What’s Your Grofit?

As you execute on your business plan, are you guided by long term objectives, short term goals or a balance of each? Agency owners often perceive growth and profit as mutually exclusive. In our consulting practice, we frequently work with agency principals that are focusing on either growing top line revenues or driving bottom line profitability. They will employ either the “grow at all costs” strategy or the “profit is king” strategy. Sacrificing growth for profit or profit for growth in the long term can be a detriment to agency value and sustainability.

Without question, the most valuable agencies in the country have created a balance between growth and profit. These agencies understand with any strategy or tactic driving a sustainable, profitable growth model should always be the goal. When evaluating the future direction of your agency, first ask yourself, “What’s my Grofit?”

There are many factors that impact the value of an agency. At its core, agency value is a function of growth and profit. When a buyer evaluates an acquisition or when a valuation expert determines an agency’s value, two of the most important items analyzed are the ability to produce historical growth and profit. Grofitability metrics were developed to illustrate how well an agency can balance growth and profit. Grofit can also be an effective indicator of agency value.

The GRO in Grofit

The first component of Grofit is growth. Over the past five years, the majority of agencies have struggled to achieve growth. Figure 1 illustrates the average growth rate in total commissions and fees over the past five years for agencies in our Perspectives for High Performance benchmark database (which contains over $2.2 billion of net revenues, in aggregate). We ranked each of the agencies in the database from highest to lowest based on the Grofit formula. References to the Most Grofitable agencies reflect the Top 20 percent of the agencies in the database with regard to Grofit. The Rest represents the remaining 80 percent of the agencies in the database. The bottom 80 percent has had negative growth over the past four years, while the Most Grofitable agencies have been able to grow despite a significant decline in rate and risk exposures. Of the agencies that had the highest Grofit, growth was driven by a continuous commitment to staff reinvestment and implementing effective sales management systems. These investments represent the cost of growth.

Costs of growth have an immediate negative impact on the agency’s profitability, which can frighten agency owners. Firms with the “grow at all costs” mindset have embraced the risk associated with making investments and are comfortable with lower profit in the short term. With this mindset, the struggle in achieving value is accountability. Agency owners must have the discipline to monitor and track the return on these investments.

For example, if a newly hired producer is not displaying the activity necessary to generate new business, the agency owner or sales manager should provide guidance to the new producer to correct behavior. If the producer does not show signs of improvement within a reasonable timeframe, that individual should be moved into another position or terminated. Holding onto poorly performing sales people for too long can be very expensive and a significant impairment to Grofit.

In this example, the key in driving value is building the sales infrastructure prior to incurring the cost of growth. Similar arguments can be made for other costs of growth such as acquisitions, building value-added service platforms, and investments in automation technology.

High performers build the costs of growth into their long term budget and, regardless of the market cycle, remain committed to the strategy. The majority of agencies succumbed to the soft market during 2011 and lost approximately 2 percent of their commissions (value lost).

However, the Most Grofitable agencies were able to grow by 13 percent, on average (value created).

The FIT in Grofit

The second component in Grofit is profit. There are several different ways to gauge an organization’s profitability. The easiest way to calculate profit is net revenues less total expenses. A more objective way to dissect the organization’s profit is by eliminating miscellaneous income, such as contingency payments, investment earnings or gains on the sale of assets. These non-core revenues can be heavily impacted by external factors. A swift change to legislation, large catastrophic loss year, or declining economic conditions could dramatically influence these sources of income. Thus, managing profitability on the core business, commission and fee income, is critical.

Core Profit (see below) is utilized in the Grofit calculation:

For agency owners who follow the “profit is king” mantra, expenses are fanatically controlled. It is easier for agencies to squeeze their expenses rather than build a growth engine. Agencies that maximize profit are quick to implement hiring freezes and layoffs, rarely invest in value-added services, and oftentimes avoid employing essential middle-level management needed to take the agency to the next level. With no plan for reinvestment, the agency is in danger of becoming a wasted asset or at best has already maximized its value.

