FEATURE1 June 2009

In search of the dawn

We’ve got the first half of the year out of the way and it’s been a bruising ride. What’s next for the research business? Analyst Stuart Butler-Smith chews over the numbers.

?It was always going to be a bad first half for most research firms. Q1 was the period when, after 2008’s benign first nine months clients discovered just how bad the last quarter was. They panicked. They found it difficult to forecast out into the next quarter, let alone the next year, and when a company can’t predict revenue they cut costs, and refuse all new spending until they get some kind of positive signal from the sales team. The sense of gloom fed on itself as company after company announced deteriorating results and set low expectations for 2009.

Companies become incredibly focused in a downturn. More focused than in good times. It’s a survival thing. ‘The market won’t let us grow so we’re cutting anything to do with growth, and anything that isn’t absolutely essential to the running of the company’ is the message. And so market research budgets were cut, along with other items on the procurement list. We estimate that market research spending fell by around 8% in the first quarter compared to the same quarter last year. Companies and industry sectors with worse results cut deeper than those with better prospects. An obvious statement maybe, but how many market research companies follow their clients’ performance and adjust their marketing effort accordingly? Growth in the second quarter of 2009 seems to be flat, or not declining year on year, and the search for swallows and green shoots is under way.

The first half analysis
We all know what spending suffered in the first half – automotive, media, retail financial services, pharmaceuticals and healthcare and we know who suffered – market research companies that have a small client base, too much debt, or who over extended themselves. It is important to detach genuine market softness from individual company execution. For example, much has been made by some companies of softening advertising markets and their effect on market research. But only 26% of market research revenues are directly affected by advertising, and if advertising revenues fell by 10%, market research revenues would fall 2.6% on average. Which turns the spotlight to the rest of the market research portfolio.

So who and what did well in the first half of the year?

  • Continuous tracking services. Depending on how you look at it, this accounts for between a third and a half of spending. There may not be a great deal of growth, but clients are reluctant to reduce spending on the core input to their manufacturing planning and marketing systems. And the link with remuneration is key too, especially for sales staff. Associated consulting and advisory services have been squeezed despite strong performance last year.
  • Anything tactical. If a short-term initiative could boost short-term sales, it gained approval. These were typically one-day sales spectaculars, early renewal discounts, vouchers and discounted subscriptions using online search advertising spending and email communications direct from the sales and marketing department. The key is speed and online research and measurement facilities have benefited.
  • Fast-turnaround research. When budgets are tight sign-off authority rises in the organisation to more senior executives who want quick black-and-white answers rather than exploration of the shades of grey. Rapid-response panels such as online have benefited from this as well.
  • Quality of service management and measurement. With price being the key weapon in luring clients’ customers to part with hard earned cash, many retailers, on and off line, have looked to add value by improving the retail experience. A lot of this spending may have gone in-house but mystery shopping companies benefited too.
  • Utilities, consumer packaged goods and telecoms. These markets all have positive and structural economic factors creating demand for information spending. The market to watch in the second half will be the financial services markets, in particular insurance.

?Companies become incredibly focused in a downturn. It’s a survival thing. market research budgets were cut, along with other items on the procurement list

What does the second half have in store?
We think spending will be flat in Q3. Clients are unlikely to commit to new spending during the holiday season, especially this year, meaning that Q4 will be the make or break quarter, and it is traditionally the quarter with the highest spending. At the beginning of 2008 we forecast that Q3 2009 would mark the bottom of the recession. We expected business investment sentiment, and therefore the appetite for market research to be neutral in Q2 and Q3 ready for a pick-up in Q4. We also expected world stock market indices to have had one further lunge downwards to 3,300 (for the FTSE) or below in Q1. This hasn’t happened, and we fear it still might. If it does, the later into 2009 it happens the more devastating the impact on confidence will be and the less likely market research spending is likely to pick up in 2009.

So what of the green shoots of recovery? We’ve seen several hopeful indicators from rising mortgage application approvals to stockmarket indices rising from their lows to ameliorating marketing manager budgets. But all of these indicators tend to show a bottoming out or a decreasing rate of decline rather than a firm uptrend. For point & figure technical analysts among you, there is no evidence to suggest that the downtrend is broken or disrupted, yet.

