Advertising Business Research Paper

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When you think about advertising, chances are you recall a favorite commercial you’ve seen recently. Maybe it’s a funny beer commercial you saw on television, a Hallmark commercial that brought a tear to your eye, or some obnoxious used-car dealer yelling at you until you turned off the television just to get him to be quiet. Advertising surrounds us everyday, all day. Some of it we like, some we like so much we actually seek it out on YouTube or elsewhere on the Internet. Much of it we may try (usually unsuccessfully) to avoid. But all advertising has one thing in common. The advertiser wants you to do something that will improve his or her business. That’s because advertising is a business. Ultimately, the only reason anyone spends money on advertising is to sell you something.

In this research paper, we are going to take a look at the business of advertising. We’ll start on a macro scale, looking at the size and shape of the advertising business globally, and work our way down to understanding the business in the United States. Finally, we’ll look at the advertising agency business to see how that business operates as well.

How Large Is Our World?

How many people are there in the world right now? Let’s try an easier one; how many people are there in the United States right now? How many families does that represent?

If you want to understand the potential of your product to sell around the world, basic demographic data like this will become very important. If you’ve decided just to sell in the United States, you should know (approximately) what your potential is. The world population is approximately 6.6 billion split nearly perfectly between males and females. The United States is 310 million, or less than 5% of the world’s population. There are 112 million households in the United States. The average size of a household today is 2.5 people. What we like to think of as the nuclear family with two parents and at least one child only makes up 20% of the total households in the United States.

Why does this matter? If you could make a $0.03 profit by selling something to every household in the United States. You’d make $3.4 million. That’s a lot. If you could sell that to every person in the United States, you’d make $9.3 million. If you could do that in the whole world, you’d make $198 million. My point? Size matters, and there are trillions and trillions at stake every single day.

How Large Is the Advertising Business?

Advertising is approximately a half-trillion-dollar business annually around the world according to estimates made by GroupM, a division of the communications conglomerate WPP ($479 billion estimated for 2008). What does that mean? It’s not easy to get your mind around what a half trillion dollars means. Consider this. The advertising business is larger than the entire gross domestic product (GDP) of Norway, Poland, Belgium, Switzerland, and about 100 other countries. It’s twice the GDP of countries such as Thailand and Argentina. Globally, it’s equal to about 1/100th of the world’s total GDP. That should give us a good idea that it’s a pretty big business.

Globally, the advertising business is growing at a healthy 6.8% in 2008. There are a number of factors that influence the highly reactive advertising market globally. The first is the condition of the economy. While most industrialized countries with mature economies faced reasonably flat growth in 2008 due to stalled economies, developing countries such as China fueled the world’s advertising growth.

The second factor that effects global advertising spending is the presence on national and international media events. In 2008, the Beijing Olympics pumped somewhere between $1.3 billion and $1.5 billion advertising dollars into the United States alone. The presidential election held in November of 2008 pumped an additional $2 billion into the advertising economy.

The third factor that affects the amount of money being spent in advertising is the maturity of different media vehicles. In 1993, the Internet changed how we thought of advertising media forever. And while the growth has been bumpy, the near- and long-term impact of the Internet has fueled the growth of the advertising market all around the world. Growth in the medium has been approximately over 20% per year ever since. The Internet is already the largest advertising medium in Sweden, and GroupM estimates that the United Kingdom and Denmark will follow shortly.

The growing influence of the Internet has resulted in a shrinking influence of daily newspapers. Sites such as eBay and craigslist are credited with the dissolution of classified advertising, a major source of revenue for newspapers.

Sure, the Internet is growing in popularity and as an advertising vehicle, but is it really all that important? It all depends on how you measure it. The traditional way of measuring the Internet as an advertising vehicle looks at banner ads and “search advertising” and says that the Internet controls approximately 10% of the total. But isn’t advertising on the Internet larger than that? Look at any auto manufacturer site. They tell you all about their car in great detail. They allow you to design and configure one exactly to your specifications. They tell you why their car is great and, more specifically, why it is better than their competitors, and in the end, they tell you where to go to get one. Isn’t that 100% advertising? How about Amazon.com? What do they have? I asked a class one time, and they told me that Amazon.com primarily has books and a variety of other goods that make it a department store on the Internet. No, they don’t. Amazon.com doesn’t have a single book or anything else. Amazon.com has photos of books. They even review the books (like ad copy), tell you what other people think about the books (testimonials from users), and offer a variety of places and prices to purchase the book. But they don’t have books; they have ads for books. Think about the Internet in these terms, and it’s almost all advertising. Search and banner ads are the minor players in what the entire cost might be. So how much is being spent on advertising on the Internet? If you look at it like I just did, it’s already globally immeasurable.

