Death by Disintermediation
By Mike Carlton
For many years Jackie was my travel agent. She was marvelous. She handled all my domestic and international travel flawlessly. She knew my preferred air carriers, hotels and car rental companies. She knew just how to get me free upgrades. She was a great asset.
All it took was a phone call and everything was taken care of.
Of course the call had to be during normal business hours and sometimes getting a direct conversation took a bit of telephone tag. However, once we connected, her service was superb.
But that was then. This is now.
Today I book all my travel online. I usually check Travelocity or Expedia for general routes and rates. Then I go to the sites of my favorite airlines and make the purchase through them. Same approach with hotels. Same with car rentals. It’s faster, easier and a whole lot less expensive.
A Changing Business Climate
I don’t know where Jackie is today. Or what she may be doing. Her firm is gone. It progressively shrank as airlines eliminated their commissions and the travel agency had to charge service fees. It went into a downward spiral. Finally, it just disappeared. Along with countless other travel agencies. And travel agents.
And it isn’t just travel agents who have disappeared. What has happened to stock brokers? Or insurance agents? Or sales agents? Or? Or? Or?
They are victims of disintermediation.
According to Wikipedia:
“Disintermediation is the removal of intermediaries from the supply chain. Instead of going through an intermediary, such as an agent, buyers and sellers can deal directly with each other.”
Cutting out the middleman has become rampant. We see it all around us. And we as consumers increasingly take advantage of disintermediation every day.
The Age of Disintermediation
Economists call it, “The Economics of Transparency.” Where buyers and sellers can directly communicate the knowledge that once was held by the middleman. And where the costs associated with the middleman are eliminated.
Powered by the Internet, we have entered a new age of business. For the web not only enables disintermediation, it encourages it. It has made it easy for buyers and sellers to meet in a virtual marketplace. A place where middlemen aren’t needed. And the cost of their services is eliminated.
Benefiting both the buyer and the seller. And the overall economy, too. In fact, it has become an important force in helping sustain widespread economic growth.
An Endangered Species
In this environment, all middlemen are under scrutiny. There is relentless economic pressure to eliminate them. Countless bright minds are constantly exploring ways to drive costs down by cutting them out of the process.
Today, it’s not a cake-walk being an intermediary. It is not a cake-walk being an agent. Or being an agency.
Those Pesky Words
“Agent.” “Agency.” Just what do they mean? Are advertising agencies intermediaries? Are they subject to disintermediation? And if so, what are the implications? And what can be done about it?
A Couple More Definitions
“A person authorized to act as intermediary for another person (the principal)”
“An organization of agents authorized to act as intermediaries for another person or entity (again, the principal)”
This immediately raises some more questions. Does the word agency (or agent) accurately describe the role of an advertising agency? Why the name agency? Where did it come from? Why do we use it? What does it really mean in the marketplace?
To get a proper perspective, we need to go back in time to the origins of advertising agencies.
A Bit of History
The advertising agency business started in Philadelphia in 1841. Initially, agencies were vendors of newspaper advertising space. They sold and placed newspaper ads, which they created, to advertisers.
Advertising was in its infancy. The only commercial medium was newspapers. Up until agencies came along, advertisers had to create their own ads. They wrote the copy. Designed the layout. Handled the production. And then placed them directly with the newspapers. They paid the newspaper the list price for running the ad.
Servicing these advertisers was something of a pain for the newspapers. First, most of the advertisers weren’t very good at creating and producing their ads. So, they continually pestered the newspapers for help. A real bummer for the journalists.
Second, the newspapers kept getting burned by advertisers who didn’t pay their bills. Establishing credit for lots of little advertisers and then collecting from them was a continuing headache.
Along came the entrepreneurial start-up advertising agencies.
Their deal was simple. They would create and place the ads they sold and guarantee the advertiser’s credit. In return, the newspaper would discount the list price of the space by 15%, thus giving the agency a “commission” to compensate it for its work.
