November 21, 2008

Why "MadMen" Lived In Barbie Dream Houses And You Live In A Shit Dump

This is the third part of "How Ad Agencies Make Money". The first two parts are here and here.

Advertising used to be a lucrative profession.

The traditional economic model for an ad agency was this: an agency's goal was to have revenue equal 15% of billings, and profit equal 20% of revenue.

So, on a hypothetical account with billings of a million dollars, the old "MadMen" financial model looked like this.
Billings: $1,000,000
Revenue: $150,000
Profit: $30,000
There was additional money to be made on other services like production mark-ups and mechanical preparation.

Today's world is way more complex and way more daunting. I haven't seen AAAA's figures recently, but I'll bet for most agencies revenue is down around 10-12% of billings and profit is 7 - 10% of revenue. It's hard to compare the old ratios to the new because so few agencies buy media anymore.

If I'm right, however, the average agency is probably making about $10,000 in profit annually on $1,000,000 of billings. You can make more money on a savings account.

I'm not bemoaning the lack of corporate profits here. What I'm talking about is that companies that can't make decent money also can't pay very well or hire very much. And if you think publicly traded companies are going to forgo their profits to pay more, you're dreaming.

Salaries consume 50-60% of agency revenue. Far greater than any other expense. When times get tough, agencies have 2 options: pay lower salaries or employ fewer people.

When I started in the business, agencies used to have, on average, 4 people per million dollars of billings. Today they have less than one person per million. This is why so many agencies have become sweat shops.

My former partner used to say that clients won't be happy till we have zero people per million.

The difficulty in making money helps explain why so many independent agencies have disappeared. Every ten years or so the agency business turns sour. When it does, independent shops don't have cash reserves like the big guys, and it's hard for them to survive.

The big global agencies will endure the next few years. But it's going to be tough for agency employees and independent shops. Take a deep breath and fasten your seat belt.

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