Demystifying
Advertiser “Hot Buttons”
Presented to the ANA Task Force September 13, 2005
by AAAA Task Force
1
“Hot Buttons”
• At our last meeting, we heard that several ANA
members have identified three agency expenses
as “hot buttons” specifically:
– Bad Debts
– New Business Costs
– Parent Company Service Fees
We would like to talk about these today.
2
Bad Debts
What are Bad Debts?
• Be definition, Bad Debts are “a sum of money
owed that is unlikely to be repaid”
• For Agencies bad debts represent billings not
paid by advertisers
– Usually bankruptcy related
– Bad debts are not related to Intra Agency
billings
3
Bad Debts (Cont.)
• All businesses have bad debts – some more than others
• Bad debts are anticipated and budgeted cost of doing business in
most industries
– Cost built into pricing
– Bad debts typically represent a very small portion of agency
overhead barring a major client bankruptcy.
• US GAAP requires that Accounts Receivable be recorded at net
realizable value, and a bad debt recorded to reflect uncollectible
billing
• Bad debts are legitimate business expenses and are 100% tax
deductible under the US Tax Code
• Which businesses do not have bad debts? We cannot think of any. 4
Bad Debts (Cont.)
• We are curious why bad debts are being singled
out in Agencies as “hot buttons” when all
businesses have them, they represent bills not
paid by advertisers and are a cost of doing
business similar to any other business.
5
Bad Debts (Cont.)
Example – Bad debt impact on overhead
Background
Tom’s Department Store was a client of XYZ Agency for several years and
its revenue served to reduce Agency overhead for the years 2000-2003.
In 2004 Tom’s Department Store went bankrupt. Because of the bankruptcy
Tom’s did not pay XYZ Agency billings in year 2004 resulting in a Bad Debt
expense in 2004.
•
Questions
Why is the 2004 bad debt on XYZ Agency an issue with some advertisers?
•
If an advertiser does not want to include the bad debt charge in XYZ Agency
overhead in 2004 should it be rebilled for Tom’s Department Store overhead
adjustment for 2000-2003 to remove positive benefit Tom’s Department
Store revenue contributed to XYZ Agency overhead?
•
If answer is no, would that seem contradictory?
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New Business Expense
What are New Business Expenses?
•
Equivalent to R & D or customer acquisition costs
–
•
Both seek to develop new products (clients), processes and innovations which will generate future revenue
streams and ensure existence of the company, funded from current operations.
In the agency business, New Business is a regular, recurring expense, required to replenish the
agencies’ revenue stream, reflecting the relationship or assignment life cycle
–
–
If on average a traditional agency – client relationship lasts 5-6 years (latest AAAA estimate), then an agency
must replace 15-20% of its client base each year
With today’s increased emphasis on projects and below-the-line work, many agencies in fact need to replace
anywhere from 25% to 75% of their revenue base every year.
•
New Business activities ensure a steady revenue stream and client base, over which a relatively
fixed overhead base is allocated, keeping overhead rates for all clients lower
•
New Business expenses are typically research, presentation and other out of pocket expenses
incurred in the effort to secure new clients
•
U.S. GAAP defines R & D as research and development costs to translate the research into a new
process, improve/develop an existing process, product or client resulting in future revenue streams.
–
–
–
•
According to GAAP R & D costs must be expensed in year incurred.
New business/R & D/Customer acquisition costs are fully deductible under the US Internal Revenue Tax Code;
in fact US government provides tax credits to stimulate R & D spending.
R & D costs are built into advertiser pricing even unsuccessful R & D/Customer acquisition ventures
Virtually all companies have new business or R & D costs.
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Top 20 Companies
Ranked by 2002 US R&D Expenditures
Rank
Company
R&D Expense
$Dollars in Billions
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Ford Motor Co
General Motors Corp
Pfizer
IBM
Microsoft
Intel
Johnson & Johnson
Motorola
Cisco System
Hewlett-Packard
Merck & Co
Lucent Tech.
Bristol Myers Squibb
General Electric
Lily (Eli) & Co
Wyeth
Sun Microsystems
Delphi Corp
Boeing Co
Texas Instruments
$
7,700
5,800
5,076
4,411
4,307
4,034
3,957
3,754
3,448
3,312
2,677
2,310
2,218
2,215
2,149
2,060
1,832
1,700
1,639
1,618
Source: Industrial Research Institute, Inc. 2005
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New Business Expense (Cont.)
• Why is new business important to Agencies?
– Ensure a steady revenue stream and client base
– Keeps overhead rates lower, by allocating fixed overhead over a
larger client base
– Provides insights and market research to expand Intellectual
Property of agency
• Builds overall Agency knowledge base, benefiting all existing clients
– Allows existing staff to work on variety of accounts/ industries
– Allows Agency to continue to attract and retain top talent
• Provides access for new talent with marketing experience in new
industries
– Identifies new processes
– Fosters positive culture and momentum
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New Business Expense (Cont.)
Questions for those who label new business a “Hot Button:
Would these advertisers …
• want dedicated agencies with no other clients?
• want their agencies not to pitch new business?
• allow their agency to work on competing brands?
• be pleased to forego the related overhead reductions or
knowledge gained through new business efforts?
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Parent Company Service Fees
What are these costs?
• Fees cover services that would ordinarily be borne by the Agency if it
were a stand-alone company, including allocation of expenses such
as audit fees, tax preparation, legal services, membership dues,
insurance costs, & centralized services (e.g. accounting, IT, HR, etc.)
• Typical costs included in service fee:
– Payroll, human resource + benefit processing admin
– Corporate insurance
– Tax research, planning and preparation (payroll, sales + use,
state, federal, property tax)
– Real Estate Management
– Information Technology Management
– Consolidated Purchasing Management
– Professional Fees
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Parent Company Service Fees (Cont.)
• The following are not included in Parent Company
Service Fees:
– Profit
– Restructuring, or acquisition costs
– Goodwill amortization
12
Parent Company Service Fees (Cont.)
• Typical business/accounting + tax treatment for all multinational and
domestic companies with multiple locations/divisions (A Best
Practice)
– All companies have these charges
• Represents value received by operating units for services purchased
centrally to leverage purchasing power
• Cost Efficient: If services purchased individually costs would most
likely increase
• Excluding these costs does not present true cost of operating unit
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Conclusion
• We are confused why these three expense items
would be considered “hot buttons” by some ANA
members
• It is our understanding that all companies have
these expenses and exclusion of any would be
inappropriate “cherry picking” without business
justification.
• Thank you – we would appreciate your help in
clarifying.
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