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Cyberdrum: digital downturn

By The Drum, Administrator

March 21, 2008 | 6 min read

Web Wobble

In an industry with such potential for high profitability, CyberDrum investigated why so much of the money churning through the digital sector is being lost straight to the trash can, rather than filling agency inboxes.

Companies “sacrificing price in exchange for top line growth” was one reason given by the Kingston Smith report for the relatively poor performance, in addition to “struggling to accurately predict staffing requirements for project-based income.”

Taking the temperature of some key players in the digital creative arena, there appears to be a consensus that, whilst staff costs are indeed a specific factor, it is good old fashioned business skill that is lacking more than anything else.

“It is a low margin industry. The operating profit per head is way down,” explains Ed Carter, managing director of Spring Corp Digital.

Pitch-tastic

“So much of the digital work is done on a project basis. No one is retained. It is a pitch business, and there are companies who are pitch-tastic out all the time. Naturally profits and costs get reviewed and people are always trying to undercut. Bizarrely, if the sector is growing, there is much more business. But people are out there being much more competitive on price,” he says.

“Because the market is still immature, the client is to a certain extent not well educated, so it is done on a project-by-project basis. There are extreme examples, where someone’s brother’s mate has quoted 200 quid, and we have pitched at twenty grand. We’ve been up against that,” Carter explained.

The relative youth of the digital sector – at best only 10 years old, and constantly evolving – compared to the century old habits of the advertising trade does provide some excuse for the market still trying to find equilibrium. Experience in established trades has given clients familiarity with fee levels, and an expectation that has yet to become commonplace in the digital arena. Despite this, John Campbell, MD of Spider Online, believes that agencies should simply be employing better management skills to avoid the profit shortfall.

“The real problem for digital agencies is managing projects. If you don’t manage them properly you don’t have proper client service,” he says.

“The digital sector is becoming more mature, and digital agencies are having to deal with the same issues in the market place as traditional advertising services. One of the things digital agencies have to look at is how they manage their business. A lot of digital agencies talk in turnover, rather than project management and profit.

“The thing digital agencies are going to have to wake up to is that it is not all about the revenue stream from new work without having to bother your backside about return on investment. You have to be more professional, and deliver on time. In the early days, a lot of leeway was given to digital. The challenge is for digital agencies to actually run their businesses properly. I have a concern that everyone talks in turnover.”

Essentially, Campbell believes that digital businesses need to run themselves like any other successful company, keeping it simple, with an eye on profit.

“It is no different from anything else. It is all about the fundamentals, despite being about technology or something new. The principles of business are still the same. You have to deliver to your clients on time and on budget. Knowledge of how you cope with that is lacking in the sector.”

This point of view is echoed by Rose Lewis, a partner at Pembridge creative business advisers who counsels digital businesses to pay more attention to basic business principles, rather than running their digital agency as part of their ‘lifestyle’. She adds that the constantly evolving technology in this newest of industries means there is a far shallower pool of talent, whom agencies are paying excessive salaries to at the expense of profit.

Poor management

“The sector is high growth. What is affecting their profitability is the ability to attract and retain staff. Staff costs in most digital agencies in the last year have gone up, which has caused profitability to go down,” she says.

“There are examples of agencies that have managed to retain their staff and keep the balance right, so it is still a poor management issue. There are other success stories in the sector that prove that you don’t have to just keep on paying people. If your staff costs go out of whack with your gross profit, you are doing something wrong and need to change that.

“It is a new sector, with more and more people going into it. There is a shortage of talent in the sector because it is relatively new. In the last 10 years there have been such huge technology changes. If you understand your business model – that is to make money from your clients at a profit – and if you are true to your business model you won’t let your staff costs go out of line. This is also very prevalent in design, where there is no barrier to entry. You haven’t got a business if you aren’t doing that.”

Campbell’s experience is consistent with Lewis’s advice, and he agrees that the recruitment shortfall is key aggravating factor affecting digital performance.

“There is an issue with recruitment. A lot of people in digital are pricing themselves out of the market because the demand outweighs the supply, so costs are being impacted on in the digital sector, perhaps more than advertising or graphic design,” he says.

“In other disciplines there have been generations of people studying specifically, being brought up through management programmes or other agencies. For us in digital, the sector is growing very quickly, and there just isn’t the selection of candidates or staff. It is going to be a real challenge and is something we as an industry have to do something about.

“To sustain your business you have to make it a profitable well run business so you can develop it. Turning over a lot of money is not the same as making a lot of money and being profitable. The challenge for the next few years is not going to be winning new business; it will be running your business.

Ed Carter agrees that the challenge ahead is to ensure that clients are aware of the value of the service agencies provide. There is a need for consistency of pricing, he argues, to avoid undercutting and profit erosion.

“There is every reason to be optimistic about how it is going. But this is a period of change and rapid growth, and the more activity you get the more you might see a downturn and margins being squeezed, by way of there being so much activity.

“Client education is one of the core elements.”

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