Merger Mania at Ad Agencies Just Won’t Sell

Hype strikes again. Another big buyout looms in the advertising world with the $725-million bid by Britain’s WPP Group to take over Ogilvy & Mather, which would be the latest of half a dozen U.S. ad agencies to be bought by British companies.

At the same time, U.S. companies have bought British agencies, French advertising companies are threatening to buy the British--and Dentsu of Japan, one of the world’s largest ad agencies, hasn’t even entered the fray.

What’s behind it? The concept of global media. That’s the idea that because hundreds of millions of people in many countries now buy similar, if not identical products--a Toyota in France being little different from one in Bangkok or Baltimore--the communications media have a growing value.

The spirit driving advertising mergers is similar to the thinking behind Time Inc. merging with Warner Communications, or Sony buying CBS Records, or Rupert Murdoch owning newspapers on three continents and launching satellite TV channels. The idea is that a global communicator can reach more customers economically than a national one.

The difficulty is in deciding which medium to put your money on. Newspapers have survived competition from TV, but now worry about direct-response advertising through the mails and computers. Broadcast television is worried by cable, and cable is worried by potential competition from telephone companies stringing fiber optics into the home.

The only certainty, it seems, is that an advertising agency will be part of the process of reaching customers. No matter what medium is used, the agency will channel the advertiser’s message.

As Alan Gottesman, analyst for the Paine Webber investment firm, sums it up: “If you’re not sure which spoke will bear the weight, it always makes sense to bet on the hub.”

Behind the Scenes Fees

That’s the concept, and financial markets are buying it. But a caution here for investors who might think that advertising firms are sure-fire merger candidates: There’s a flaw in the concept and a weakness in the current takeover wave.

So be wary as you see consolidation in the ad business continue, as it will. For there are reasons smaller firms are merging into larger holding companies. It has to do with fees and services behind the scenes, where the money really is made in the ad business.

The ad game may be known for creative symbols, from the Volkswagen bug to the California raisins, but the money is made in less glamorous production services, in fees for filming and printing, for distribution, for this and that service. Ogilvy’s attraction for WPP in fact may lie less in its stylish ads than in its No. 1 position in direct response advertising.

“Today’s merger makers are not ad people,” says Jerry Della Femina, head of Della Femina, McNamee WCRS Inc., “they’re building communications companies.”

Yes, but if that’s such a good idea, why aren’t big American investors--the Bass brothers or the Pritzkers--being more aggressive about it?

Simple. Because advertising is becoming a less profitable business. That’s where the flaw is. The big companies being created are not inherently more profitable than the smaller firms they’re gobbling up.

Advertising companies as a rule made higher returns on capital years ago than they do today. That results, says Gottesman, from international giants adding staff and costs at the same time that advertisers are driving down the rates they’re willing to pay.

So costs are growing but not profits--guaranteeing that someday soon the very companies now being put together will be dismantled.

But meanwhile, if you’re small, you’re at a disadvantage in bidding for business, says Della Femina--a creative legend who recently gave us the Joe Isuzu commercials. Della Femina sold out last year to a British firm, White, Collins, Rutherford & Scott.

The British have been most prominent in advertising mergers: Saatchi & Saatchi owns Ted Bates, Dancer Fitzgerald Sample and Backer & Spielvogel; WPP owns J. Walter Thompson and now wants Ogilvy.

But an accounting anomaly helps explain that prominence, and therein lies another weakness in the current takeover wave. British accounting rules allow firms to increase reported profits through mergers faster than would be the case for U.S. companies.

That makes British ad firms look more profitable than they otherwise might be and also indicates that the economics behind those takeovers is artificial. To the extent that it is so, the merger wave is vulnerable to correction in the stock market.

But correction may not come immediately. The latest news is that French advertising agencies are threatening the British with takeovers.

So the buyout game will go on until that moment when somebody wakes up and asks whether merger prices make sense--that moment, as Madison Avenue might put it, when they run up the flag and nobody salutes.