Globally, spending is concentrated in mature economies. North America leads the world with 38% of all advertising spending, followed by Western Europe with 27%, Asia with 24%, Central and Eastern Europe with 5%, Latin America with 4%, and the remaining 2% in the Middle East. What does this tell us? For one, that there are mature advertising markets (e.g., North America and Europe) and growing markets (e.g., Asia, Eastern Europe, Middle East, etc.). The difference often has to do with the spread of democracy, capitalism, and a market-driven economy.

Largest Advertising Market in the World

The United States is the largest single advertising market in the world, with an estimated $169 billion in advertising spending. Yes, the United States makes up 5% of the world’s population and 35% of the world’s advertising spending. Due to the sheer number of advertising vehicles, it’s been estimated that the United States also receives nearly 60% of all advertising messages. Advertisers spend $545 per year to reach every man, woman, and child in America, compared with about $54 in the rest of the world.

It’s no real wonder that Americans see more than 1,000 advertising messages each and every day; six times as many as the French, four times as many as the British, and twice the amount Canadians see.

Name all the ads you saw yesterday. Stop reading just long enough to write down every ad you saw. We’ll wait.

Done? OK, if you are like most of the students in my class, in about a minute you could remember between three and five commercials. And chances are you didn’t even see one or more of those yesterday but just remembered commercials you like.

What happened to the other 995 ads you saw yesterday? Advertising agencies tried their best to get your attention a thousand times yesterday, and only a few succeeded. Why? Because our brain has trained itself to forget more than 85% of everything we see and hear everyday within minutes. There is simply too much information bombarding us, so we filter out everything that is not relevant to us or that we don’t enjoy or want to know, to constantly have room for things we do want to know.

Does this mean that 995 advertisers wasted their money on us yesterday? Not necessarily. I saw an ad for a Nissan Z. It was a truly beautiful ad and a beautiful car. It wasn’t topof-mind for me because I’m not looking for a car right now. However, I’m thinking of buying a car next summer, so I’ve conveniently placed it in a folder in my brain. Next summer, when it is relevant to me, I will likely recall the ad and the car and consider that car. I also saw a feminine hygiene ad (five of them actually). I couldn’t tell you anything about any of them because they are not relevant to me and never will be.

The Top 10 Advertising Markets in the World

The United States is the largest advertising market, representing 35% of global spending. Japan is the second largest advertising country in the world (representing approximately 5% of global spending), followed by the United Kingdom (2% of global spending), Germany (2% of global spending), and France (1% of global spending). Note how quickly these markets fall off. Obviously, this is the result of size of both population (e.g., the U.S. population is 310 million, compared with France’s 64 million) and the frequency with which we see advertisements in the United States.

Advertising, a Small but Important Part of Marketing

As large a business as advertising is, it’s a relatively small part of the entire world of marketing. Marketing covers the creation, manufacturing, pricing, selling, and placement of goods and services. If we consider the total GDP of the entire world at something just over $50 trillion per year, we can see that advertising is only about 1% of the world’s GDP, whereas marketing covers much of the rest.

What is marketing? According to the American Marketing Association, “marketing is an organizational function and a set of processes for creating, communicating, and delivering value to customers and for managing customer relationships in ways that benefit the organization and its stakeholders.” In the 1950s, Jerome McCarthy, a Michigan State University professor, wrote a defining textbook titled “Four P’s of Marketing: Product, Place, Price and Promotion.” This certainly wasn’t the creation of marketing, but it was a formalization of how we would come to talk about marketing.

Advertising is only one part of the promotion “P.” Along with advertising, the promotion “P” includes things such as sales promotion, public relations, event marketing, and personal selling.

