Musings On Incentives

I had a long conversation recently with a friend who is serving as the president of a large REALTOR Association. He had heard my latest podcast in which I debate two of my friends about the value of the REALTOR brand, about the Association, about professionalism, and so on and he had questions. It was a great talk, and his basic question was how he and his Association could improve the situation… but realistically.

After we hung up, I began mulling some of the things we discussed in between actual client work. The thing that occurred to me was that we talked a lot about what the Association can and cannot do, should and should not do — but in terms of policy and activities. We didn’t really dig into the issue of incentives.

It is sort of a truism… maybe I could call it an axiom of economics that people respond to incentives. You get more of what you incentivize, and less of what you disincentivize. That’s the theory in tax policy: subsidies for solar power because we want more of that, and taxes for cigarettes because we want less of that. Neither have much to do with raising revenues for the government; both have to do with encouraging more of one and less of the other.

I am not in the least bit ashamed to say that my favorite economist is Thomas Sowell, and one of his quotes is:

As I kept thinking about the question of incentives, however, it occurred to me that if incentives lead to more of what you incentivize, then logically, getting less of something means you have not incentivized that activity. (This is the “If A then B = If not B then not A” or modus tollens. I almost made the error of affirming the consequent… but anyhow….)

Critically, intentions have nothing to do with that state of affairs.

And if Dr. Sowell can apply the logic of incentives to economic policies, it seemed to me that we might profitably apply the same logic to Association and MLS policies as well as brokerage and agent behavior. It seems to me that the real estate industry is full of such examples where intentions and hopes are divorced from incentives and outcomes.

The Eternal Question of Professionalism

Let me start with the topic that my Association president friend raised: REALTOR professionalism. We know for a fact that this topic more than any other has been, is, and likely will be a perennial complaint in the industry. Various solutions and suggestions have long been floated: licensing should be more difficult, dues should be raised, there should be more of a penalty for unprofessional behavior, etc. None of them have actually produced the outcome we all say we want: more professionalism among REALTOR ranks.

[I do note that “professionalism” is ill-defined in the industry. Broadly speaking, it appears to kinda sorta refer to adhering to the Code of Ethics or at least the principles in it, along with some notion of fiduciary duty to the client and courtesy to other professionals. But it is not well-defined. That might lead to differences in opinion on my thoughts below.]

I have long had my own theories on why we don’t have more professionalism in the industry but applying the logic of incentives, I have to conclude that the lack of professionalism means that we have not incentivized professionalism. (“If not B, then not A.”)

So let’s think about this: What incentives are there to be professional?

Do more professional REALTORS make more money? That can’t be the case, or else, we’d have more professionalism since incentives –> more of what is incentivized. And off the top of my head I can think of a number of ways in which behaving in an unprofessional manner makes you more money: double-ending deals, manipulating clients, playing favorites with offers from friends, etc. Furthermore, I have heard from too many people I truly respect that some of the worst offenders, some of the least professional REALTORS, in their local markets are the top producers who rake in millions.

Do more professional REALTORS get higher social status? Everybody wants to be be liked and respected, and one might think that those REALTORS who behave in exemplary fashion might find themselves higher up on the social ladder. That would be a powerful incentive to do the right thing all the time. But again, having less professionalism suggests that it is not incentivized, which argues against the proposition that professionalism –> popularity.

In short, it is not obvious to me that there are any extrinsic incentives for REALTORS to be more professional. It’s difficult to see what the concrete benefits are to the REALTOR — money, fame, status, etc. — for being more professional. It is easy to see what the concrete benefits are to the REALTOR to be less professional: money.

Most of what drives professionalism in real estate appears to me to be intrinsic incentives: how being more professional makes that individual REALTOR feel about himself or herself. There are moral and emotional rewards from a job done well, from having served the client as best as one could; and for some, that’s reward enough. For most human beings, it is not.

So instead, the industry as a whole tends to approach the question of professionalism through disincentives — that is, we punish those who are unprofessional, rather than rewarding those who are professional. Code of Ethics, MLS rules, fines, damage reputations, etc. etc. We demand certain levels of professionalism, then punish those who fall short.

On the one hand, following economic axioms, that does lead to less unprofessional behavior. On the other hand, it often leads to more and more sophisticated ways to evade detection, find loopholes in the rules, and in some cases, simply accept fines and penalties as “cost of doing business.”

Professionalism Incentives for Institutions

Furthermore, consider the incentives to the institutions — REALTOR Associations, brokerages, franchises, vendors, etc. — to drive greater professionalism. What extrinsic incentives exist for them to drive professionalism?

Most of the critics of the Association often mention that the Association doesn’t want to do anything about professionalism because they want/need dues dollars. That’s a fair criticism, but it’s shallow. Because we have to look not only at the faceless companies and organizations, but at the individual decision-makers and their incentives.

Plainly put, what’s in it for the staff of the various Associations, brokerages and franchises if their members/agents become more professional? We’ve already established above that there does not appear to be any extrinsic benefit to the agent for being more professional, so what does professionalism do for the Association Executives, for the brokerage manager, or for the franchise owner?

