GroupM, which handles about $70 billion in media-buying for hundreds of the world's top advertisers, has found itself suddenly trying to explain to the world what "arbitrage" is, and why the WPP-owned agency is doing no such thing.
"Arbitrage" occurs when an agency buys online ad inventory on its own account, and then sells it to a client at a higher price, keeping the margin. It's controversial because the client may not know what the original price of the ad was — and therefore may have difficulty judging whether they're paying a fair price.
GroupM's CEO, Rob Norman, and its chairman, Irwin Gotlieb, both said at a conference panel that ad pricing schedules are not fully disclosed to clients. That, it turns out, was the advertising equivalent of the French police chief in Casablanca announcing that he is shocked — shocked! — to find that gambling is going on in the casino.
Vast sums of money are at stake. WPP CEO Martin Sorrell wrote in The Telegraph that a third of his company's business now comes from digital marketing of one sort or another.
Those two factors — money plus controversy — explain why everyone in the online ad world is buzzing about arbitrage this week.
Is arbitrage the same as "frontrunning"?
Critics — and competitors — of agency trading desks say the lack of transparency on ad prices looks a lot like "frontrunning," a practice that is banned on Wall Street. Frontrunning occurs when a broker, upon learning that her client wants to make a big stock buy which will drive up the price of the stock, acquires a bunch of that stock for herself ahead of the transaction, and thus profits.
To be fair, this is not what is going on in the ad biz.
But critics say it amounts to the same thing. It's a measure of how controversial the topic is that I had four conversations this week with high-level digital ad agency executives about arbitrage — and none of them wanted to go on the record about it. They were all fuming, however.
Interpublic, a competitor to WPP, says it does not practice arbitrage. "We are TOTALLY transparent. We don't arbitrage. A client's money isn't the agencies money," it tweeted recently.
Omnicom, another competitor, says it doesn't do arbitrage, but left the door open to maybe doing it in the future when asked about it by Ad Age.
Critics say that arbitrage is a conflict of interest that jacks up the price of advertising for clients who aren't sophisticated enough to audit their buying agencies. They also allege that agencies take a fee for managing the client's ad budget, and then take the arbitrage margin on top of that — which looks like double-dipping.
If it's disclosed, who cares?
In their defense, agencies say the practice is fully disclosed to clients. The margin comes from value that is added when they apply extra data to the buy that makes it more targeted, more useful to the advertiser. In short, what the agency is reselling is a new and different thing than what was bought from the publisher. It's better, and it deserves a higher price. That, therefore, is not arbitrage, because they're not simply frontrunning and flipping a commodity they bought first. They're creating a new product out of an old commodity.
The margin also pays for the risk of not being able to resell the inventory. A huge amount of inventory goes unsold, so that risk is real. And, of course, agencies have to pay for the technology platforms they build to create these buying networks. Trading desks don't grow on trees, after all.
What clients don't know
The last part of the controversy is what clients know and don't know.
WPP's Norman told Business Insider that he has 1,500 agreements with clients globally, in which the clients do not get to know the original price of the advertising sold to them. The clients know how much they are paying, and what the performance of their campaigns is, but they don't get to see what value GroupM created in the secret sauce it applied after the original ad impression was bought from the publisher. "We never operate on a non-disclosed basis without the specific contractual consent of our clients," Norman tells us.
A lot of clients don't want to know. One of the reasons they hire agencies is because the online ad world is so complicated — sales are traded in fractions of a second, so it's literally not visible to observers. They want their agencies to handle it for them.
And, of course, clients tend to judge agencies by performance. Trading desks can't stay in business if they cost more than their competitors — so as long as superior performance is there, does it really matter how the agency makes its margin?
One of the reasons GroupM is taking such flak is because people don't understand exactly what it does. For example, in 2010, chief marketing officers at four major car advertisers confessed at a conference that they did not know what "demand-side platforms" are. (They're online ad buyers who often compete with agency trading desks).
It might, however, behoove clients to become a little more interested in how online advertising works. If that were the case, some of these misunderstandings might not arise.
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