WPP’s ad spend warning is probably not worth worrying about

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In the coal mine of financial commentary, everything’s a canary. A reader of these pages might be forgiven for thinking the average coal mine has more canaries than coal.

It’s with some caution then that we note the warning from WPP that US tech companies have been cutting ad spending. On an otherwise quiet Friday in the UK market it’s been an easy hook for commentary, such as this, from stockbroker AJ Bell:

Advertising agencies are a good proxy for the state of the economy. If corporates are worried about the near-term outlook, they cut back on advertising and marketing. If they’re bullish, they spend more on promotions.

The fact WPP has issued a profit warning is telling. The problems lie with US technology companies, many of whom have spent this year slashing costs across their business, including jobs. Many over-hired as we came out of the pandemic and are now having to right-size operations. Paying close attention to money coming in and money going out will naturally lead to a sharper eye on marketing and advertising expenditure.

WPP’s cut follows similar caution last month from Omnicom, as well as a profit warning from Martin Sorrell’s S4 Capital, so isn’t wholly unexpected. What’s slightly surprising is the speed of deterioration: WPP’s US organic growth went from 1.9 per cent in the first quarter to minus 4.1 per cent in the second. Even though other regions accelerated the first quarter, targeted full-year organic growth goes from 3-5 per cent to 1.5-3 per cent.

WPP is the most tech-exposed of the big ad agencies; the sector contributed nearly 18 per cent of first-half net sales. Much of the miss has therefore been anticipated, with this year’s consensus organic growth forecast having moved down to 3.3 per cent, so the EPS cuts will be tiny. Downgrades you’ll see ticking through over the next few days have more to do with sterling strength, with the current exchange rate knocking 2023 and 2024 sales and margin expectations by 2 per cent each.

Since ad spend is discretionary it can be a reasonably reliable lead indicator for company performance, and for economic activity, though there are lots of moving parts at the corporate level. About a third of big agency revenues come from media buying, which is unforgivingly cyclical. Consultancy projects like big-data wrangling make up about a quarter of revenue and are considered secular, with the Cubitts-and-silver-straws creative types residing somewhere in the middle.

For that reason it’s worth looking at WPP numbers by vertical rather than territory. Its hyper-cyclical media buying division, GroupM, reported 6.1 per cent growth with no slowdown from the first quarter. Agencies slowed a bit, to 2.2 per cent growth from 3 per cent the quarter before, but it was creative that took a bath, going from 0.7 per cent growth in Q1 to negative 0.8 per cent in Q2. As WPP says, the US tech spending cuts were “felt primarily in our integrated creative agencies”.

A few years ago, prompted by Procter & Gamble bringing media planning in-house, investors had a panic about creative revenue as companies including Lloyds Bank, M&S Food and Three set up their own internal agencies. It hasn’t played out exactly as expected. The main beneficiaries of insourcing seem to be specialist consultants, probably because they can make impressive Powerpoints about digital transformation then take the blame when things go wrong. The big-three of Accenture, PwC and Deloitte have muscled in to take an almost 25 per cent share of global ad spend, from zero a decade ago.

Competition means that for the traditional ad agencies, the trend since 2016 has been fading organic growth — albeit distorted by a big blip around Covid. The below chart (from an outdated Morgan Stanley note) is for WPP; the one for Publicis is almost identical:

And the link between agency revenue and GDP has become less convincing as a result, per this chart from JPMorgan:

To be sure, tech’s not having a blowout quarter. Most problems stem from China supply chains, as they have not recovered fully from last year’s Covid shutdowns, and interest-rate sensitive end markets like auto manufacturing. Microchip said December quarter shipments would be weaker than expected while Apple (a company big enough to generate its own cycles) reported its third quarter in a row of declining sales.

On the flipside, Amazon’s behemoth AWS cloud computing division reported better operating margins after more than a year of declines, suggesting customers are back to deploying new stuff rather than just squeezing costs. There’s not much here to disrupt the “no-landing” narrative.

It’s worth remembering also that incremental changes in global ad spend are often explained by the often obscure actions of just two companies:

All of which means that ad agency updates tell us lots of useful things about ad agencies, but not that much about macroeconomics. The canary’s fine. Probably.