So, to put it simply, if we want to market a product, we must design that product (i.e., how it will be made, its size, its smell, its packaging, maybe its taste, etc.), we must price it (generally at a price that will allow us to maximize sales and or profits), we must figure out where to sell it (the Place “P”), and we must figure out how to sell it (the Promotion “P”).

Who Is Spending All This Money?

The largest advertiser in the world and in the United States is Procter & Gamble (P&G), maker of megabrands such as Tide, Oil of Olay, Pampers, Tampax, Gillette, Pantene, Oral B, Crest, and about 400 more brands around the world. According to Advertising Age (Ad Age), the leading advertising publication in the United States, P&G spent $8.5 billion globally and $4.9 billion in the United States during 2006. That’s nearly 2% of all the advertising spending in the world. They were the number one spender in 16 of 90 countries measured by Ad Age. Keep in mind though, with so many different brands, the highest-spending P&G brand, Oil of Olay, is only the 34th largest spender, at nearly $360 million.

The top megabrand spenders are phone companies, with AT&T/Cingular investing more than $2.3 billion in the brand, followed by Verizon at $1.9 billion and Sprint at more than $1 billion.

Auto manufacturers make up the largest single category of advertisers, with 6 among the top 15 spenders (Ford is the largest auto advertiser, at more than $1 billion).

How Do Marketers Determine How Much to Spend?

How much you spend on advertising depends on quite a few factors in your marketing plan. Are you advertising a new product, or is this an established brand? What are your competitors doing? Is the product category growing or declining? Are we trying to push the product into retailers by building consumer demand or pull it off the shelves?

And while there are many methods for budgeting advertising, there are several that are commonly used.

  • Advertising to sales ratio: Most companies use some form of advertising to sales ratio. Sometimes called a “case rate” (i.e., $X per case of product sold goes toward advertising), this method rewards growing brands with larger advertising budgets and keeps company focus on the most successful brands. On the downside, a product that has a bad year can be hurt for years to come by shrinking ad budgets.
  • Fixed allowance: Some companies spend a certain amount on advertising every year and may adjust that by factors such as media inflation and new competition.
  • Zero-based budgeting: Every year, the company starts from scratch, trying to figure out in the current competitive environment exactly how much should be spent.
  • Customer valuation: Actual dollar amounts are put on customer groups that consist of your most likely purchasers and less on potential customers. For example, if you have a Porsche dealership, chances are your best customer is one who has already bought a Porsche from you at least once. Your second most valuable customer is one who is buying from your direct competitor (e.g., Mercedes SL). This customer has enough money and merely needs to be persuaded to go a bit sportier. And the third and least valuable consumer is a Porsche “wannabe.” This person would love to have a Porsche but can’t afford one right now. While he or she may be your least valuable customer in the short term, this is your most valuable customer in the long term, when you are trying to replace old customers.

Where Is the Money Being Spent?

We’ve looked at how much money is being invested around the world and in advertising’s largest market, the United States. We’ve looked at what companies are investing that money, and now let’s take a look at where the money is being invested.

Asked        to   guess   the   largest   advertising   medium in the United States, most students answer “Television.” Television is large, but the number one advertising medium isn’t television, it’s direct mail. Why direct mail? Simple! You have to print an envelope full of full-color pieces and mail the entire ad to each house, whereas for television, I make one ad and then run it.

Every year, numerous agencies predict the future media spending habits of top advertisers. The industry standard has been Robert J. Coen of Universal McCann. Table 1 gives the most recent percentage by medium of total ad spending in 2006 from top to bottom.

Table 1. 2006 Spending by Advertising Medium

Advertising Business Research Paper Table 1

The big news going into 2008 is that the Internet is expected to overtake radio this year in spending. I still contend that if the spending on the Internet were calculated correctly, it would already be in the top three and growing. Where is this going in the future? Personalized media. Media vehicles that can personalize the news and content I want and eliminate the content I don’t want will become my personal choice. I suspect that devices such as Apple’s iTouch will be in all our pockets, capable of downloading and storing news and content we want so that we can be connected anywhere at any time to the content we seek. Do you want to watch the evening news? Do so on your schedule on your screen of choice. Missed The Daily Show last night? Watch it from the screen in your pocket or any other screen you happen to use. Newspapers, radio, TV, the Internet, whatever you want, wherever you want it, and at whatever time you want it. That’s the future of media.

