Last week I had the joy of attending the PRCA public affairs awards. Looking around the room (weirdly bathed in ultraviolet light, as though we were all desperate to shoot up; in fairness, when we got to the award for Best Party Conference Stand I wondered if I was on hallucinogens) it was impossible not to be struck by the plethora of newish agencies present. Morbidly I began to contemplate their demise: how rapidly would each one of them lurch from boom to bust in the way that seems to be happening to more and more communications agencies these days.
In my decade-and-a-half in the industry I’ve run an agency owned by private equity, then one which was part of a (tiny) listed group, and now Park Street Partners, where I am my own shareholder. I am enjoying most the current experience, when I don’t really have to answer to anyone other than clients. And it has led me increasingly to the view that for most (not all) PR agencies being owned by external shareholders is a Very Bad Idea.
The life story of all too many agencies is this. They launch in a blaze of glory, maybe with an all-star cast, or a new way of doing things, or just with youthful vigour and a whole lot of momentum. They win a few things quickly because they are on a promise from an old client or because they are bright new things genuinely shaking things up, and it all seems quite easy. Revenue grows strongly in percentage terms for a few years, because not much on top of not much translates to double digit growth. And they begin to think that expanding by 15 to 20 percent is sustainable and realistic for the medium-term at least.
At that point they make bad choices. Perhaps they invest in a swanky office, or in a lot of people; after all, they need it with that sort of expansion going on. But that means the principals find themselves managing buildings and staff rather than clients. Quality suffers but that doesn’t matter so much for now because there is work pouring in the front door; who cares about losing that boring old client out the back? The seeds of self-destruction have been sown but nothing is visible above ground yet.
Then, all too often, they make a really bad choice, and go looking for investment. Maybe all that giddying growth has made them think that yes, they can be the ones to create the new Edelman, with an office in every nation. Or they want to take some value off the table to pay the school fees or for that oh-so-reasonably-priced house in Salcombe. Or the agency is owned now by someone else but an MBO looks super appealing. Either way they open the doors and bring someone else in.
At this point everyone gets carried away. Investors should know better, but this shiny new agency looks so compelling (who knew PR folk could convincingly bullshit?) and they persuade themselves that double-digit revenue growth at a 25 percent margin is going to be what this new business can do ad infinitum. The agency principals get greedy as big cheques are waved about. So everyone conspires to agree a valuation that is ambitious at best, fantasy at worst. As agency principals transition to become mere management the valuation is locked into a business plan, everyone crossing their fingers that the money will continue to roll in and the worth of their venture will go up and up.
But reality eventually bites – at least it does for most firms, since only very special firms can outpace the market for a long time. Inevitably, a big client will leave or a senior person will depart, and the agency will stumble. Revenues will dip a bit, and that nagging feeling shareholders have had for a while that maybe they overpaid starts to crystallise into proper anxiety. To sooth their worries they start to exert pressure: they may graciously concede that income can be lower going forward but gently insist that management sticks to the agreed EBITDA targets. And that means that unless revenues can pick up quickly costs have to go down; what else can they do?
Now one of two things happens. Shareholders may ‘generously’ allow or even encourage management to try to shore up revenue. “Hire a rainmaker!” they cry. Let’s just pause a second and consider that word “rainmaker”. It is pretty much interchangeable with “unicorn” when it comes to recruitment. If someone can make it rain new business you can be pretty sure they are already safely stashed in a better agency than yours, on a fat salary. Or they are doing their own thing. What they are not doing is sitting on the books of a recruitment consultancy waiting to join your mid-table, stumbling, agency.
So unless management get very lucky it is cost-cutting all the way. So here comes some good news: the shareholders have a Very Clever Spreadsheet which tells them there is fat to be cut, there are people who can be fired without losing any clients or revenue. Unfortunately the Very Clever Spreadsheet can’t tell exactly who the idlers are. But no worries, because if the agency is especially fortunate the shareholder used to run a sales business and knows the agency should just junk the bottom 10 percent of new business winners, even if these people are great at keeping clients (the famous ‘hunter’ vs ‘farmer’ debate). Or the shareholder really understands advertising and so tells management to junk the ‘long tail’ of small clients and the people who work on them (often the most profitable of all PR clients) to concentrate on the big names (often the most over-serviced). And so it is revealed that cutting costs painlessly is as much of a myth as finding a unicorn or a new business rainmaker.
