BEIJING (AdAge.com) -- A scandal unfolding in China that involves kickbacks, money laundering and prostitution at a five-star hotel in has set off a firestorm in the country's ad industry -- but more broadly is shining a light on the unusual media relationships that often foster media corruption in the country, one of the world's most promising ad markets.
At the center of the investigation is Zheng Zhixiang, who works for media-brokerage firm Chongqing Huayu. He is accused of laundering money through a brothel in the basement bar of a Hilton Hotel in Chongqing. Because Mr. Zheng was a broker for Publicis in Chongqing, a paper trail in a government investigation led to a pair of prominent agency executives: Vivaki's China CEO Warren Hui and his colleague, Ye Pengtao.
Two weeks ago, government investigators detained Messrs. Hui and Ye for extensive questioning about their involvement with Mr. Zheng. The two execs have not been charged with anything and Mr. Zheng's Huayu media brokerage worked with other agencies too, not just Vivaki. Vivaki Exchange buys media for Publicis Groupe's media divisions like Digitas, Starcom MediaVest Group and ZenithOptimedia. Other Vivaki executives are handling daily China operations, and contrary to local news reports, the two men have not been fired. Vivaki's chairman for Greater China, Beijing-based Yifei Li, referred questions to the agency's PR firm in China, MS&L, another Publicis division.
"They are still with the company. We know there is a police investigation but when we try to get more information, we can't, because [Vivaki] is not directly involved," said Benjamin Tan, managing director, MS&L, Shanghai. "We don't know what happened, so we don't want to make a decision [about their future]."
Details aside, media corruption has been a not particularly well-kept secret in China for years, and companies, not just individuals, are involved. Industry execs estimate more than half of the revenue earned by multinational media agencies in China comes from media owners rather than clients' budgets. "That's corporate corruption, not personal corruption," said a media industry veteran in Shanghai.
In China most multinational media agencies buy media through sub-contractors (in this case, Mr. Zheng's Huayu) in a complicated system that resembles banks and commodities brokers who make money on margins. One of the perks of using brokers is their ability to store cash earned from rebates and discounts far from the prying eyes of industry auditors, tax authorities and clients.
An advertiser's media budget commonly gets chipped away at several points before it ends up with a TV station, outdoor media vendor or publisher, starting with the initial media negotiation, followed by a scheduling discussion and then the final deal for payment terms. Media buyers, brokers and owners often make private arrangements that are seldom reported back to the advertiser. Individuals and agencies pocket the difference.
"No one can stop these individual deals, because you can't be with people 24 hours per day and control what happens under the table, literally, at a restaurant after a deal is done," said a media expert in Shanghai.
The scandal Vivaki is embroiled in has placed an unwelcome spotlight on that practice and "is bad for the industry. It creates mistrust between agencies and clients," said Quinn Taw, a venture capitalist in Beijing who has worked at GroupM, Zenith Media and China Media Exchange, or CMX, the former name of Vivaki Exchange before a rebranding in January 2010.
"Advertisers will start looking at rebates and conducting quiet audits. They should look at their media business, but they should also look internally," Mr. Taw said. Some suggest that across China media directors and brand managers at multinational companies could be padding personal bank accounts as well.
As executives at multinational marketers get savvier about China and better understand the risks involved, they are putting in place checks and controls to regulate their media cash flow. Some companies like Procter & Gamble Co. and Coca-Cola Co. "are taking strong initiatives to take efforts to prevent this by engaging in three-way negotiations," said Greg Paull, a Beijing-based principal at R3, a consultancy that specializes in agency-client relationships. "To be effective [as a client] you need to have a seat at the table."
But marketers still find it hard to pull the plug on illicit trading deals for several reasons: China is becoming more competitive as well as more fragmented with the rise in digital media, driving buyers and sellers to further bend the rules. As there are more options for spending ad dollars, sellers get more creative about kickbacks and other incentives they can offer to agencies.
"These sorts of things didn't happen 20 years ago when there was only [state-owned national TV network] CCTV to deal with. The problem is that the media sector is getting bigger and more competitive, so there is more pressure on media venders to look for competitive edges," said Mr. Paul.
Further, marketers are moving more deeply into China's harder-to-police second, third and fourth-tier cities, where transparency issues are even murkier than in Shanghai and Beijing. Chongqing, for instance, has a population of more than 5 million in the city itself and over 30 million in the greater urban area, and is considered a second-tier city.
Finally, enormous amounts of money are pouring into Chinese media. Measured media spending in China will reach $45.1 billion in 2010, according to GroupM, a 16% increase over last year, and is likely to hit $49.9 billion in 2011.