Markets

How a Middle-Aged Ex-GE Quant Made a Fortune From the Fantasies of Teen Girls

By Jim Edwards

Updated on: June 7, 2010 / 4:14 PM EDT / MoneyWatch

It's hard to believe that the person who knows more than anyone else about manipulating the sex and shopping fantasies of teenage girls is Matt Diamond, a 41-year-old numbers geek who rarely grants interviews and who had no experience in advertising or entertainment before his company, Alloy Inc. (ALOY), invented The Sisterhood of the Traveling Pants, Gossip Girl, and The Vampire Diaries, among others.

Diamond received a pay raise last year to $3.4 million -- more than double what he earned last year, even though his company's revenues declined and it lost money. But this is a rare case of an ad agency whose recent financial sins can be forgiven in favor of its overall performance: It's vastly more efficient than its larger competitors such as Omnicom (OMC), Interpublic (IPG) and MDC Partners (MDCA).

More significantly -- and this is the key strategy message for managers -- Diamond has exploded three long-held myths about the ad biz: that creative talent needs to be expensive; that media should be bought from third parties; and that there's a clear separation between editorial content and advertising.

Although it is most famous for Gossip Girl, Alloy is a collection of different businesses that are focused on the teen market. It sells advertisers access to its school, college and military media properties, and offers them involvement in the books and T shows it creates. The company perfectly mixes entertainment and advertising, with a heavy emphasis on digital products such as Teen.com, retailer dELiA*s.com and social networking site gURL.com.

I've written about Alloy occasionally on BNET (see related stories below), but almost no one else pays attention to the agency despite the fact that it is the future of the advertising business. Although Alloy is publicly traded, no analysts cover it. Ask someone in the ad biz to name Alloy's chief creative officer -- or to simply guess whether it has one -- and you'll be met with blank stares. In terms of its relationship with Madison Avenue, Alloy is like North Korea: A hermit kingdom about which little is known but which everyone fears.

Adweek's Noreen O'Leary did us all a huge favor a couple of weeks ago by interviewing Diamond (pictured), something no one else has ever bothered to do. (Alloy's publishing arm was profiled by the New Yorker last year, but Diamond didn't merit a mention.)

We find that Diamond's previous experience was at General Electric (GE)'s power systems division in Japan, and that the founding partners of Alloy are another GE alum and a Goldman Sachs banker. They're quants from Harvard Business School. No one from advertising or Hollywood, in other words.

So how did these spreadsheet jockeys come to be experts in the inner angst and drama of the adolescent female consumer? Given that they know more about creating excess profit margins than they do about advertising, the trio seems to have decided to dispense with the usual way of running an agency, which is to spend all your money on the best talent available and hope clients follow.

Instead, Alloy hires young unknowns, sometimes without relevant experience (just like management) to create their products. The staff is only a few years older than their target audience. The New Yorker said:

Alloy's writers are usually in their twenties, and often have little or no experience writing a full-length novel.

This is crucial. By employing rank amateurs with no experience Alloy can pay them less, lowering its costs and upping its margins. Alloy earns $1.70 in revenues for every dollar spent on quarterly operating costs -- far more than any of the other major ad agency networks. Aegis (AGS.L), the next best performer, earns back $1.30 for every dollar spent, and it's a media specialist. Only web ad provider ValueClick (VCLK) can match Alloy, with a $1.89 return. (You can see more of these agency efficiency comparisons here.)

Advertising is famous for its razor thin margins, low barriers to entry and fierce competition. It's impossible to start an agency and get paid more than anyone else because there are so many other agencies that they're all constantly engaged in a race to the bottom. Clients these days often pick agencies based on price. What's remarkable about Diamond is that by ignoring traditional ad media such as TV and magazines, he's found a way to increase the amount he gets paid by clients and make more money. Owning the media he's selling as ad space is almost certainly a big part of that.

This cost-conscious ethos apparently extends to Alloy's own offices. If you've ever seen an ad agency's interior decor, chances are the experience was like being beaten in the eyes with a meat tenderizer (remember Grey Group's glass-walled bedroom or JWT's in-office nightclub?). When O'Leary expressed surprised that the shop looked a bit "no-frills":

Diamond seems surprised, explaining that the space has just been completely remodeled. "You should have seen it before," he quips.

What's scary for the rest of the ad business is that to compete with Alloy, networks like Omnicom and WPP (WPPGY) would have to gut their agencies not only of their middle management but of the upper ranks of creative management, and admit that lucrative creative offerings can come from just about anyone -- no experience required.

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