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Advertising's Future


Simply put, online media is cheap, but the value is growing. Less will be more. That is a notion to bank on.

In 1998 I had a meeting with a senior manager from Unilever. He reported to Charlie Strauss, the then CEO of Unilever North America. As we walked down Park Ave. he asked, "So, what do you think the future of advertising looks like." Here's what I told him:

Consumer goods companies live by the 20/80 rule. 20% of your target accounts for 80% of your profits. However, you spend your marketing and advertising budget against 100% of your target in the hopes of catching that profitable 20%. It's a wide net.

That strategy is dying. In the future you will spend 100% of your budget against the 20% and you'll have a halo affect where you'll catch more. In the end you'll go after the 40% of people who might actually buy your product.

Translated, this meant that instead of spending $100 mln (yes, in many instances, that is what a consumer goods company would spend marketing a single product) to market and advertise, you will spend $40 mln and accomplish more. This will all be done with the help of technology. It also means that the spending of major advertisers will decrease in the years ahead and the profitability of media companies and ad agencies will decrease.

TNS Media reported recently that the top ten advertisers spending for 2006 dropped by 2.8%. The top ten accounts for roughly 13% of the total media spent in the US, which is roughly $150 bln.

As most media outlets have reported, much of this decline was driven by the US auto manufacturers who historically have been the largest media spenders. However, the bigger 'tell' has been from companies like Johnson & Johnson (JNJ) and Time Warner (TWX) who both had double digit declines in their spending. For JNJ, it is something to keep a close eye on but for Time Warner, it signals a major shift from traditional to non traditional marketing efforts. Now you could attribute the J&J decline to a pullback in prescription drug marketing, but I think it may point to a more macro shift away from the "big ticket" advertising to more niche opportunities. I have a hard time still referring to the Internet as a 'niche' but the fact is…it is! So what does this mean for investors?

I wrote an article on the shift of media and information distribution a few weeks ago and touched on the thesis of investing in the new media economy. There are three components: Content, Distribution and Infrastructure. I think it's worth a revisit as advertising is a core part of the mechanism and it will be affected in the coming years.

If you invest in marketing companies like WPP, OMD, MDC, IPG or Publicis, you need to watch their revenues closely for the next year. When spending goes down, so does their revenues. In addition, I'm seeing a macro trend where clients or moving their services from large agencies to niche creative shops. These companies like Taxi, Mother, Strawberry Frog and any other really odd name that can be devised are going to become much more prevalent as creative talent realizes independence is better than…dependence on the large agency infrastructure. Today service revenues account for 40-50% of the holding companies total revenues, but the economies of scale have tipped and in the next four to five years, I think we'll see a big decline in the big agency revenue streams.

The fact remains, the agencies have been extremely slow to move from a commission to fee based system of compensation. Even when they say they have, they still base their primary compensation on a percentage of the total media budget. The system simply does not work and I would go so far as to add that the major agencies are in for a big shock as Google (GOOG), Yahoo! (YHOO) and MSN develop technologies to centrally serve media across the entire spectrum of media channels – Internet, Print and Cable. When this happens, we will see a MASSIVE decline in revenues for the agencies as clients shift their dollars and more importantly their service support to these providers. It will be a boon for the media companies.

The final stage of this shift in marketing will be an increase in the value of online media. Simply put, online media is cheap, but the value is growing. Less will be more. That is a notion I will bank on.

After my discussion with the executive from Unilever, Charlie Strauss stood up at a conference and declared that Unilever would no longer spend the way that they were spending and that they would pursue the 20% that accounted for 80% of their revenues. I read this in the main stream press and had a laugh. Only two days had passed between our conversation and his exaltation.

For the ad agencies, the sky isn't falling, but the ceiling is certainly getting lower. And ultimately, less will be worth a whole lot more.
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