What challenges are WPP and the wider advertising industry facing?

WPP has historically snapped up agencies and allowed most of them to operate independently, but the benefits of this model are under threat as the advertising landscape changes.

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Source: Bloomberg

‘The major factors influencing this performance were probably the long‐term impact of technological disruption and more the short‐term focus of zero‐based budgeters, activist investors and private equity than, we believe, the suggested disintermediation of agencies by Google and Facebook or digital competition from consultants.’ – Martin Sorrell, chief executive of WPP.

Sorrell compared the year to similar difficult periods in 1991, 2001, and 2009, but said the threats are different this time around, as a result of rapid change within the marketplace, stating it is a combination of cyclical and structural challenges, the latter of which it is tackling head on.

In a nutshell, WPP and the wider industry is having to react to the rise of digital advertising online, and the threats posed by dominant online players like Alphabet’s Google, and Facebook. In addition, marketing budgets have been impacted by companies focusing on short-term costs, while some of the world’s largest advertisers are increasingly undertaking their own marketing in-house as fears over brand safety and concerns over value for money become more prominent.

Technology disruption and the rise of digital and online advertising

‘There is an inevitable surge, an unstoppable surge, in the rise of online advertising.’ said Sorrell.

One of the major consequences of the rise in digital advertising is how effective the return on investment can be calculated compared to more traditional methods. There is a much clearer line between what advertisers spend online and the amount of customer leads or interaction it creates, compared to more traditional blanket advertising on the likes of television and print.

Sorrell acknowledges the significant growth that the digital market still has to offer, and admits that digital developments will ‘probably permeate everything we do.’

Over 40% of WPP’s revenue comes from digital advertising, considerably higher than the worldwide average of around 30%, according to Sorrell.

Many advertising clients are shifting their marketing dollars to digital activities, as companies try to defend themselves from the growing threat that massive online retailers like Amazon and Alibaba pose.

Back in the year 2000, WPP was deploying the lion’s share of its client capital into broadcasters like Comcast, News Corp and Disney (its top three destinations that year), while Google was the only online advertiser to feature in the top ten and Facebook was only 28 in the list of the most popular place to advertise for WPP clients. However, the amount of investment into broadcasters has dropped, as WPP shifts more its client’s advertising online.

This is also compounded by the likes of Netflix and Amazon tightening their grasp on online content. Their wallets allow them to spend big on original content. This is detrimental to the likes of terrestrial broadcasters like ITV which are struggling to stump up enough cash.

Sorrell said it is ‘very important’ for firms like ITV, one of its top ten media destinations for its client’s budgets, to develop its free-to-air and content offerings in a way that appeals to WPP’s clients.

As the advertising industry has continued to transition to digital, the door has opened up to other players in the market, which has heightened competition for WPP. Big tech and consultancy firms have stepped in to fill any gaps that marketing groups like WPP have left, with the likes of Accenture, Deloitte, and IBM all having developed offerings to help clients transform their platforms, that are integral to their client’s customer interaction.

‘Technological disruption – whether it be in production, in media or in distribution with Alibaba and Amazon, for example – is changing the dynamics of all industry.’ – Sorrell.

Digital Duopoly: are the likes of Google and Facebook a threat to WPP?

‘We don’t want to disintermediate advertising agencies. We are actually working very, very closely with agencies all over the world. It’s important to understand that we see ourselves as a supplier of technologies and we would like agencies to actually apply our technologies and smartly use our technology…we see agencies as trusted advisors to the customers and clients.’ - Philip Schindler, chief business officer at Google.

Sorrell classes the likes of Google and Facebook as ‘flexible friends’, having previously regarded them as ‘frenemies’. This is because WPP’s relationship with the pair both gives and takes.

Google and Facebook control an overwhelming portion of the online advertising market, anywhere from 60% to over 80% of world’s digital ad market depending on what estimates you read, and the pair’s penetration of the market is growing.

One of the major consequences of online advertising and the dominance of the two companies is that buying digital advertising space has become an increasingly automated activity. This questions the role that intermediaries and agencies play, and whether advertisers need companies like WPP to deploy their capital for them.