Who Pays for Advertising?

Actually in a market-driven economy, the answer is you do, and if everything goes right, no one does.

Advertising increases sales, which allow a manufacturer to make the product at a lower cost per item, with those savings getting passed along to you. Generally, that means that the cost of advertising disappears in the economies of scale that allow the manufacturer to make and sell dramatically more product at a greatly reduced cost per item.

Let’s take a look at an example. A friend is starting a gourmet cookie business in the New York City area. He sells the cookies for $5.00 per bag. How much of that $5.00 per bag do you think he spends on advertising?

Here’s a look at his balance sheet. Of the $5.00 to the consumer, the retailer keeps $1.00 per bag (20% retail margin), leaving him $4.00 per bag wholesale. The product ingredients cost him $1.75 per bag, and the services of the baker who makes the cookies cost him $1.25 per bag. That leaves him with a net margin of $1.00 per bag.

He can do anything he wants with that $1.00 per bag he makes. He can keep it all, but he can’t grow his brand if he does. He can reinvest most of it back into the brand and continue to grow. Since the product is new and relatively unknown, my friend reinvests $0.40 of every bag sold back into sales promotions (in his case he uses it for sampling) and $0.30 in advertising, and he keeps $0.30 as his profit.

That’s pretty typical in the food business. So, of every $5.00 at the retail level, $0.30 will return to advertising. Fortunately, he sells about 100,000 bags of his cookies per year, giving him a net margin of $100,000, a sampling budget of $40,000, and an advertising budget of $30,000 (which isn’t a lot nationally but adequate in his local area), and he keeps a salary of $30,000 from the new venture (don’t panic, he has other businesses).

As he considers regional expansion, he has estimated that he can increase sales to about 3,000,000 packages. If he does this, the cost per item will fall by $0.50, which he plans to give back to the consumer in the form of reduced price ($4.50/bag). Additionally, using the same formula, he will have a net margin of approximately $3,000,000, a promotional budget for sampling of $400,000, an advertising budget of $300,000, and a salary of $300,000. Not bad for making cookies!

But the product actually costs him $3.50 per bag to bake and package. At this level, he makes only $0.50 per bag, and since he only sells about 100 bags a week, the venture doesn’t appear worth doing.

So money for advertising comes from sales of the product and then is invested back into advertising to increase sales, so there is yet more money for advertising.

Is Advertising the Only Way Marketers Compete?

Of course not. There are variations and combinations on four major ways that marketers compete. They are product superiority, distribution superiority, consumer insight, and marketing communications.

Product Superiority. Is your product simply a better product than any of your competitors? Certain companies such as Procter & Gamble, BMW, and Apple try to put clear product superiorities into everything they make. Tide detergent gets out stains no other detergent will get out. Crest toothpaste leaves your teeth whiter. Pampers leave your baby drier. BMWs accelerate faster, last longer, and so on. Product superiority is a great way to compete but becomes increasingly difficult in a world where almost all products perform pretty well.

Distribution Superiority. Is your product ubiquitous? I can give you $2.00 and 10 minutes just about anywhere in the world, and you can come back with a Coca-Cola. The product is marketed “everywhere” and not difficult to find. In the early days of marketing Tampax in Spain, the General Manager of the company decided that his personal goal would be that consumers couldn’t walk 2 minutes in any direction in Madrid without encountering a Tampax logo (in a shop window, on a billboard, on the side of a city bus, etc.). In less than a year, this unknown brand became a normal household word simply because it was everywhere.

Consumer Insight. Do you understand your consumer’s wants and needs better than any of your competition? I love Amazon.com because the more I look at the site and the more I order from Amazon, the better they get to know me. When I log onto Amazon.com, they have loads of recommendations of products similar to what I purchased that they think I will like. Have you ever logged onto Pandora.com? Pandora, the music genome project as they call themselves, analyzes the style and structure of your favorite song and recommends songs and artists that you are likely to like. I hear new musicians all the time who I’ve never heard of, and I think they are fantastic. And as you can guess, they will take me right to a place where I can buy their CD. These marketers know me. They know what I look at, what I like, what I buy, what I reject, and in many cases, they even know why.

