Transit Advertising Sales Agreements (2004)

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25 CHAPTER FIVE CONTRACTING ISSUES Transit agencies that contract with an advertising sales contractor must address a litany of contract-related issues ranging from how to structure the contracts to contract length to calculation of revenues. These decisions potentially affect transit agency revenues, although it is often difficult to predict which course of action will produce greater revenues. Industry practice and experience can help agency staff make informed decisions about contracting issues. MULTIPLE VERSUS SINGLE CONTRACT Most transit agencies enter into one contract with one ad- vertising sales contractor to handle all of their advertising space. A single contract provides simplicity of administra- tion and oversight for both the transit agency and the ad- vertising sales contractor, and clarity for advertisers. Occasionally, however, agencies may split contracts for different types of advertising space or may administer some types of advertising space in-house while contracting for other types. Examples include • VTA (San Jose) contracts with one company for bus and light rail interior and exterior advertising. A much smaller contract (in dollar terms) is with a sec- ond company for bus shelter advertising. • The Golden Gate Bridge, Highway and Transportation District (San Francisco) contracts with one large adver- tising sales contractor for bus sides while selling bus tail advertising in-house. The bus tail advertising is sold primarily to local businesses, whereas the contractor’s advertising sales are more national in scope. • MBTA contracts with a firm for vehicle and station advertising while selling advertising on maps, sched- ules, and passes in-house. MBTA also sells the right to distribute product samples at specific stations for periods of 4 hours or less. • Muncie Indiana Transit System and Star Tran (Tuc- son, Arizona) contract with advertising sales contrac- tors for bench and shelter advertising while selling bus interior and/or exterior advertising in-house. Although it may be desirable to do so, there are impor- tant reasons to be cautious about splitting contracts. Issues that agency staff should consider include • Will the presence of multiple advertising sales con- tractors cause confusion among advertisers who are alerted to the availability of advertising space in the transit system from two different sales representa- tives? • Will additional advertising space on transit property dilute the market for transit advertising space and thus depress the rates that a given advertising sales contractor can charge? • Do the advertising venues offered by different sales contractors appeal to different segments of the adver- tising market? For example, video or electronic signs that can display time-sensitive advertisements appeal to advertisers who are not served with static bill- board-type advertising. Or, will there be competition between the advertising sales contractors that result in lower rates for transit space? • Will multiple sales channels divert advertising sales revenue from one contractor to another? If this may occur, what is the impact on transit agency revenues? Does the new advertising space command premium rates and will the transit agency benefit from them? Or, does the diversion move advertising sales from a contractor who shares a relatively large percentage of revenue with the transit agency to one who shares a smaller percentage? This situation could result in a loss of revenue to the transit agency. These issues are particularly acute when the advertising market is depressed. When demand for advertising space is low, adding to the inventory may not increase overall reve- nues from advertising. Conversely, a robust market for ad- vertising space is more likely to attract new advertisers and new advertising revenue. Although these issues are a topic of discussion among transit agency staff, there has not been sufficient experi- ence to draw conclusions on the effects of multiple versus single contracts. Nevertheless, transit agency staff believes that these issues should be considered in deciding whether to engage in multiple contracts. Issues related to multiple contracts almost unavoidably arise when transit agencies venture into nontraditional forms of advertising. Video screens and in-tunnel advertis- ing have been developed by relatively small and new com- panies rather than the large, established advertising sales contractors that normally serve transit agencies. Contracts that give the main advertising sales contractor exclusive rights to all advertising in the transit system preclude in- troduction of nontraditional forms of advertising from

