November 19, 2008

The 3 Numbers You Have To Know

How Ad Agencies Make Money, Part 2.

Yesterday we started a series on the economics of the ad business. It's not meant to be in-depth or technical, but just a simple overview for non-financial types.

I am constantly amazed that people who've worked in the agency business for 10 years or more have no idea of the economics of the business. They've heard all the terms but are not really sure what they mean.

Most people who work in agencies would probably be shocked to learn that today the average ad agency is lucky if it can make 10 thousand dollars in profit on a million dollar account.

So before you and your pals decide to quit your jobs, have your moms sew some costumes, and open up an agency, you better get a handle on how the money part works.

Today we're going to define our terms for the three key numbers.

First is billings.
Billings: It's the number that the trade press is obsessed with and agencies lie their asses off about. Yet to smart people, it's the least important of the three numbers.

Billings is the total amount of a client's money that passes through an agency. If you think of billings as the client's total ad budget you won't be far off. It might include the media budget, production budget, agency fees, etc.
Next is revenue. It's sometimes called "gross income."
Revenue: It's the amount of money the the agency actually gets to keep. Most (90% or more is not unusual) of the billings dollars get passed through the agency to someone else (tv networks, production companies, printers, etc.) In other words, billings tell you nothing about how much an agency is making. It only tells you about how much it is touching. Revenue (or gross income) tells you how much it actually gets to keep.

may come in the form of fees, commissions, mark-up, hourly charges, etc.
Finally there's profit. To agency managers, this is the number that really matters.
Profit is revenue minus expenses. In other words, how much money is left after all the bills have been paid.
One of the huge misconceptions about the agency business is that large billings are always a sign of economic health. It is nothing of the sort. If you refer to the economic history of Interpublic Group (IPG; it owns McCann, Deutsch, HillHoliday, etc) you can see how an agency with billions in billings can lose money.

A small 3-woman shop in Toledo, on the other hand, with a few hundred thousand dollars in billings can be more profitable than IPG.

Later this week we'll put these numbers together and see why the ad business has become such a piece of shit.

Proud To Be...
...the only ad blogger in the universe who hasn't blogged about the Motrin mess.

The arrogance and stupidity of big corporation ceo's is beyond belief. Here's a tip: Before you go begging for 25 billion, sell your fucking private jet.

1 comment:

Mohammad Awadalla said...

Really interesting. I had a dream to open up my own shop but this officially killed it. :)