Real estate is the second-largest expense for ad agency companies, which are exiting leases and shifting operations to cut costs and improve profit margins.
The top three agency holding companies spend from 4% to 6% of revenue on office rent. It's a small percentage next to salary costs, the top expense at up to 60% of revenue. But rent adds up: Omnicom Group, Interpublic Group of Cos. and WPP Group collectively spent nearly $1 billion on rent in 2002, according to an Advertising Age analysis. That's about $6,000 for each employee's cubicle.
Holding companies were built on hundreds of acquisitions, and Mark Costello, managing partner of the New York real estate practice at Ernst & Young, notes ad conglomerates long encouraged agencies to keep their autonomy. But with fee cutbacks, the ad slump and a weak economy, he said, the move is on to cut costs by consolidating real estate and support functions. "Real estate can often serve as a catalyst to enable those kind of changes," he said.
Reducing real-estate expense helps the bottom line at a time when revenue is flat and clients demand lower fees. Assuming Interpublic delivers on planned real-estate consolidation this year, that should lower its costs by more than $50 million this year-and increase profit margins by 0.5% to 1%. WPP, meanwhile, expects real-estate costs in 2004 to take a half cent less of each revenue dollar vs. 2002-meaning a 0.5% boost to margins.
"Our priority is to reduce real-estate costs as a proportion of revenue," said Paul Richardson, group finance director at WPP, which has trumpeted to Wall Street its strategy to control property expenses.
Cost disciplines should resonate with agency clients, said Gary Singer, a principal at McKinsey & Co. and former ad agency executive who consults with marketers on marketing-spending effectiveness. While clients a generation ago didn't worry much how agencies spent their 15% commissions, he said, it's an issue today when cost-plus compensation contracts mean clients in effect are paying for salaries and overhead. "Overhead is dominated by real estate," Mr. Singer noted.
For holding companies, the ultimate efficient model would be to outsource more functions to lower-cost providers, reducing space and labor needs; consolidate support functions in places-the U.S. or even offshore-with lower-cost real estate and labor costs; house operations of various units in one building, allowing flexibility to shift space from unit to unit; and harness technology to connect with other talent working from home or other offices in the network.
Parts of that ultimate model won't fly. Agency executives, for example, said client conflicts would preclude many sibling agencies from sharing one building. But holding companies are making moves. In New York, for example, 36 WPP companies by 2006 will consolidate to 17 from 30 locations, eliminating about 20% of WPP's space in the city and cutting WPP's annual Manhattan rent to $64 million from $77 million. At the one property that WPP owns- Young & Rubicam's headquarters on Madison Avenue-Mr. Richardson said WPP is doubling the number of staffers in the building by, among other initiatives, remodeling the building and moving Y&R sibling Wunderman into the space.
Holding companies are saving money by consolidating back-office services. Interpublic, for example, is expanding a financial-services center in Omaha that eventually could handle accounting-and possibly other support functions-for all units except McCann-Erickson WorldGroup (which has a similar function in Louisville, Ky.). "We are looking to move more and more of these kinds of services to Omaha," said Terry Peigh, Interpublic's recently appointed senior VP-director of corporate services.
The effort builds on programs in place at the acquired True North Communications. It complements existing initiatives at Interpublic to standardize units' employee benefits and to consolidate purchasing of everything from real estate and computers to temp labor and travel. Interpublic has made the most progress on shared services in the U.S. and intends to develop them in Europe.
Mr. Peigh, who developed shared services at True North, said the programs have received "very, very positive" endorsements from Interpublic operating units. "The guys want to play," he said, in part because lower-cost services help their margins. "It's free money," he said. Such cost-reduction programs are a high priority for Chairman-CEO David Bell.
Ernst & Young's Mr. Costello bets the agency field will shift more support jobs and functions to low-cost markets. Agencies could even get a tax break; Advance Magazine Publishers, the New York-based owner of Conde Nast and Parade, last year snared tax breaks and other incentives when it created a "shared services center" for accounting, human resources and technology in Wilmington, Del.
