The big payback: Agencies brace for Obama's new overtime rules

Americans making less than $50,000 a year may soon be entitled to overtime pay. Can the agency model survive the death of "sweatshop culture?"

The big payback: Agencies brace for Obama's new overtime rules

NEW YORK: Advertising is an aspirational industry, selling consumers a vision of hope, freedom, and fulfillment. The harsh irony is that those images are made possible through undercompensated toil.

For years, the industry has thrived on the backs of people — mostly young — working 80-hour weeks for salaries less than $50,000. Thanks to new rules expected from the Obama administration this summer, that’s all about to change.

Two weeks ago, the Department of Labor submitted a final proposal for an update to the Fair Labor Standards Act that would require overtime pay for all employees making less than $50,440 per year. Salaried employees who make more than $23,660 are exempt from overtime requirements, a threshold that’s only been raised once since 1975.

Given the long hours required of most entry-level employees, this could amount to a huge raise for large swaths of the industry, one that’s causing consternation among agency executives who are scrambling to find room in their budgets for millions of dollars in additional staffing costs.

This is about far more than the bottom line. Late nights and low pay turn work/life balance on its head, drive talent out of the industry, and hinder agency recruiting efforts. For decades, ad agencies have harbored a "sweatshop" culture — some more than others — that feels increasingly archaic to the Millennial mindset, putting the industry at a disadvantage in attracting and retaining young talent. For executives who have wanted to raise wages but feared losing a competitive edge, being forced to change en masse is a relief. No one agency need be brave on its own.

But for agencies already struggling to survive under razor-thin margins and downward pricing pressure from clients, which is to say, all of them, the change represents one more strain on their already fractured business model, and is setting the stage for a showdown with clients — long in the making — about the true cost of the value they provide.

"The model is broken, and this is something that will illuminate at least part of how it’s broken," said the chief executive of a major holding company agency who asked not to be named. "What this is going to do is prove what the real cost of the work is and force a dialogue around real costs. Because right now, we’re running people into the ground."

Obama’s legacy vs. adland
The first signs of change came in July, when the Labor Department announced its intention to extend overtime pay to 5 million white-collar Americans who were not being fairly compensated thanks to the lag in updating standards.

"A convenience store manager, fast-food assistant manager, or some office workers may be expected to work 50 or 60 hours a week or more, making less than the poverty level for a family of four, and not receive a dime of overtime pay," the department said in a release. "Today’s proposed regulation is a critical first step toward ensuring that hard-working Americans are compensated fairly and have a chance to get ahead."

Nancy Hill, president and CEO of the American Association of Advertising Agencies, sent a letter to its members warning of the coming change in November.

"As many of you know, the issue of increasing the number of US workers who are eligible for overtime pay has been in the news lately, and the 4A’s has been keeping a close eye on it," she wrote. The 4A’s had joined the Partnership to Protect Workplace Opportunity, a coalition spearheaded by the Society for Human Resource Management that included pro-business groups like the U.S. Chamber of Commerce. 

A letter sent to the Labor Department in December by PPWO is "critical of the proposed rule — it's really designed to fight it — but constructively, it offers some counter-suggestions," said Peter Kosmala, SVP for government relations at the 4A’s. Rather than instantly raise the overtime threshold to $50,000, which business might have to comply with just 60 to 90 days after the rule is finalized, the 4A’s pushed a cap of $35,000, to be phased in over a period of months or years.

"We understand the underlying policy thrust of this, which is wage equality, an effort by government to create better wage structures, and treatment for a variety of workers. That's something we can all certainly applaud and work together on," Kosmala said. "We just have a serious problem with how they're deciding to go about it, and the sort of unilateral way they're doing it."

But as the 4A’s was quick to take up the issue in Washington, agency heads were slow to recognize the danger.

"There was a lot of stick-your-head-in-the-sand reaction," Hill said. People told Hill they believed it would "never make it through legislation," failing to grasp that no action from Congress was needed. "But pretty quickly after that, the HR and talent community started to wrap their head around it, and started going to their CEOs and CFOs."

Now, there is little doubt, inside or outside the industry, that the new rules will soon take effect.

"It’s one of those things we believe the president thinks needs to be part of his legacy," said Hill. "It’s about pay equality and closing that pay gap."

Of more than a dozen agencies, plus each of the major holding companies, contacted for this article, each one said they were aware of the issue and working to address it.

"We are currently — as I imagine every employer is — exploring the impact the new law could have, but it’s not something that we would publicly talk about," said a spokesperson for an Interpublic Group agency.

"We're aware of the upcoming change and have been working closely with our agencies to ensure compliance," said IPG in a statement.

