Media

Leila Abboud is a Bloomberg Gadfly columnist covering technology. She previously worked for Reuters and the Wall Street Journal.

Like the alcohol in a dusty old bottle of vermouth, trust has evaporated in ad land.

After a damning investigation by a U.S. trade association, many big brands no longer believe agencies act in their best interest when buying online and TV ads on their behalf. They fear that agencies instead favor ad placements where they make a better margin and scrape off unauthorized rebates.

Meanwhile, faith in fast-growing internet marketing has been shaken by the prevalence of fraudulent ads and admissions from Facebook Inc. that it inflated metrics for video ads.

It's all a bit grim. A Wall Street Journal report on Tuesday added to the despondency by revealing that the U.S. Department of Justice is investigating whether agencies unfairly steered business to their in-house commercial production units. Exane analyst Charles Bedouelle figures that such TV ad production accounts for a mere 2-3 percent of revenue for WPP Plc and Publicis Groupe SA. It would be much worse if the DoJ were digging into the media-buying practices, a far bigger contributor to profit.

Nevertheless, WPP and Publicis shares fell about 2 percent on Wednesday morning. Omnicom Group Inc. fell as much as 5 percent after hours. It caps a disappointing year for the big six advertising groups, whose shares declined by about 4 percent on average, according to Bloomberg data.

Dry Patch
Valuations for global ad agencies have trailed the U.S. index all year on an enterprise value to Ebitda basis
Source: Bloomberg Intelligence

A fresh probe won't restore the confidence of big clients, some of whom appear to think their agencies are shafting them every time they're not looking. Since the Association of National Advertisers' June report, alleging questionable media buying practices in the U.S., CEOs like WPP's Martin Sorrell and Omnicom's John Wren have sought to calm clients, while vowing to eradicate any wrongdoing.

While there's been a small increase in the number of audits by advertisers, the ANA fallout has been manageable. Japan's Dentsu Inc. is worse off after allegations in September that it overcharged Toyota for online campaigns, prompting emergency talks with hundreds of clients, according to the Financial Times.

Of course, the client brands aren't blameless here. Global advertisers such as Samsung Electronics Co., AT&T Inc. and Coca-Cola Co. have been squeezing lower fees out of agencies for years, even as they demand more services. If ad groups turn to alternative income sources like TV production or trading online ad space -- as WPP does with its platform Xaxis -- that's a rational response. Some big marketers don't mind these practices, so long as they're disclosed, because they understand the impact of their own cost-cutting.

It Doesn't Ad Up
The U.S. ad market, which is worth about $180 billion, is bracing for a slow down next year
Source: Bloomberg Intelligence, Magna Global

Such mutual understanding is essential for the industry. Even in the web era, the ad business relies on relationships. If agencies lose their privileged role, it clears the way for consulting groups such as Accenture and IBM to step in. And that's not counting web giants like Facebook , Google, and the new cool kid Snapchat, which offer brands more direct access to their audiences.

Red, White and Blue
The two largest U.S.-based agencies are more exposed to their domestic market than European peers
Source: Bloomberg

Playing defense isn't much fun, especially for veterans like Sorrell and Publicis's Maurice Levy. To get off the back foot, they need better communication and more openness to clients checking their work. A good start would be better audits, where neutral parties review contracts or billing practices to restore trust. The alternative would be like that ancient vermouth: unpalatable.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Leila Abboud in Paris at labboud@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net