Where Did All the Money Go?

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.