How cost cutting can come back to bite you

When former Mediacom chief executive Jon Mandel revealed a rampant practice of “kickbacks” in the advertising industry two years ago, media agency CEOs around the world ducked for cover.

Media agencies, that book advertising space for clients, were essentially being paid twice for the same pieces of work and, often, not disclosing it.

While advertisers are questioning the allegiances of their agencies, those same agencies may reply, “What do you expect when your cost cutting effectively reduces our fees and commissions to zero?”

Marketing management consultant, Darren Woolley, says it is time to consider the ethical impacts of a cost-cutting culture.

“I think it is interesting to see how ethics are quickly reframed or compromised, based on profit”, says Woolley, founder and CEO of TrinityP3 Marketing Management Consultants.

In the case of the media agencies, their duty to clients is to find the most effective advertising space for their clients at the best price.

However, things become complicated when the media owners of print, radio, television, and websites started handing back a proportion of the client’s media spending to the agencies as an incentive to get more of their business.

Those “rebates” were often not disclosed to the clients and were often not passed on. They could be from around 1.67 percent to 20 percent per cent of “aggregate media spending” and took various forms.

“Clients could not be sure that the advertising space purchased was the right strategy for them, or just the most lucrative for the media agency.”

An investigation commissioned by the Association of National Advertisers (ANA) in the US also revealed media agencies were buying heavily discounted media space and not passing on or disclosing those savings to their clients. The agencies’ mark up on these transactions ranged from 30 to 90 percent.

Mandel’s “truth bomb”, delivered at a conference in the US, and the ANA report confirmed suspicions that media agencies around the world may no longer be acting in the best interests of their clients.

Clients could not be sure that the advertising space purchased was the right strategy for them, or just the most lucrative for the media agency.

Were they being pushed into digital advertising, for example, because it offered more lucrative rebates? Were their advertisements being seen by the right people in the right places?

Woolley says instances such as these have eroded trust but are the result of a number of factors affecting agency profitability, including industry disruption, rampant discounting, and endless expectations of cost-cutting by clients.

“We have been in a world of cost-cutting for ten years at least”, says Woolley.

Media agencies are also under pressure from the large holding companies that are often their owners. The holding companies and their shareholders expect to see rising profits each year, irrespective of market conditions.

“The industry is struggling. The traditional remuneration models – the way money moves through the industry, has changed. Firstly, there is less of it and there is a constant demand to do more for less”, says Woolley

“The obsession with cost is at the very core of this issue about ethics and ethical behaviour.”

Woolley says clients should be aware their own cost-cutting has contributed to agencies trying to find new ways to get paid.

“It is interesting to see at which point they [agencies] are willing to do something they wouldn’t normally do, willing to act in a way that is not in the best interests of their clients, but is in the best interests of their own company.

“To me, that is the interesting tipping point. What does it take?”

Woolley says agencies are not out to do their clients harm, but the system is supporting harmful behaviour.

That system includes an expectation that everything should always get cheaper and profits should always increase. Clients over recent years have cut their fees and commissions to media agencies from about 10 percent to around 3 or 4 percent and less, he says.

Melbourne Business School Marketing professor, Mark Ritson, has written that it is possible some media agencies are now effectively working on zero commissions and their only remuneration is through kickbacks from media owners.

“Most experts estimate that if you were to properly assess the revenue streams funding any major media agency, rebate income would significantly, and perhaps in some cases completely, overshadow commission income”, Ritson wrote in a column in The Australian newspaper in October.

Woolley says that with fierce competition from digital media owners, kickbacks have grown dramatically. Traditional media owners (newspapers, radio, and television) used to budget 20-30 percent of revenue as sales incentives, discounts, bonuses, or rebates.

But the owners of websites and social media platforms, which do not have the labour and production costs of newspapers and broadcasters, can “rebate” up to 90 percent of revenue, says Woolley.

This means there is a clear incentive to steer client advertising to digital platforms, whether it is the most effective strategy or not.

Since the widespread practise was discovered, most large advertisers have closed the kickback loophole by drafting contracts that ensure savings are passed on and don’t only benefit the agency middlemen.

“Agencies should be rewarded for delivering value and performance, not just for reducing costs.”

Some have also mitigated the risk by dividing their advertising work between multiple agencies “to keep them honest”, says Woolley.

Getting the advertising and marketing industry back on a sustainable footing will take a lot more than encouraging clients to pay a fair price for their agencies’ work or allocating a reasonable budget towards effective advertising campaigns.

Marketing executives have told Woolley they cannot convince their own chief financial officers to pay their agency more – even when that lack of investment is resulting in ineffective campaigns.

“But it is not working as it is, so everything they are spending is a waste and an increase in spending could make it functional”, he says.

Woolley says the advertising and marketing industry needs to change the conversation if it wants to survive. “It has been about cost for the last 15 years. It is not easy, but the way forward is to actually talk about value”, he says.

“Cost is a downward spiral to zero.” Agencies should be rewarded for delivering value and performance, not just for reducing costs, he says.

“By considering an ethical approach, rather than just a financial or cost approach, it will open up possibilities for people to do and think differently because, certainly, we are in a spiral.”