The Unbundling of Advertising Agency Services: An Economic Analysis

by Mohammad Arzaghi, Ernst R. Berndt, James C. Davis & Alvin J. Silk

Overview — From 1982 through 2007, U.S. advertising agencies increasingly "unbundled," or disaggregated, services such as copywriting and media placement, moving away from the industry's traditional one-stop-shop model. At the same time, agencies began to charge clients based on a fee-for-service system, rather than collecting commissions on media placements. The researchers analyze this trend and consider how it may be interpreted by the economic theory of bundling. Key concepts include:

Agencies are more likely to unbundle services with increasing size and diversification but are less likely to do so with increasing age.
A strong trend toward unbundling over time is evident, a result partially explained by increases in media prices during the study period.
With the arrival of new media technologies and lower-priced digital ads, holding companies are considering re-organizing their media agencies with digital and other capabilities so as to position themselves as offering clients broader "marketing solutions" beyond media planning and buying. Such "re-bundling" may also reflect the lower prices for digital advertising.

Author Abstract

We address a longstanding puzzle surrounding the unbundling of services occurring over several decades in the U.S. advertising agency industry: What accounts for the shift from bundling to unbundling of services and the slow pace of change? Using Evans and Salinger's (2005, 2008) cost-based theory of bundling, we develop a simple model of an agency's decision to unbundle as a tradeoff between the fixed cost to the advertiser of establishing a relationship with an agency and pecuniary economies of scale available from providing media services. The key predictions of the model are supported by an econometric analysis of cross-sectional and pooled data from the quinquennial U.S. Censuses conducted between 1982 and 2007. Agencies are more likely to unbundle with increasing size and diversification but are less likely to do so with increasing age. Longitudinal growth in unbundling is partially explained by increases in media prices over time.