The Outlook for Advertising and Marketing Firms

David L. Lindsay, President and CEO, Ontario SuperBuild Corp. and Director. The Empire Club of Canada; Rev. Dr. John Niles, Victoria Park United Church and Director, The Empire Club of Canada; Colleen Moorehead, President, E*TRADE Canada; Beth Horowitz, President and General Manager, Amex Canada Inc.; Ivan Fecan, President and CEO, Bell Globemedia; Sir Andrew Burns, British High Commissioner; Bart Mindszenthy, APR, FCPRS, Partner, Mindszenthy and Roberts Communications Counsel and 2nd Vice-President, The Empire Club of Canada; Frank Maw, President and CEO, Motorola Canada Limited; Alain Batty, President and CEO, Ford Motor Company of Canada; Michael Coates, President and CEO, Hill & Knowlton Canada; and Gordon M. Nixon, President and CEO, Royal Bank of Canada.

Introduction by Ann Curran

Sir Martin Sorrell is Chief Executive Officer of WPP Group plc, a post he has held since founding the company in 1986. Over this period, WPP has become one of the world's leading communications

December 12, 2002

services companies. The group is a member of the FTSE-100, FTSE-Eurotop 300, the MSCI and Business Week's Global 1000 companies. WPP's 90 operating companies, including Hill & Knowlton, J. Walter Thompson, Millward Brown and Ogilvy & Mather provide national, multi-national and global clients with advertising, media investment management, information and consultancy, public relations and public affairs, branding and identity, health-care and specialist communications services. The group employs 64,000 people in 1,400 offices in 103 countries. Clients include more than 300 of the Fortune Global 500 and over half of the Nasdaq 100.

Before founding WPP, Martin Sorrell held a number of positions. From 1977 to 1984, he was Group Finance Director of the advertising agency group, Saatchi & Saatchi Company PLC and instrumental in planning and implementing its international expansion.

His background also includes working as business and financial advisor to British food retail entrepreneur James Gulliver and with the Mark McCormack Organization in London, where he managed the commercial and financial affairs of sports personalities and celebrities.

Now for a man so steeped in the advertising world it may come as a surprise to some of you that he has never penned a line of copy or conducted a pitch to win a client's business. According to the April 2002 edition of Wired Magazine: "Most people are drawn to the creative side of advertising and marketing. With an economics degree from Cambridge and a Harvard MBA, Sorrell saw the beauty of the business side--a great generator of cash, without costly factories, R&D budgets, or inventory to lug around."

In 1986, Martin Sorrell spotted a small, publicly traded manufacturer of wire shopping baskets known as Wire & Plastic Products. He bought control of the company and eventually, through acquisitions, turned WPP into one of the world's largest marketing and communications companies.

Success like this just doesn't happen. The advertising business like many other service industries went through the wringer during the '90s and last year, needless to say, was brutal.

WPP is diversifying--growing the research division, building up Web operations and building a broad worldwide network to handle the rise of a global consumer culture. In fact, Asia and Latin America now account for about 17 per cent of its revenue.

In 1997, Mr. Sorrell was appointed an Ambassador for British Business by the Foreign and Commonwealth Office and subsequently appointed to the office's Panel 2000 aimed at rebranding Britain abroad.

In 1999, he was appointed by the Secretary of State for Education and Employment to serve on the Council for Excellence in Management and Leadership and this year was appointed a member of the Committee for the Special Olympics, serving on the Board.

It is not surprising that the British advertising publication campaign calls Mr. Sorrell "one of the most famous workaholics on the planet."

However, there is a silver lining. Two years ago, Martin Sorrell was knighted in the millennium, alongside Richard Branson, Sean Connery and other distinguished individuals for advancing Britain's stature.

Ladies and gentlemen, I give you Sir Martin Sorrell.

Martin Sorrell

Thank you Madam President and Reverend Niles and ladies and gentlemen. It is a pleasure to be here particularly after such a flattering introduction, which would absolutely delight my mother, but probably nobody else.

You forgot to mention Young and Rubicam and other companies such as Berson-Marsteller and I should mention them. It's not true that I haven't conducted a pitch. I have actually done one or two, but it is true that I haven't penned copy, of which David Ogilvie was always quick to remind me.

I thought I would use this opportunity to talk about how we see the challenges facing our clients. I am pleased to say a number of them are represented on the podium.

