Imagining the Future: Part 3 — Shifting the Grounds of Competition

So let’s say that some brave soul out there has decided to gamble away his life at the urgings of a certain blogger who works for a certain data company in New York City. To him, I offer my deepest sympathies.

But courage! If this works, please do remember to look down upon us peons as you fly overhead in your Gulfstream G650. (Damn, even the website for that plane looks like it cost more than I make in a year.)

This brave soul would have gone forth, found rainmaking partners, installed an institutional CRM system, and is ready for business!

Well, not quite… there are still more steps, more things to consider.

One of the things this brave soul and his partners must do is to think about redefining the profession of “realtor”. [ED: Oh, is that it? I was worried they might have to do something hard…. /rolleyes]

Keep in mind that by going the institutional route, the Firm has taken on a very different cost structure than traditional brokerage. Instead of commissioned 1099 independent contractors, the Firm has 1040 salaried employees with benefits (which are costly). It has to take on the cost of CRM, of support staff, and of support professionals in IT and marketing that a traditional brokerage simply does not have. As older and wiser heads have pointed out, the Firm forgoes the very sweet IRS rules treating real estate agents as Statutory Nonemployees.

The 1099-based approach rewards brokerages that unleash a horde of low-training, low-skill agents to go forth and blanket the marketplace. They will make up in volume what they lack in quality, because even the worst agent will probably get her sister to list with her, at least once. Since the 1099 doesn’t actually get paid until some sort of transaction has closed, the brokerage could have nearly an unlimited number of such agents running around. For that matter, it almost appears as if some traditional brokerages have become de-facto landlords to their agents based on some of the desk cost oriented business model.

The 1040-based approach simply cannot compete with this low-cost, low-skill, high-turnover model on the same basis. At the same time, it should be pointed out that the 1099’s simply cannot compete with the high-cost, high-skill, low-turnover model of the 1040-based Firm on its home turf.

Therefore, for the Firm, it becomes necessary to shift the grounds of competition. If your thoroughbred can outrun any other horse running in a straight line, you don’t take him to a steeplechase competition. You take him to the Kentucky Derby.

A Brief Detour

While it’s tempting to think of the Firm as having taken on “more costs”, that isn’t precisely true, in my view. Rather, I think it’s more accurate to think of it as exchanging risk on the revenue side with risk on the cost side. The Firm unquestionably has higher overhead and operating costs. On the other hand, it unquestionably has larger company dollar on the revenues, since it has no agent splits whatsoever.

I can’t embed an iframe on WordPress.com blogs (boo!) so I find it impossible to insert a table. But you can mosey on over to this here terribly simplified, terribly naive spreadsheet. What I’ve attempted to do is to show using very rough assumptions (that naturally favor my argument) about what the financials between comparable institutional brokerage might look like vs. a traditional brokerage.

What the very rough analysis (which is likely full of holes) shows is that while the Firm might spend $650,000 more on overhead, salaries, and such than the 1099-based traditional brokerage, it captures 100% of the commission as company dollar. I assumed a 70/30 average agent split on the part of the traditional brokerage, which doesn’t seem that unrealistic considering this:

The splits to the brokerage are set annually as a percentage of gross commission income, and there’s flexibility in how the percentage is set. Many associates take a 70 percent split until the 30 percent contribution to the broker equates to $18,000. Once that happens, they get 100 percent of their commissions. They may also opt for a higher, 80–20, split, up front in exchange for guaranteeing the $18,000 to the brokerage before the end of the calendar year. On top of the $18,000, each associate pays a franchise fee, which is capped at $3,000.

On that basis, even assuming that both go after the same size transaction, the number of transactions to breakeven is lower for the Firm than it is for the traditional broker: 111 vs. 130. Of course, after the breakeven point is reached, the Firm takes in an additional $6,300 per transaction than its competitor. Assuming both companies are profitable and do 200 transactions, the Firm will take in $800,000 in profits as compared to $190,000 for the traditional brokerage, even though the GCI is identical at $1.8m.

If we further assume — as I am arguing — that the additional support, the CRM system, the marketing staff, and the other things discussed in this series leads to the Firm having an advantage in going after more sophisticated clientèle with a higher price point, and in fact does more deals than its army of low-skill  agents competitor, the advantage becomes pronounced.

Obviously, the analysis is extremely elementary, and probably doesn’t capture all of the nuances, different business models, the actual costs of operation, and so forth. But all the model shows is that there is nothing inherently unrealistic about moving to an institutional model simply because its cost structure is higher — because its revenue structure is also much higher.

End detour.

What Do You Compete on Today?

Whatever the Department of Justice might say, fact is that real estate brokerage is one of the most competitive service industries out there. The barrier to entry is so low as to be practically nonexistent. Combine this factor with the various “make it up in volume” business models prevalent in real estate, and you have a recipe for brutal competition.