No AE anywhere in the country has his or her compensation tied to the level of professionalism of the membership. Not one. Same goes for brokerage managers or franchise employees. There are no big industry awards for the Association staff with the highest metric of member professionalism. There are rewards, however, for agent satisfaction… which is why so many of our institutions focus on making agents happy, on member benefit, on member value.

So why would any of them want to drive professionalism when the incentives are so weak (and mostly intrinsic emotional rewards) and the disincentives are so strong (lost income)? It’s fair to criticize the organizations, but at the same time, it isn’t fair; the critics in the same position would do the same thing. Because it’s all about incentives.

MLS Consolidation

Another area where we see a disconnect between intentions and incentives is MLS consolidation. Ever since I got into the industry some 15 years ago, just about everyone wanted to see fewer MLSs. Consolidation has been a goal for the industry as a whole for decades. Through that effort, we are now somewhere near 600 MLSs in the country, down from over 850 when I began. Yet… just about everyone agrees that’s hundreds of MLSs too many.

So what gives? Why do we have so little in the way of MLS consolidation?

Examine the incentives for consolidation. I think that makes things easier to understand.

What are the incentives for the MLS to consolidate with another MLS? Taken at face value, by looking at the arguments offered by the pro-consolidation folks, the biggest one appears to be lower cost for MLS services/technology. The basic idea is that by bringing more subscribers together under one entity, the MLS can negotiate better rates from vendors and afford more products and services for the members. A small MLS can only offer so much, while a larger MLS could offer more and at lower cost.

The issue is that this is a fairly weak incentive for decision makers. For the CEO of the MLS looking at consolidation, it isn’t as if lowering the cost to members leads to a bonus or personal wealth via stock options; most MLSs are nonprofit, and even if for-profit on paper, they operate as if they are nonprofits. I’m not aware of a single MLS that offers stock options or RSUs to its employees the way Zillow or EXP or Compass do. For Board members of the MLS, lowering the cost is nice, but every consolidation scheme in the industry inevitably revolves around the question of control: who has it, who will share it, who will “have a voice.” To dilute their own power by bringing others into the boardroom for the sake of lowering costs is… well, let’s just say that isn’t a particularly strong incentive.

Furthermore, that incentive is stronger for the larger MLS and far weaker for the smaller MLS. A large regional with 25,000 members can add a board member “representing” a smaller Association of 2,500 members and still maintain most of the power. That smaller Association, however, is now completely dominated on the regional Board… and the compensation for that loss of power and influence is  slightly lower costs for MLS services.

Think of the membership as well. Say I’m the #1 brokerage in my 2,500 person MLS with 30% market share. That brings me enormous benefits from a marketing standpoint, both for consumers and for agents. If my MLS joins a large regional with 25,000 members, I might end up as the #30 brokerage. What is the incentive for a big fish in a small pond to become a small fish in a big pond?

In normal non-MLS world, consolidation happens because those being absorbed into the larger get paiiiid. When CoStar acquired Homesnap for $250 million, or Zillow acquired ShowingTime for $500 million, the CEOs and board members of those smaller companies were fully aware that they were giving up power and control. But they got paid millions for what they had built. Most of their employees, I’m sure, got paid a windfall via stock options as well. This dynamic simply does not exist in the MLS world, since most are nonprofits with no shareholders whatsoever.

So what’s the incentive to consolidate especially when compared with the disincentive to consolidate?

The lack of actual consolidation signifies a lack of incentives to consolidate. And until we create real incentives to come together, it isn’t likely to happen.

Create and Align Incentives to Achieve Intentions

If the industry truly wants to achieve what it wants to, then it is necessary to create and/or align incentives accordingly.

Take the professionalism issue. If we really want more professionalism, creating more rules, more policies or more education programs — all of which we have tried and continue to try — won’t work. Instead, we need to create incentives for professionalism that aren’t simply intrinsic emotional satisfaction.

For example, look at the program I mentioned on the podcast with Jeff and Phil: Best of Zillow. That program rewards customer satisfaction, which at least partially comes from professionalism (e.g., faster response to inquiries, etc.), by providing branding that might make a difference. Money is the incentive; the result is better responsiveness (a feature of professionalism). If brokerages and franchises wanted to reward professionalism, they could provide financial incentives for results as well — better splits for higher rated agents perhaps?

Could REALTOR Associations do something similar? I don’t know, since there are all kinds of political problems with promoting specific members, but perhaps Associations can at least incentivize the staff somehow through bonuses for professionalism of members or some such thing.

If MLS consolidation isn’t working out, instead of just blaming politics or personalities, perhaps we need to be looking at incentives. As things stand today, I think incentives are weak while disincentives are strong. We’d need to look to change that if we want more consolidation.

Fact is, you get more of what you incentivize. We’ve tried preaching. We’ve tried education. We’ve tried cajoling and threatening and begging. We’ve tried punishing bad behavior, with mixed success. Maybe it’s time we try incentivizing behavior we’d like to see.

-rsh