The ad agency sector faces overall headwinds, top line erosion, and limited cost savings due to macro trends, micro trends, and operating model inefficiencies.

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Dr. Augustine Fou
http://linkd.in/augustinefou
May 2014
Investment Thesis:
Ad Agency Sector
2014

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Executive Summary
THESIS
We remain bearish on the ad agency sector, represented
by agency holding company stocks (OMC, IPG, etc.);
we believe they have started a secular decline –
precipitated by the onslaught of digital alternatives in
general and specific tactics like video advertising –
which will lead to accelerating erosion of top-line
revenues and years of depressed net income.

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Current Financials

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Omnicom (NYSE:OMC)
$14.6B revenues
$1.8B operating
income

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Publicis (PINK:PUBGY)
$6.6B revenues
$1.0B operating
income

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Interpublic (NYSE:IPG)
$7.1B revenues
$0.6B operating
income

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MDC Partners (NASD:MDCA)
$1.1B revenues
-$0.03B
operating
income

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AGENDA
1. Macro Trends – Headwinds and Shrinking Industry
2. Micro Trends – Eroding Top Line
3. Operating Model Challenges – Limiting Cost Savings
• Shift to digital making industry more efficient
• Polarizing ad spend to branding vs performance
• Users’ consumption and habits/expectations changing
• Specialization and Insourcing
• Self-serve and programmatic
• Procurement involvement and Fee, Project, Performance
• Billable rate (capped by project) vs cost of labor
• Giving ideas away; making money on low/no margin production
• Departments prevent knowledge sharing / innovation

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Macro Trends
Overall Headwinds

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• Shift to digital making industry
more efficient – smaller pie

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TV is $69B Digital is $48B
TV vs Digital Ad Spend
TV DigitalPrint Radio
Out-of-Home $8 (5%)
Other $2 (1%)
$75 billion
42%
$43 billion
24%
$32
18%
$17
10%
Display
$8 billion
19%
Search
$18 billion
43%
Video $3 (7%)
Mobile
$4B$3B
display search
17%
Other
$5
11%
Lead Gen $2 (4%)
• classifieds
• sponsorship
• rich media
Source: IAB Full Year 2013 report
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branding performance

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TV Ad Spend Topping
Ad rate (per 30 second spot) falling

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TV is $69B Digital is $48B
Broadcast vs Cable TV
TV Digital Print Radio
Out-of-Home $8 (5%)
Other $2 (1%)
$75 billion
42%
$43 billion
24%
$32
18%
$17
10%
Broadcast
$40 billion
Cable
$34 billion
Source: IAB Full Year 2013 report
54% 46%
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Digital exceeded cable in 2011Digital exceeded broadcast in 2013

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In 2013
Digital marketing was $42B
Broadcast TV was $40B
Cable TV was $34B
Network TV vs Cable TV
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Source: IAB Full Year 2013 report

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Measured Ad Spend FY 2013
March 2014 Data

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Broadcast TV $20 cpm
Cable TV $18 CPM
Radio $5 cpm
Magazines $20
Newspaper $35
Out of Home $4
Internet $11
Direct mail $40 CPM
Comparative Media Costs
Cost per Thousand (CPM): Cost to reach 1,000 users or impressions
Source: OAAA, 2011
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• Polarizing ad spend to branding
vs performance – shift away

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Left-side Right-side
branding performance
“Soup and Soda” “Cars and Computers”
• Low cost
• Low complexity
• Low consideration
• High cost
• High complexity
• High consideration
Metric:
Size of
Audience
Metric:
Actions of
Users

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1st screen 2nd screen 3rd screen
• Television
• Magazines
• Newspaper
• Radio
• Display Ads • Search Ads
• Search Optimization
• Email
• Social Media
Marketing
• Mobile Marketing
awareness consideration choice purchase advocacy
• In-store
The Marketing Continuum
branding performance

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• Users’ consumption and
habits/expectations changing

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Time Spent TV vs Internet
In 2013 share of
time spent per day in
Digital
(314 mins or 5.2 hrs)
exceeded share of
time spent on
TV
(271 mins or 4.5 hrs)

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Live Broadcast vs Online TV
Source: Diffusion Group March 2014 via MarketingCharts

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Streamers Watch Less Pay-TV
Source: GfK July 2013 via Marketing Charts

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Why People Stream Video
I can’t find what
I’m looking for
on a licensed site
Source: BusinessInsider Poll April 2014

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What People Stream
I stream TV
series and
movies
Source: BusinessInsider Poll April 2014

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DVR Owners Watch 23m
Source: Nielsen Dec 18, 2013 Source: Netflix
DVR owners watch exactly 23
mins (i.e. skip exactly ALL ads)

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Marketing Science March 2014

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Micro Trends
Eroding Top Line

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• Specialization and insourcing

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Source: ANA via eMarketer, Sept 2013
Brands Use In-House “Agencies”
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56% have
already
started
moving
work in-
house to
save costs

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Source: ANA via eMarketer, Sept 2013
What In-House “Agencies” Do
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• Magazine ads
• Social media
• Online display ads
• Search engine marketing
• Newspaper ads
• Search engine optimization
• Mobile advertising
• Out of home advertising
• Radio advertising
• Tv advertising
• Social Media
• Display Ads
• Search Marketing
• Search Optimization
• Mobile Ads
Are being done in house
because they can buy direct
or use ad networks
themselves.