I thought I would talk about the challenges that face our clients and to do that I have to talk about WPP. It is not an ad but talking about our strategic objectives sets the stage for what our clients are doing. Obviously if we're going to be successful we will only be successful if we're doing what our clients really believe they should be doing. So I'll talk a little about that and then the thesis is the following: the short-term is going to continue to be tough. I don't think 2003 will be materially better than 2002 or indeed 2001 and certainly nowhere near the stratospherics that we saw in 2000--the tulip mania and the South Sea bubble. It had to stop. It couldn't carry on forever and the correction that is taking place in most of the economies of the world is I think fundamentally sound and healthy. Expectations were raised too high.

Having said that, however, I think things will change in 2004 and some things that have been happening recently give me even more encouragement. I am talking about the changes in administration south of the border. I feel that in 2004 we will witness a change and I will come to that in a minute.

In the long term, I think the underlying trends for the advertising and marketing services business are very healthy. I think our business, which at its heart is about differentiation (we are in the business of differentiation of products and services), is going to be strong and very successful. In other words, advertising and marketing services as a proportion of GNP will bust through the cyclical highs that we saw in the year 2000 at the top of the next cycle.

Having said that, let me just say three things about WPP, which I think are very important. And those are the three strategic objectives that we have. The first is that currently about 45 per cent of our business is in the United States, about 35 per cent is in Europe and 20 per cent approximately is in Asia-Pacific, Latin America, Africa and the Middle East. It is that last piece that really is the most important part of our future. There are currently a billion people in India and 1.3 billion in China, which in the context of the U.S. market (280 million) really puts it in perspective. By the year 2014, two-thirds of the world's population will be in Asia-Pacific and Latin America. I'd remind you that we are going to have an Olympic Games in 2004 in Athens. The 2008 Beijing Olympics will be a major event. The Chinese government has already committed $45 billion in infrastructure investments around the Olympic Games and last week we saw the Expo 2010 awarded to Shanghai and Shanghai has already invested $3 billion in that market too. It is an extremely strong base for future development. Asia-Pacific, Latin America, Africa and the Middle East will be about a third of our business in five or 10 years' time. So it will be U.S. a third, Europe a third, Asia-Pacific, Latin America, Africa and the Middle East a third.

The second major objective is that our business, which is currently 45 per cent advertising and 55 per cent other (market research, direct interactive, Internet-based activity, public relations and public affairs, branding, identity health care and specialist communications) will switch from 45-55 to one-third - two-thirds. Now that doesn't mean that people in our advertising businesses should get dispirited about the prospects for advertising. What it means is the non-network television parts of our business will become fundamentally important. Cable and satellite obviously. You saw recently the ratings for the end-of-season "Sopranos," the highest audience on cable, certainly higher than anything on network television and we are seeing the ramifications of that in other media such as radio and outdoor and direct and public relations and market research and the like.

And within that, the third objective is also important. Our direct business, our Internet business, not exactly fashionable after the compression that we have seen since 2000 and our research business is about a third of our $6 billion of revenue. So $2 billion of our revenue comes from those areas. Over the next five to 10 years I anticipate it will be half of our business, because measurability, tangible measurability of what our clients do and how they spend their money on communications, is going to become increasingly important. So that's the background on what our clients are doing.

Let me say a little bit about the short term. I've touched on it already.

I don't think we will see a significant economic recovery from the current position until 2004. Why do I say

that? Clearly President Bush will want to be re-elected for a second term. That always underpins the quadrennial cycle which comprises the American presidential election, the Olympic Games which in 2004 will be in Athens, the football cup, the European Cup in Germany, which will also be stimulative, and we'll have heavy political advertising which will squeeze the media markets and improve media pricing in a similar way that we saw in the congessional elections earlier this year in the United States. So I think the basic background for 2004 is strong. But the recent changes in the administration, the treasury secretary and the support to the treasury secretary in time, are indicative of a significant change--a move away from Friedmanite monetarist policies, which concentrate purely on controlling inflation to a more Keynesian fiscal-based policy. The comments made by Treasury Secretary Snow a few days ago are very revealing I think in his reference to the right of everybody to a job. This is the sort of thing that I haven't heard from major administration figures for a number of years, certainly since I graduated from university in the mid-sixties. So I think there will be a shift in financial policy away from monetary policy to fiscal policy. Any invasion of Iraq, if it were to come early next year, obviously would have some fiscal stimulatory effect in the medium to long term although the short-term effects would not be pleasant and there will be considerable dislocation as a result.

