Consultant and author Michael Farmer is one of the most incisive and knowledgeable commentators on advertising and the wider business environment. His new book Madison Avenue Makeover: The Transformation of Huge and the Redefinition of the Ad Agency Business will be launched at the Cannes Lions on June 27.
Here he looks at how the business orthodoxy of shareholder value has affected advertising (and not in a good way.) From C-Suite Blues.
The quality of CEO leadership has deteriorated, hijacked by short-term “shareholder value” concerns and corrupted by high CEO compensation levels, which are themselves driven by short-term earnings and share price levels. The deterioration began in the ‘80s and ‘90s, with the rise of deregulation, global competition, technological changes and the rise of investment banks and institutional investors who promoted M&A as a way of growing company share price levels. Boards decided to pay very high compensation levels to encourage CEOs “to have some skin in the game.”
In 2021, a typical CEO at one of the top Fortune 500 firms in the US was paid $27.8 million. This level is about 350 times the compensation of a typical worker. Before shareholder value boiled down corporate purpose to matters of money and wealth for shareholders, CEO compensation was only 30-40 times the compensation of a typical worker.
CEO pay has grown faster than tuition at private universities and colleges. CEOs live a life today that was inconceivable only a few decades ago.
Shareholder value has made many corporate executives very rich, and this kind of wealth has had a major influence on the quality of corporate thinking, priorities and actions. There have been many failures in the marketplace: Kodak, Sears, Nokia, Toys “R” Us, Circuit City, Yahoo, Borders, GE, Blockbuster, BlackBerry and recent bank failures like Signature Bank (CEO pay $8.6 million), Silicon Valley Bank ($9.9 million), and First Republic Bank ($17.8 million).
Media holding company CEOs at Publicis Groupe (CEO pay $3.3 million), WPP ($8.4 million), IPG ($13.2 million) and Omnicom ($20 million) have been adept at playing the shareholder value game, but holding companies are very vulnerable today. Each of the holding companies generates income through “labor-based fees” earned by their subsidiary companies — media agencies, creative agencies, production companies, PR firms, research firms, data and analysis providers and the like — companies who receive “fees per head” from their clients for the people who are assigned to work on their accounts.
Clients have relentlessly cut the fees paid over the past two decades, but the holding companies have survived and increased shareholder value by aggressively downsizing their companies every year to maintain profit margins.
This downsizing might have been ok if agency workloads were declining, but quite to the contrary, workloads have been growing while fees have been declining. Downsizing in the name of shareholder value has liquidated much of the talent in the industry, and agencies are now “underpaid sweatshops” where agency personnel struggle to keep up with the work required by their clients. Holding companies have managed to “make their numbers” through this crude and short-sighted way. What they have not been able to do is maintain their client relationships. Clients now turn over every 3 years or so. The agency downsizings have certainly had an adverse effect on agency quality. Clients now change agencies regularly, seeking lower fees with every change of agency.
The downsizing game cannot continue. The holding company agencies are already on shaky ground, even if Wall Street investors and analysts are not yet aware of the workload versus staffing versus quality problems.
What will make things worse in the future, of course, is AI, which can replace (by today’s estimates) up to 35% of the people who make up agency headcounts. What will happen to holding company revenues when clients either use AI themselves or force agencies to use AI to lower their headcounts and fees? Will holding companies survive such a dramatic decline in staffing and income? If holding companies maintain a business model based on “selling heads for a fee” to their clients, they will surely get into very hot water.
Unless holding companies pivot to get paid for the work they do rather than being paid for the number of people they allocate to clients, they are sure to enter the rogues gallery of failed companies listed above.
Holding company CEOs need to personally lead transformations throughout their portfolio of companies. This will create an uncomfortable situation for these CEOs, since they will no longer be able to focus on “making the numbers” They will have to worry about the progress of their transformations as well.
To date, in my experience, only Huge, the modest-sized digital creative agency owned by IPG has gone through such a transformation, led by Mat Baxter, Global CEO. Huge’s example could serve as a bellwether for other agencies — or for the holding companies themselves. (Huge’s transformation has been documented in “Madison Avenue Makeover: the Transformation of Huge and the Redefinition of the Ad Agency Business,” to be published in the summer of 2023).
Shareholder value is based on an illusion that CEOs can manage certainty and avoid taking risks. Yet, transformations require risk-taking. If there were any reason to pay CEOs major amounts of money, it should be because of their successes in taking measured risks for the future rather than relying on the certainty of “making the numbers.”
Let’s see how WPP, Publicis Groupe, Omnicom and IPG play the AI hand in the coming years. AI poses a major risk for each of these companies. How will they be led? That’s a fair question for CEOs Mark Read, Arthur Sadoun, John Wren and Philippe Krakowsky.