Hidden risks at creative agencies

While media invariably grabs the headlines, are advertisers missing a trick with their creative agencies?

Creative agencies are quite different beasts when compared to media agencies. For a start, there are many more of them and a greater proportion are independent, often still owned by their founders. This point is very important. The type of people who set up creative agencies excel at being creative. While they care about money and running a profitable business, financial matters are normally not at the forefront of their minds. Based on what we’ve seen, there are lots of small and successful creative agencies that don’t have full-time finance resource and, at a senior level, the last person to get hired is the Finance Director.

What that means is, unlike at most advertisers, the CFO is not the second most influential person in the organisation after the CEO. This takes time for many advertisers to get their heads around, as it’s a very different dynamic to their own experience. Accordingly, there are likely to be relatively fewer members of the finance team at a creative agency than there are in your business. Furthermore, they are less likely to have professional accounting qualifications (although this is changing) and more likely to be over-stretched.

If we then look at financial systems, processes and controls, we see great variability in the functionality and usability of job accounting systems, as well as how well the finance teams have been trained to use them.

Recently, we found that one agency was using a very well-known system and was struggling to provide certain standard reports. After digging a bit further, it turned out that they hadn’t updated their software for over five years! That particular agency was independent, had won many awards for creativity, and yet its finance team was understaffed and its finance system neglected.

It’s easy to understand the pressures that a young, independent agency may be under, but can the same exist for more established agencies or ones that are part of a network? The simple answer is “yes”. Not only does organisational maturity have a bearing on how strong finance teams are, but having a capable Finance Director, who is well respected by the rest of the management team, is critical. From the outside, that’s very hard to assess and it’s only when we go in to audit that it becomes apparent how well the finance department is performing. While, generally, network agencies are more established, it doesn’t necessarily mean that their financial practices are better than at a younger independent: a capable FD, supported by a similarly capable and appropriately resourced team (especially a diligent Financial Controller), makes all the difference.

So how else might a brand look at how capable their agencies are at managing their media and creative budgets? One way is to take time to ‘stand in the shoes’ of their holding company partners, and imagine how they might perceive financial risk differing between their media and creative agencies.

In the table below, we look at important factors from a financial perspective and how they differ, albeit relatively.

For each of the above attributes, the relative risk of financial mis-statement or error is greater at creative agencies than media agencies. If you’ve ever spoken to someone in the internal audit function at a holding company, you will have found out that they spend the majority of their time auditing creative agencies. Put simply, holding companies perceive their creative agencies to be more risky than their media agencies.

How can this be the case? Well, it all comes down to the lens through which they perceive risk. Just as many advertisers struggle to understand that finance functions at many agencies sit lower in the pecking order than in their own organisation, agencies also have a very different attitude to managing financial risk.

Indeed, this is one of the main reasons we believe that advertisers audit their creative agencies so infrequently. If you’re spending €100 million a year on media and €10 million a year on creative, then which are you going to audit more regularly? Based on spend alone, media, as you are spending 10 times as much. The P&L does not lie.

In the same vein, how might the two agencies look at it from the perspective of their P&Ls? They are primarily interested in the level of fees they are billing. On €100 million at a media agency, an advertiser might be spending €94,000,000 on media costs and €6 million on fees. On €10 million at a creative agency, an advertiser might be spending €6 million on production costs and €4 million on fees. Hence in terms of your attractiveness as a client, you are only paying 50% more in fees to your media agency than your creative agency, despite the headline 900% difference in spend. On this measure, therefore, you are only 50% more interesting to your media agency than to your creative agency, not 900%.

Well, I hear you say, the real focus should be on the pass-through costs and €94 million is a lot more than €6 million. While that’s true, how much contingency is built into the €94 million as a matter of good practice? None. What about the €6 million? Likely 10%, whether you are conscious of that or not (and we would argue that a 10% contingency built into the cost of a production is sensible), so €600,000. Are you starting to look at the commercial and financial risks differently now?

Many creative agencies will, understandably, ask for most, if not all, of the money in advance of the production costs having been incurred. It is therefore critical for detailed and accurate job reconciliations comparing estimated / billed costs to actual costs to be performed on a timely basis. Now, if you as an agency finance team are already stretched and all of your clients’ contracts require job reconciliations, how will you respond? You could quickly become overwhelmed, meaning the reconciliations aren’t done or, if they are, they’re rushed, increasing the risk of error.

In our experience, most advertisers are owed money back by their creative agency at any given point in time. It’s often a natural consequence of the commercial arrangements in place. Yet we find that less than a handful of advertisers will know exactly how much is owed, or are even equipped to find out on a regular basis. Indeed, if it’s left for an extended period of time, those unspent contingencies can really start to add up. In fact, the amount of money that it represents is likely to be proportionately far greater than an audit might uncover at your media agency.

So how can you as an advertiser respond?

1. Make your creative agency contracts as robust as your media agency contracts (ISBA can help with this one)
2. Audit your creative agencies at least once every 2 years (we can help with that one)
3. Implement the recommendations arising from those audits promptly and in partnership with the agency (that one is down to you!)