Marketing Communications. Do you simply out-advertise your competition? Remember the iPod launch? We all saw that dancing silhouette on posters, on TV, on the Internet, in print ads. Everywhere we turned, we saw bold colors with a dancing person in silhouette. Now, do you recall Microsoft’s launch of their mp3 player Zune? Neither do I. Apple supported the launch with a huge advertising expenditure, brilliantly simple advertising from the TBWA/Chiat/Day advertising agency. Microsoft did something I can’t recall and don’t remember. Guess who sells more?

Please understand that marketers may “major” in one of these four techniques, but they use all four. The iPod, for example, was a clearly superior (at least in consumer perception) mp3 player compared with the competition, the product wasn’t difficult to find; the company understood their target audience’s total love for personal music anytime anywhere as well as its appreciation of the uniqueness (color) and contemporary design of their product. Finally, they simply advertised more than did any of their competitors.

What Are Marketers Really Selling?

Brands. Marketers manufacture products but sell brands. What’s the difference? The product is simply the tangible product. The brand is the product with all the added value elements that makes the product worth having. Let’s consider an example.

What is the iPod as a product? It’s a portable computer hard drive that can replay music and videos on a small screen with headphones. But as a brand, iPod is much, much more. The iPod is a high-tech device that not only allows you to carry 1,000 songs in your pocket. It’s about design, being in the “in-crowd” that “gets it,” and so much more. Probably the smartest marketing decision of the decade was making iPod’s earphones white. I don’t have to see your player to know you are a member of the club . . . or you aren’t. All the added value created by the design, the ease of use, the simple interfaces with Mac or PC, the advertising, the unique (and frequently changing) colors, the variety of shapes and sizes and memories, the unique look of the Apple Store, the Web site, iTunes, the packaging it comes in, the accessories you can add on, the experience of buying the product as well as the experience of both using and being seen using the brand, all add to an overall brand experience that makes the iPod worth more money than it’s competitors.

An iPod is a pretty sophisticated brand, so let’s take a look at something simpler. My local grocery store contains 54 facings of orange juice. There are differences in size, calcium content, level of pulp, and so forth, but it’s all basically orange juice. The prices range from $2.99 to $4.99 for the same 64-oz amount. What’s the difference? The cheap one is an unbranded generic, and the expensive one comes from Minute Maid. Is one really worth nearly 70% more than the other? I don’t know, but I always buy the Minute Maid. What am I really buying? I’m paying for belief in the brand. I believe it will be fresher, of higher quality, better tasting, and I consider not buying it a risk. I’d rather pay the additional $2.00 as “insurance” and for the assurance that I’m buying something I will probably like. That’s the power of a brand over the existence of a product.

We’ve looked at the business of advertising. Now let’s flip that statement around and look at the advertising business.

So Which Advertising Agencies Are the Most Successful?

It depends on how you define success. Is it the size of an agency that makes it successful? Is it the number of creative awards the agency wins? Is it the success of their clients? Is it the fastest-growing agency? As you can see, answering what is the most successful advertising agency is as complicated as asking what is the most successful ad on air today. There is no one definitive answer.

So let’s look at this in a number of ways and see what names pop up over and over.

Advertising Agency Holding Companies

Earlier, we saw how advertising agencies are in “holding companies.” The four largest are Omnicom, with $12.7 billion in 2007 global revenue, followed by WPP Group ($12.4 billion), Interpublic Group ($6.6 billion), and Publicis Group ($6.4 billion).

Worldwide Advertising Agency Size

The following is a list of the largest consolidated worldwide advertising agencies (all headquartered in New York except where noted):

  1. DDB (with a 2007 global revenue of $2.6 billion)
  2. McCann Erickson (with a 2007 global revenue of $2.5 billion)
  3. Dentsu (headquartered in Tokyo, with a 2007 global revenue of $2.5 billion)
  4. BBDO Worldwide (with a 2007 global revenue of $2.4 billion)
  5. Young & Rubicam Brands (with a 2007 global revenue of $2.2 billion)
  6. Ogilvy & Mather Worldwide (with a 2007 global revenue of $1.8 billion)
  7. TBWA Worldwide (with a 2007 global revenue of $1.8 billion)
  8. JWT (with a 2007 global revenue of $1.5 billion)
  9. Euro-RSCG (with a 2007 global revenue of $1.3 billion)
  10. Draft/FCB (with a 2007 global revenue of $1.2 billion)

What do these agencies have in common? They all have 50-plus-year histories as advertising agencies and manage many of the largest marketers in the world.