The long-term picture I think is much more attractive. And I want to cover four or five points that I think are fundamental to the way our clients think about their business. I should emphasize that about 40 per cent of our business is with 40 major multi-national clients, 29 of whom are based in the United States and North America as a whole, including Canada, about 10 of whom are based in Europe and one of which is based in Asia-Pacific and Latin America. That gives you an idea of the balance of our clients, but the first point really is the background to their expansion. About 20 years ago there was an article written by Theodore Levitt in the Harvard Business Review about globalization. When I was at Saatchi we seized that article and distributed it to clients and we told them that that was the new way of thinking. You may remember that Levitt's thinking was that we were going to market and develop products on a global basis in very much the same way and that advertising and communication would be very similar. I think 20 years on from that article the position is actually very different. I think Theodore Levitt was basically wrong. The consumers are more interesting for their differences rather than their similarities. And I would say only about 10 to 15 per cent of our business is truly global in the Levitt sense.

What's been happening in the last 20 years in our view is not globalization. The world is not being globalized. It is being Americanized. And I don't mean Americanized in the sense of cultural imperialism. I mean economic imperialism. The simple fact is that if you want to develop a global brand or product on a worldwide basis you have to dominate the U.S. market. Why? It's big in advertising. It's about six or seven times bigger than the U.K. market. About 40 or 45 per cent of advertising on a worldwide basis emanates from the U.S. If I want to be more controversial, I could say that almost two-thirds of it is controlled, or to be more politically correct, influenced by U.S.-based corporations, pretty much in the north-east corridor of Detroit, Boston, Chicago, New York and Washington. There are big corporations elsewhere but that's the heartland. If you want to raise money through equity or debt you have to do it in the U.S. markets; they're more efficient; they're more effective. And finally it is their technological lead. I'm hard-pressed to think of any area where the Americans don't have a significant technological lead. The average U.S. multi-national corporation is still 70-per-cent U.S. and 30-percent outside. So there is a lot of global expansion to come. The one check to American hegemony--financial, political and economic--will come obviously from China. And clearly China is the productive base that is the challenge to America in the longer term. So that's the first point.

The second point is that in every single category of our work with clients, there is severe over-capacity. Our largest client is Ford Motor Company. It operates in an industrial segment where world car and truck manufacturers can produce 80 million units. Consumers can only consume 60 million units. There is a clear disconnect there and you can see the way the industry will go. You can see the consolidation of Ford itself, as has been done with Volvo, with Mazda, with Jaguar, with Land Rover. You can see what's happened with GM and what may happen between GM and Renault. You can see Daimler and Chrysler and Mitsubishi, Renault and Nissan. There is more to come. The capacity economics of it means there is more to come.

And what is happening in Detroit at the moment between the big three U.S. based car manufacturers is unpleasant and in the long term probably uneconomic. Led by GM there is heavy price competition. It is not the way to build brands. It is the way to commoditiee products. Giving cars away and giving trucks away stimulate sales but what you've got is really break--even economics at full capacity. That is not a situation that can last in the long term. And if you cut prices, you create commodities. If you build innovation and product you create brands. So you have a situation there as a result of over-capacity which I think in the long term is probably untenable.

The interesting thing is that whilst there is over-capacity in production, where is there under-capacity? And the answer to that is in human capital. In the nineteenth and twentieth centuries the problem was getting goods and services to market. The question was: "Could we produce enough for the consumer?" In the twenty-first century that's not the issue. You have over-capacity in the sectors I've indicated, food manufacturing is another area, telecommunications, computers another area, but there's a shortage of people. All the demographic statistics--birthrates, marriage rates, aging of the population, single-parent families, divorce rates--are indicating that the supply of human capital is going to be under greater and greater pressure. The competitive battle will be between corporations, not on the basis of differentiating their businesses tangibly, but intangibly through lifestyle, philosophical differences, and also by the behaviour of people inside companies.

Motivating the 65,000 people at WPP is a terribly difficult task, particularly so given our multi-branded structure. If we were uni-branded it might be easier. But given the fact that there are dis-economies of scale in our business, keeping the tribes as I call them separate and customer-facing is critically important. But what we have to do is to stimulate and motivate the 65,000 people at WPP and to get them to face in the same direction at the same time. And that is an issue that our clients are facing with increasing intensity. Identifying, rewarding, motivating and keeping people in the long term is going to be critically important.

