Will Grey turn down the volume to please WPP?

Grey Global’s business has always been volume-oriented, but WPP is likely to demand bigger profits.

There are, broadly speaking, only two business models for running a professional services company. Either you operate at low profit margins and go for volume, or you run the business at high margins across the narrower client-base that a more demanding and sophisticated service necessitates. Very few operations crack a model that is both high-volume and high-margin; quality-control is almost impossible to monitor effectively once a corporate structure is created to generate a high volume of business.

These are business truths that are almost universally acknowledged. An exception that proves the rule is the business conducted by some of the better American investment banks. But their markets have been exceptionally demand-led – that’s why investment bankers became so rich. Elsewhere, the sacrifice of volume to margin is far more typically the rule of thumb. What is really interesting is what happens when a low-margin concern is acquired by a relatively high-margin outfit, with ambitions that almost certainly require a concentration on both volume and margin.

Such is the position now that WPP Group, ranked as the world’s second-largest marketing services group, has acquired Grey Global in a cash-and-share deal worth some $1.4bn (&£778m). Grey is historically a single-digit margins operator – WPP is expected by its institutional shareholders to deliver margins in the mid-teens or higher.

The reason that is usually given for this discrepancy is that Ed Meyer, who is not only chairman and chief executive of Grey but also its controlling shareholder, can run the publicly listed advertising conglomerate as though it is a private company. It makes one heck of a difference to your business life if, when a minority shareholder proposes that you run the company more profitably, you can reply that you speak for a majority of the equity when you say that things are just fine as they are.

The question arises as to why the 77-year-old Meyer should have been content all these years with a low-margin performance. Nobody is about to accuse him of having been an indolent man. The business he has built is the seventh-largest of its kind in the world and the competition to acquire it, between WPP, Havas and American private equity interests, was intense. The answer is to do with human nature and the quality of relationships. Some people, quite simply, are better suited to a high-volume, low-margin way of life – and the client relationships in this model are very often of a longer-lasting variety.

This has less to do with the intrinsic value of the low-margin option (though many low-margin operators are highly able) than with the characteristics of the competition from the high-margin shops. This is a variant of the “tallest poppy” syndrome. If you operate at high margins, you are likely to be considerably more expensive, since you are unlikely to have widened the margin by running down the cost-base, but rather by charging highly. This has a two-fold implication for relationships with the client-base. Firstly, you are a highly visible expense and consequently an easy economy to be made during hard times. Secondly, an expensive service provider is expected to be brilliant all the time; the lower-margin provider can get away with being brilliant only some of the time. It follows that low-margin operations allow more room in which to establish long-term client relationships.

One of the juicier accounts WPP has been anxious to acquire is home-products leviathan Procter & Gamble. Meyer has worked for P&G since he was an account supervisor in the Fifties, producing wholesome-housewife endorsements. Put at its simplest, it is far easier to establish that kind of service loyalty when P&G brand managers aren’t seen to be subsidising the lavish lifestyles of some of the higher-margin agencies.

But the issue now is what WPP will do with Grey. WPP chief executive Sir Martin Sorrell is no Meyer and has the earnings aspirations of major shareholders to satisfy (not to mention his own). Sorrell has let it be known to analysts that he can make significant tax savings at Grey.

And there are economies of scale to be struck, with the sharing of global business services. But there are still issues of culture. Grey needs to decide what it now is – a decision that has admittedly largely been taken by its sale to WPP.

Gone are the days of the client relationships that go with low margins. And going will be the staff who cannot adapt to a harsher, high-margin environment. But, before we get too carried away with the charm of the old Grey, let’s remember too that as well as delivering cosy relationships, low-margin operations can also deliver shareholder value. The company’s biggest shareholder, Meyer, personally walks away from the deal with as much as $350m (&£194m). Not such a bad margin.

George Pitcher is a partner at communications management consultancy Luther Pendragon

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