However, fact is that a volume-based commodity business can only compete on the basis of three things: Price, Luck, and Lies.

Price competition takes all forms. In real estate, not only is there competition on commissions, we are starting to see the whole notion of rebates really take root. Redfin is probably the biggest proponent of rebates to consumers, but it is by no means alone now.

Rebates are simply a form of price competition. When you are in the business of undifferentiated goods or services, then competing on the basis of price is not only smart business, it’s probably the most effective form of competition.

Luck is also a basis of competition, although it is rarely thought of that way.

In New York, we have legions of street vendors that hawk their “genuine” articles on street corners. It is almost entirely by happenstance that some tourist will stop by their cart or table and decide to enjoy some “bargain hunting”. Sure, these vendors believe that certain locations are better than others and jockey with each other for the good street corners.

But getting that street corner in and of itself is in many respects a function of luck. You happen to be lucky enough to get that street corner before someone else could set up shop. This isn’t terribly different to me of someone who was lucky enough to find a great street-front location for their brokerage office. (Yes, yes, I know it takes months of searching, detailed trade area analysis, and savvy negotiation with retail landlords, and so forth to find the perfect location. But first, that location had to be available, right? That’s usually a function of luck.)

So much of what passes for “relationship marketing” in real estate (and in law, for that matter) is really luck-based competition. A friend of mine from law school is a major rainmaker-in-training for a top law firm in NYC. His grades were truly abysmal in law school. I can’t really understand how he passed the Bar. But he happens to be the son of one of the top government ministers in Argentina. He’s bringing in so much Latin American business to his firm that they had to make him a partner. Since none of us chooses our parents, his lucky break in being born to the right father is his meal ticket.  Same thing in real estate happens every day of the week, and twice on Sundays. (Of course, if my friend’s law firm is savvy, they are trying their damnedest to make sure his Latin American contacts are parlayed into the firm’s clients through application of many of the principles I’ve discussed already.)

Even some of the listings-based competition, where brokers will enter a listings into a bazillion websites, has a large dose of luck-based marketing to it. The hope is that by dangling the bait out there in as many places as possible, some consumer will chance upon it and bite. The inability to conduct targeted marketing on a Seven Year Cycle customer, coupled with the fact that the service of real estate brokerage is seen as undifferentiated commodity service, necessarily leads to this approach.

Finally, commodity service providers compete on the basis of lies. Usually, these lies are called “marketing”.

I’m sorry for picking on Stacy Gee, but… gee whiz… that is a horrible ad deserving of much abuse!

There are some real negative effects of these kinds of marketing. For one thing, today’s consumers are practically trained from the time they can walk to disregard advertising. They have learned that advertising lies. That it too often misleads. That the Big Mac on the poster looks nothing like the thing you actually receive in the paper bag.

In real estate, the prevalence of lies (particularly by agents claiming to do everything but cure cancer and solve world hunger) means that even agents who opt for the honest, authentic, transparent approach are often regarded as “just another lyin’ marketin’ huckster”.

An institutional approach simply cannot compete on the basis of Price, Luck and Lies. Indeed, the whole point of institutionalization, with its attendant costs, is to avoid having to compete on the basis of Price, Luck, and Lies.

Competing on Strength

What institutional strength gives the Firm and its realtors is the ability to deliver extremely high-quality service customized to the needs of a particular client.

Properly implemented CRM enables the Firm to avoid having to compete on price, luck, or lies. Instead, the Firm provides consumers with relevant performance data, knowing much more about what a particular customer wants to know and why. Is Mr. Smith a bargain-hunter who needs to be sent an email when a below-market listing hits the system? Mrs. Jones may have really wanted to live within walking distance of downtown, but nothing was available when she bought three years ago. Does she need to be contacted now that something has become available? The Keller family may be looking to move, since they are in their sixth year of homeownership, but Mrs. Keller is a lawyer who was very demanding — maybe we need to start sending them newsletters about zoning changes in her neighborhood, tax consequences of the new legislation, and so forth.

The Firm does not rely on luck, but mines the data in its system to determine with far greater precision whom to target when and where with what message and why. And it can report on all of these activities to a customer. “Yes, Mrs. Jones, we marketed your property on BassAngler.com because our analysis shows that 22% of the people who bought in your development over the last ten years are avid fishermen. Why yes, I can send over the clickthru rates for the past six weeks.”

It does not compete on price, because it knows and can prove the value of its services. As an institution that knows what its people worked on, it can provide a detailed itemized invoice to every client who asks for it. Weekly reports on marketing activities on your house? No problem — I’ll email that right over.

Institutionalization also allows for specialization to a degree that traditional brokerage cannot — because of the pooling of revenues. (This will be covered in detail in a future post.)

In short, the Firm can force its competitors to live up to its service standards.

