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CompensationMaster Newsletter Article, February 2008 Are you still operating with the same compensation plans you used during real
estate's heyday three years back?
These same plans that netted a profit in 2005 have now put many brokers in a
world of hurt. With revenue dips as high as 30-35%, brokers are seeing their
bottom lines turn from black to red.
While a revenue dip is expected in a down market, evaporating profitability
can be a sign of problems with your compensation plans and business model. Left
uncorrected, these problems leave you vulnerable.
Cutting expenses is not a silver bullet
Your likely first reaction to a profitability squeeze is to look for ways to cut
costs. But for a typical broker, operational expenses only represent about 20%
of total costs. Agent commissions can account for as much as 80% of your
expenses.
Even if you find 10% savings in operational costs, effectively you'll only
cut total expenses by 2%. That's not going to make much of a difference,
especially when faced with a 30% drop in revenue.
To make a significant dent, you need to take a more wholistic approach,
addressing commission plans in addition to operational expenses.
Update your value proposition
Once you recognize that plans need adjustment, the question becomes "how?"
It's important that you don't simply cut what you pay. You need to
restructure your value proposition for agents. Find out from them what they do
(and don't) value.
Listen for things you provide now, that they say aren't important. Here's
your opportunity for cost savings.
Also listen for what they want, and then find a way to give it to them. It
may mean adding some expenses so you can deliver what your agents need in the
changing marketplace. But by cutting out items agents don't value, you'll have
money to provide them what they really want.
Reliance on ancillary services is risky
Many brokers have given up hope that their core business will ever be
profitable. They rely on ancillary services – monies earned from mortgages,
title insurance, and other services – to turn a profit.
Known as the popcorn theory in the movie theater industry, the assumption is
that any losses to the core business (ticket sales) can be recovered by
ancillary products (popcorn). But for the model to work, you need a consistently
high-volume core business.
Consistency in the real estate market is hard to come by, which makes
ancillary services risky business. Your revenue source could dry up overnight
if, for example:
- The market declines and the number of units drops, or
- Government legislation is enacted that prevents you from combining real estate
and ancillary services.
Commission problems result in recruiting imbalances
Your commission plans should motivate and compensate agents at all levels, while
giving you enough money to pay your bills and make a modest profit.
If your plans are not designed correctly, you are most likely overpaying one
group of agents. Naturally, your generosity will only attract more and more
agents like them to your firm. As each year passes, the ratio of agents at each
level gets more out of whack, and your unrecovered costs multiply.
What's the bottom line?
Ancillary services won't fix profitability problems. We've seen several
companies that relied on the popcorn theory (ancillary revenue from units) go
bankrupt this past year.
Meanwhile, companies with sound commission plans have remained financially
stable and profitable… despite lower revenues. Some are even taking this
opportunity to acquire other brokers who are in trouble.
Companies that are going to suffer the most this coming year are the ones
that have commission plans that are not designed around their core business and
that depend heavily upon ancillary revenue for profitability.
Make sure your core business is profitable. Understand your value proposition
and breakeven point for every agent in your firm. Adjust compensation plans to
ensure you reach breakeven, under the best – and worst – market conditions.
You can read how one broker used a wholistic approach to change his company's
value proposition to agents in the October 2007 issue of REALTOR Magazine. It's
available online at "From Mutt to Best in Show."
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