Margin pressures and cost-cutting efforts are likely to continue even when the economy improves. As the ad market picks up, one agency executive said, his company might shift some back-office functions to lower-cost U.S. cities where it operates, such as Detroit, rather than adding expensive space in New York.
There's no indication agency companies will follow clients and export certain back-office work to low-cost places such as India, which has built a booming business in managing phone centers and other support functions. Yet Mr. Costello doesn't dismiss the possibility. "I can't imagine why any large employer would not consider at least some element of offshoring certain functions," he said.
staying in ad centers
Agency executives contend most jobs-account service, creative, production, media-will remain in ad centers. "You've got to have your real estate where your talent is," said a veteran agency financial and operations executive. Even so, it's possible to save money in big cities by taking less expensive space and outfitting it more frugally. "I don't know the correlation between expense of real estate and talent [of employees], but I suspect that it is not as high a correlation as some people think," said McKinsey's Mr. Singer.
Agency real estate is problematic: a long-term fixed cost in a business where fortunes can turn on short-term wins and losses. While agencies can hire and fire staff to keep the top expense in line, they're stuck paying rent year after year.
"An ad agency usually has the right amount of space for 15 minutes of its life span," said David Wiener, a New York accountant who has worked with such agencies as former independents Chiat/Day and Deutsch and Maxxcom-backed Crispin Porter & Bogusky. "They usually have too much or too little."
WPP and Interpublic have too much given a slow ad market and, in Interpublic's case, a drop in revenue. Omnicom declined to discuss its real estate, but its property portfolio should be in better shape because it's been growing revenue and adding employees through the downturn, making rent less of an issue.
Among the big three, Omnicom has the highest revenue per employee, lowest office rent per employee and highest salary expense per employee, according to Ad Age's analysis (see chart). The result: high productivity, low overhead and apportionment of money to an expense-salaries-directly tied to the end product. That's in sync with the priorities Mr. Singer said clients want to see at agencies. "The most important thing for agencies right now is to put the money where it matters," he said. "Agencies need to focus on where they add value to clients and put as much of their investment behind that added value as they can."
WPP, meanwhile, expects to end this year with 12.4 million square feet of office space worldwide, down 8% from year-end 2002. (Figures exclude space that will be inherited with the Cordiant Communications Group acquisition; WPP expects to take on about $49 million in liabilities for Cordiant's surplus real estate and reorganization costs.) Over time, WPP wants to reduce the square feet per employee to 225 from the recent 273 while also improving the design quality of the space using a WPP-owned office design company.
For 2002, Interpublic had the highest estimated annual office rent per employee at about $6,600-or $550 a month for each staffer's cubicle. Interpublic, the weakest performer among the big three in recent years, is working hard to cut costs. It this quarter plans an approximately $200 million restructuring charge for job cuts and real estate consolidation. New installations will be 250 square feet per staffer.
The company ended 2002 with 17 million square feet of space (335 square feet per employee). It expects to end this year with 15.25 million, including NFO WorldGroup space-and less without NFO, which will be sold this summer.
Walking away from leases can be expensive. In a 2001-2002 restructuring, Interpublic terminated about 7,000 employees and closed or downsized 180 locations. It took pre-tax charges of $299.8 million ($43,000 per employee) for severance-and $320.7 million ($46,000 per employee) to jettison real estate.
For all the money they spend on real estate, holding companies until now have offered little disclosure on their second-biggest expense. That's starting to change. In a presentation to Wall Street analysts, WPP earlier this year made a detailed disclosure on real estate to show how its strategies will reduce costs.
"The key is good property management provides a stimulating and efficient working environment and adjusts both up and down to the business needs of the day," Mr. Richardson said.
Fixing long-term real estate issues will take time. "It's not the thing to move easily," Mr. Richardson said. But there's plenty of room to save money.