The question is not whether to prepare, but how. Some may just bite the bullet and raise all employees above the $50,400 threshold. Other options include shifting overtime work to more senior employees not eligible for overtime or increasing reliance on freelancers and technology. In a paradoxical twist, some may actually lower entry-level salaries so those employees ultimately cost the same, and make the same amount of money, after the overtime rules are in effect.

Regardless of the solution, the agency world seems to have grasped that the changes will be seismic.

"This is a big deal," said Kathleen Brookbanks, COO at Omnicom's OMD U.S.A. "It means a lot of money for a lot of companies."

Whether it will heal some of what ails the suffering industry or be the straw that finally breaks its back is a question yet to be answered.

Crunching the numbers
Estimates of the total cost to the industry, and to individual agencies, vary. According to Liberty Blue, a search firm focused on young talent, one in five people working in the U.S. advertising industry makes less than $50,000 per year. And it takes 18 months to two years of working 50 to 60 hours per week – if not more, particularly during new-business pitches – before employees can expect to make more than that.

Some estimates suggest those numbers are low. The November bulletin sent to 4A’s members said the ruling would affect "approximately 30% of 4A’s members’ employees." According to the 4A’s 2015 Employee Compensation survey, an entry-level assistant media planner took home $30,583, while an entry-level assistant account executive made $35,562, two positions the organization considers "the most likely entry-level jobs in the industry."

Agency CFOs have been hard at work calculating the cost to their own business.

"I had a fairly large agency say they went through the exercise of going through entry-level salaries," Hill said, "and they found it would cost $15 million," partly due to a "rising tide effect."

One media agency with more than 1,000 employees said 10% to 12% of its workers fall below the new threshold salary. The cost of bringing them all above it? About $3 million or $4 million, not including the rising tide effect.

For smaller agencies, the price tag is naturally smaller, though the burden potentially bigger. Sharon Napier is chief executive of Partners + Napier, a Project: Worldwide company with 150 employees split between Rochester and Manhattan. With one-third of her staff making less than $50,000 annually – the average salary excluding top management is $63,000, she says – Napier estimates the cost of bringing everyone to compliance levels to be between $150,000 to $200,000 — a significant burden given her company’s size.

"For small to medium-size companies that are in secondary cities, it’s going to have more impact, because our average salaries are low," she said. "Having to raise someone from $32,000 to $50,000 is a big jump."

Given the thin margins under which her company is already operating, Napier said the changes could prove an existential threat to her business.

"If I were to take everyone in Rochester and bring them to $50,000, I would be at 68% compensation-to-income, which means I have no money for training, no money for bonuses, spot bonuses, or just your incremental cost-of-living raises," she said. "Where is it going to come from?"

That Napier has two young daughters working junior positions at ad agencies in Manhattan makes this issue particularly sensitive for her.

"I speak out of two sides of my mouth on this," she said, shrugging. "I’m a mom of two young kids in the industry and the CEO of an agency." As CEO, she says she simply cannot afford to bring everyone into compliance. Yet as a mom, "I want my kids to stay in this industry, but I would like to not have to pay for their rent."

Weighing the options
Ask most agency CEOs, and they’ll tell you they’d love simply to give all their junior people raises. But in practice, the issue is far more complex. An across-the-board raise still leaves the "rising tide" issue to deal with. If someone making $40,000 suddenly gets a raise to $50,000, what do you do about the person already making $50,000? And so on up the line.

Agencies are scrambling to find less painful options. One could be to simply keep salaries where they are and pay the necessary overtime. But as Brookbanks pointed out, beyond being expensive, that would likely result in an employee with a salary of, say, $42,000 going home with more money than someone making $50,000.

"It’s enough of a leap that someone at our entry level could be making more than our next level up," she said. The result would be resentment among mid-level staff and a disincentive to move incrementally up the ladder. 

The head of one holding company agency plans to raise just enough salaries to compliance levels to ease the burden of the new rules.

"I’d still look at what’s appropriate for a particular role," the CEO said. "If it’s $42,000, we’ll bite the bullet and pay the overtime," the CEO said. "I don’t think the right strategy is just put everybody above that level so you don’t have to pay them overtime."

Napier, to her chagrin, sees no option but to lower salaries. That way her agency would end up paying junior staffers the same once the overtime is taken into account, "but their base compensation — which they have to live on and use to pay rent and buy meals — could be $5,000 to $7,000 less," she said. 

There are other solutions beyond salary adjustments. For example, agencies could simply try to rely less on workers making under $50,400, a novel idea in the agency world. On the upside, this would restore some semblance of work/life balance to junior employees, a mission nearly every agency has undertaken in recent years to remain competitive with less work-intensive industries. But that’s easier said than done.

Some low-level employees could be replaced by technology, though that’s a greater likelihood in media agencies than creative shops. For media agencies, that could mean finding an automated way to run competitive reports, or simply relying more on programmatic buying, though junior staff doesn’t typically handle enough buying to make programmatic a wide-scale solution.