26 these smaller companies. Agencies wishing to pursue these opportunities must keep the door open to multiple con- tracts. For example, the Metropolitan Atlanta Rapid Transit Authority (MARTA) inserted into its most recent contract a provision that reserved the opportunity to sell advertise- ments on electronic signs and trash receptacles in MARTA stations. In-tunnel advertising is also excluded from the contract. Others, such as BART, reserve the right to im- plement new forms of advertising, but grant a right of first refusal to the advertising sales agency already under con- tract. REQUEST FOR PROPOSAL PROCESS Transit agencies almost universally use an RFP process to procure the services of an advertising sales contractor. Unlike a low-bid procurement, an RFP allows transit agen- cies to consider both the quality of the proposal as well as the price. The typical process involves releasing an RFP with a detailed scope of work and other contracting requirements, holding a pre-bid conference to answer questions from prospective proposers, and reviewing extensive written proposals. Proposals typically include a description of the company’s experience and the experience of individuals who will be assigned to the contract, demonstration of the agency’s ability to perform, information about other cur- rent and completed contracts, financial statements, refer- ences, and the financial bid. It can be useful to require a listing of past markets no longer served, bankruptcies, law- suits, and names under which the proposers have done business in the past to fully evaluate each firm’s ability to perform under the contract. Evaluation criteria typically include experience, organi- zation, staffing, revenue, ability to perform, and the quality of the marketing plan. Evaluation of proposed revenues must balance the guaranteed annual revenue and likely revenue under proposed revenue sharing. Transit agencies may select a winning firm after evalu- ating the written proposals and interviewing firms. Many agencies, however, treat the procurement as a negotiated RFP process and negotiate with one or more firms for the best possible terms before making a selection. See Appen- dix C for examples of recent RFPs. CONTRACT TERMS Length of Contract One critical decision in formulating an RFP is determining the length of the contract. Until June 2001, FTA regula- tions prohibited transit agencies from entering into con- tracts of greater than 5 years, inclusive of options, without a waiver. The new ruling permits revenue contracts of greater than 5 years provided certain requirements are met, such as awarding exclusive contracts through a competitive process (FTA 2001). Notwithstanding this new ruling, most new contracts reported in the survey were for 5 years or less, both before and after the ruling was issued. Of agencies surveyed, 35% contracted for 3 years and 38% for 5 years (Table 7). Contracts most commonly provide for a 3-year term with two 1-year options. Some contracts provide for op- tions for 1, 3, or 5 years, usually in 1-year increments. Agencies with relatively long contract terms include WMATA, Sun Tran, and the Potomac and Rappahannock Transportation Commission, all with 10-year contract terms. VTA and the Muncie Indiana Transit System have entered into 15-year contract agreements. VTA’s 15-year contract is for bus shelter advertisements; the contract term for advertising on buses and light rail has not exceeded 5 years. WMATA asked proposers to bid on both 5- and 10-year contract terms, with the intent of awarding for the 10-year TABLE 7 LENGTH OF CURRENT CONTRACT (excluding option years) No. of years Top 20 Media Market, Large Agency Other Transit Agencies in Top 20 Media Markets Mid to Small Media Market Total 1 7% 0% 0% 3% 2 7% 14% 7% 8% 3 29% 14% 53% 35% 5 43% 57% 27% 38% 6 7% 0% 0% 3% 10 7% 14% 7% 8% 15 0% 0% 7% 5% Total 100% 100% 100% 100% No. responding 14 7 15 36

27 term if revenues produced would be more than for the 5- year bids, which turned out to be the case. The best length of the contract depends in large part on timing. A long contract term can be beneficial to transit agencies when the advertising market is highly competi- tive. This was illustrated by the experiences of WMATA and VTA, both of which benefited from revenue guarantees set in the late 1990s. As of mid-2003, transit agencies had avoided long contract terms, awaiting advertising market improvements. Option years can provide flexibility in deciding when to issue an RFP. King County Metro Transit, for example, will pick up both option years on its current contract, which will extend the contract through December 2004. King County Metro staff hoped that by the time a new RFP is issued in 2004 the advertising market will provide a favorable climate for bidding on the contract. Similarly, VTA extended its contract with its existing firm through December 2003 (at a much lower guarantee level than previously) and can extend the contract through 2004. 