Current progress and future prospects
The second quarter of 2011 continued the improvement in like-for-like revenue growth seen in the first three months, despite tougher comparatives, with year-to-date like-for-like revenue up over 6% and gross margin up almost 7%. July revenues were up 4.3% and gross margin up 5.2%, against even tougher comparatives. Cumulative like-for-like revenue growth for the first seven months of 2011 is now 5.9% and gross margin 6.6%. The Group's quarter two revised forecast, having been reviewed at the parent company level in the first half of August, indicates very similar levels of like-for-like revenue growth and gross margin growth for the year.
Our budgets for 2011 indicated like-for-like revenue growth of 5.0%, gross margin growth of 5.3% and operating margin improvement of 0.5 of a margin point. The quarter one revised forecast raised the revenue and gross margin forecasts to over 6% respectively and the operating margin forecast improved too, as indicated by the actual improvement in operating margin of 0.7 of a margin point in the first half. As mentioned above, the quarter two revised forecast for the full year, indicates very similar levels of like-for-like revenue and gross margin growth to the first seven months and, in addition, indicated further possible operating margin improvement beyond that reported in the first half.
Any slowdown in the growth rate in the US is forecast to be balanced geographically, by faster growth in the UK, Western Continental Europe, from admittedly low levels, and faster growth in Asia Pacific, Latin America, Africa and the Middle East and Central and Eastern Europe. Functionally, any slowdown in traditional media spending, is similarly forecast to be covered by increasing digital spending and, in our case, by continued growth in media investment management.
Whilst it is too early to predict the impact of the recent vicious correction in the world's equity markets on consumer and corporate behaviour (there have been no resultant cuts to date), these forecasts and significant recent very successful new business activity are encouraging signs, despite stock market pessimism – pessimism which is much greater in our sector in Western Europe than in the US, reflecting the better performance of American-based media owners, particularly American-based television media owners, to date. There does seem to be a dissonance or disconnect between the macro picture as defined by the stock markets and the micro picture as defined by individual company results, which have continued to be generally better than expectations into the second quarter. It is true, however, that markets look to the future, often a year or so in advance, and are rarely wrong.
2009 was, as you know, a brutal year, when following that fateful Lehman weekend in September 2008, many clients thought the financial world might come to an end and focused relentlessly and, even ruthlessly, on cutting costs and on liquidity.
The mini-quadrennial year of 2010 saw a very significant recovery, particularly in the US and in traditional media, as clients realised that the world had not actually come to an end. The US and traditional media bit back. Categories that had cut spending severely, like autos, financial services and retail, amongst others, returned to spending. Excess traditional media inventory resulted in lowered prices and made traditional media more attractive absolutely to advertisers and relatively to new media. The Winter Olympics in Vancouver, the World Cup in South Africa, the Shanghai World Expo and the US Congressional mid-term elections, all stimulated the level of spending and reinforced any element of dead-cat bounce generated by the massive fiscal and monetary stimulus post-Lehman. Finally, and probably most significantly, boardroom fear may have encouraged chairmen, CEOs and non-executive directors to rein in fixed capital spending and focus more on brand spending to maintain or increase market share. Why increase fixed costs in uncertain times, when you can increase or maintain sales by increasing variable marketing expenditures – even if we think marketing spending should be a more fixed investment, not a variable cost? Currently, as a result of this conservatism, Western-based companies may have as much as $2 trillion sitting on relatively unleveraged balance sheets and we have had a relatively jobless recovery.
2011 has, so far, exhibited a similar pattern to 2010, except, as predicted in our budgets and in our reporting to share owners, the rate of growth in the US has slowed. However, this has been compensated (last year's like-for-like revenue growth was 5.3%), by good growth, again somewhat surprisingly, in the United Kingdom and some growth, admittedly from very low comparative levels, in Western Continental Europe and by a "last-in, last-out" recessionary recovery in Asia-Pacific, Latin America, Africa and the Middle East and Central and Eastern Europe. Functionally, direct, digital and interactive have resumed their relatively stronger growth rate, when compared to traditional media. Newspapers and magazines, in particular, remain challenged, although the apparent success of charging for content, that consumers value, has helped somewhat. In essence, China and the internet have bitten back in 2011 and regained their strategic importance and inexorable growth, at least for the moment.
