In this episode of “The Digital Broker”, Steve and Ryan discuss the need for growth in an agency and compare the pros and cons of organic growth versus acquisitive growth.
By listening to this episode, you will learn:
- The difference between organic and acquisitive growth
- How to determine the value of an acquired agency
- When the operations department should be involved
- The components of organic and acquisitive growth
- Problems inherent in each type of growth
- Distinct kinds of perpetuation models
In this episode, Steve and Ryan discuss the methods in which agencies can grow and survive. They look specifically at the two type of growth models – organic growth (by increasing business through sales) and acquisitive growth (by increasing business through acquiring other organizations). Each type of growth has its own advantages, challenges, and peculiarities. Steve and Ryan will guide you down this road to help ensure a healthy and growing agency.
What Type of Growth is Better? (1:32)
There are pros and cons that come with both organic and acquired growth. In a dream world, an ideal organic growth rate would be 25% or more per year. More times than not, acquisitions happen for strategic initiatives, or to stopgap a lack of organic growth.
From an operational perspective, organic growth is much easier to control than acquisitive growth. In an acquisition, the client base is being purchased with the inherent hope to retain the business going forward, however, this is easier said than done. Often problems emerge, such as organizational culture issues, which may impact the customer experience and threaten retention.
Currently, agencies are selling at exceedingly high multiples, which can make acquisitive growth very challenging option, if not impossible, for smaller agencies. As a result, acquisitions tend to be a growth tool for larger agencies who can identify smaller agencies with poor perpetuation plans. The larger agencies are in a better position to take advantage of acquiring a smaller agency. Another factor to be considered are rising interest, which makes it more expensive to raise capital and take out loans.
Is An Acquiring Agency Actually Getting the Value Expected? (3:55)
There is a honeymoon period during the acquisition process. Everyone is excited by the prospects. One agency is looking to acquire more business opportunity while the owners of the other agency are excited by the prospects of cashing out. Yet, it’s crucial that the proper due diligence is done.
It is important to examine whether the agency being acquired is following similar best practices that the larger agency may have already implemented. The acquiring agency needs to ask whether there is an ability to build processes and procedures to maximize efficiency. The answer, while frequently no, needs to be understood before a purchase decision is made.
A significant consideration should be spent on assessing an agency’s culture and operation. The processes for larger agencies are often different than those of smaller ones. During an acquisition process, it is critical for the operations staff to have the necessary time to effectively implement and integrate the two businesses. It is exceedingly difficult to complete an acquisition in an abbreviated time. A considerable amount of time will be needed from all key departments, including Human Resources, IT, and Financial Operations to properly prepare and integrate two businesses into one. Often the normal day-to-day business of the acquiring group comes to a halt as the integration process takes a lot longer than was expected. Unlike the television advertisements, there is no “Easy Button” to streamline the process.
Involvement of the operations department is critical to ensure that the value expected is actually there. An acquisition is much more than simply obtaining the book of business. The transition and how it is done is a major part of the acquisition. It may prove necessary to operate two systems for a period of time while the agencies are merged. The organization will also need to be perceptive enough to examine what the smaller agency has done in the past for clients that will not scale effectively in a larger operation. As an example, some clients might be accustomed to receiving specific periodic reports or other custom services that the acquiring agency cannot immediately implement. It sometimes becomes necessary, or even critical, that the acquiring agency explains to customers what’s occurring during the assimilation process. During this time, the operations team must interface with producers to effectively communicate with the new customers and hopefully obtain the understanding and patience. If this part of the transition is done poorly, then some of the customers of the acquired business could churn.
At What Point in the Acquisition Process Should Operations Be Involved? (7:00)
Operations must be part of the initial discussions in any acquisition. The assessment of the operations team could affect the actual valuation of an agency being considered for acquisition. Operations can ascertain if proper procedures are in place or if effective data collection and storage is being done. Without effective and efficient operations, the value of an agency can be diminished versus one which is well-run.
During an acquisition, there will obviously be a great deal of negotiation. Once negotiations are complete, there’s the threat that agencies will get blinded by the deal’s excitement when in truth, the work has just begun. The operations team can build in disciplined operations and sales processes to ensure the building up of that client base that has just been acquired. Properly done, it will be evident within a couple of years if the value has been developed in the way that it was intended.
What Types of Organizational Problems Emerge During an Acquisition? (8:40)
When a smaller organization is acquired by a larger organization, especially one that is acquiring several agencies, there are often producers and staff that have no interest in being part of the larger organization. These folks may leave and start their own agency. The creation of a new agency is the ultimate example of “organic growth” rather than acquisitional growth. Even with various legal restraints such as non-compete agreements and restrictions on piracy being in place, the departure of staff is a loss from the organization and the acquired value. There are no easy answers that can solve this problem.
Agencies need to continue to grow. If an agency is not continuing to grow, it is losing because it is not keeping pace with the market. They’re diminishing in monetary value as well.
When an agency has no growth, it also becomes very challenging to hire and retain good producers, which only compounds the challenge of limiting future growth.
What Are the Components of Organic Growth? (10:20)
The agency must look at both sides of the business to assess organic growth. Growth does not always have to come from new business. Existing business can be a very strong source of growth.