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Specialization Rules
Source: SoDA 1H 2013 Digital Marketing Outlook

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Outsourced Digital Marketing
Of the services that
advertisers outsource,
traditonal ad agencies
have little to no
experience or credibility
-- these services are
outsourced to small
specialist agencies.

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• Self-serve, direct-buying, and
programmatic

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Buying Direct from Facebook
Source: AdAge RBC Capital Survey September 2013
More clients/advertisers are buying direct from Facebook (similarly
with Google Adwords, Twitter, etc.); so the “buying power” rationale
is no longer valid, or will be less so going forward,

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It turns out that cord-cutting isn’t the only threat facing cable channels.
Several of the big ad-supported online video outlets, including Google Inc’s
YouTube, AOL and others, plan this upfront season to target some of the ad
dollars that currently flow to cable channels, industry executives say.
The web video outlets see a vulnerability in second tier cable networks, and to a
lesser extend in the local TV-station market, executives say.
According to multiple media buyers and ad sellers in the Web video industry,
digital media companies are looking to draw direct comparisons between their
audiences and cable TV networks, a match-up Web video outlets think they can
win.
Buyers say Google is likely to be the most aggressive on this front, given
YouTube’s massive size and its young demographics that don’t necessarily
watch a lot of TV. The company has been selling directly against cable
networks, with pitches like “X YouTube net reaches more women than E! or
Awesomeness TV reaches more tweens than ABC Family.”
In one pitch, for instance, YouTube cited Nielsen data from November showing
that it reached 49% of all 18 to 34 year olds, versus 45% for FX, 44% for TBS’
comedies, 41% for Comedy Central and 40% for AMC.
YouTube also thinks it can capture more local broadcast and cable ad dollars
from national advertisers looking to boost spending in certain markets. The
company is targeting automotive and wireless advertisers in particularly, said
executives with direct knowledge of YouTube’s plans.
Loss of Ad Dollars to YouTube
Source: WSJ
March 2014
Don’t forget about
Facebook video ads
which debut at $1 -
$2.5 million a day.
Source: Business
Insider, March 2014

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• Procurement involvement and
Fee, Project, Performance

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Procurement Involvement
Source: Assoc. of National Advertisers, via MarketingCharts June 2013

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Changed from 70% commission and 30% fee to 81% fee and
only 5% is commission; Increasingly clients add in
performance clauses
Fee-based Compensation
Source: Association of National Advertisers

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Performance-based Incentives
Source: Adweek, August 2013

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Operating Model Challenges
– Limiting Cost Savings
• Billable rate (capped by project) vs cost of labor –
choose junior staffers to work on after the pitch
• Giving ideas away; making money on low/no margin
production – procurement involvement has led to
lower cost sources
• Departments prevent knowledge sharing / innovation
– account people separate from IT, analytics, digital,
etc.

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Lower Cost Alternatives
Brands now have ways to produce quality original content at a
fraction of what it used to cost to produce a glossy TV ad.
Ford sponsored video
by DevinSuperTramp
Showcases new electric
Ford car, used in the
bike tour to various
locations around San
Francisco.

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Crowdsourced Creativity
Brands can now crowdsource ideas from fans and then produce
the original content (in this case videos) for marketing.
Mini USA engaged
their loyal owners to
create ideas for the
launch of the new
Hardtop.
10 winning stories
were selected and
produced into videos,
some of which went
viral.

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Other Points
• Clients view “small is better” now – more
specialized experience, less overhead
• Clients start to ask who is working on the
project, may specify names in contract
• Agency consolidation plays have not worked
well due to inexperience, and coordination
overhead

45. Augustine Fou- 45 -
Dr. Augustine Fou – Digital Consigliere
“I advise clients on optimizing
advertising across all channels. When
users are moving away from traditional
TV viewing, advertisers need to find new
ways of reaching them and attracting
their attention, likely in digital.”
FORMER CHIEF DIGITAL OFFICER, HCG (OMNICOM)
MCKINSEY CONSULTANT
CLIENT SIDE / AGENCY SIDE EXPERIENCE
PROFESSOR AND COLUMNIST
ENTREPRENEUR / SMALL BUSINESS OWNER
PHD MATERIALS SCIENCE (MIT '95) AT AGE 23
@acfou
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Related Articles
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http://www.slideshare.net/augustinefou/viewability-of-display-ads-vs-video-ads-
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APPENDIX

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Trends
1. Insourcing - Brands/clients take tasks in-house (e.g. in-source
social media, analytics, and digital media buying)
2. Direct buying – Brands have enough leverage themselves to buy
direct from Facebook, etc, plus self-serve interfaces
3. Procurement intermediation - departments involved in sourcing
by triple-bidding, adding performance clauses
4. Projectization - Shift from commissions to fee-based
compensation; from AOR (agency-of-record) to project basis
5. Zero to negative margin production work (e.g. HTML coding,
graphic design) no longer profitable for large agencies due to
lower cost alternatives (e.g. small firms) and globalization
6. Trend towards specialization – new and highly specific digital
tactics require individuals with real hands-on experience, big
agencies dont have those.