A great deal for the advertisers because having professional guidance in creating and placing their ads cost them nothing. And a great deal for the newspapers, too. They could go back to publishing the news without being bothered by a bunch of unsophisticated advertisers.
So a New Industry Was Born
While these new enterprises were ostensibly acting as agents of the advertisers, they were, in effect, being paid by the newspapers. Agencies bought advertising space in the name of their client (the disclosed principal), paid the medium 85% of its list price and then rebilled the client at 100% of list price. An unusual twist to the traditional agency-principal compensation method right from the start.
But advertising agencies were, in fact and in law, functioning as agents. They were intermediaries.
For over 100 years this business arrangement worked quite well. The commission system was extended to magazines, then radio, TV and other various media.
And under this business model the industry flourished. Advertising, created and placed by advertising agencies, changed the face of the world. Great brands were built. And consumers enjoyed unparalleled freedom of choice. Times were good.
The Decline of the Commission System
You know the story. During the past forty or so years the advertising agency industry slowly moved from a primarily commission compensation business model to a primarily fee or hourly charge compensation system.
Lots of factors were at work here. Mostly driven by the desire to reduce costs. Both the media and marketers worked at squeezing out cost. And most agencies went along, beguiled by the downside protection apparently offered by hourly charges.
Right from the early beginnings the market slowly, but inexorably, redefined the role of the advertising agency. The initial role as the seller of media space was overshadowed. The agency’s primary importance morphed from a focus on selling advertising space to the creator of innovative strategies and client messages. People no longer thought of an advertising agency as a peddler of media.
The intellectual value of an advertising agency’s strategic and creative ideas overwhelmed its original transactional purpose. So the definition of just what is an advertising agency changed along with this evolution.
Today, Wikipedia defines an advertising agency as:
“A service business dedicated to planning, creating and handling advertising (and sometimes other forms of promotion) for its clients.”
You’ll notice no direct mention of media buying or selling. Nor anything that connotes its historically legal “agency” status. At its core, the modern advertising agency essentially is in the behavior modification business. Helping its clients change the commercial behavior of their customers for the benefit of the customer, the client and society.
Yet the preferred nomenclature in the marketplace continues to be “advertising agency.”
Stuck in No-Man’s Land
Today, agencies are in a difficult position. No, make that a terrible position.
Sometimes they act as agents, buying media and production for the benefit of their disclosed principal, the client. Handling all the billing and paying. And automatically transferring all the ownership rights in their work to the client.
But often when they are doing that the client thinks of them as a vendor. And treats them as if they are making a product for sale to the client. With little regard for the legal responsibilities of the principal in an agency-client relationship. They can view buying an ad like buying a piece of sausage.
Sometimes agencies act the way consultants, lawyers or accountants do. Providing services which are paid for by the hour or in an hourly based fee. Unfortunately, this can lead clients to believe that ideas generated under a time billing system are a commodity. That hours equal ideas. And the quality and effectiveness of the ideas are directly linked to the time it took to create them. A patently stupid notion.
A variation on this is the project fee. Usually it is based on hours. In those instances it is just a different way of packaging hourly charges. Only very rarely do agencies charge project fees based on the anticipated value to the client the work represents, with little regard for the cost of the time needed to fulfill the project.
Sometimes, but not very often, advertising agencies do retain some form of equity in their ideas. And are paid in some form for the effectiveness of their work in changing behaviors in the client’s marketplace.
And it is not unusual for agencies to confusingly mix and match these various business models simultaneously with the same client.
And while this is all happening, media, particularly new media, is increasingly bypassing the advertising agency altogether and dealing directly with clients. They are actively practicing disintermediation.
A Rotten Business Model
The industry’s evolution has put advertising agencies into a business model trap. They are neither fish nor fowl. They sometimes act like agents. They sometimes act like vendors. They sometimes act like consultants. And they seldom get long-term rewards for the value of their ideas.
This means that when it suits an uncaring client’s purpose it can treat the agency like a vendor. Or it can treat it like an agent. Or it can treat it like a consultant. And the choice of this is usually in the hands of the client. And may change frequently on a situational basis.