U.S. Advertising Agency Size

Looking at just the United States for a moment; the list is a bit different according to Advertising Age. The largest advertising agencies in the United States are as follows:

  1. McCann Erickson ($490 million in 2007 revenue)
  2. BBDO ($472 million in 2007 revenue)
  3. JWT ($316 million in 2007 revenue)
  4. Young & Rubicam ($307 million in 2007 revenue)
  5. DDB ($291 million in 2007 revenue)
  6. Ogilvy & Mather Worldwide ($255 million in 2007 revenue)
  7. Grey ($249 million in 2007 revenue)
  8. Campbell-Ewald ($239 million in 2007 revenue)
  9. Draft/FCB ($221 million in 2007 revenue)
  10. TBWA ($208 million in 2007 revenue)

Creative Awards

Creative awards in advertising are like the Academy Awards for film. It doesn’t mean that the winner is the absolute best; it just means that the particular group of judges liked it best. Like the Academy Awards, most award-winning ads are quite good, and agencies that win a lot awards are producing work that is admired by their peers and usually (but not always) by consumers as well. When it gets right down to what an advertising agency actually does, it’s the quality of their work as judged by consumers that makes the cash registers ring. But let’s take a look at the top award-winning advertising agencies.

Every year, The Gunn Report tracks all the major advertising award shows around the world to rank the top 100 award-winning commercials (and print ads). In creating this database, they also analyze which agencies, agency networks, production companies, and even commercial directors are winning awards. The top award-winning agencies in the world for 2008 are as follows:

  1. BBDO (New York)
  2. Fallon (London)
  3. DDB (London)
  4. Saatchi & Saatchi (New York)
  5. McCann Worldgroup/T.A.G. (San Francisco)
  6. TBWA (Paris)
  7. VegaOlmosPonce (Buenos Aires)
  8. , 10. (tie) BBH (London, Jung von Matt (Hamburg and Berlin), Saatchi & Saatchi (Singapore)

Advertising Paid for by Media Commissions

For decades, the vast majority of advertising agencies were paid a commission by the medium they placed the ad in. For example, if Procter & Gamble wanted me to handle the Ivory Soap ad, I would create ads, and every time I placed one in a magazine, in a newspaper, or on TV, that medium would pay me 15% of the value of the purchase as a commission. This commission system spread around the world and was the primary way clients paid their agencies for nearly 100 years.

In the 1980s, when agencies were acquiring other agencies at an unprecedented rate, a few of the CEOs of advertising agencies became very wealthy, and publicly so. Bob Jacoby, CEO of Ted Bates Advertising, sold the agency to the Saatchi brothers in 1986 and personally pocketed well over $100 million. While that is certainly still a lot of money, it was unheard of in 1986 and led many in the industry to think that they were overpaying their agencies. (It didn’t, however, stop advertising agency CEOs from pocketing large sums of money. Ed Meyer, CEO and Chairman of Grey Global Group, sold that agency to WPP in 2006, personally pocketing stock worth approximately $625 million.)

The 1990s were a decade of renegotiating contracts and renegotiating how advertising agencies should be paid. The end result is that agencies were generally paid less for the same amount of work, and the entire pay system became far more transparent. Marketers determined exactly what they wanted and estimated how much time and manpower it should take to provide the service. Agencies reorganized and cut back substantially on the service they were able to provide their clients. Agencies prided themselves on being “leaner and meaner,” but generally it just meant that since they were making less, fewer people had to do as much of the same work load as they could.

