If you’re like most agency managers you’ve probably noticed the agency landscape changing more quickly over the last few years.

In the early 2010s it seemed almost easy to build a successful agency. Adwords, and Facebook ads let you target your client’s prospects like never before. Designing for the internet and smartphones was a new frontier that let you differentiate your client’s brands in an entirely new way. Inbound marketing was all the rage, and if you did it right you created a magical flow of seeming endless leads for your clients.

Now, targeted ads, responsive design, and robust inbound strategies are simply the costs of playing the game. Agencies are constantly being asked how they can do more for their clients.

This report will provide you with a better understanding of the various shifts happening across the agency landscape. Let it help inform your strategy and execution. It doesn’t look like it’ll get easier any time soon.

This increase in competition is due in large part to a few key shifts in the industry.

The first is that brands are adding marketing talent and they’re developing their own internal capabilities. This is putting pressure on agency revenue as multiple services are becoming redundant.

Second, there has been a shift from companies accepting retainer billing to project-based billing. This shift has made agency’s revenue profiles riskier as brands shop projects around to more agencies than they have historically.

Third, the days of just being present in the marketplace being enough to build a business are coming to an end. Brands are demanding specialists and as technological prowess becomes an even greater differentiator, we’re seeing the market shake out the less capable agencies.

Fourth, the large management consultancies are moving into the CMO suite. They already dominate the rest of the C-suite and they’re throwing their weight into marketing. They’re accomplishing this though strategic acquisitions and a number of large brands have already begun using them for their agency needs.

The agency world isn’t all doom and gloom though. The turbulence in the marketplace is providing opportunities for well differentiated agencies to take significant market share. We expect to see the industry consolidate somewhat from where it is now as technological barriers to entry grow.

Over the last year, there has been significant growth in the number of new agencies. Our estimates put this growth ~23%. As we stated last year, we expected to see increased competition in this space, but this growth is impressive for an industry that has grown revenue by ~15% in the same time frame. This furthers our view that we’ll see increased competition among smaller firms.

Outside of the large agency networks like WPP, Publicis Group, Dentsu Inc, Interpublic, and Omnicom Group, the digital marketing industry is highly fragmented. Over 73% of agencies are firms of less than 10 employees. About 21% have between 11 and 50 employees. Combining these shows that 94% of digital agencies have fewer than 50 employees.

Most of the large firms (>150 employees) in this industry are comprised of agency holding companies. These are firms who own multiple smaller independent agencies that specialize across different focus areas. These allow the holding companies to work with many clients who could be competitors by distributing them across their network of agencies. This lets the holding company avoid any conflicts of interest while still providing a diverse set of creative solutions.

The small and medium sized firms (<50 and 51-150 employee firms) are typically single agencies who can offer more services as they become larger with respect to revenue. The smaller agencies tend to be specialty shops, while the medium sized firms tend to be more full-service.

Growing Digital Spend

Best Practice Implementation

Acquisition Opportunities

Exit Opportunities

In-housing of Marketing Spend

The in-house agency capabilities are also expanding. The top two things being handled in-house are social media management and basic design work. Three-quarters of in-house agencies handle public relations and digital marketing, while a little over half handle campaign development, production, and media planning.

Shift From Retainer to Project-based Billing

This shift is increasing the risk profile of agency’s revenue mix. This makes it more difficult to budget and plan growth as revenue streams are less reliable than before. We are seeing some success with a simple terminology change, from “retainer” to “subscription” but this involves productizing the agency’s services. Note also that this strategy has only been tested on smaller clients and we would expect limited success with larger brands.

Changing Marketplace with Sophisticated New Entrants

First, there are very low barriers to entry to set up a digital marketing firm. The demand for specialists ensures that top-tier talent will always have the option of setting out on their own. This option, coupled with the challenging working environment at many agencies, makes “working for yourself” and attractive option to many.

Secondly, M&A activity in this industry has remained steady over the last few years. We believe that this is due in part to the third force, limited benefits to scale. M&A in this industry tends to favor strategic capability additions rather than scale benefits.

Finally, there are limited benefits to scale for the digital marketer. After an early point, cost reduction opportunities become negligible and the perception of working with a large monolith can actually be seen as a negative by brands. Low employee tenure numbers also play a factor in lower retained corporate knowledge. It is difficult to benefit from employee learnings when they aren’t around long enough to pass them along to others.

The significant new entrants in the space over the last 10 years have come from the large consulting players. These firms already have deep ties into the CFOs, the CTOs, and the COOs and now they’re expanding their business into the CMOs budgets. The consulting firms are entering the agency space primarily through strategic acquisitions of both general agencies and small specialized shops.

Talent Retention & Acquisition

Talent acquisition is a difficult challenge as evidenced by the consistently large number of job openings at U.S. agencies. The high industry fragmentation makes building a good reputation difficult which in turn makes it harder to attract applicants. Once they are attracted though, work-life balance, compensation packages, promotion potential, etc. all play a part in the ability of an agency to secure a candidate. Unfortunately, at a large number of agencies, these are not robust enough and work against the firm during the hiring process.

Return on Investment Transparency

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The vast majority of the marketing spend is controlled by Chief Marketing Officers at large brands. Their budgets tend to fall in the 10-15% of revenue range and they are impacted by multiple forces from within the organization. Over the last few years, roughly 2/3 of their marketing spend has been focused on existing customers (growth and retention) with 1/3 being spent on new customer acquisition.

Fixed Fee

This model works best with clients who have a set budget they’re unable to exceed and need to know project costs beforehand. Both parties assume risk with these types of arrangements though as cost overruns are absorbed by the agencies while cost savings aren’t typically passed to the client. Fixed-fee models also may limit agency revenue growth as the option to add additional services typically isn’t available until the contract renewal time.

Value Based

Hourly Rate

The hourly rate model has the potential to incentivize inefficient practices and can misalign the agency’s incentives from the client’s. A number of industry leaders advise against this model for these reasons.

Point-based Pricing

Even with the trend towards building out sales teams, agencies still derive over half of their new leads from personal networks and referrals. This can be a growth limiter though as referrals and personal networks are primarily comprised of individuals with similarly sized businesses. Therefore, new referrals are very likely to be similar to your current client base. This makes it difficult to attract larger clients than you currently work with.

The majority of blended agency billing rates fall in the $101-200 per hour range. However, our research has shown that these vary widely based on the location of the agency, the types and sizes of clients served, and the types of projects worked on. Smaller market, generalist agencies tend to operate on lower billing rates while larger market, specialist agencies tend to command higher hourly billing rates.

Agency margins are influenced by numerous business levers. The most impactful is often the billing rate. The average agency margin is clustered closely around 18%. Similar to the billing rate, this is heavily influenced by the size, the location of the agency, the types and sizes of clients served, and the types of projects worked on. In addition to those factors, the agency’s cost basis (primarily employee costs) will have an effect on margins. Agencies with employees located in higher cost of living locations will have a higher cost basis than those in lower cost of living locations. This is typically offset by a higher hourly billing rate.