The little-known ‘dowry’ Engine is bringing to Lake Capital

Lake Capital’s purchase of marketing agency Engine means the venture capitalist firm will unlock a sort of modern-day dowry; a brave and forward-thinking project to turbo-charge Engine’s margins. Is this the future?

Last week I talked about how agencies can tweak their business model so that they can get paid more and, by getting into a virtuous circle, compete better in the war for talent.

This is part two, with a stimulating example of one agency group that is trying to move away from the ‘doing’ stuff, which is where the margins are tightest, to do more ‘thinking’, where margins are higher and the possibility of being rewarded for generating growth/profits/shareholder value for clients is most likely.

That group is Engine, which is currently in the somewhat prolonged process of selling itself to Lake Capital for £100m (or thereabouts).

I say ‘thereabouts’ because of an entertaining little spat involving former Engine staff who are shareholders. Lake Capital is offering current staff one price for their shares, and former staff a lower one. To complete the deal, Lake Capital will have to cough up a little more.

Anyway…when Lake Capital, which is a venture capitalist with a nice portfolio of US marketing communications agencies, finally takes control of Engine, one of the first things it will do is look to improve the latter’s margins. This is because a) it’s a VC outfit, and that’s what they do and b) because, despite all the bluster from Engine boss Peter Scott about building a £1bn empire (he only ever got about 15% of the way there), it is not a Premier League performer in financial terms.

According to my bible, the Kingston Smith Agency Financial Performance survey 2013 (covering the year to end-2012), Engine generates an operating profit per head of £7,500, well below rivals and approximate comparables like CHI (£19,600) or Karmarama (£20,571).

However, one of the things that just might have Lake Capital slavering at the mouth is a sort of modern-day dowry, none of which will be recognised in the purchase price but could unlock tons of additional value for Lake Capital.

This is a two-year project to turbocharge Engine’s margins. It’s under the command of Engine CEO Debbie Klein, who also doubles up as chair of WCRS, the ad agency that is at the heart of Engine.

Last month, Klein gave a fascinating talk to the IPA, starting with the story of two old but phenomenally successful WCRS launch campaigns. One was for Orange, for which WCRS created £3bn of shareholder value, but for which it was rewarded in the normal way (i.e. for its inputs). The second was for 118 118, for which WCRS – fingers burned by the Orange case – negotiated a payment-by-results (PBR), or outcome-based reward.

This involved dropping its base fee, but taking a bonus for every percentage point of market share held by 118 over 20%. Equipped with either great foresight or confidence, WCRS achieved a 60% market share for 118. Mega bonuses all round.

Of course, 118-type campaigns (or clients as innovative as that) are rare and, as a launch, success for 118 was easy to measure, but the current climate and the changes in the marketing eco-system mean such reward systems are no longer just talk.

As I reported last week, we can see this in the willingness of more big advertisers to entertain these arrangements.

Why? Well, after years of hunkering down, they are fixated on growth, and growth is most likely to occur when client and agency work together in close partnership to tackle business issues, not just communications ones. Focusing on outcomes, not inputs, binds the two sides together. Real commercial creativity is the best engine of growth for clients.

Second, the vastly increased complexity of the marketing eco-system means clients need agency partners more than ever, but at the same time offers data that allows outcomes to be measured faster and more accurately – isolating, if you like, the agency’s contribution. This removes one of the historic obstacles to PBR, which was that it was very hard to measure success other than by crude metrics.

Engine’s strategy is to divide the work it does for clients into three: at the bottom end is what it calls the ‘doing’ stuff. This is the bread-and-butter, output-based, agency model where, according to Klein, margins are a low 8%. This is what you might call ‘normcore’, and getting stuck here is not a good place to be, because with all the competition and the influence of procurement, it is hard to squeeze any more money out of the client.

Next up is work classified as ‘helping clients think’ – up a notch in terms of margin (13%) – which begins to move agencies towards management consultancy territory.

And third is what Klein describes as ‘thinking for the client’, where margins can be as high as 25% (and income per head £110,000, versus £90,000 for the doing work). And this, margins aside for the moment, is the exciting space because it presages a completely different type of agency-client relationship – one based on genuine long-term partnership, trust and respect – and opens up the possibility of payment by results or some kind of co-investment arrangement where agencies take some risk, but share in a greater reward.

Klein says Engine is working with a few forward-thinking clients on this, but she made it clear that the balance between low-margin ‘doing’ and higher-margin consultancy/thinking would probably be around 70:30.

One client that might be interested is B&Q, whose £50m business it was handed late last year by the retailer’s incoming marketing boss. He is one Chris Moss, former 118 118 marketing honcho, so he knows what a motivated Engine/WCRS might achieve.

And bringing it back to talent, Klein is adamant that the opportunity to work in this way – aside from the extra money that can go into fighting the talent war – is highly motivating for staff. Few want to be at the grunt, ‘doing’, end, when they can be exercising their creativity in the widest sense of the term to solve business, as opposed to communications, problems.

Ah, but you say, what about the dreaded procurement? Here is Wieden and Kennedy finance director Bronwen Hemming on her experience of one procurement gathering.

This may describe the long-tail of procurement, but from what I’m hearing – and the new levels of co-operation between the IPA and ISBA-member procurement specialists bears this out – there are sufficient forward-thinkers active in this space to move the game on.