A confusing situation at best. And untenable one at worst.
What a mess! No wonder advertising agencies are receiving a diminishing share of the marketer’s budget.
What Marketers Value
It’s not all gloom and doom. Not long ago the 4As (American Association of Advertising Agencies) and the ANA (Association of National Advertisers) conducted an Advertiser-Agency Value Study. The results are rather encouraging.
Advertisers believe agencies add value by:
“Providing fresh creative ideas and developing programs that can be executed across multiple channels including new media and technology solutions.”
While there are a number of other specific ways in which advertisers believe agencies add value, the above is at the top of the list.
Is it any surprise that buying and selling traditional media and production is not among the services advertisers most highly value from agencies?
Transactional vs. Intellectual
The root issue is simple. Agencies started as agents getting paid for transactions (buying media). But today, their primary value to marketers is intellectual (creating strategic ideas and developing programs).
Yet most agencies' business models are stuck somewhere between being an agent and being an hourly paid consultant. And their compensation methods are stuck right there with their business models.
No wonder agency leaders are frustrated. No wonder it is harder to make money. No wonder it is increasingly difficult to attract existing talent. And the best future talent is not attracted to the industry the way it used to be.
Nibbled to Death by Ducks
On the intermediary (agent transactional) side, disintermediation is diminishing the advertising agency’s role. There is no place for the middleman. New media is increasingly bypassing advertising agencies. Titans like Google, Yahoo and Microsoft as well as social media and big data newcomers are staking out the advertising market for themselves. With little interest in running transactions through advertising agencies.
And on the intellectual (strategies and creative ideas) side advertising agencies are trapped in an hourly charge billing system (or time based fees) that shows little or no respect for the value of their ideas. It frequently assumes that every idea has the same impact in the market place. That ideas are a commodity.
Yet all around us intellectual work is being compensated for the long-term value it brings to the beneficiary. Actors get residuals. So do photographers. And artists. And songwriters. And authors. They have continuing rights to their creations. Rights that reward them not for the time it took to create the work, but rather the value the marketplace bestows upon it.
They have a business model that makes sense. Agencies don’t. Yet their value based business models are readily accepted by the same marketers agencies work for. In fact, agencies regularly bill clients residual charges for the talents of others but not for themselves.
Doesn’t make sense, does it?
Pay for Results
There are increasing calls for agencies to invoke a revised business model. A system of compensating agencies fairly for their contribution to wealth creation for their clients. A system based on results. Not on hourly costs.
Pay for results is not an easy sell. Nor will it come quickly. But it is absolutely necessary.
The Importance of Your Business Model
Jackie, my travel agent, worked for a firm that was unable (or unwilling) to change its business model. Today it is gone. Disintermediation did it in.
Advertising agencies, which are at least partly intermediaries, are also endangered. Disintermediation is at work. Agency employment is below where it was a decade ago. And agency share of total marketing spend is declining, too.
Yet, the intellectual value agencies can bring to marketers is greater than ever. Clients increasingly need big ideas that will move their customers. Big ideas that can come from advertising agencies. The future can be incredibly bright.
But, that happy future will not likely happen without a business model change.
It’s Not Too Late
You, and every other advertising agency leader, can look at your own business model right now. If a large portion of your income is coming from transactions (being an intermediary) recognize that price competition in that segment of your business will only get worse. Disintermediation will exert increasing pressure.
If a large portion of your income is coming from hourly charges (or time based fees) recognize that clients and their procurement people will continue to try to drive your rates down. Especially if they view the ideas generated by those hours as a commodity.
Look at the value your ideas are bringing to your clients and how much wealth they are creating. Then begin talking with your clients about value. About alternative compensation methods that can benefit them as well as you. And recognize that to get bigger rewards you will most likely have to take bigger risks.
It won’t be easy. And it probably won’t happen quickly. But the consequences of not doing it are grim.
Remember Jackie and her firm. Even though travel spending grew dramatically, they stuck with their traditional business model. And they went down with it.