Today, there are hundreds of compensation methods that marketers and their agencies use. While as far back as 1994, a full 61% were using a commission-based system, today that number is way less than 10%, and the commission they are paid is generally less than 10% as well. Most marketers and their agencies have gone to some sort of fee system (e.g., hourly fee, fixed fee by project, etc.); ideally, that links the agency’s compensation to the success of the advertising in the market (e.g., percentage of sales, percentage of sales increase, etc.). Moreover, over half of all large advertisers pay bonuses for extraordinary results. The Miami-based advertising agency Crispin Porter + Bogusky broke new ground several years back when they agreed to be paid for their efforts in stock ownership of their client Hagger. While this hasn’t picked up as a major trend, the intention of rewarding the agency for success is built into most compensation systems. There is still no perfect compensation system. Why? Because the overall success of a brand is far more complicated than just the advertising. Success depends on the product, the pricing, the salespeople selling the item, the competition, the stores that sell the product, and a thousand other things. If you run the world’s best ad, and the product isn’t on the shelf, is it fair that you should be penalized for something you have no control over? Certainly not. Marketers and consulting companies continue to work on fairer and better compensation systems all the time, but it’s fair to say that none have found that magic bullet yet.

How Does an Advertising Agency Work?

With more than 25,000 advertising agencies in America today, needless to say there are many different ways to work. If you have an idea and a client, you can call yourself an advertising agency, and many do. However, the classic agencies that handle most of the business around the world all follow a pretty similar structure.

There are five departments in an advertising agency: the account management department, the research and planning department, the creative department, the media group, and finally the administrative department.

The Account Management Group. The account group (also called account executives, client service, and content managers) works directly with clients to determine the best ways to sell their products and manage the process from start to finish in order to ensure the best possible results.

Research and Planning Group. While the research department’s job is self-evident, planning is a relatively new position in advertising agencies in the United States. The planning department was invented in the United Kingdom. The idea of an account planner is to have someone well versed in research techniques who could work alongside the creative department as the “voice of the consumer,” helping to guide the work and inspire great work.

The Creative Department. The creative department is made up of copywriters (who write advertising copy), art directors (who determine what the ads will look like), and production personnel (who turn the ideas into finished ads). Copywriters and art directors work in teams, developing ideas and reporting to a creative director, who ultimately chooses the best ideas to present to clients.

The Media Group. The media group determines where and when an ad should appear. It must understand the target audience’s habits and preferences to develop the best possible plan for reaching these people.

The Administrative Group. The administrative group houses all the support groups in an advertising agency, such as finance and accounting, legal, traffic (the people who physically get the right advertising to the right media outlets).

How Do We Go From “I Need an Ad” to a Commercial On-Air?

The account manager working with the client will determine that a new ad is needed. They will call a meeting to brief the team that will develop that ad and shepherd it from a mere idea to a finished ad running on whatever medium you choose. The briefing meeting will be attended by the account management person, the client, a planner, a creative director, and the media. The client will discuss the state of the business and the objectives going forward. At the conclusion of the meeting, the planner will write a creative brief, which defines what is to be accomplished and what we need to say to our potential consumers to get them to do and say what we hope they will. Once the client has agreed with the creative brief, teams of copywriters and art directors brainstorm hundreds and maybe thousands of ways to solve the problem in communications. The media person determines the best places to run the new ads and discusses this with the creative teams to make sure they develop the right type of media ads. Once the team believes that it has the best possible ad ready, it presents that idea to the client, who either agrees with it or sends the team back to do more work. Once everyone agrees to a certain ad, the production staff takes over in preparing the finished ad that will actually appear in the media.

Why is this important? Because in the advertising world, time is money, and this process, which can take 40 weeks for a reasonably complex commercial and involve more than 125 people, is an expensive one. Controlling costs in a business of low margins is critically important.

Economics of Running an Advertising Agency

Who needs to understand the economics of running an advertising agency? Everyone in the agency business needs to understand the basics. Advertising agencies are not all that complicated to run financially, but they are very fragile financially. One lost account can mean the difference between a good profitable year, where everyone gets a bonus, and mass layoffs.

Everyone in an advertising agency is held accountable to some extent for the profitability of their particular account, and ultimately the overall profitability of the agency. Account management personnel will be held accountable for the profitability of their accounts and won’t get promoted or receive any bonuses if they don’t “make their numbers.” Account planners and creatives often work on an hourly basis, so they not only must keep an accurate account of their work but frequently have assigned amounts of hours they are allowed for each project. If they go over their time allotment, the profitability of the assignment is immediately in danger.

How long does it take to develop a brilliant idea? You can easily see the conundrum in that question. Creativity doesn’t work on timetables, but ultimately if an account isn’t profitable, it can’t be serviced. Media professionals work on budgets all day long and can’t overspend a budget. The same is true of their time.

