Rising stock

There is a continuing drive to develop digital expertise. Clients are demanding it and businesses which can’t deliver are trying to recruit people or buy consultancies which can. The inevitable result is escalating salaries and escalating prices for digital groups.

But what do we mean by digital? It’s certainly more than an on-line brochure or even a fully interactive website. A number of traditional businesses have described the Internet as ‘just another medium’ but it’s far more than that. It’s an environment where large numbers of the population spend their time looking for entertainment, information and interaction. It’s also a shop window for a number of companies that are increasing their on-line communications spend at the expense of other areas.

At a seminar we held last year, Dominic Chambers, marketing director at Vodafone, explained that Vodafone’s on-line spending was coming not only from his marketing budget, but also from cost of sales as customers were signing up on-line.

The digital world is a topic for debate as businesses assess how best to embrace changes on almost every front. In a recent survey carried out by Willott Kingston Smith and Results International, entitled ‘Merger and acquisition prospects in the marketing services industry’, the expectation of respondents was that open media (blogging, podcasting and so on), interactive TV, rich media and mobile marketing will all grow at the expense of search marketing and, to a lesser extent, on-line advertising and media buying. The challenge for designers is to understand how best to help clients extend their brand in this changing environment.

Our survey also found that Web/interactive marketing was expected to grow exponentially compared with other communications disciplines. Unsurprisingly, respondents also believe that Web/interactive specialist businesses will be the primary focus for acquisitions.

With most acquisitive companies keen to buy digital, the price for these companies has soared. Private equity houses, awash with available funds, have also been keen to invest in this sector. This has also fuelled increased prices.

Merger and acquisition activity has been extensive and highly priced. At the start of the year AIM-listed Digital Marketing Group bought digital planning and buying agency Cheeze, for a multiple estimated to be more than 12 times pre-tax profits.

Two later deals added Graphico New Media, a mobile marketing specialist, and Hyperlaunch New Media, which specialises in the music and entertainment industry. This last deal was reported to be a multiple of more than seven times profits before interest and tax. This is much closer to the top end of what is being paid for traditional consultancies.

Media Square, the AIM-listed marketing group, sold its on-line technology business to US group Doubleclick for an estimated 35 times pre-tax profits, according to the industry analysis publication Financial Intelligence. Meanwhile, traditional groups are not being left behind in the dash to buy digital. Publicis Groupe apparently paid a multiple of 30 times post-tax profits to buy US-quoted group Digitas. More recently, Dare Digital reportedly sold to Canadian-quoted group Cossette Communications, for a deal which could bring the vendors as much as £30m over the next six years if the company grows at 25 per cent annually.

Do digital businesses justify the prices paid? Well, maybe. One of the criticisms levelled at digital consultancies is that their profitability has been lacklustre compared with more traditional marketing companies. This seems no longer to be the case.

In our most recent issue of Marketing Monitor, we reviewed the performance of the top 30 digital groups. We found that operating profit margins made a dramatic improvement from 8.6 per cent to 11 per cent. This still falls short of the 15-20 per cent we’d expect, but easily exceeds the 8.6 per cent operating profit margin for the top 30 design consultancies we also review in Marketing Monitor.

Digital businesses are growing faster too, and it is this which has led to improved profitability. Digital consultancies can have a different infrastructure than a traditional design business. For example, hosting websites involves superior and more robust systems than a consultancy business. Digital specialists have had to invest in advance of income to put these systems and expertise in place. Income has now caught up and we are seeing the resulting growth in profits.

It is this growth which is most likely to justify the apparently higher multiples. A well-run and established design business might anticipate achieving a value on sale of up to seven times pre-tax profit. This compares with digital business multiples of up to 12 times pre-tax profit. But valuing a business which is growing twice as fast at twice the multiple is entirely reasonable and the buyer can anticipate an appropriate return.

There is no crystal ball to show us how the economic climate will change in the next few years but on-line spend continued to grow steadily in 2001/2 when the design sector suffered a significant downturn. This suggests that, for the short and medium term, well-run digital businesses will still command reasonably high values compared with the rest of the sector.

Amanda Merron is a partner at Willott Kingston Smith

Staff Costs

Lynda Relph-Knight

One of the biggest overheads in any consultancy is staff salaries and it isn’t rocket science to understand that these need to be taken into account fully when a sale or merger is mooted.

Inevitably, the best merger deals involve efficient businesses, where income generally outstrips outgoings by a healthy margin. In the case of salaries generally, industry pundit Amanda Merron, a partner in accountancy firm Willott Kingston Smith, suggests in excess of £80 000 in fee-income per head of staff as a guide to efficiency. Though this doesn’t take account of freelance workers, it is a start.

Traditionally, digital groups have paid their staff more than consultancies specialising in, say, branding or print. This is currently not really the case, according to the trawl of salaries we carried out earlier this year (Salary Survey, DW 15 March).

The tables here show that senior and middleweight digital designers have a slight edge over their print and packaging/branding counterparts, while digital ‘suits’ generally fare better. But the margins are slight, compared with the hefty hikes we saw in the dot.com boom of the late 1990s.

That earlier discrepancy in pay rates was due in part to a surge in demand for digital designers at a time when there were few with any experience around – and colleges had yet to catch up with industry needs. Though things are stable now, digital salaries could well, as Merron says (see page 27), escalate again, fuelled this time by a combination of client demand and merger activity.