The next point is the Web. It is fashionable to decry the Web and to say that, since 2000 and the compression that we saw, the Web is no longer as important as it has been. We think completely opposite. One-sixth of our business ($1 billion of revenue out of $6 billion) comes from Web-related activities using a fairly narrow definition. Why do we think the Web is going to continue to be important?

The first reason is that most of our businesses continue to be threatened by disintermediation. Let me give you one example in our business. Our research business, which is another billion-dollar business, traditionally does research in two ways--mail and telephone. We've created an Internet-based panel called Lightspeed, which is connected to 600,000 consumers in North America. We can instantaneously--overnight or during the course of a day--get answers to research issues that historically have taken three to six months to develop. Most CEOs, some of whom are represented in this room, express tremendous frustration that the answers to research issues often come back after the problem is changed. That is an example of disintermediation in our industry. You can also be disintermediated by businesses, which are invested in by institutions in a totally different way. Institutions look at WPP on the basis of growth in margins, growth in cash flow, earnings per share, return on capital, but for the new companies they don't. Despite what happened in the year 2000, and the collapse of many Internet-based companies, they still look at them on the basis of sales growth and market-share growth. So they are evaluated on a different basis.

Another issue is that it still steals your people. We lost a number of people during the Internet boom to the new start-ups--young people, bright people, intelligent people--who didn't want to work in large bureaucratic companies. And a number of them, I'm glad to say, have come back to us. I've conducted re-entry interviews and I expected them to grovel for their jobs. I have to tell you it is bad news. They don't grovel. They would far rather go back to those small, unstructured, entrepreneurial lively companies where they didn't have to deal with bureaucracy The error of apprenticeship is over. The loyalty to companies was destroyed by the downsizing that we saw in the '80s and the '90s.

Two other quick points. The first is the importance of internal communications. I would say that well over half of what we do, somewhat puzzlingly to some people, is actually aimed at internal audiences rather than external audiences. I've talked about the importance of human capital, about getting people to face the same direction at the same time. That is going to be a critically important factor. A lot of the advertising that we do, the branding and identity that we do through companies such as Landor or Enterprise, the research that we do through Millward Brown etc. or Research International, the public relations that we do through Burson or Hill & Knowlton, are aimed at internal audiences as much as they are aimed at external audiences. And the reason for this is very simple. If you can get your people onside internally to your strategy and your structure, they will send out positive messages to customers' suppliers, potential employees, institutional investors, analysts, trade, television, NGOs, the government, all the communities that we have to manage.

And the final point is the issue of distribution. The biggest challenge to most of our clients is the concentration of distribution. You have concentration amongst clients. You have concentration amongst media owners, which is going to intensify. You have concentration amongst agencies, but you also have concentration amongst distribution and retailers. The statistic that I thought was amazing in the recent PNG filing was that 17 per cent of PNG sales go through Walmart. There are more people who go to Walmart than go to church on a Sunday in America. Walmart is a phenomenon. It is a trillion-dollar company already and it's just one of the examples. It's not just concentration in the obvious areas that f have just mentioned. I was talking to one media owner recently and I asked him: "What's your biggest problem?" He said: "Distribution." This is what most package-goods companies will say. Their biggest problem is distribution--controlling distribution or influencing distribution. I said: "How could distribution be important in the context of a magazine and media company?" And he said that 10 per cent of their volume goes through Walmart and Walmart is putting tremendous pressure on the magazine in terms of cover prices on their returns. The real problem for him was that 10 per cent of his sales was significant but for Walmart it was almost a rounding error.

And therefore he was dealing with second- or third-level procurement people who weren't exactly sympathetic to his case.

Advertising was created to appeal over the heads of retailers and wholesalers direct to the consumer. And therefore the role of advertising and the other things that we do outside advertising are going to increase in importance over the coming years.

So to sum up, short term it will not be easy. I don't think 2003 will be an easy year although easier than 2002. I think 2004 will be a much better year. Maybe we will start to worry in 2004 and 2005 about the impact of fiscal stimulation on inflation, but it will be a shift in thinking. I do think in the medium term things will be better. And then finally there are a number of fundamental issues which are driving our clients' businesses and our business that will ensure, I have no doubt, that advertising and marketing services as a proportion of GNP will bust through cyclical highs yet again at the top of the next cycle.

Thanks very much indeed.

The appreciation of the meeting was expressed by Bart Mindszenthy APR, FCPRS, Partner, Mindszenthy and Roberts Communications Counsel and 2nd Vice-President, The Empire Club of Canada.