Giving a performance that’s value for money

Amanda Merron gives you a more in depth review of Willott Kingston Smith’s yearly report on the financial performance of marketing services companies

It’s been a difficult year for most marketing services groups and design groups were no exception.

The headline figures are striking. Take the top 30 consultancies as a whole: operating profits are down by 51 per cent and pre-tax profit by 37 per cent, according to our survey of the most recently published company accounts (News and Comment, DW 9 October).

With client spend decreasing by nearly 12 per cent, the revenue these groups extracted naturally declined too – by 8 per cent. And yet, we saw the familiar sight of escalating employment costs – up by over 7 per cent. Why?

As non-staff operating costs fell by 20 per cent, lack of control over staff costs was single-handedly responsible for the disproportionate decline in operating profit – despite the fact employee numbers fell by 12 per cent, suggesting junior staff were shed, but some difficult decisions were avoided.

Responding to market difficulties is costly, but the top 30 consultancies had comparatively few exceptional costs. Only five reported exceptional costs, the majority of which related to restructuring and redundancies.

In part, the lack of redundancy costs in these figures may reflect the fact that several groups have deferred filing accounts this year – perhaps with the intention of putting off the public exposure of bad news. As we complied our survey, FCB (trading as FutureBrand) and Wheel Group had not filed accounts since 31 December 2000 and 30 June 2001 respectively.

The battle to contain employment costs within income levels stems back to the last recession within the industry. Recruitment slowed, creating a shortage of talent as business picked up. Throw in the dotcom pay frenzy and salaries inflated to a level not sustained by the revenue generated.

When income decreases, it’s very difficult to reduce costs quickly enough – especially if they were too high in the first place. Consultancies that shy away from addressing this now may be storing up trouble for the future.

Thankfully, it isn’t all doom and gloom though. Cash generation has improved. In the current climate, this is easily as important as profits. Nearly half the top 30 had £1m or more in cash on their balance sheet and only eight groups had net overdrafts.

Perversely, this might be partly due to reduced revenue – companies collect cash from work completed in busier times and have to spend less on reduced overheads. Long-term debt also reduced, as did the net interest cost. This is particularly helpful if profits continue to fall or interest rates rise in the future.

The top five consultancies all reported decreased revenue. Imagination still dominates, with generated gross income of more than double its next largest rival, Wolff Olins. However, both groups reported decreased gross income.

Imagination’s August 2002 accounts show gross income fell by 13 per cent and pre-tax profit halved. In part, because the previous set of figures included revenue from millennium-related projects completed during that year. Also, Imagination incurred additional costs this year establishing new offices in Germany, Sweden and the West Coast of the US. Nonetheless, the group remained in profit.

Wolff Olins, bought by Omnicom in May 2001, reported a fall in revenue of 14 per cent in its accounts to March 2002 and an operating loss of £2.38m before exceptional staff compensation of £1.76m. Largely as a result of this, average pay rose by nearly 47 per cent – from £48 627 to £71 267.

In its December 2001 figures and in keeping with other branding consultancies, Interbrand Newell & Sorrell (as the limited company is known) suffered a significant decrease in income (21 per cent) and an operating loss. However, the group reduced its headcount by approximately 15 per cent, spending almost £1m on severance compensation.

South African-owned Wheel Group experienced a decline in revenue, but managed to cut its operating costs more or less in line with this in the year to June 2001.

However, restructuring costs had an impact and were further exacerbated by a loss on disposal. Wheel acquired Foresight (Europe) from its parent, Primedia Communications, and sold its 30 per cent interest in Dunn Humby and its 95 per cent interest in Alpha Mail.

Design has been hit harder than other sectors. Groups are usually more dependent on project income than other marketing suppliers. One-off projects are easy to cancel or defer when clients’ budgets are cut. But design businesses are slower to cut staff costs than some other sectors and this has probably been the most damaging factor in terms of profitability.

Nevertheless, some individual performances show what can be achieved, even in the face of significant adversity. Operating profit per head is a key measure. It depends not on size, but how efficiently a business manages to turn top line income into operating profit.

Bamber Forsyth (now subsumed within Fitch London) and Lambie-Nairn were in the top ten best performers for productivity (gross income per head), gross income to staff costs and operating profit per head.

Other strong operating profit per head performances were reported by Enterprise IG, Jack Morton Worldwide, FBC (FutureBrand), Coley Porter Bell, Sandom Group and Allan Burrows.

So the message is clear – design can be profitable. But profitable businesses have balanced productivity and pay by making sure they charge their clients enough and balance revenue with staff costs – ideally in a ratio of 2:1.

Amanda Merron is a partner at accountant Willott Kingston Smith

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