you have my word. 😉
2. Threat of Substitution: HIGH
   As somebody who has only recently started observing, if I look at the film that starts with the agencies on Madison Avenue, I think that progressively from a balanced situation, where yes, the client decided at the end, but the impact of the individual agency, or the creative, was very strong to… . I’ve heard nostalgic tales (and in all tales there’s a kernel of truth) about CEOs and Marketing Directors managed, almost as if they were subordinate, by Creative Director children of the Mad Men era. The Creative Director selected which clients to work with and who would be “gifted” with their talents. Over the decades marketing has become a little more technical (and therefore objective) and a little less artistic (and therefore subjective), and the Manager has reclaimed the role of leadership and even creativity at times, partly removing it from agencies. Let’s think about it: how many agencies are consultants in the eyes of the client, able to bring about a business impact? And how many work on autopilot, even if they’re amazing? So… who do we want to be when we grow up? 🤔
3. Bargaining Power of Buyers: HIGH
   The power of clients has perhaps never been so high; mistakenly there is a perception that one agency’s service is fully substitutable with another, with low switching costs (after all, contracts hardly ever exceed one year, and if they do, they are confirmed from year to year). There are low costs for a tender (I invite 6 agencies, and make them all work for a month for free: after all, if they want the job, that’s how it works, isn’t it?), excluding the cost of the time needed to organize the tender process (often unfortunately very amateurish). There are Purchasing Offices convinced that each agency’s yearly margin is built solely on that tender and on that economic proposal. I’d love to meet a manager who can actually admit they’ve used their power in a dictating way, rather than in the proper way like the C-level zens we read about in the managerial case studies in the Harvard Business Review. 🤓
4. Bargaining Power of Suppliers: LOW
   Perhaps I could also call it “medium-low”, because between agencies there is a reputation for managers and clients: those who are inspired treat their agencies well and will be in the palm of their hand forever, and those who work badly will prevent the best from working with them. But in such a fragmented market, where agencies have medium-high turnover rates (sometimes “caused” by the agencies themselves), and clients who sometimes move communication or content activities internally (typical Make or Buy choices) to optimize budgets subject to cuts and pressures, there are no partners, but only “replaceable” suppliers (in the minds of the most uneducated managers with little vision). Contracts are signed where all intellectual property is sold and where there is a right to withdraw with 30 days’ notice. 😓
5. Competitive Rivalry: HIGH
   Every agency is in competition with all the others, and each one is alone against all the others, in a market characterized by a huge number of players providing digital, marketing and communication services. It is a market with high fixed costs (due to the headcount — or payroll and startup costs in all agencies). Of course, there are those who have more flexible business models, thanks to freelancing and short-term contracts. But is this what Communication and Marketing have to offer to those who want to pursue a profession in this sector? The low loyalty and turnover (of clients, this time) characterizes a market made up of fixed costs and variable revenues. Finally, it is a market in difficulty where digital has opened up space, but has greatly impoverished the value of the agencies’ creative and strategic work, making it difficult to always compete on quality, given the tight budgets and negotiation struggles that shift the focus and in many cases the decisions, on the price element (obviously, with repeated tenders).

Ok, so now what?

From this point of view we could propose the hypothesis that … Only “raving lunatics” (© Monty, Marco Montemagno) would want and could work in this market.

With “hindsight” (ah, such popular wisdom), I understand the meaning of Networks (or the Big Six) much better; let me somehow re-evaluate their meaning and existence: I see them as a possible solution for the industry to balance the market situation mentioned above, and ensure a future in our industry (even if perhaps in the past we have taken advantage of arbitrage and unclear situations, so today we are all still in the same boat).

In difficult situations there are two choices: either you suffer them, or you ride them out.

And so, I would like to open up the discussion to gather experiences and ideas on how to change and evolve. I don’t want to think about it alone (that is, “only” with people at Caffeina) because I think it’s a topic that requires different points of view compared to what we have.

And it is a topic where benchmarking is not enough, because you don’t find articles that talk about experiences with data and elements of our market that allow you to learn and rethink in search of solutions.

Quite honestly, I don’t really have a good idea how to do it, for the reasons above, but I think we should take it on in this way.

If you read all these stuff and you landed here, please leave a comment, drop me a line (name.lastname at caffeina.com) or a send me a tweet here. I’m very curios to know your opinion and gather other point of views on our industry.

#ideasneversleep