Are Holding Companies Ready for a Phase III Strategy?
Phase I -- 1980s to 2005 -- acquire and squeeze; Phase II -- 2005 to 2022 -- pitch holding company relationships; Phase III -- 2023 to 2028 -- proactively transform agency operations and pricing
Credit: Charles Barsotti, The New Yorker, The Cartoon Bank
Holding companies, rather than the agencies they own, have occupied the media’s center stage for so long that we assume that they represent the advertising industry. When is the last time you heard about Saatchi & Saatchi? Leo Burnett? Ogilvy? Grey? BBDO? TBWA? Probably only when they either win a creative award or announce the departure or arrival of a senior executive. Otherwise, all the news is about WPP, IPG, Publicis, Omnicom, Dentsu or any other of the financial owners of individual agencies.
This is no accident. Each holding company has assiduously trumpeted its own identity and minimized publicity eminating from its agencies.
Phase I Strategy. Between the 1980s and 2005, holding companies acquired agencies across the media spectrum, and they routinely forced them to downsize and cut overhead costs. That was the “Phase I strategy” — holding companies knew that their agencies had surplus staffing and costs, left over from the salad days of 15% media commissions. If the agencies could cut people and costs, and show growing margins, then the holding companies themselves would show growing margins, and this would lead to growing share prices and personal wealth for holding company shareholders (including holding company CEOs).
Phase I was never enough, though, even though cost cutting remained the dominant holding company strategy. “Buy and squeeze” seemed inelegant, and beginning in 2005, when all the surplus agency resources were gone (although this did not stop relentless downsizings), the holding companies looked for loftier strategies — for Phase II strategies. As Martin Sorrell explained in my book, Madison Avenue Manslaughter (3rd Edition 2019):
The people running the agencies were more aligned to their brands than to the holding company. I had to bring about a change in this alignment if we were to achieve something important. We couldn’t have a holding company that had a number of businesses that operated independently in 115 or 205 countries, whatever the number was — my thinking was “it has to be WPP, one united company,” so we can operate efficiently and competitively on behalf of our our clients. We had to become one company, like a McKinsey or Goldman Sachs.
Phase II saw the beginning of “holding company relationships,” which came into being during the digital / social marketing era after 2005. In a holding company relationship, the clients agree to largely, or exclusively use the agencies owned by a holding company. In return for this exclusivity, and on the assumption that there are genuine economies of scale (a dubious assumption), the holding company offers to do all of a client’s media and / or creative work for highly competitive fees.
Curiously, though, it is not the holding companies that invoice clients for the work in holding company relationships. Invoicing comes from the agencies who staff the work and struggle to make profits from the low prices. Holding company relationships are a low-priced way for holding companies to increase their revenues, but they’re tough on their agencies.
The holding company business model is based on “remuneration from the sale of agency man-hours for an unknown quantity of work.” Margins have been generated, as noted above, through downsizings and cost reductions.
The 2023 introduction of AI threatens this business model in significant ways. One agency CEO has predicted that AI will replace 20% of holding company hours and income. If this is true, then holding companies face an existential threat.
What they and their agencies need to do is transform their business model from “remuneration for man-hours” to “remuneration for work” — which means being paid for outputs rather than inputs. The industry has long talked about this — for decades, really — but only Huge, the Brooklyn-based creative digital agency led by CEO Mat Baxter has taken this step, along with declaring that Huge’s mission is “accelerated growth for clients” rather than the provision of “creativity.” I recently wrote about this in Madison Avenue Makeover: the Transformation of Huge and the Redefinition of the Ad Agency Business (2023), noting that the only way an agency can get better remuneration is to help clients solve their growth and performance problems, just like the consulting firms, but using other tools. Other agencies have avoided the transformation subject, believing that any efforts to transform their agencies might upset their ability to “make the numbers” for their holding company owners.
This brings us to the need for a Phase III holding company strategy. If the owned agencies will not transform themselves in an effort to protect themselves from the AI threat, then their holding company owners need to step in, like private equity owners, and direct the transformations from the center.
Bear in mind, though, that holding companies do not have these transformation skills, and the holding company CEOs may be disinclined from being pro-active. They, too, may fear that the disruption from agency transformations will interrupt holding company growth rates and profit margins, leading to difficulties with share price growth.
Consequently, holding companies may find themselves between the proverbial rock and the hard place. Do nothing, and let AI destroy their current business model, or do something, and disrupt the Phase I and Phase II strategies of the past 40 years. Either way may bring about chaos and loss of shareholder value.
Instead of pursuing Phase III pro-active strategies, holding companies may punt, and elect to let their agencies “figure out how to deal with AI.” This would be consistent with they way they have worked with their agencies in the past. If this is their desired course of action, we can be sure that the industry will see 20-30 unique ways that agencies will try to price their services — a real Tower of Babel. Will this work? It’s not very likely. Clients, instead, will take control of pricing, as they have in the past, and that will be the end of agency pricing initiatives. They may say, “enough of this nonsense. We’ll continue to pay your hours, even if there are fewer of them!”
If this is likely, then a Phase III strategy is a must for the holding companies.
Is a Phase III strategy likely to happen? It will be interesting to see how holding companies face the threat of AI, and whether the threat will stir their interest in being pro-active or not.
We’ll watch developments and keep you informed.
Excellent viewpoint! 🧐Thank you for sharing Michael Farmer! 👏🏻
Phases II and III will be simultaneous for the next 3-4 years, and the pace of the need for painful transformation shall intensify depending on AI's actual industry application. AI is bigger than we may think, still. If some of my former (and admired) London colleagues spoke about FB and G as they had eaten their/our lunch around 2015 already, now you need to calculate in Salesforce, MSFT, AMZN or ADOBE, to name a few. Additionally, the best and the bravest leadership people who wanted to leave or should have been ousted for any corporate politics/restructuring reason left already. Now I wonder who is meant to hold the torch and lead through these unique, once in a life time challenge for regions, inherently not growing like Europe, and local marketplaces on board -1 & -2 level for those companies.