Under some circumstances, it is necessary to make tough decisions to survive. However, eliminating critical growth components will have a negative impact on value over time. The more Grofit-minded agencies balance the continuous reinvestment in crucial growth components with adequate profitability to ensure sustainable value.

In 2011, the Most Grofitable agencies achieved core profit of 16.5 percent (value created) versus the Rest of 3.7 percent (value lost).

Agency Compensation: You Get What You Pay For

Compensation costs represent the largest expenses of an insurance agency. No other agency component has the ability to simultaneously incentivize growth and contain costs to enhance profit.

There is a perception in the marketplace that profitability is driven primarily by lean payroll. Agency owners who pay employees less, have significantly higher margins. This is not the case however. The more Grofitable agencies actually have higher total payroll expenses as a percentage of total commission and fees than the remaining agencies.

In 2011, total payroll for the Most Grofitable agencies (Top 20 percent) equated to 64 percent of total commission and fees versus the Rest (Bottom 80 percent) with 63 percent. So, if Grofitable agencies have higher payroll expenses how is it possible for these agencies to drive more profit? The answer is two-fold.

First, those agencies driving positive organic growth have properly structured producer compensation. For some agencies, proper compensation relates to the differential between new and renewal commission splits. For others, proper compensation may relate to net new business or minimum account thresholds. The commonality in high growth agencies is that producers are paid incentives on new business. Producers not delivering growth by default are not compensated as well as producing producers.

Secondly, the Most Grofitable (Top 20 percent) agencies are more productive. Highly Grofitable agencies displayed total commission and fees per employee of $176,400 in 2011 compared to $143,300 for the remaining agencies. While there is little difference in total payroll expense (64 percent versus 63 percent), there is a significant difference in the total number of employees.

The more Grofitable agencies employ fewer individuals (see example in Figure 2), but pay them more.

Grofitable agencies also use compensation to motivate and incentivize behaviors that link agency performance and value. Not only are producers paid new business incentives, but staff bonuses are paid based on growth and profit. Driven employees are hired, compensated well and retained, which results in lower turnover and less retraining costs. Less productive employees are moved out of the organization. The service staff understands the importance of growth to the value of the enterprise and willingly takes on more renewal related activities to free up producer capacity.

All of these practices have a dramatic impact on the Grofitability of the organization.

To accomplish balance within compensation, tie pay and bonuses to measurable metrics that improve both growth and profitability. In the end, compensation is not only a critical financial metric; it also has a significant impact on agency value.

Plot Your Agency’s Grofit

Figure 3 illustrates the Grofitability Matrix. The vertical axis represents growth and the horizontal axis represents core profitability. When you plot your agency on the Grofitability Matrix, you will fall into one of the four quadrants.

Quadrant I — Grow at All Costs: The agency is growing total commission and fee income, but is not producing a core profit. Agencies in this quadrant should evaluate the current expense structure and implement cost reduction strategies.

Quadrant II — Grofitable: The agency is Grofitable and maximizing shareholder return.

Quadrant III — Hanging by a Thread: The agency is not growing total commission and fee income and not producing a core profit. Shareholder value is significantly distressed. Agencies in this quadrant should evaluate the current sales management infrastructure and implement cost reduction strategies.

Quadrant IV — Profit is King: The agency is producing core profit, but not producing total commission and fee growth. Agencies in this quadrant should focus their attention on improving the current sales management infrastructure.

Conclusion

Which is your strategy: to enhance growth, enhance profit or drive Grofit? Whether the short term strategy is to drive growth or drive profitability, the long-term plan should aspire for a healthy balance of each.

If Grofit is your answer, modify your strategy to correlate with enhancing value, such as “grow at a reasonable cost” or “drive the bottom line, while growing.” We personally prefer “predictable, sustainable, profitable growth.”