In Sorrell’s eyes, Google and Facebook are not competitors. WPP pumped a total of $75 billion worth of client’s capital into media during 2017, and more was invested in Google than any other destination at about $6 billion (up 10% from the previous year), while spending on Facebook rose by about 30% to over $2 billion, becoming the second most popular advertising destination for WPP’s customers.

To put that into perspective, WPP deployed about $2 billion in Twenty-First Century Fox, Sky, and News Corp combined, and about $1 billion in Disney – all of which were previously where WPP primarily funnelled client’s budgets back in 2000.

Sorrell admits the digital duopoly does mean the market is imbalanced, but WPP is shifting more of its client’s budgets to emerging online players that are becoming ‘a third force’. For example, investment in Snap doubled in 2017 to about $400 million, while other firms like Verizon Communications Oath, which holds brands like tumblr, Yahoo! and HuffPost, are also presenting alternatives to the big two.

Activist investors and consultants are detrimental to marketing budgets

‘The world we face is a low growth world, 3% to 4% growth, low inflation, limited pricing power – and therefore clients are very much focused on costs.’ – WPP.

For Sorrell, the biggest problem is the amount WPP’s clients are putting aside in their marketing budgets. A growing number of big advertisers operate zero-based budgeting (when companies reset their marketing budgets each year, rather than using the previous years’ budget as a benchmark) such as 3G Capital and Reckitt Benckiser.

One of the main drivers for this attitude toward marketing budgets, WPP believes, is the mounting pressure from activist investors that has pushed big firms like Procter & Gamble and Nestle to cut costs in order to improve margins and returns, with variable marketing budgets one of the first to head to the chopping board.

For example, about one-third of WPP’s revenue comes from the packaging sector, which has been one of the industries to be hardest-hit by the relentless focus on costs by the big consumer goods groups, according to Sorrell.

WPP has also denied that consultants assisting companies with their digital transitions have eaten into its sales, as its performance against them remains solid, winning more contracts over consultancy firms than it is losing them – particularly in higher value work.

However, WPP admits that consultants are probably pressuring companies to reduce costs in general, with marketing budgets often one of the first to be placed in the crosshairs.

‘The consultants have certainly been mopping up some small, fragmented digital agencies, but there is little evidence so far of significant competitive penetration.’ WPP said in its results.

Clients are taking more marketing work in-house

If 2017 was the year of the wake-up call, 2018 is the year we take back control to transform the industry through mass disruption.’ – Marc Pritchard, chief brand officer at Procter & Gamble.

Procter & Gamble is one of WPP’s biggest clients, with its slew of household brands including Tampax and Braun, but Pritchard recently conceded that his company had outsourced too much work to agencies, pledging to reduce the amount of agencies it works with by about 60%. There are a few reasons why the attitude toward advertising agencies has soured somewhat.

Firstly, advertisers believe the holding company model boasted by WPP and its peers are too complex, and should be more integrated with one another to offer a simpler and hopefully more transparent and cost effective service.

Pritchard has said it is time to disrupt the advertising industry’s ‘archaic Mad Men model’ by ‘eliminating the silos between creatives, clients and consumers, and stripping away anything that doesn’t add to creative output’.

Secondly, clients are becoming more concerned about the safety of their brand after the recent furore about adverts appearing next to videos featuring children with sexualised comments or other inappropriate content like extremist videos, which led to big brands like spirit maker Diageo, tech-giant Hewlett Packard Enterprise and food firms Mars and Mondelez International all pulling advertising from Alphabet’s YouTube.

Procter & Gamble and peers like Unilever, another massive client for WPP, are therefore taking more control over their marketing activities by bringing them in-house. This is also in response to scepticism that large proportions of those viewing digital adverts, for example, are actually made up of bots rather than actual consumers.

Procter & Gamble and Unilever have trimmed marketing budgets in order to trim costs, but overall spending has remained fairly stable. However, less of these budgets are heading to agencies as they complete more of their marketing work themselves.

Still, WPP believes there is an opportunity as clients consolidate the amount of agencies they work with, as it may allow the company to ‘carve out a greater share despite the fact the top-line growth might be coming down’.

How is WPP responding to the challenges?

