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How Ad Agencies Divert Clients' Money to Their Own Bottom Lines

The allegation that Ogilvy & Mather overbilled IBM by "millions" of dollars should remind clients just how much cash they leave on the table by not auditing their ad agencies properly. That fact was writ large in Interpublic (IPG)'s annual 10-K filing with the SEC today.

The SEC forced IPG in 2008 to restate its numbers because it improperly recognized $199 million in media credits from vendors as revenue when those credits should have gone back to their clients (the SEC described it as a "fraud" that centered on IPG's McCann Erickson unit). But IPG has actually managed to keep about $113 million of those credits. There is currently another $82.5 million in media credits sitting on IPG's books. If clients don't claim it, IPG says in its 10-K, the ad agency holding company will keep it.

Here's how the scheme works:

When an agency places an ad for a client, any kind of volume discount, rebate or price advantage ought to benefit the client, not the agency. In return, the agency gets a flat fee or a commission for placing the ads. But if agencies can figure out a way to keep the credit they can book it as revenue for themselves. Usually, client contracts ban this practice, but clients are historically bad at auditing their agencies' accounts, and so sometimes the agencies keep the money. That, basically, is the allegation in the lawsuit currently facing Ogilvy, owned by WPP (WPPGY).

Because Interpublic is now required by the SEC to properly account for media credits, we can get an idea of just how much money clients lose through this process. In 2004 and 2005, when IPG first began restating its books to account for the scandal the company said it had about $284 million in outstanding liabilities to clients, mostly in the form of media credits (see page 70).

The company wrote down its revenues by a total of $160 million from 2000 through 2003 to account for the money it was returning to clients (see page 64):

IPG's revenue reductions

  • 2003: $50.6 million
  • 2002: $40.2 million
  • 2001: $42.8 million
  • 2000: $25.9 million
  • Total: $159.5 million
But then a funny thing happened. The remaining $284 million sat on IPG's books as liabilities to clients for the next several years. IPG said (see page 60):
Reductions to these liabilities are achieved through settlements with clients and vendors, but also may occur if the applicable statute of limitations in a jurisdiction has lapsed.
Those settlements and statute lapses have worked out quite nicely for IPG over the years. When clients decline to take the money, or go out of business, or forget, or contracts become too old to be enforced, IPG keeps the money. It's kept a total of $112.9 million in "liabilities" over the years, which it records as "net income, other":

IPG's "net income, other" revenues

  • 2010: $12.7 million
  • 2009: $24.4 million
  • 2008: $20.7 million
  • 2007: $24.3 million
  • 2006: $28.2 million
  • 2005: $2.6 million
  • Total: $112.9 million
The money IPG keeps is significant. In 2010 it was 4.5 percent of its net income, in 2009 it was 17 percent. Note that last year IPG kept $12.7 million even though the balance of its liabilities was reduced by $23.9 million, from $106.4 million to $82.5 million. It would appear that the other $11.2 million went to clients who were smart enough to realize that they didn't have to leave their money on IPG's table.

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Image by Flickr users happyeclair and Todd A. Porter, CC.