What actually happens is management cuts easy things. First to go? The bonus scheme, because after all, shareholders say more in sorrow than in anger, no-one can think they still deserve a slap on the back, right? No-one except the shareholders themselves, who continue to take that profit out and continue to congratulate themselves all the way to the bank while the people who actually generate the money feel resentful and angry. Next up? Training, and development, maybe the free breakfast: anything soft that makes people who work at the agency feel good about being there.
And then it is people. Some folk look easy to fire, but management discovers only afterwards that this client or that really liked Jonny and will be taking their business elsewhere, or maybe they didn’t like Jonny but they really hate churn on their agency team. Then it turns out Jonny was really popular internally, the glue that holds the team together, and his departure pisses other people off. Or he wasn’t popular, but the fact the agency is now firing staff breeds more anxiety, and makes everyone else that bit less committed than they were when the agency was smaller, friendlier and faster-growing.
The upshot? People go, clients follow, revenues slip further. Shareholders continue to maintain the EBITDA target, so more costs have to be chopped. And so it goes, on and on, a cycle of anxiety and resentment on all sides, a downward spiral. This might take years, and there may be brighter moments along the way. But it leads inexorably to doom.
So how to avoid this fate? There is no simple answer, but I have some suggestions. First, management and shareholders should invest heavily and repeatedly in the agency’s brand. Too many firms think that their most important asset is their people, because after all it is senior staff who hold client relationships. Keep them happy and all will be fine, right? No, if you are trying to build asset value (NB: a big ‘if’, see below) it is crazy to put all of your eggs in a basket that walks out the door every day. Successful, larger, companies have strong brands that have some meaning in the market: think Portland, Blue Rubicon, Brunswick et al. This allows them to weather senior departures and attract new staff and clients in a way not open to more insipid names.
Second, by the same token, investors should seriously discount the value of agencies that have no brand strength. All too often money has been plowed into minor companies, presumably in the hope that they will become world-beaters (clue: they won’t). If an agency is unknown or unappealing then it is just a collection of practitioners and clients who can leave anytime. What multiple would you put on that?
Third, and the flipside to investors being careful about the valuation of agencies is that agency managers should be too. It may feel good to receive a slightly bigger cheque (or help your previous owner to do so), but if you have done so on the basis of puffed up profits or projections of heroic future growth, you will rue the day when down the track you are trying to deliver the undeliverable. You may even believe your business is worth what you are paid for it. Trust me, it isn’t.
Fourth, if they get the valuation right agency owners should be far more picky about who invests in them. Find someone who really understands PR and how it works. This won’t be most advertising and marketing groups, and nor will it be the average private equity firm (albeit there are now some specialist companies out there). Apart from anything else, endlessly fighting the fight for the ‘long tail’ and for keeping a few Steady Eddy farmers amongst the prima donna hunters is tiring.
Fifth, if revenues dip a little bit shareholders should fight their instincts and relax planned targets, at least in the short-term. Give management a margin break, and encourage them to take time to shore up clients and rebuild teams. Have some faith in the people you were lauding only a few months ago, and help them get things back on track. By the way, if your financial model doesn’t allow you to do this you overpaid in the first place.
Sixth, if there are any profits at all, maintain the bonus, at least for members of the team who are making a big contribution. There is nothing more likely to stoke discontent than the sense that shareholders are maintaining their slice of the pie by stealing crumbs from the workers. It is simply not fair, but more to the point it is self-destructive and daft. Eliminating bonuses or imposing pay freezes may not drive folk to leave, but all too often it discourages them from going the extra mile. Should I go to that networking event after work when any extra fee I bring in just makes some Yankee money guy richer? Nah, I’ll go home and watch Narcos instead.
Seventh, the best idea of all: avoid all of this pain and anxiety by not making or accepting the investment in the first place. Hopefully everything I have said so far has convinced you that, in 9 cases out 10, PR companies are really bad investments. Just in case, let me say it again: PR companies are really bad investments. My guess is that spending money on another professional services firm is just as bad an idea, although I wonder whether the problem of having low (by which I mean zero) barriers to entry to the PR market thus allowing good people to walk anytime makes it an extreme case. Whatever, it is certainly hard to think of a situation recently when an investment in a PR agency in the UK has gone brilliantly for all concerned.
When I set up Park Street Partners I was given a sage piece of advice: work out at the start whether you are trying to build an agency to sell or one to make a living from. It is certainly the case that too many people do the first, and should do the second, given everything I’ve said about valuations. But actually it is the wrong question. Instead ask whether you are setting up a company to serve clients or to serve shareholders. As you look at what you are doing now, what answer would you give? Unless it is “serve clients” you are doing it wrong.