Thursday, February 04, 2010

Digital Margin

Over the last weeks I traveled to South Africa and a few European countries to meet with colleagues and some local industry experts, all with the goal to better understand how marketing agencies are dealing with the accelerating influence of digital marketing. Independent of how brands are spending their marketing investments, from less than 2% in South Africa to over 30% in the UK on digital and mobile activities, a lot of the marketers on the service side of our discipline are asking the question of how they can truly make a decent margin on digital work. The question has moved from how much they should invest in the build out of their digital capabilities into the challenge of how to make money with it.

The large agency holding companies (IPG, WPP, Omnicom, Publicis) report EBITA numbers of between 6% on the low end and 15% on the high end. It’s very difficult to find out the profit margins of the various pure digital agencies within the holding companies, so one has to rely on estimates and insights derived from industry experts. There definitely seems to be a challenge for larger traditional agencies to make decent margins on their digital work. After discussing this with a few knowledgeable marketers some explanations rise to the top:

  • Scale: Even most pure digital players had a difficult time to create a decent margin until they reached a sufficient size to not just recoup initial investments but have the expertise and size to monetize on their offering. Size does matter. Interestingly enough smaller very specialized boutique agencies can make good money, too, due to low overhead cost and flexible delivery mechanisms. But most small digital departments within a large marketing offering have huge trouble to generate a positive short or medium term ROI on their personnel and infrastructure expenses.
  • Premium versus Discount pricing: A lot of the large marketing service firms know that they have to expand their digital offering. Therefore they are willing to discount their digital work to enter this fast growing discipline. After winning the work (by buying it through cut throat prices) they often realize that they can not deliver the work with sufficient quality while simultaneously loosing money. It takes take them much longer than ever envisioned to build a profitable digital practice, and quite a few of them still have not achieved it.
  • Lack of paid search capability: A lot of the marketing service firms have either still not realized that paid search is almost 2/3 of all digital spend, or they lack the internal media planning expertise to build it out in a smart manner. They are victims of the separation of creative and media offerings in the 80ies and 90ies. For a lot of these companies it might be too late to ever regain the lost territory.
  • Resource allocation: The haste of hiring digital talent leaves quite a few large marketing service players with too much unbillable or incorrectly hired expertise that drags down any profitability. It’s very challenging for traditional marketers to identify and attract the right digital personnel that can build a well oiled delivery machine while creating brilliantly engaging and business building digital programs.

While a lot of marketers at service firms talk about the urgent need to expand the digital side of their business, they are flying blind in how to make it happen without eroding their good margin from their more traditional core business. It will be interesting to observe of who is able to make this transition to not only great but profitable digital work.


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