It’s also important to remember that there are outside factors that can control an affect an agency’s growth in value. Examples include insurance rates, uncontrollable events such as massively destructive natural disasters, or corrections in the greater economy and financial markets.
Each of these factors must be considered and it’s important to analyze the business statistics at a granular level to show where there is growth and where there are problems.
How is Retention Measured? (8:40)
Part of the value brought to the client is bringing in loss control and risk management services in addition to simply providing the traditional insurance value of replacing the loss. In this situation, there is a reduction in premium collected because the organization insured has become safer. In some instances, lost revenue can be replaced by cross-selling additional insurance for other gaps in coverage. With a long-term client, something that must be recognized is that there will not be a linear growth in revenue. One tension in the insurance industry is that agents and brokers have been historically paid a percentage of the policy premium. Healthy organizations need to look at other options for the longer term that are not “commission-based” on premiums. The industry needs to shift from a model based on revenue generated from commissions to a “fee for service” model that provides customer experience and value. Over time, the compensation model in the industry will shift toward the fee for service model. There are, of course, monetary limits that clients are willing or able to pay. A good agent should be able to generate value for clients because of the existing trust that has been established.
Data analytics is becoming more important in understanding losses. It is important for the agency to begin considering and discussing with the client things that can be done to help reduce losses. New technology will lead to a dampening effect on both the number of claims and the severity of claims. The new “Internet of Things” technology is leading a shift from insurance being designed to repay loss to one that is more of a protective mode. Over time, this will change the method of compensation.
What Are Operational Problems Inherent in Acquired Growth? (18:38)
If the agency being acquired operates on a different agency management system, then an immediate decision should be made on whether to move them to the acquiring agency’s software or allow them to continue operating on the legacy software. Both routes have proven to be successful but in most cases, it will come down to the needs and wishes of the customers that determine the transition. Sometimes the most effective way to transition clientele is at the time of policy renewal. The downside is that the agency will need to operate two systems as well as perform dual accounting.
The best results often occur where the agency has a great training and onboarding program. The easiest and cleanest way to operate is to allow the CSRs from the acquired agency to operate on the system of which they are familiar with most while a transition plan is designed, taking into all of the financial nuances and coding. The agency can also work with the AMS vendor to do a conversion of the records while establishing a “cutover date” for change in systems. For historical purposes, it can also be wise to keep a few licenses of the old system. It is often difficult to transition from one system to another and even with programmatic conversion, the accuracy is not 100 percent. Often manual intervention and system patches are required.
With many small agencies, records are still handled on paper and this should play a large role in valuation and whether to acquire the agency altogether. The agency making the acquisition will need to factor in the loss of business, soft costs, and time necessary to integrate and assimilate the new agency.
In incorporating an acquired agency, the operations team needs to review everything in detail to avoid incorporating any unhealthy habits or inefficiencies. Part of the value that the operations team provides during an acquisition is assessing components including staff and systems to provide a truer value of the business to be acquired. A good analysis will consider as to what those losses may be and what impact they might have on buy-out provisions. One consideration might be to keep someone from the acquired agency on in a role to help ensure retention of business.
What Are Operational Issues Inherent in Organic Growth? (24:00)
Some factors that need to be considered are lead generation, CRM, and follow-up. Producers that are well-paid need to produce. Some producers are overpaid, especially on renewals, which have become operationally driven. If an agency has become “operationally-centric” or operationally mature, it might be possible to create “micro-products”. In some cases, an agency can approach a carrier and make suggestions to create programs with minimal underwriting. An example of this type of business is represented in the growing food truck business. This is a way that can create a good customer experience that is not producer-centered. If the agency is trying to self-perpetuate in the traditional manner, they will have to bring in producers which will become increasingly challenging in the future. Focusing on producer-generated business does not scale as well as being able to write business without a producer. This change in focus highlights the need for different skill sets, such as digital marketing, online processes, lead generation, and marketing automation. These areas are key if an agency wants to grow organically. In this situation, the traditional producer may not need to be involved and can be replaced by an internal salesperson. This obviously has an effect both operationally as well as compensation structure. Sales expenses may decline while marketing expenses increase. Each of these factors will directly affect the profitability of the organization.
What Are the Two Types of Perpetuation Models? (27:08)
When talking to agencies, it is critical to understand the focus of their perpetuation model. There are two mindsets. One is an operationally-driven, growth-oriented model not focused on individual wealth. This type of organization cares about money but is not focused on a large producer driving up the price of the stock and the value of the agency. Inversely, there are agencies that need a large producer to generate the capital to buy the stock. In this situation, marketing is not a significant factor because the organization is based on a production model. Which mindset is prevalent is important because it impacts other areas of the agency. An agency owner needs to determine which perpetuation plan is in place if any. A producer-centric plan is focused on someone who can come in and buy the stock while the organizational plan is based on building revenue to allow someone to acquire the systems and processes rather than the personnel. The producer model can be a trap. Money applied to marketing efforts will pay off better as the agency gains experience and marketing savvy as opposed to simply spending money on producers.
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