Opinion

Don Draper would be wrong to be optimistic, and why diversity is a professional necessity

Sir Martin SorrellThose working in the communications industry should prepare for another tough year as global economic growth continues to slow, warns WPP boss Sir Martin Sorrell in this extract from the company’s market update on its annual profits.

The always on, Don Draperish general industry optimism seems misplaced.

To survive in the advertising and marketing services sector, you have to remain positive, indeed optimistic, seeing the glass half-full and industry and company reports generally continue, understandably, to reflect that attitude. 

However, general client behaviour does not reflect that state of mind, as tepid GDP growth, low or no inflation and consequent lack of pricing power encourage a focus on cutting costs to reach profit targets, rather than revenue growth.

Don Draper is mistaken If he’s optimistic, Don Draper is mistaken.

In addition, there seem to be little, if any, reasons for an upside breakout from the current levels of real or nominal gross domestic product growth, which remain stuck around 3 per cent to 4 per cent.

In fact, in recent months, while real GDP forecasts have remained steady, nominal forecasts have deteriorated significantly to under 3 per cent, due to the strength of the US dollar, although the same pundits expect inflation (somewhat optimistically?) to increase in the coming years.

In this respect, oil price reductions, the Iranian nuclear “armistice” and the international currency wars have not been helpful black or grey swans.

The faster growth markets of the BRICs (Brazil, Russia, India and China) and Next 11, located in Asia, Latin America, Africa and the Middle East and Central and Eastern Europe continue to grow faster than the slower markets of North America and Western Europe, although the growth gap has narrowed significantly as Brazil, Russia and China have slowed and the United States and United Kingdom and, even some parts of Western Continental Europe, have quickened.

Geopolitical issues remain top of business leaders’ concerns. The continuing crisis in the Ukraine and consequent bilateral sanctions, continued tensions in the Middle East and North Africa and the continuing risk, despite the negotiated agreement, of a “Grexit” (Greek exit), or even more seriously now, a “Brexit” (British exit) from the European Community top the agenda.

Lower oil prices and first time and continued quantitative easing in Europe and continued easing in Japan may seem to bottom or underpin the recovery and a continued, but somewhat patchy, United States recovery and United Kingdom and Indian strength may help confidence.

But concerns about China, aggravated by the recent renminbi devaluation and stock market decline, and Brazil remain, although we remain unabashed bulls of both.

Countries and opportunities like Indonesia, the Philippines, Vietnam, Egypt, Nigeria, Mexico, Colombia and Peru and now post-Macri Argentina add to confidence (and maybe even Cuba and Iran will), along with a mild recovery in Western Continental Europe, chiefly in Germany, Spain and Italy.

France remains soft, although there are some small signs of improvement.

But there are other “grey swans”, chiefly three.

  • First, will the Federal Reserve pre-Christmas tightening falter, or even reverse and what will be the further impact on bond and equity markets? Although interest rates are likely to remain lower, longer than many anticipate, due to mediocre growth rates, when the tightening comes, as it inevitably will, it may have a dramatic impact on bond and equity valuations, as recent gyrations in the markets indicate. Will continued renminbi weakness, for example, blow the Federal Reserve Bank off course from further tightening in 2016?
  • Secondly, the somewhat surprising result of the United Kingdom General Election (at least to the pollsters), with the Conservatives winning an overall majority, has resulted in an uncertainty-stimulating European Union referendum, now pegged for June 23. In addition, the reduction of the still remaining, substantial, United Kingdom budget deficit, is being re-addressed in the context of a new fixed five year political cycle.
  • Finally, the free fall in the oil price, although effectively a tax cut for consumers, has not resulted, it seems, in increased consumer spending, perhaps due to the lingering, psychological impact of that now infamous weekend in September 2008. Moreover, oil producing states and their sovereign wealth funds have had to pull in their investment horns, which in turn has caused concerns in relation to energy bank loans to both public and private sectors and the liquidity of banks themselves.

So all in all, while clients are certainly more confident than they were in September 2008 post-Lehman, with stronger balance sheets (over US$7 trillion in net cash and limited leverage), sub-trend long-term global GDP growth at around 2.5 per cent to 3.0 per cent real and 3.5 per cent to 4.0 per cent nominal, combined with these levels of geopolitical uncertainty, with low inflation or fears of deflation resulting in limited pricing power, with short-term focused activist investors and strengthened corporate governance scrutiny, make them unwilling to take further risks.

Uber Disrupters like Uber and Airbnb hover

They, therefore, focus on costs, rather than revenue growth. If you are trying to run a legacy business, at one end of the spectrum you have the disrupters, like Uber and Airbnb, and at the other end you have the cost-focused models like 3G or JAB in fast moving consumer goods and Valeant and Endo in pharmaceuticals (although their models are under pressure currently), whilst in the middle, towering above you, you have the activists led by such as Nelson Peltz, Bill Ackman and Dan Loeb, with a perception of stressing short-term performance – maybe they need a marketing campaign to establish they really are long-term? Not surprising then, that corporate leaders tend to be risk averse.

The average “life expectancy” of CEOs is around six to seven years, chief financial officers around four to five years and chief marketing officers two years. No wonder conservatism rules.

Interestingly, the company structures that offend corporate governance with “geared” voting structures, seem to be the ones that encourage more long-term strategic thinking. In these conditions, procurement and finance take the lead over marketing and investment and suppliers are encouraged to play the additional roles of banks and/or insurance companies.

At best, clients focus on a strategy of adding capacity and brand building in both fast growth geographic markets and functional markets, like digital, and containing or reducing capacity, perhaps with brand building to maintain or increase market share, in the mature, slow growth markets. This approach also has the apparent virtue of limiting fixed cost increases and increasing variable costs, although we naturally believe that marketing is an investment, not a cost.