For creative agencies, shifting some of the full-time work to freelancers may be enticing. As it is, agencies have long relied on flex staff to swell their workforce during busy periods or to service project accounts.

But freelancers are not a realistic long-term solution when trying to build a company, says Napier.

"Flex staff is great, but I want people who are all in, so when something doesn’t work you can look ‘em straight in the eye and say, ‘It didn’t work.’ You need to be able to celebrate together and fail together."

Another option is pushing responsibility to more senior staff, to "begin to give the work to account directors or account supervisors," said Jay Haines, founder of Grace Blue, an executive search firm and parent company of Liberty Blue.

But that means worse conditions for managers, who already put in long hours and aren’t eligible for overtime. And like the freelancer option, it would mean investing less in junior employees — hardly a solution to repairing the industry’s talent problems.

"Either [the agencies] don’t invest at the lower level, thereby compounding the talent issue coming at the industry by hiring fewer graduates, which would be a great shame, or the holding companies have to have a conversation by which their expectations are managed," Haines said. "They have to begin to say, fine, 22% becomes a 20% margin, or 20% becomes an 18% margin, to continue to invest in entry-level talent and to absorb what is clearly going to be another financial inconvenience."

The client showdown
Advertising is a service industry. Agencies charge clients for the staff hours dedicated to their account, and clients pay the bill. In theory, the new overtime rules should be nothing but good news for agencies. With the law on their side, agencies could tell clients they have to pay more for staff assigned to their account, and there would be no room for debate. In the current system, agency bosses complain, the lack of a white-collar minimum wage enables clients to apply endless downward pressure on agencies to pay their people less or simply work them harder.

"Right now people are working so many hours for that salary that they make — we’re just killing them — there’s no incremental cost to the agency, so the client doesn’t want to pay you more," said the CEO of the holding company agency. "If they did, we’d hire another person, but they’re trying to keep numbers down, so everybody has to work more hours. It’s at a level that is inhumane."

Keeping salaries where they are but paying for overtime could serve as proof of that. Rather than bury sleepless nights under a flat salary, the itemized costs for overtime hours could serve as a ledger.

"It may cost us more to do overtime, but actually we’ll get paid for it because we’ll be able to prove incremental hours, and our clients will have to pay us," the CEO added.

"Boy, I wish that was true," said Napier. She, and others, fear clients will take a "not my problem" attitude — after all, they too will have to comply with the rules — and continue to insist agencies provide more value for ever less cost, to say nothing of continuing to provide spec work and to pitch for even the smallest pieces of business, despite the narrowed margins.

In a sign of just how delicate the issue is, seemingly no agency has yet approached its clients about how they plan to deal with it.

"It’s very difficult to have that talk with them until it’s clear that this is law," said a top financial executive at a large holding company agency. Once the exact wording of the overtime rule is available later this year, the officer said it will be easier to tell clients, "Here’s the cost associated with that to manage your business," rather than requesting additional funding for a theoretical pay hike.

Support from industry organizations and an effort toward agency solidarity would go a long way, said agency heads.

"We as an industry would have to have a pretty strong statement: ‘If our compensation is X it needs to be raised to Y to cover this,’" said Napier. "If that’s so, hallelujah, everyone wins."

"If the ANA and 4A’s come out with a joint statement saying, ‘This is the law, guys. The agencies can’t swallow one more hit on margins,’ then I’m all for it," she said. Despite their recent failure to see eye-to-eye on the media rebates issue, the Association of Advertisers and the 4A’s do have a long history of cooperation

A spokeman for the Association of National Advertisers said the group had no comment at this time. 

An uncertain road
The timeline for implementation of the overtime rule is short. The White House’s Office of Management and Budget has 90 days to review the finalized proposal, a clock that started ticking two weeks ago. After that, the specifics of the law become public, including the exact amount of the new overtime threshold and the amount of time businesses have before they need to be in compliance, typically between 60 and 90 days. That means agencies need to be planning for increased wages in August or September, barring quick action from Congress.

And that scenario is unlikely. Joint congressional action on any issue is nearly impossible in the current political climate, and the president would need to sign off on any roadblock. The short timeline also makes it difficult for opponents to delay implementation until after the election, when an administration with a different outlook might be in power.

But the panic induced by the proposal suggests the ad industry has some soul searching to do. An increase in the overtime threshold would have been a non-issue if entry-level employees weren’t traditionally expected to work unreasonably long hours or if starting pay were more competitive. Instead, the industry has spent decades carefully making an uncomfortable bed, only to curse the sun when night inevitably falls.

Executives wondering whether the pay model is sustainable have long been asking themselves whether it is defensible. The rule change may be remembered as the moment the industry confronts its core hypocrisy: that companies so focused on the dreams of the consumer are too often a nightmare to work for.

This story originally appeared on Campaign US.

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