‘We have to revamp our offer, we have to make it much more integrated for our clients so its seamless – we’re running one Profit and Loss Statement (P&L) rather than managing multiplicity, and we’re very much focused on efficiency as well as better work, effective work. Secondly, you focus on the fast growth markets, the Asian, the Latin American, the African, the Middle Eastern, the Eastern European markets because that is where the next billion consumers will come. And then last but not least, digital and data.’ – Sorrell.

In a nutshell, WPP plans to tackle the structural challenges by bringing the majority of its services under one roof, rather than allow its hundreds of agencies to operate independently.

For growth, WPP plans to focus on emerging markets where the next billion consumers will come from. Expanding its digital offering whilst also tying in data should also help WPP get back to growth.

Simplifying WPP through ‘horizontality’

‘As we build an increasingly unified WPP, we are focusing on a number of areas that will allow us to deploy our deep expertise with greater flexibility, efficiency and speed.’ – WPP.

Integrating its agencies, or ‘horizontality’ as Sorrell calls it, is key to simplifying WPP’s offer to its clients as it streamlines its business model, having already merged some units so it is easier for customers to utilise the various different services its agencies offer.

WPP had already started to shift management from individual agencies or types of activity to ones that manage specific regions or countries to help agencies share their cross-capabilities, for example, but is now accelerating its restructuring efforts following the 2017 results.

Emerging markets to get WPP back to growth

Where the new middle‐class consumers will flourish.’ – Sorrell.

In 2017, WPP acquired or invested in 16 agencies in fast growing markets such as Eastern Europe, China, the Middle East, Kenya and Brazil – and ten of those agencies have some form of digital offering.

WPP’s aim is to grow revenue ratios for fast growth markets and new media to 40% to 45% over the next three to four years. At present, fast growth markets generate about 30% of WPP’s revenue while new media, or online, stands at over 40%.

WPP to continue expanding digital and data offering

‘Digital and data must now be the default settings for advertisers. Evolving to people-based marketing rather than audience-based marketing and using data to increase addressability is essential for brands to manage tighter conditions… while positioning themselves for future growth.’ – Dentsu Aegis Network.

With clients better positioned to evaluate the returns of digital advertising, data is set to be the important accomplice that will allow the likes of WPP to tap in to important consumer trends and better advise its customers. Data accounts for about 25% of WPP’s revenue, but continuing to link data to its offer is 'critically important'.

The vast majority of WPP’s acquisitions and investments in 2017, around 34 in total, focused on quantitative and digital offerings in both mature and developing markets. 

What is WPP’s outlook?  

‘Obviously we were sort of embarrassed by what happened in the last three quarters of the year, where we were over-optimistic.’ – Sorrell.

Despite stating that 2018 ‘should in theory be a better year’, WPP expects a rather stale performance, guiding for revenue and operating margins to be broadly flat on both a like-for-like and constant currency basis, although it said its guidance going forward is 'deliberately cautious'. The year will still be second-half weighted as usual.

Still, earnings per share (EPS) is anticipated growing by 5% to 10% in 2018 through acquisitions, share buybacks, and by reducing debt. WPP plans to generate that growth by budgeting £300 million to £400 million for acquisitions this year and by maintaining its share buyback and dividend. WPP plans to buy between 2% to 3% of its share capital in 2018 while maintaining the 50% payout ratio to shareholders.

WPP had a long-held target to grow EPS by 10% to 15% annually, but downgraded this to 5% to 10% when it released its 2017 annual results – stating it provides ‘a more realistic view about what could take place’ after being too optimistic last year.

Conclusion: does the WPP share price forecast look bleak? 

‘We start this new phase of our journey from a position of market leadership, and with total confidence in the enduring value of what we offer our clients.’ – WPP.

WPP believes the challenges facing the industry are not unique to itself, with competitors like Publicis Groupe also restructuring its business model at present, both structural and because of the cyclical nature of the market.

Still, WPP is one of the best-placed companies to tackle the problem, with a highly regarded chief executive that few in the market doubt. WPP still stands high above its competition and, if its strategy pays off, could grow its leading position even further amid a fast-changing environment. 

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