We know from our own annual Millward Brown BrandZ Top 100 Most Valuable Global Brands Survey, that brand investment drives top-line like-for-like sales growth, which, in turn, is the biggest determinant of total share owner return. Investment in the top 10 brands from this Survey annually over the last 10 years would yield a total investment return 300 per cent greater than the MSCI.

We see little reason, if any, for this pattern of behaviour to change in 2016, with continued caution being the watchword.

There is certainly no evidence, based on 2015, to suggest any such change in behaviour, although one or two institutional investors are saying that they are tiring with some companies’ total focus on short-term cost cutting and would favour strategies based more on the long-term and top line growth and the end to quarterly reporting.

The pattern for 2016 looks very similar to 2015, but with the bonus of the maxi-quadrennial events of the visually-stunning Rio Olympics, the UEFA Euro Football Championships and, of course, the United States Presidential Election to boost marketing investments, as usual by up to one per cent or so, above advertising as a proportion of GDP.

Forecasts of worldwide real GDP growth still hover around 3.0 per cent to 3.5 per cent, with recently reduced inflation estimates of 0.5 per cent giving nominal GDP growth, in dollars, of even less than 3 per cent. Advertising as a proportion of GDP should at least remain constant overall.

Although it is still at relatively depressed historical levels, particularly in mature markets, post-Lehman, it should be buoyed by incremental branding investments in the under-branded faster growing markets.

Although consumers and corporates both seem to be increasingly cautious and risk averse, the latter should continue to purchase or invest in brands in both fast and slow growth markets to stimulate top line sales growth.

Merger and acquisition activity may be regarded as an alternative way of doing this, particularly funded by cheap long-term debt, but we believe clients may regard this as a more risky way than investing in marketing and brand and hence growing market share, particularly as equity valuations have been, at least until recently, strong.

The recent, potentially record, spike in merger and acquisition activity may be driven more by companies running out of cost-reduction opportunities, rather than trying to find revenue growth opportunities or synergies.

Financial guidance

The budgets for 2016 have been prepared on a cautious basis as usual (hopefully), but continue to reflect the faster growing geographical markets of Asia Pacific, Latin America, Africa and the Middle East and Central & Eastern Europe and faster growing functional sectors of advertising, media investment management and direct, digital and interactive to some extent moderated by the slower growth in the mature markets of Western Continental Europe.

Our 2016 budgets show like-for-like revenue growth of well over 3 per cent and net sales growth of over 3 per cent.

In 2016, our prime focus will remain on growing revenue and net sales faster than the industry average, driven by our leading position in the new markets, in new media, in data investment management, including data analytics and the application of technology, creativity and horizontality.

At the same time, we will concentrate on meeting our operating margin objectives by managing absolute levels of costs and increasing our flexibility in order to adapt our cost structure to significant market changes.

Flexible staff costs (including incentives, freelance and consultants) remain close to historical highs of above 8 per cent of net sales and continue to position the Group extremely well should current market conditions deteriorate.

Some commentators and analysts believe that the markets are signalling a recession. Whilst some countries may technically go into recession (i.e. two consecutive quarters of negative GDP growth), we do not believe there will be a general recession.

More likely the markets are adjusting to continued low growth; so lower, longer – both growth and interest rates.

Horizontality has been accelerated through the appointment of 45 global client leaders for our major clients, accounting for over one third of total revenue of almost $20 billion and 17 regional and country managers in a growing number of test markets and sub-regions, covering about half of the 112 countries in which we operate.

Emphasis has been laid on the areas of media investment management, healthcare, sustainability, government, new technologies, new markets, retailing, shopper marketing, internal communications, financial services and media and entertainment.

The Group has been very successful in the recent tsunami of media investment management pitches, chiefly in the United States and is now ranked first by RECMA, for both net new business reviews and retentions.

The swing factor between the most and least successful firms totals approximately $5 billion on net new business currently, and even more including retentions and will probably go higher in due course. This has resulted in an increase in our media investment market share to about a third and market leadership in all regions, with North America now at around 30 per cent.

Whilst talent and creativity (in the broadest sense) remain key differentiators between us and our competitors, increasingly differentiation can also be achieved in three additional ways – through application of technology, for example, Xaxis and AppNexus, through integration of data investment management, for example, Kantar, Rentrak and comScore, and investment in content, for example, Imagina, Vice, Media Rights Capital, Fullscreen, Indigenous Media, China Media Capital and Bruin.

Acquisitions

There is still a very significant pipeline of reasonably priced small- and medium-sized potential acquisitions, with the exception of Brazil and India and digital in the United States, where prices seem to have got ahead of themselves because of pressure on competitors to catch up.

This is clearly reflected in some of the operational issues that are starting to surface elsewhere in the industry, particularly in fast growing markets like China, Brazil and India.

Transactions will be focused on our strategy of new markets, new media and data investment management, including the application of new technology and big data.

Net acquisition spend is currently targeted at around £300 to £400 million ($575-765m) per annum, excluding slightly more significant “one-offs”, like IBOPE in Latin America and comScore.

We will continue to seize opportunities in line with our strategy to increase the Group’s exposure to new media and data investment management, including the application of technology and big data.

Diversity

WPP companies have always been conscious of the need for diversity in the workplace; and not just out of a sense of moral responsibility, which we take very seriously. On behalf of their clients, our companies’ people are responsible for understanding, and appealing to, just about every one of the world’s 7 billion citizens.

And while we have never believed that only a teenager can understand a teenager or only a pensioner can understand a pensioner, there can be no doubt that diversity among our people is a professional necessity.

For us, diversity is not simply a question of race, colour or gender; at least as important is a diversity of attitude, of mind-set, of ways of approaching problems.

Uniform, conventional thinking will never of itself meet the demands of our clients.

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