A New Way for Ad Agencies to Fleece Clients: Barter-Based "Trading Units"

The hot new trend for ad agency holding companies is to set up a "trading unit" to execute barter deals in which a company trades its products for advertising airtime on TV networks or pages in magazines. But few people -- advertisers included -- know how they work.

WPP (WPPGY) and Havas (HAV) both set up such units this week. WPP's is called the Midas Exchange. Havas has yet to come up with a name for its new division. Existing trading units include Aegis (AGS.L)'s Carat Trading, Omnicom (OMC)'s Icon, Interpublic (IPG)'s Orion Trading, Argent, Active International, a division at Horizon Media, Trade X Media, and a unit of the independent media agency R.J. Palmer.

It's worth knowing what trading units do, however, because so-called "prop trading" brings two potential problems for clients:

• Such trades potentially have the effect of overstating the value of assets on a client company's books -- which is bad for investors trying to assess how much a company is worth.
• Clients might naturally suspect that these trading units are competing with the regular media buying agencies owned by the same corporate parents, thus creating a conflict of interest within holding companies that might drive up the overall average price of advertising.

Here's how a trading unit barter deal works, according to Omnicom's helpful web site for Icon. Let's say your company sells trendy clothing. Unfortunately, a shipment delay means that the miniskirts you ordered from your factory arrive too late, just as long dresses become fashionable. Now you're stuck with inventory you can't sell at full price.

The normal procedure would be to "write down" the dresses and sell them to a liquidator, at perhaps just a third of their previous market value. That writedown becomes an expense, lowering your net income and reducing your assets.

Ad agency trading units say they have a better idea for those miniskirts. They'll offer to buy them at "book value," or the price they're being carried at as inventory by the company -- far above the writedown/liquidation price. In addition, the trading unit will give the company a credit note for advertising media. Your clothing company has thus exchanged a bunch of unsellable dresses for some cash and some usable advertising time.

This seems like a remarkably good deal for the dress company and a terrible deal for the ad agency. Of course, the deal has strings attached: The trading unit demands that the media credit be used as part of larger, cash-based ad buy at some point in the future, in just the same way you'd use a coupon to lower the price of a packet of cereal. Media credits can be held for years, according to Omnicom.

The trading unit is able to make a profit doing this because it buys advertising time far in advance, like a commodity, when it's cheap. By the time it's sold to the dressmaker, it's at market price. In addition, the trading unit will come up with some imaginative way to sell the minskirts for its own profit, perhaps by shipping them to a foreign country where the weather is warmer and the long-dress trend has yet to take hold.

That's why IPG's s Orion Trading tells clients that it charges no fees for making such deals (look under Question 11 in the FAQs).

It all sounds remarkably useful -- and for many clients it undoubtedly is. The problem is that it changes the quality and quantity of assets being held on the dressmaker's books. What was once an impaired asset that should have been written down has been replaced by cash and some credit. These are useful assets to be sure, but the credit can be used for only one thing -- the trading unit's ad time. In addition, the company has a new long-term liability hanging over its head: It must spend even more money on a new advertising campaign to fulfill its side of the bargain.

In other words, this is not an asset that will produce cash (like the sale of a dress). It's an asset that will expend cash (like any other ad campaign). Here's an example, again from Omnicom's Icon:

A large brokerage house had a portfolio of margin accounts that were in arrears. We offered to buy the entire portfolio of obligations at book value, but only because we knew the brokerage house was able and willing to purchase sufficient advertising through us. In fact, we collected very few of the accounts in full but did a great job serving the broker's advertising needs.

In these matters, agencies and media buyers sometimes mistakenly assume barter firms are rivals. They are not, nor do reputable barter firms ever intend to be. Put bluntly, a company's advertising agency and media buyer (if separate) are the proper and sensible source of a company's strategic media planning in any corporate-barter transaction. The barter company is simply there to fulfill what the company decides it needs.

Can a media-buying company or an advertising agency do good corporate barter? Not likely.

Even if you ignore the potential conflict, the bottom line is that trading units bring advertisers into the market who, through their own incompetence at handling inventory, may not have ordinarily been there. That must, by definition, raise the aggregate price of advertising by increasing demand.

Related:

• Client Hell! BNET's Guide to the Advertising Underworld