Why is the Digital Agency Market’s Tail Growing Longer?
The evolution of digital marketing agencies and the overall online marketing sector is a conversation that demands attention. The world of digital marketing is moving so fast that we should expect to see an increasing number of B2B marketers who want an agency regardless of which inbound marketing software provider they use.
The average marketing team simply cannot keep up with, nor do they have the expertise in, the number of digital channels and cross-channel campaigns available to them. It is inevitable that marketers will need a service partner to help them prioritize resources and efforts, along with providing specialized channel expertise. In fact, the market demand is so large that we predict the digital marketing agency segment to double in the next three years.
The more we study the market, however, the longer we see the tail growing, especially for small, local and metro-area agencies. So while the big guys like WPP and Publicis will see their share of growth, a more interesting phenomenon is the massive growth in the digital marketing agency tail, meaning the smaller, more local agency. An academic framework below helps explain why.
Porter’s Five Forces – Quick Overview
Porter's Five Forces Analysis is a framework for industry analysis and business strategy development formed by Michael E. Porter of Harvard Business School in 1979. Industry attractiveness in the Porter context refers to the overall industry profitability. An "unattractive" industry is one in which the combination of these five forces acts to drive down overall profitability.
Porter’s model includes five forces we will glance at briefly:
• Threat of new competition
• Threat of substitute products or services
• Bargaining power of customers
• Bargaining power of suppliers
• Intensity of competitive rivalry
Using this model, companies can analyze the attractiveness of an industry and determine if they can get a favorable (above normal) return if they decide to step into that market. Let’s take a look below at the incentives and opportunities to step into the digital agency market based on this framework.
Threat of new competition – low barrier to entry
A profitable market will attract new entrants that will eventually saturate the market, cutting prices and making the profit margins low to minimal. Barriers to entry like technology and setup costs, will limit entries to the market extending its future profitability.
One of the largest barriers to entry in the digital marketing world is account control and executive relationships. Very few agencies can undertake the cost and time to break into a Fortune 1000 client like P&G or Ford, where the large incumbent agencies already have many relationships and internal referral business. At the same time, few agencies have the scale to execute massive campaigns for Fortune 1000 clients even if they could win the business. So the threat of new competition at the high end seems small.
Head down market, to a mid-size enterprise in $25m-250m revenue range, and a different dynamic appears. The big agencies have too high a cost structure in billing rates due to their size and overhead to be competitive in this arena. They also lack all the client relationships to the many regional businesses in this market. So a large opportunity exists for new competition. In the local metro areas, small owner-operator agencies with local contacts in small family owned businesses see the same opportunity in the hyper-local markets.
The low cost strategy of entry is contributing to the rapid expansion of digital marketing agencies; start an LLC, print a business card, put up a WordPress site and you’re ready to go.
Threat of substitute products or services – software is a complement, not a substitute
Unlike competitors, substitutes are products outside of the industry that can substitute for the need of your services and by that reducing the overall size of the market.
The emergence of marketing software can be considered as a threat of substitution to the digital marketing agency, but that would be a mistake. Agency clients feel the need for advice, expertise, and execution assistance as digital channels proliferate regardless of whether or not they have inbound marketing software in-house. Therefore, as the digital marketing world expands so will the digital marketing agency market.
Ultimately, inbound marketing software is a complementary product that helps increase the “pie” by providing a platform on which to train new hires with less experience, standardize service delivery, deliver consistent reporting metrics to clients and more.
Bargaining power of customers – the tail grows longer
Bargaining power is determined by the ability of the buyers to put pressure on digital agencies. The bargaining power of customers is influenced by the ratio between the number of firms and the number of buyers (supply and demand).
As more and more money is being invested in digital marketing, budgets inherently are under greater scrutiny. Customers engage with their professional purchasing organizations with more heavy-handed negotiating tactics. Consequently, campaign reviews become more ROI-based and metric-focused.
When this happens, the cost structure of the large agencies and their associated high, billable rates to support huge campaigns, premium services and account control at P&G and Ford becomes a barrier to move down market. Therefore the mid-market, including local businesses, begins looking at more cost competitive agencies, which provide more bang for the buck for their business size.
As the availability of smaller agencies grows, the effect of increased bargaining power is not so much about pushing down the profitability of the market than it is pushing out the agency market tail to service smaller companies with less overhead costs and leaner cost structures in local markets.
Bargaining power of suppliers – unorganized suppliers
Similar to the bargaining power of the customers, suppliers have the ability to put pressure on firms in the industry with increased cost for materials, high switching costs and over-reliability on specific suppliers or distribution channels.
But in an industry that relies heavily on labor, the primary suppliers are employees themselves. Given the job market since 2008, many folks are just happy to have a job. Therefore few people are secure enough to negotiate with their employers about increased pay and benefits.
Intensity of competitive rivalry – going local
Said to be the determining factor of the overall competitiveness of the industry, the intensity of competitive rivalry is influenced by the strength of the major players in the market, the levels of competitive advantages and the market potential.
At the high end of the market, the competition for Fortune 500 accounts is especially fierce because the prize, or “market potential”, is so large. This same level of competition is not nearly as apparent neither in the mid-sized enterprise nor in the small business market where the individual prize for any given account is relatively small. Also, the digital marketing agency ecosystem is local and relationship-based like many services industries even though the Internet has made physical location somewhat irrelevant.
Clients still like to have a face they can talk to, meet for coffee and periodically meet in-person. Additionally, since the market is highly fragmented and tiered (small agencies treat small businesses, big agencies treat big companies), no distinct leaders have emerged, and the market share is distributed.
With a localized market, no true leader and highly fragmented industry, the intensity of competitive rivalry in the segments below Fortune 1000 remains quite low. This encourages many large agency veterans to break out and start their own shop.
Digital Marketing Agency Growth Will Be Concentrated Most in the Tail
The framework of the Porter Analysis leads to a simple conclusion we are seeing daily in the marketplace. The demand for digital marketing agency services is extremely large, while the barriers to entry are low for target clients in the small and mid enterprise sectors.
We've seen an exponential rise in the overall digital agency industry, but that growth will continue to be concentrated in the long tail of small agencies. Will there be a consolidation and bundling of services through marketing software, acquisitions and new technology, or will this market continue to be fragmented and tiered? Only time will tell. But for now, look around at your local indicators of agency growth in the tail.
About the Author: Rob Eleveld, the CEO of Optify, is an evangelist on the Digital Marketing Ecosystem and a seasoned expert in both developing and executing successful go-to-market strategies. At Optify, he is setting the company's course on building software that helps B2B marketers and digital marketing agencies excel and profit in their quickly changing online world.