Truth be told, every service provider tries to do this. In 1099 companies, however, the lack of control by the broker over the agents leads to real problems with quality control. They also lack the revenue model that brings in enough company dollars to fund much of the items described above. In the Firm, with its 1040 employees, it can actually enforce service standards. Furthermore, the stronger revenue model means that the Firm can retain resources, such as graphic designers, marketers, and IT professionals, to provide truly meaningful support to its producers and to its customers.

Ads like Stacy Gee’s do not come out of institutional Firms (unless the leadership is truly idiotic). Not if you have a professional marketer and graphic designers on staff or on call.

Marketing a client’s house for sale is not reliant on individual agents (or their administrative staff) of varying skill and talent. In an institutional setting, the partner secures the deal, the associate works the deal, and the marketing department takes over for the task it is good at doing: marketing properties. As a matter of fact, since the customer is hiring the Firm to market his property, he has a range of choices on just how intense an effort he wants the Firm to make — and pay accordingly. The Firm is more than happy to hire U2 to throw a concert at your house — provided that you have the money to pay for such an event, as well as a fee to the Firm’s marketing group for organizing such an event.

Furthermore, when every dollar of revenue is company dollar, the Firm can more easily offer a wide range of service and compensation options for its clients. (This recent post on Sellsius is of interest here.) Rather than sticking everyone with a percentage-of-sale commission model that the 1099 Statutory Nonemployee strongly incentivizes, the Firm is free to offer services a la carte, by the hour, by the project, or on a commission basis.

It can vary the pricing based on who handles the transaction. Want the partner to handle everything from start to finish? That’ll be 8%. Want the partner to work with an associate? That’ll be 6%. Want the bargain rate where the associate does most of the work, but supervised by the partner? That can be as low as 3%.  You want someone in our Transactions Settlement department — a non-agent salaried employee — to just provide you with a checklist and help you with paperwork?  That’ll be a flat fee of $500, thanks.

Note that this is not your typical competition on price. It merely makes transparent the pricing scheme within the Firm, and at the same time establishes the rule that the customer is actually paying for experience, expertise, and assistance. The senior people are simply more expensive. That is how it is in every other service industry, and I just don’t see a lot of consumer resistance to the idea.  In fact, it seems silly that a 30-year veteran charges the same price as a newbie agent who doesn’t know enough to wipe his own nose: 6% of the sale price.

The Firm can offer true buyer representation, by allowing its buyer clients to pay the Firm directly for its services, or let the buyer select the type of agency he wants and the type of compensation that goes with it.

The Firm can break up the compensation to take account of the different services your firm can provide:

• Advisory services
• Marketing services
• Transaction Management
• Vendor Management
• Etc. etc.

Leveraging the power of institutional CRM, the Firm can actually turn customers away because analysis shows that representing them is not profitable. It will send those folks to its competitors. This makes the Firm look like a company that isn’t grubbing for every penny, earning goodwill, but at the same time, it punishes the Firm’s competitors by saddling them with money-losing clients.

Requirements

What underlies this whole approach is data. You must have data on your market, on your customers, on your past customers, and on your prospects. You have to be able to mine the data, slice and dice, to find the insight you need to make decisions. You have to keep very detailed records on every client and every transaction, and enforce data entry discipline across the whole Firm.

Your employees have to be trained to take data seriously, and be made to do data entry. Or they can find a different job.

You cannot afford to have legions of low-skill agents, because you’re paying each and every one of them a salary. You will, instead, hire the most promising young agents who can be trained, groomed to become rainmakers, or if not, brings value to the Firm in other ways — for example, by being an excellent transaction manager.

You must have a marketing director who is savvy in the ways of data-driven marketing, and analysis. Your finance and operations people must be comfortable with analyzing data to see trends and engage in predictions based on facts.

And of course, the Firm requires unusually strong leadership at the top, at the partner level — specifically, at the managing partner level. These individuals are rare, but they’re not mythical creatures. I have met a number of brokers who are savvy operators, astute businesspeople, who are excellent managers. They are shackled by a structure that makes it nearly impossible to manage effectively.

Conclusion

These efforts to shift the grounds of competition end up redefining the profession of realtor. By clearly differentiating how services are offered, delivering superior service, and delivering measurable metrics to customers, the institutional realtor is able to professionalize to a degree that traditional brokerages find difficult. Contrasting their ability to deliver, the expertise and high skill level of their people, with the competition’s inability to control its own agents, control its brand message, and provide much of the services that an institution can, the Firm and its people are able to slowly shift the consumer’s perception of what the practice of real estate really is.

In further parts, we will dive into the concept of Systemic Brokerage that this approach enables, and discuss Specialization — yet another competitive advantage enabled by institutionalization.

-rsh

Part 1 can be found here.

Part 2 is here.