2 Revenue Guarantee and Revenue Share Advertising sales contractor payments to transit agencies are usually computed by taking the greater of the revenue guarantee and a stated percentage of advertising sales con- tractor revenues. Contracts generally include a minimum guarantee. Of agencies surveyed, 92% reported that their contract in- cludes a guarantee. The guarantee amount often escalates each year of the contract, with 88% reporting this to be the case. The guarantee is usually set in bidding on the contract. Transit agencies may require a certain guarantee level in the RFP; 39% of agencies surveyed reported that they set a required guarantee in the RFP and then allowed advertising sales contractors to bid that guarantee level or higher. As would be expected, the size of the guarantee is dependent on the size of the transit agency and its market. In 200 • Guarantees varied from $50,000 to more than $600,000 for transit agencies in small- and mid-size markets that operate bus service but not rail service. • For large transit agencies in top 20 media markets, the guarantee varied from $1.7 million to $20 mil- lion. • For small- to medium-size agencies in top 20 media markets, the guarantee ranged from $17,000 to $2.1 million. In addition to computing revenues based on a guaran- teed revenue level, contracts typically provide for the advertising sales contractor to pay a percentage of annual billings. Of agencies surveyed, 92% reported that their contracts included a revenue share. The guarantee is usually paid monthly, with a subse- quent reconciliation at year’s end if the revenue share cal- culation exceeds the guarantee. The definition of “net bill- ings” is not completely uniform. Some agencies exclude the cost of production services provided to advertisers and some do not. Most agencies exclude commissions paid to advertising agencies that buy advertising space on behalf of advertisers. In some cases, agencies exclude bad debt, although they may cap the amount of bad debt allowed at a specified level. However, agencies usually base the reve- nue share on billings and not collections. It is important to be sure that in the calculation of net billings other expenses not be deducted, because if this occurs it may reduce the amount of revenue to the transit agency. The revenue share ranges from 10% to 80% in agencies surveyed (Table 8). As with the guarantee level, the size of the metropolitan area influences the revenue share. • For transit agencies in small- and mid-size media markets, the revenue share ranges from 10% to 62% with 50% to 60% being typical. • Revenue sharing for large transit agencies in the top 20 media markets ranges from 55% to 80%; 65% is typical. • Small- to medium-size agencies in top 20 media mar- kets reported revenue shares of 25% to 65%. A critical aspect of evaluating advertising sales contrac- tor proposals is weighing the relative importance of the guarantee level and the revenue share. Clearly, relatively high guarantees are attractive as providing a predictable level of revenues to the transit agency and guarding against downturns in the advertising market. Recent experience has underscored this point. On the other hand, the revenue share can provide a greater upside. This is particularly at- tractive when guarantee levels are depressed and economic conditions may improve over the term of the contract. In practice, the revenue share was less than the guaran- tee in 2002 for two-thirds of the agencies providing reve- nue data. As a result, payments for most agencies were based on the guarantee rather than the revenue share, which is not surprising given the depressed state of the ad- vertising market in 2002. Some RFPs specify the revenue share and then evaluate proposals based on guarantee levels. For example, WMATA fixed a 65% revenue share, thus narrowing the evaluation to the proposers’ different guarantee levels.

28 TABLE 8 REVENUE SHARE IN ADVERTISING CONTRACTS Revenue Share Top 20 Media Market, Large Agency Other Transit Agencies in Top 20 Media Markets Mid to Small Media Market Total 10% — — 7% 3% 12% — — 7% 3% 18% — — — 3% 25% — 20% 7% 6% 45% — — 7% 3% 50% — — 21% 10% 51% — — 7% 3% 52% — — 7% 3% 55% 17% 20% 14% 13% 58% — — 7% 3% 60% 17% 40% 7% 16% 62% — — 7% 3% 64% 8% — — 3% 65% 50% 20% — 23% 80% 8% — — 3% Total 100% 100% 100% 100% No. responding 12 5 14 31 Note: Percentages may not add to exactly 100% because of rounding. Conversely, the Milwaukee County Transit System (MCTS) sets the guarantee level in the RFP and allows firms to bid on the revenue share, believing that when advertising sales con- tractors overreach on a guarantee bid, they cut corners on the quality of service. Other agencies, such as the CTA, set both a minimum guarantee and a minimum revenue share and let bidders bid to those levels or higher. Note that although direct payments from the advertising sales contractor constitute most of the value of the con- tracts, agencies may also include other types of compensa- tion such as credits for purchase of advertising in other media. Performance Bonds and Letters of Credit Contracts often require a performance bond, letter of credit, or provisions for liquidated damages to protect the transit agency from contractor nonperformance. The most reliable form of protection is a letter of credit. To obtain a letter of credit, the contractor puts aside a sum of money with a bank or other financial institution. The transit agency can draw on this money in the event of contractor nonpayment. A performance bond is similar to an insurance policy. If the contractor fails to perform, the agency makes a claim. Because the contractor can make defenses against the claim, a