What are agency groups to do about China?

My piece last month caused a slight bit of controversy, including a riposte from several agency APAC heads which include some very valid points. I still stand by the thrust of the article – the numbers do not lie after all – but I did want to delve a little bit more in why APAC has not lived up to some of the dreams of the agency groups 15 years ago.

First of all, it is important to say that there are plenty of important markets in the APAC region, both from an established size standpoint and the growth potential. India is a very fast growth area for the agencies and the potential remains huge, as it does in countries such as Indonesia and Vietnam. Stalwarts such as Australia and Singapore also play prominent roles. Hong Kong has also historically been an important market for agencies. No agency group can ignore the APAC region.

For the global agencies, APAC has always been a slightly distorted region because Japan – historically the biggest market in APAC pre-China’s rise and still the third largest global advertising market – was effectively out of bounds due to the position of the domestic Japanese agency groups (Dentsu, of course, has expanded internationally). However, the hope was that the opportunity in China would make Japan’s barriers to entry irrelevant. I remember as an analyst sitting in agency presentations from 15+ years ago with the CEOs explaining to us the system of Tier 1-5 cities in China and the size of the potential market.

It is fair to say the opportunity in China has not worked out as was expected (and hoped). As I mentioned in the previous article, WPP probably has the biggest exposure to the APAC region and China makes up about 6% of its revenues. That is substantial but China is approaching 20% of the global advertising market. For other groups, China is almost certain to make up a smaller proportion of revenues.

What is causing that disconnect? Sitting 5,000 miles away, I am slightly conscious of claiming a detailed knowledge of the market but sometimes leaning back can provide clarity. I do not think this has anything particularly to do with the heavily online nature of the Chinese advertising market (the agencies do perfectly well in the UK, for example, where digital makes up about 70% of ad spending) nor the quality of the agencies’ offerings. What it probably has more to do with is the westernised nature of the agency groups and whether that is a natural fit for the Chinese market.

I am a historian by training and, looking back, the hopes of the 1990s that China would adopt western ways of thinking and business look incredibly naïve. I would argue the agencies generally held the same view and that distorted their view on the potential of the market. The calculation done – which was a natural one – was that, given the size of the population and rapidly expanding wealth, China could easily become second or third in importance.

Yet a reading of China’s history of the 19^th Century to mid-20^th Century would tell you the view western companies would just march into China and dominate the landscape would come up against some very big obstacles, not least the historical association between China’s humiliation at the hands of western powers during that time and the wants of western commercial interests.  That historical baggage also applies to the agency groups. China, like Japan, has some unique characteristics.

What does this mean for the agency groups moving forwards? None of the major players is going to exit China (at least it is very unlikely) simply because:

• (a) it remains an important market
• (b) they need to service their international clients in the market and...
• (c) such clients would likely view an exit as negative.

However, my view is that there is a tacit recognition the market opportunity for the agencies in China is unlikely to grow much more. The days of the charge into the Tier 3/4/5 cities is over.

However, go back to the sentence before, namely that China, like Japan, has some unique characteristics. As mentioned previously, Japan has its own ‘proprietary’ agency groups, with which the global agency groups have links in order to help service the global needs of their clients. Perhaps this is the longer-term trend for the Chinese market, namely the emergence of China-centric agencies with which the global group maintain relations.

Finally, what does this mean for investors if it is true China will not be a major part of agency revenues? To be frank, probably not that much. Investors are looking at the bigger picture of what the agencies are doing, particularly from an organic revenue growth standpoint and their strategies. If the expected growth in China can be substituted elsewhere, then that is not an issue. In truth, investors discounted the China growth story a long time ago.

As usual, this is not investment advice. 

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Ian Whittaker is founder and managing director of Liberty Sky Advisors.