Eye on the indicators
The two indicators of recovery we are paying most attention to at this stage of the downturn are;

  1. Successive quarters of revenue and profit growth for financial services companies. In the recessions we have studied at Research Ratings, the sectors first into recession are usually the first out. This time round, it was the banking and insurance industries that led other sectors in. Up until the time of writing, a significant number of financial institutions had reported improved performance in Q1, but in many cases the growth figures are not organic or are masked by changes in accounting policy or year-end. So, in our view, we’ve not got our first data point yet.
  2. CEOs of major research buying companies starting to talk about growth strategies again.

We’ve been following what CEOs say about company strategy across different industry sectors. And they aren’t talking about growth yet. The number one priority for 88% of our sample of 130 CEOs has been a cost reduction programme, as has been stressed in more than one of their recent public communications. The second highest priority, at 68%, is selling more of existing product, as opposed to developing new ones. Though this gives opportunity for lifecycle management techniques it still demonstrates a lack of willingness to expand a business from its core. By contrast, last year the number one CEO priority was to expand to emerging markets. This has slipped to fourth this year.

Even though growth strategies are not at the forefront of communications, the fastest rising priority for CEOs is the whole area of risk management. If market research companies are to position themselves for a new period of growth we think they may need to adapt their growth strategies to this new and more conservative positioning.

?Valuations are down for most media and information companies, though market research company valuations have been dented less than most

Looking out to the second half of the year, we see no let-up in the rate of acquisition by the major consolidators, who tuck 25-30 companies into their organisation every year, funded by cash flow. This is a good time for them to buy. Valuations are down for most media and information companies, though market research company valuations have been dented less than most. They are currently around 0.9 times 2008 revenue, depending on profitability and perceived growth prospects. Access to capital for smaller companies will still reduce the volume of acquisitions for smaller consolidators.

Larger deals may still happen but would have to be justified to investors by a strong cost synergy argument, and this is sure to become more prominent in the future with Kantar/TNS an important watershed. Up until then, market research acquisitions have tended to create federalised corporate structures with much potential for value destroying fiefdoms and pockets of (self) interest rather than unified and integrated structures. If a larger deal does happen, we wouldn’t be surprised to see an information company from outside the traditional market research business to buy in.

Shaping for the long term
On average, profit margins for market research companies are lower than any other type of information provider. And they are likely to go lower. Intensity of competition will erode online margins, which in turn erodes offline margins, and respondent fatigue costs will increase. Market research companies will be forced either to develop higher-margin but niche panels and techniques, consolidate or, like other information providers, develop job-specific solutions and analytics. This route has enabled practitioners to boost their margins by a factor of two and a half, but it requires a change of mentality.

At Research Ratings we believe that information companies, irrespective of discipline, are competing for the same information budget – the $113bn spent by companies in 2008. Market research companies, in particular, tend to limit their universe to the $30bn spent on market research in 2008, and that’s because they tend to think of themselves as some kind of adjunct to the advertising industry or in a constant battle with consultants over access to the boardroom. This is misguided, and has contributed to the growth of other information providers – credit reference companies, data and analytics companies, B2B publishing companies and reports and advisory companies. These companies are growing into the information opportunities that market research companies miss.

Other information providers tend to think of themselves as, primarily, information companies, aiming to service a particular and defined job function with all of their information needs. It doesn’t matter how senior or junior that job function is. Crucially, these companies deliver their products through a desktop interface or “workflow solution” to enable the customer to use and interact with the various information sources. The customer becomes loyal to the technology and wants everything to be supplied through it. Acquisition and licensing deals are made to provide information through that workflow solution, based on the need of the client.

As an example, perhaps the most significant deal of the first half of the year was the deal between Ipsos and Thomson Reuters to provide panel/market research services to Thomson Reuters clients through its platform. Investment Banking and Fund Management are the biggest buyers of information, and Thomson Reuters has third of that market. Though the deal is currently for polling, it has enormous potential for both parties. How many market research companies have since approached Bloomberg or Moody’s or Morningstar for a similar deal?

Stuart Butler-Smith is the founder of ResearchRatings.com. He has spent 22 years in the information industry, first with Bain & Company, then at AGB (later Taylor Nelson Sofres). In 1993 he joined Datamonitor plc, a start-up business information company which became the best performing media stock on the London Stock Exchange and was bought by Informa plc for close to $1bn in June 2007.