performance bond can be less attractive than a let- ter of credit. Among surveyed agencies, 69% reported requiring a performance bond, letter of credit, or provisions for liqui- dated damages. Large agencies in top 20 media markets are very likely to include these provisions (85% reported doing so). By contrast, just 44% of agencies in small- or me- dium-size markets required one or more of these provi- sions. Somewhat more agencies require a performance bond than a letter of credit; some agencies accept either one. The dollar figure required for a performance bond or letter of credit varies somewhat. One common requirement is 25% of the annual guaranteed revenue, which is required by CT Transit (Connecticut), BART, and SEPTA. Other re- quirements were 50% of the total contract (Port Authority of Allegheny County in Pittsburgh), the annual amount due (Big Blue Bus, Santa Monica, California), a $1 million bond (Maryland Transit Administration), and $20,000 in escrow (Sun Tran). One large agency, WMATA, chose not to require a per- formance bond out of the expectation that a bond require- ment would reduce revenues from the contract. Ownership of Advertising Equipment If the advertising sales contractor owns advertising frames, electronic signs, bus shelters, and other infrastructure, the question arises about the disposition of the property at the end of the contract. Does the transit agency need to pur- chase the property if it changes advertising sales contrac- tors? Is the property transferred to the new contractor and, if so, does the new contractor pay for it? Most transit agencies appear to avoid this set of issues by retaining ownership of advertising frames and other equipment. In the survey, 61% of responding agencies re- ported that equipment is owned by the transit agency. In

29 these cases, bringing in a new contractor does not raise equipment ownership issues. An additional 15% of transit agencies retain ownership of some equipment, whereas the advertising sales contrac- tor owns some of the equipment. For example, MCTS owns advertising frames, whereas the advertising sales contractors or other vendors own bus shelters and televi- sions inside buses. NJ Transit owns equipment on bus and rail exteriors and interiors, whereas their advertising sales contractor owns commuter rail station poster frames. Of transit agencies surveyed, 23% reported that the ad- vertising sales contractor owns advertising equipment. Several arrangements were cited for disposition of the property when the advertising sales contractor is replaced. MARTA purchases equipment from the out-going vendor using the depreciated value. VTA bus shelters are turned over to VTA, with the cost of the shelters depreciated over the life of the contract. In Tucson, the advertising sales contractor would sell equipment to the new vendor or to the city of Tucson. BART retains an option to buy equip- ment based on the capital account balance, or equipment would be sold to the new advertising sales contractor at a negotiated price. NJ Transit intends to purchase rail station poster infrastructure at the end of the current contract as part of a migration toward self-ownership. Audits Three-quarters of transit agencies responding to the survey reported that they perform audits of advertising sales con- tractors. Asked for the frequency of the audits, the majority reported that they are conducted on a spot check basis rather than on a regular basis, although 19% said that they audit on an annual, semi-annual, or monthly basis. Within the group of agencies that reported conduct- ing audits, 41% conducted some type of formal audit. The most common auditing methodology is comparison of the advertising on buses with the advertising sales con- tractor’s reports. These reports may also be compared with individual advertising contracts. A third approach, used by a few agencies, is to call on the services of an independent auditing firm or the city’s internal audit di- vision. By contrast to these relatively rigorous approaches, a number of agencies simply review advertising sales con- tractor financial reports without any outside verification of revenues. Sales contractors are sometimes required to submit to the transit agency a copy of each sales contract. SEPTA, MCTS, and WMATA are examples. MARTA approves each contract and therefore also receives a copy of each contract before its execution. Agency staff believes that seeing the contracts gives them a better understanding of the market for advertising sales and provides useful infor- mation for audits. (See Appendix D for two examples of revenue reports.) Renegotiating Contract Terms The economic downturn at the time of the survey raised the question of how often transit agencies were asked by their advertising sales contractor to renegotiate contract terms. One-third of the agencies surveyed reported that a contract renegotiation had been requested; however, only three agencies reported changing the financial terms. Revi- sions involved reductions in guaranteed revenues, substitu- tion of media trades for revenues, and switching from guarantees to revenue sharing.