Once upon a time, marketing agencies were profitable businesses. They were tough to get into and get the first few accounts, but competition was reasonable and the business model provided sufficient profit margins.
Today, that is no longer the case. It is very easy to get into the business, but it’s very hard to grow an agency and make money for many reasons.
Here are six of the toughest challenges to growing an agency.
In this article:
Scaling: An inherent service business predicament
The most profitable businesses scale very well — the cost of both adding more customers and servicing customers drops as more customers are added. This is not the case with service businesses.
The only two ways to scale a service business are to land large, multimillion-dollar projects or to offer repeatable services sold in mass quantities. The first is very difficult in a field saturated with firms and new entrants, especially since the marketing field is shifting away from retainer contracts to individual projects. The second method, inspired by product companies, is just as difficult to pull off as it requires the particular service to have a large customer base and resemble a product that can be componentised and mass produced.
By definition, service businesses offer a custom solution for each customer. Therefore, a project done for one customer cannot be resold to another, at least not without significant customization and changes that result in significant new costs. According to a report by The Economist, the traditional marketing skills of creative, graphics, advertising, and branding are resistant to scaling.
This is in direct contrast to the software companies that compete in digital marketing. For example, consider Facebook’s native advertising platform. Facebook must hire software engineers and graphic designers to create the platform, but it does not need to hire them at a rate directly proportional to the number of clients using its advertising. Revenues can grow much faster than costs.
Similarly, small agencies must find ways to increase their ability to scale, meaning they must efficiently find new customers and service them at a much lower cost than they currently are.
For marketing agencies, the threat of competition is acute: A 2019 study on digital agencies by website builder Wix found that competition is the top challenge. There are relatively low costs to setting up a new digital marketing agency, so it is easy for new competitors to appear at any time. Fifty percent of agencies named competition as an issue, while the second greatest challenge noted was adapting to new technology.
Growing competition from everywhere
Competition especially affects smaller firms: 94% of digital agencies have fewer than 50 employees. Yet, competition for clients among these firms is greater than that statistic implies. The majority of large
firms are agency holding companies that own a number of specialized agencies. Consequently, these large companies can work with competing businesses and capture different segments of the market.
New technologies are constantly revolutionizing the face of digital advertising, while new businesses launch in response to innovation. Recessions actually increase competition as laid-off workers start their own businesses. Despite current economic turbulence and high unemployment, the rate of new business growth remains high.
According to the U.S. Census Bureau’s Business Formation Statistics (BFS), new business applications grew each year from 2013 to the present.
In 2020, business applications increased 54.2% over 2019. The scale of the competition is daunting: The Digital Marketing Agency Industry Report estimated a 23% increase in the number of new firms since 2019.
Given this striking growth, small agencies must find ways to compete and win in the face of such relentless competition from everywhere.
Differentiation: Both necessary and a hurdle to growth
In software and other product companies, the differentiation scales with the product. Whether a vendor produces one or one million softwares or products, each one contains the same differentiating feature.
With service, the differentiating feature is the service provider — the intellectual capital found within the individual doing the work. The differentiator, the creative work, is custom and doesn’t scale. This is a paradox in that to compete and win business, marketing agencies must differentiate from competitors and demonstrate value beyond what in-house marketing teams can provide. Yet, this differentiator becomes the hurdle to scaling and growing.
There is also a skills gap in the marketing world between agencies that need employees with technical and soft skills and the job candidates on the market. A report by The Economist and Marketo, which surveyed marketing executives worldwide, predicted this talent gap would drive the marketing world.6 The report states that CMOs “want people with the ability to grasp and manage the details (in data, technology, and marketing operations) combined with a view of the strategic big picture.”
Another report by Econsultancy and SmartFocus surveyed 500 marketing agencies and found that 30% of respondents rated “finding marketers with the right skills” as highly difficult.
This labor shortage creates another major problem: high churn rate. According to a 2018 LinkedIn analysis, the turnover rate in marketing is the highest of any industry.
500 marketing agencies found 30% of respondents rated “finding marketers with the right skills” as highly difficult.
Difficulty in providing proof before buying
A barrier to attracting new clients is the difficulty of proving competency. Clients only hire agencies they trust. In the absence of reassurance before jumping into a contract, corporations tend to choose in-house marketing. CMOs believe it is easier to track ROI internally, and when they do hire outside agencies, performance matters most.
Once a marketing agency takes on a project, ROI is still difficult to prove, yet clients need quantifiable results. Finding new clients is difficult, as shown by a HubSpot survey, which found that 60% of agencies struggle.
As a result, most agencies rely on referrals and repeat business, which is not scalable.
First to get cut when the economy sours
Marketing services are price-elastic. When demand is high, marketing agencies can charge high prices, but when demand drops, the price that clients are willing to pay drops. In a downturn, marketing budgets are the first to go. Beyond severely curtailing budgets, economic reces sions change the nature of the marketing field itself. The 2008-2009 financial crisis accelerated the pivoting of B2B marketing to online marketing, social media, and analytics.
The current 2020 economic recession created by the global coronavirus pandemic dramatically differs from previous downturns due to its cause. While unemployment remains at a historic high, the S&P 500 also remains high and retail sales grew by 1.2% in July. The long-term effects on the marketing world are still unfolding, but the impact is uneven. The tenure of CMOs is decreasing, yet a small part of the market is growing. The Association of National Advertisers found that 36% of CMOs have increased their technology investments and 12.5% have increased their media budgets.
Still, consumer spending in general continues to decline. This, in turn, causes marketing budgets to shrink. Competition for remaining busi ness is intensified by the high number of new firms.
Digital Marketing: Both an opportunity and a threat
On the demand side, technology such as SEO, Google AdSense, Facebook Ads, and other platforms has caused an increase in com panies doing in-house digital advertising instead of outsourcing it to digital advertising agencies.
Digital marketing has contradicting implications for small marketing agencies. On one hand, more of the marketing is done digitally, and technology improves scalability and turns insights into results. On the other hand, digital marketing lowers the barriers to entry. Small agencies must not only compete with new competitors, but also with in-house marketing departments that feel they can do marketing themselves.
The COVID-19 pandemic accelerated the shift to digital marketing, and e-commerce is one area of digital marketing that’s currently growing.15
Janet Balis, Ernst & Young’s Americas marketing practice leader, stated that the current recession:
“has created a dramatic acceleration, first and foremost in terms of customer behaviour, and then in terms of leadership priorities, where things that would’ve taken years are now taking a matter of weeks or months with respect to digital marketing."
Digital marketing increases competition for clients, forcing marketing agencies to struggle to distinguish themselves. With social media, it is easier than ever for rival marketing companies to copy social me dia approaches and online strategies. New players with technological solutions often offer low prices in order to enter the market and attract clients, and more companies take advantage of digital tools to conduct in-house marketing.
As we have seen above, small marketing agencies face a number of challenges and must find viable, cost-effective strategies to compete and win profitable business in this new age. The next section provides an effective guide for addressing these challenges.