Despite these encouraging signs there remain significant challenges, even before the recent stock-market meltdown. First, there have always been fears of Euro contagion, which have oscillated quite violently and are now firmly focussed beyond Ireland, Portugal, Spain and Greece, on Italy and even to France. Second, there have always been concerns about the failure of the US Government to address the growing Federal deficit. It seemed that the rubber might not hit the road until after the US Presidential election, but the recent Presidential and Congressional indecision and the Standard and Poor’s downgrade, seem to have brought concern about the potential crisis forward, although the relatively mild actions agreed, will probably postpone the really evil day again beyond the Presidential election in November 2012. Third, there was and still is concern about the increase in commodity input prices and its potential impact on profit margins, particularly if pricing power continues to be limited, although recent inflation seems to have helped, particularly in the FMCG sector. Fourth, political events in the Middle East, apart from slowing the rate of growth of the region have increased levels of uncertainty. Fifth, the tragic events in Japan slowed growth even further in the world’s third largest economy, despite its 20 year stagnation, although the rebound seems faster than at first thought, due to the positive effects of heavy renewal investment. Finally, and what probably triggered the stock market fears, was the need to initiate the inevitable withdrawal of the massive fiscal stimulus, which was needed to stabilise the world economy post-Lehman and which may have amounted in total to about $12 trillion or 20% of worldwide GNP. Going cold turkey and weaning the economy off the stimulus drug is clearly painful and will take some time. The nearest historical parallel to the latest recession, which started with the sub-prime and insurance monoline crisis in August 2008 seems to be the Great Crash of 1929, which took at least 10 years to recover from – a long hard slog.
So in summary, so far so good in 2011, with forecasts in reasonable heart, but there are storm clouds and we still have to see how the latest stock market crisis affects consumer and client thinking and actions. Although there could be changes in the pattern of behaviour after the Western summer holidays in August and after Labour Day in the US, given the fact that most client budgets and plans are calendar year, any impact may not be felt until 2012. And in 2012 we will have the maxi-quadrennial positive impact of the London Olympics and Paralympics, the Eastern European-based UEFA European Football Championships and, most importantly, the US Presidential elections (where political spending alone may reach $4 billion), all of which usually add at least 1-2% to worldwide demand for advertising and marketing services. The ‘LUV’ or ‘LuVVy’ shaped recovery remains battered but intact, particularly with the world moving at different speeds both geographically and functionally, but there is need to exercise significant caution.
For the remainder of 2011, the focus will continue to be on ensuring that our operating companies balance revenue, gross margin and headcount growth, while at the same time capitalising on the various client and market opportunities that continue to arise and investing in both existing and new talent, where necessary. Given recent events our operating companies will be even more cautious about hiring additional staff in the balance of this year.
Plans, budgets for 2012 and forecasts will, therefore, be made on a conservative basis and considerable attention is still being focused on achieving margin and staff cost to revenue or gross margin targets. Margins have recovered in almost all important parts of the business and overall are approaching pre-Lehman pro-forma levels of 14.3%, the attainment of which would be a considerable achievement. In addition to influencing absolute levels of cost, the initiatives taken by the parent company in the areas of human resources, property, procurement, information technology and practice development continue to improve the flexibility of the Group’s cost base. Flexible staff costs (incentives, freelancers and consultants) have returned to historical highs of around 7% of revenues and continue to position the Group well, if current concerns result in client budget cuts.
The Group continues to improve co-operation and co-ordination between companies in order to add value to our clients’ businesses and our people’s careers, an objective which has been specifically built into short-term incentive plans. Particular emphasis and success has been achieved in the areas of media investment management, healthcare, corporate social responsibility, government, new technologies, new markets, retailing, internal communications, financial services and media and entertainment. The Group continues to lead the industry, in co-ordinating investment geographically and functionally through parent company initiatives and winning Group pitches. Increasing co-operation, although more difficult to achieve in a multi-branded company, which has grown by acquisition, than in an organically grown uni-branded one, remains a priority.
As economic progress, particularly in the West, continues to be, and is likely to remain a 'slog', the Group continues to concentrate on its long-term targets and strategic objectives of improving operating profits by 10-15%; improving operating margins by half to one margin point per annum or more depending on revenue growth; improving staff cost to revenue or gross margin ratios by 0.3-0.6 margin points per annum or more depending on revenue growth; converting 25-33% of incremental revenue to profit; growing revenue faster than industry averages and encouraging co-operation among Group companies.
As clients face an increasingly undifferentiated market place, particularly in mature markets, the Group is competitively well positioned to offer them the creativity they desire, along with the ability to deliver the most effective co-ordinated communications in the most efficient manner. The Group’s performance this year at the Cannes Advertising Festival, the industry’s most prestigious event, was particularly pleasing – winning the Lion for the leading group in the world with the most creative awards.
Even as economic stress levels increase and intensify, the Group’s strategic focus on new markets, new media and consumer insight, along with the application of technology and data analytics will become even more important. Clients will be increasingly looking for growth, advice and resources in the BRICS, CIVETS and Next 11, in digital communications and in understanding consumer motivations and changing media consumption habits. Your Group is ideally placed to deliver.