In theory, 2007 should have been a weaker year, since it is one of the two years in the quadrennial cycle that has no notable events. It did not prove to be so, as two major opportunities continued to drive our business – the faster-growing geographic markets such as Brazil, Russia, India and China, (the BRICs) and the new Goldman Sachs' 'Next 11' (Bangladesh, Egypt, Indonesia, Iran, South Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey and Vietnam); and the growing impact of new technologies on our media consumption habits, such as personal computers, mobile and, most important of all, video.
In addition, clients also realised that like-for-like growth could be stimulated by increased spending on differentiation of products and services, as in 2006. The industry will probably grow at more than 4% in 2008, and probably faster than 2007, with marketing services outpacing advertising, driven primarily by growth in direct, interactive and internet marketing.
2008 should again be a good year, despite the sub-prime, insurance monoline, house prices and private equity crises, reflecting three major events which drive client spending and normally add 1-2% to worldwide spending – the Beijing Olympics, the 2008 US presidential election and the European Football Championships. As we know, the political campaigns have started early, as far back as the summer of 2006, and the tight race for the Democratic nomination will continue to drive above-the-line spend towards $3 billion. Goodness knows what it would have been if Mayor Bloomberg had entered the race. 2008 may see growth stronger than 2007, with 2009 slowing to 3-4%, as the real world catches up with the financial markets and the disconnect disappears.
In early 2009, a new US president may have to deal with part of President Bush's legacy – a fiscal deficit, a trade deficit and a weak dollar. In a way, we are back to where we were almost 16 years ago, when President Clinton entered the White House. Faced with Congressional mid-term elections in 2010, the new president may want to kitchen-sink the economic situation, (as any new CEO does in any company to lower expectations), call foul and claim the books were in worse shape than he or she ever imagined because of over-spending – which may be true in this case, as the US government continues to hire, despite falling overall employment. Withdrawal from Afghanistan and/or Iraq would also be deflationary.
Faced with all this, any unpleasant electoral news, such as increased taxes or decreased government spending, will be delivered quickly. In addition, China cannot continue to grow its GNP at 10% per annum forever. There must be some cyclicality, although the long-term prospects are still very good and we remain bulls on China. There must be some relaxation and the post-Olympic year of 2009 will probably be that year.
2010, a so-called mini-quadrennial year, should see a return to growth for the industry at 4%-plus, as we see the impact on client spending of the Winter Olympics in Vancouver, the FIFA World Cup in South Africa and the mid-term Congressional Elections in the US. China, also, is likely to see stronger growth due to the impact of the Shanghai Expo and the Asian Games in Gaungzhov.
2007 was an excellent year; 2008 has started well. The Company continues to be in its most robust position since 2000. Revenue growth, cost management, productivity, liquidity and balance sheet strength all continued to improve over last year and continue to do so in 2008. Most important, our talent base continues to strengthen, particularly as we invest in increasing headcount in 2007 and in 2008, adding almost 10,000 people to our over 100,000 people each year.
As for 2008, there may be two principal concerns: America's twin deficits, and Western Europe's stagnation. How long growth can continue when the US government continues to run current account and fiscal deficits remains to be seen. The American consumer remains under pressure from the financial crisis and declining house prices and chairmen and CEOs do not seem willing as yet to raise corporate capital spending consistently to bolster the economy, which – in our view – remains patchy.
The 2000 recession was stimulated by a sharp decline in corporate capital spending, which was then ameliorated by stronger consumer spending. The reverse has not happened yet, notwithstanding the absolute levels of corporate profitability, liquidity and margins. Profits as a proportion of GNP are at a 50-year high. At the same time, inflation stimulated by commodity price inflation, in oil and steel in particular, has returned, and the dollar has weakened. Perhaps this is an old-fashioned approach, but operating beyond one's means seems perilous to us. And a country's currency, we think, comes close to representing its 'stock price'.
Our second worry is that Western Europe continues to stagnate, although there have been signs of improvement. France, Germany, Italy and, to a lesser extent the UK, resemble a mature company in a mature industry. There is little top-line growth. With healthcare and pension costs becoming an increasing burden, unless relative interest rates decline and growth is stimulated by further broadening of the European Union, for example by the early entry of Turkey or by more liberal corporate and social tax policies, Western Europe may be trapped in a sluggish, lack-of-growth scenario, falling further behind the US and Asia Pacific. Social and structural costs are significant elements of this concern. The recent extension of transfer of undertakings legislation in the EU (TUPE), for example, represents another burden to bear. In certain circumstances, it is possible that having won an account, the winning agency would have to take on the losing team or pay severance.
Despite these issues, there is evidence – particularly in 2005, 2006, 2007 and the early part of 2008 – of a growing focus on top-line growth. Given a low-inflationary environment, limited pricing power and more concentrated retail distribution, clients are increasingly coming to the view that there is only one way to compete – through innovation and branding. Promote on price and you create commodities. Innovate and differentiate, you create brands and the right to demand a premium from the consumer.
There is a growing realisation that cutting costs alone will not deliver growth targets promised to Wall Street and the City of London. There is a limit to cost reduction, but no ceiling on top-line growth – at least until you reach 100% market share. Reinforcing this trend, strategic advisors, such as management consultants like McKinsey and Bain, counsel a switch in focus from costs to revenues. Corporate strategic plans are increasingly concentrating on managing for growth, instead of managing for value.
Furthermore, in recent months there has been growing inflation in commodity prices and a resulting increase in input costs. In an increasingly inflationary environment, clients have more pricing flexibility. As a result, package-goods clients or fast-moving consumer goods companies, which account for 20-25% of our business, have been forced and have been able to pass on price increases to retailers, who have chosen to pass these increases on to consumers or absorb them. Consequently, steep price increases have been obtained even in commodity categories, such as paper towels and toilet tissue. The danger is that the manufacturers price themselves out of categories, against private label or in faster-growing markets, where domestic competitors brand less and price-promote more.
Finally, managements may be just plain tired of grappling with debilitating cost-management programs. For the past three or four years, there has been an inexorable focus on cost. It is much more fun to focus on growth – perhaps this partially explains the surge in merger and acquisition activity before the sub-prime crisis.
Our acquisition focus in 2007 has been on the twin opportunities of faster-growing geographic markets and technologies, totally consistent with our strategic objectives in the areas of geography, new communication services and measurability.
Our largest acquisition in 2007 was 24/7 Real Media. It was much commented on for two main reasons. First, it was a radical departure from digital agency acquisitions in our industry and followed Google and later Microsoft into the application of technology in our industry. We believe that the nature of our business is changing radically. Whilst talent and creativity remain central and we do invest $7 billion a year in talent, versus only $350 million in capital expenditure, given the rise of new media, which is more targeted, technical and precise, we are having to hire different talents and build new capabilities – involving more detail, engineering and measurability. Second, the pricing, at approximately three times revenues and over 20 times EBITDA, was expensive – although not as expensive as others. We felt that strategically this was an important move and it has proved to be so, offering us interesting opportunities and flexibility in competition with non-traditional competitors.
24/7 Real Media's search business has been merged with GroupM to create a new leader in search marketing. Its technology business continues to thrive and grow. The only area where there is a need to grow faster is in media sales, particularly in Europe.
Our competitive world is becoming more complicated and 24/7 Real Media clearly differentiates us from our traditional competition and was a contributory factor to our unprecedented run of new business in 2007.