THE FOUR FACES OF PROFITABILITY: PART II
by Diane Herbert and Pamela Millard
The first part of this article focused on two faces of agency profitability: Pretax profit and Cash Flow from Operations. This part reviews Departmental Profitability and Producer Profitability.
THE FAIR SHARE
Departmental Profitability is the third face of profitability. Each department or division of the agency should be generating an appropriate profit. What’s “appropriate”? Well, as with everything else, it depends on the goals, objectives and strategies of your agency.
As a practical matter, Personal Lines or Small Commercial, with their lower revenues per account, won’t generate the same level of profit as large Commercial Lines. On the other hand, agencies with highly automated Personal Lines departments will have lower expenses. Surety usually produces higher commission rates, but is often more labor intensive. A book heavy in Construction risks develops large premiums, but is usually very labor intensive; so in a tight market a lot more of this business will go to surplus carriers who pay lower commissions.
Understand the revenue and cost drivers for each department and instill a focus on profitability. The way to ensure this is to measure profit at the department or profit center level. Getting behind the numbers allows owners to make better business decisions consistent with their strategic objectives. Your strategies might include loss leaders — the need to offer certain products or services to be competitive in your marketplace. But this should be a conscious decision; one made with all the right information.
Looking at departmental profitability doesn’t need to be just for the obvious lines of business. Any product set or service can be designated a profit center.
Most agency management systems provide for departmental allocation of income and expenses. However, be sure to include indirect expenses: Such items as rent and utilities, telephone, office supplies, and data processing expenses. You should also allocate a proportionate share of general support expenses, such as the salary and related expenses for receptionists, accounting staff, and others. It might also be appropriate to allocate some owner/manager compensation expense to each department.
Because there are no industry benchmarks published for departmental profitability, you’ll have to look at results from the perspective of what’s reasonable based on your goals and objectives and track your performance over time.
Departments that show a loss year after year should be viewed critically. Remember, expense reductions alone generally won’t deliver profitability over time. Is this department a core business for your agency? Can it be brought to profitability by growing revenues? Do you have, or can you acquire the resources needed to make it happen? Would you be better off to discontinue this product, phase it out, or sell the book? However, if you’re considering getting out of a line of business, be sure to take the long view. Agencies that got out of Personal Lines a few years ago because it was so unprofitable might now wish that they hadn’t. Personal Lines is delivering a solid, profitable revenue stream in many agencies.
WHO’S FOOTING THE BILL?
The fourth aspect or face of profitability is Producer Profitability. Each producer should be making a positive contribution to the agency’s bottom line. That means each should generate more revenue to the agency than it costs to service their book of business and to support their sales efforts. Viewing each producer as a “profit center” has several benefits.
- Gauging the effectiveness of your sales force becomes easier and more accurate. You can evaluate individual producer performance not only on the size of the book of business, but on its ability to produce a sufficient return on investment.
- Measuring individual profitability is a help to individual goal setting for new, as well as experienced, producers. It’s a great management tool for helping producers understand the economic drivers and their contribution to agency profits.
- Understanding the costs associated with producing business allows you to make more intelligent business decisions about adding to the sales force. It also provides insight into the size of the service staff required to support a producer’s book of business.
- Looking at income and expense at the producer level enables you to know what you can afford to pay your producers, allowing you to measure the success of your compensation plan and make adjustments where necessary.
How you compensate your sales force will affect producer satisfaction, producer effectiveness, and agency profitability. Your compensation program should help your agency: (1) recruit the best staff available; (2) retain and motivate these employees through incentives; and (3) reward behavior that helps the agency meet its overall business goals. But if you pay too much, you’ll never see the benefits of your investment on the bottom line. And if you pay too little, you won’t be able to hire the producers who can do the job for you — or if you do, they’ll leave for greener pastures before you’ve recouped your investment.
Of course, not all producers will produce the same level of profitability — and that’s okay. The type of business targeted and size of account will have a big effect. And new producers can’t be expected to produce a profit right away; it might take three to four years for a producer to build a book of business and generate sufficient revenues to cover costs. But it’s unlikely that experienced producers generating less than $300,000 of revenue are profitable for your agency.
Looking at individual producer profitability will allow you to reward your best producers for their outstanding contributions. You’ll also be able to easily follow the progress of developing producers and implement improvement strategies for unprofitable producers. It’s okay to fund new producers through the profits from your best producers, as well as your “house” business. But no one should be funding lazy or incompetent producers. Being able to evaluate producers as profit centers will help you ensure that this isn’t happening in your agency.
Your agency management system might be less helpful in allocating expenses to individual producers, so you’ll have to do it manually. In addition to compensation and related expenses for each producer, add direct sales expense and allocation for general sales expenses, operating expenses, customer support salaries, and related overhead and management expenses.
MEASURE YOURSELF AGAINST YOURSELF
It’s good that we have comparison data available to add perspective to individual agency results. Comparing your own results to industry averages can help you set a benchmark for improvement where the relevant numbers are available. However, do your comparisons within the context of your individual agency, looking at your strategic goals, marketplace, and mix of business.
Where the industry doesn’t publish average agency statistics you’ll need to develop your own benchmarks. Look at where you are today and use good judgment to determine whether you should be concerned about your performance. When results are good, make sure you have strategies to maintain them. When results aren’t so good, you’ll need to take action that is more positive.
Once you’ve reviewed your historical performance and set your own benchmarks, track your results. Measure yourself against yourself.
WHAT CAN I DO?
Commit to continuous profit improvement by following these four steps:
- Assess your situation. Examine the four faces of profitability in your agency. Use industry tools where available, but keep the perspective of your unique agency goals and characteristics. Where industry tools don’t exist, spend the time to develop the numbers manually. If you need some help, seek tools for modeling departmental and producer profitability.
- Develop your own benchmarks. Set reasonable targets for profit improvement where they are needed. Don’t settle for “average.” Make sure that you’re getting an adequate return on your investment.
- Implement positive change. Implement action steps to address unprofitable situations. Look for expense reductions where they make sense, but remember that you can only reduce expenses so far. You’ll often need to generate additional revenue to reach an adequate level of profitability over the long run.
- Monitor progress. Measure yourself against yourself. Track results over time and take corrective action when it’s necessary.
Diane Herbert and Pamela Millard are partners in Transformation Advisors, a client-focused management consulting firm. You can contact Herbert at (239) 948-6888, Millard at (530) 295-1083, or either of them at Web site www.transformationadvisors.com.