Higher interest rates are coming: here’s how they hurt ad agencies, clients and M&A
Worsening economic prospects in the UK, US and Eurozone have agency leaders planning cautiously for “difficult business conditions” in the coming months. The Drum asks – just how bad will it get?
The Bank of England raised interest rates last week – the sixth time this year / Unsplash
The Bank of England announced last week that its analysts expected a full-blown recession by October, triggered by rises in energy prices. It also increased interest rates to 1.75%, the biggest rise in 27 years and the sixth this year, while warning inflation would soon reach 13%; deputy governor Dave Ramsden noted this week that the central bank would likely push rates even higher before the year was out.
According to Sir Martin Sorrell, executive chairman of S4 Capital, ”it’s not a surprise the bank did what it did, but it is exceptionally gloomy.” Those developments, added to higher interest rates and inflation in the US and in the Eurozone (the European Central Bank raised its own rates three weeks ago), have major implications for agency businesses.
Client response
The most immediate threat is the knock to client confidence. Kate Howe, executive director of MSQ, tells The Drum: ”The best marketers and the best businesses know that continuing to maintain investment in their brand through a recessionary period is how they come out the other side stronger. You only have to look at how big, global brands such as Diageo and P&G have attributed their investment in marketing as a key driving force behind their recent growth.
”The way that agencies can most support brands in being able to do this is by helping them really understand how they’re getting the very best return on investment in every pound they spend.”
That will likely lead clients to shift spend to areas with stronger financial accountability. According to Sorrell: ”Clients are becoming more performance-driven and do more activations and lower-funnel. Should they shift spend, it’s moving from analog to digital for better measurement.
”There’s more lower-funnel work and less awareness work, with a bit of a delay in decision-making, but [clients are] not cutting spend.”
MSQ has invested specifically in its data team and effectiveness training to ”justify the most effective strategies,” says Howe. ”These are serious times, we understand that, but the best brands will continue to spend and the best agencies will continue to support them and give them the evidence needed so that they can do so with confidence.”
Labor costs
Interest-rate rises are designed to bring higher inflation under control – Threadneedle Street has a target of 2%. But these have a knock-on effect.
”The central banks have been behind the curve because they’ve been surprised by the impact of the Ukraine war. The question is whether the bank should have moved quicker, but it’s hard with the context of the past couple of years,” says Sorrell.
In the short term, both factors will contribute to a higher cost of living. That may put more pressure on agencies to offer wage increases in line with the rest of the economy, but Tristan Rice of SI Partners tells The Drum that higher living costs could actually curtail wage inflation for senior agency roles because it will shift power back to employers.
He says: ”When I talk to founders, some are actually hoping for a recession because it will take the pressure off salaries. Most of them would take a bit of pain on budgets for a few months if it meant people got a little less greedy and a little keener to come and work.
”Agencies don’t have enough people to do the work they’ve got and they’re struggling to control salaries. Talent is pretty scarce and expensive. So for the salary issues to improve, you need a little less employment demand. The only way that’s going to happen is a recession.”
Furthermore, Sorrell suggests clients may seek to reduce their own wage bills by delegating more of their marketing functions to agencies.
”There is more outsourcing ... they are shifting headcount to the agencies.”
Acquisition impact
Higher interest rates are also likely to dampen the recent enthusiasm for agency acquisitions. Mergers and acquisitions need financing, which often depends on some form of debt. But increased borrowing costs make raising capital for a deal – with a loan, for example – more expensive.
Data from the Office of National Statistics shows UK M&A deals fell 59% in the twelve months prior to March this year, following a peak last spring. According to Rice, private equity-funded deals will be particularly affected.
”An amazing percentage of M&A has been driven by private equity money. That is often leveraged using banking leverage, and that sort of deal is going to become much harder,” he says.
”That will tighten the market a bit for private equity ... and probably limit the number of deals.”
Additional reporting by Hannah Bowler.