So what’s so difficult about running an advertising agency profitably? Leo Burnett was credited with saying that 75% of his inventory went down the elevator every night. Think about it, what does an advertising agency make? They make ideas. They don’t have factories or even machines that put out products. They have people who work hard and, if all is going particularly well, come up with brilliant ideas that grow brands. That’s all they have. Most marketers invest about 5% to 10% of the revenue their company makes in personnel. The rest is invested in buildings, factories, and other capital expenditures. If they have a major downturn, they are more likely to get rid of a factory than try and save the money by laying off employees. On the other hand, about 70% to 80% of an advertising agency’s revenue goes to paying employees. If they lose an account, they have no other option except to lay off employees.

There are just a few simple financial terms you’ll need to understand. “Revenue” is the amount of money your client pays you for the work you do. Direct expenses are the salaries and bonuses of your personnel. Indirect expenses (also called agency overhead) include things such as building rental, computers, health insurance, and even the support departments, such as accounting and finance. Your direct expenses plus your indirect expenses are simply your total cost of doing business. The difference between your revenue and costs is your profit. When shown as a percentage, it’s called an operating margin. It’s really quite simple (see Table 2).

Table 2. Calculation of Operating Margin

Advertising Business Research Paper Table 2

Advertising agencies target between 10% and 20% operating margin. Less than 10% (especially for a smaller company) is very dangerous and means that the company could be put out of business very easily, and more than 20% is generally seen as greedy by clients.

While a 15% operating margin may seem high to many marketers, the difference is the actual amount of money that represents. In our $1,000,000 agency below, the final profitability is $150,000. While that may seem like a lot of money, we could easily lose all that by one account walking out the door or by overspending on a new business pitch we don’t win or by any number of other scenarios. This is what makes running an advertising agency so difficult. Consider a few scenarios.

Scenario 1: A Good Client Cuts Advertising Late in the Year

  • Your client has promised to spend $10 million on advertising and agrees to pay you 10% of that amount (i.e., you have $1 million) as revenue.
  • You have 10 people working on the account across all departments, with a combined salary of $420,000 (average salary $42,000).
  • Your overhead (e.g., health care, building rental, desks, computers, etc.) costs you an additional $420,000.
  • The total for salaries and overhead is $840,000, leaving
  • $160,000 as profit. Your operating margin is therefore 16% ($160,000/$1,000,000).
  • Everyone is happy, and your business is growing!
  • Oops! Another product in the division isn’t doing well, so in September your client asks you to cut all advertising from October to December.
  • Your revenue just dropped from $1,000,000 to $750,000 for the year. But your costs are still $840,000.
  • What do you do?

Scenario 2: Account Losses

  • You have 10 accounts all roughly equal in size. All are profitable, with a 10% operating margin.
  • Two of your clients fire you (they don’t like the work), and suddenly your revenue is off by 20%.
  • What do you do?

You can easily see why everyone in the advertising business goes through periods of lay offs, as well as mass hiring when they win a new piece of business.

Conclusion

We’ve looked at the business of advertising and the advertising business in this research paper. The business of advertising is a large and growing business, with marketers spending nearly $500 billion a year promoting their goods. The United States, only 5% of the world’s population, is the number one advertising market in the world, with 35% of the total global spending. And as important as advertising is to the success of a brand, advertising is only one small part of marketing.

As for the advertising business, we saw how this business evolved right in step with the expansion of media outlets in the United States. After looking at how an advertising agency works from the inside out, we looked at the fragile economics of running an advertising agency to better understand how it is managed day to day.

Bibliography:

  1. Advertising Age. (2008). Ad Age annual 2008. Retrieved from https://adage.com/
  2. Jones, J. P. (2006). When ads work: New proof that advertising triggers sales (2nd ed.). Armonk, NY: M. E. Sharpe.
  3. McCarthy, E. J. (1960). Basic marketing: A managerial approach. Homewood, IL: Irwin.
  4. McNamara, J. (1990). Advertising agency management. Homewood, IL: Dow Jones-Irwin.
  5. Russell, E. W. (2008). Fundamentals of marketing communications. Lausanne, Switzerland: AVA.
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