Soft Market Strategies
by Bobby Reagan and Brian McNeely, May 2008
National Underwriter
With no end in sight to the soft market, the question that agency leaders must ask themselves is - "Are we going to play offense or defense?" The answer to that question is going to depend on the agency's situation. And everybody's situation is different.
For the public brokers, they must maintain their earnings or they will be penalized by Wall Street. Therefore, they will turn to acquisitions to drive earnings growth and focus on cost containment strategies. Private equity firms are also under pressure to generate the same level of earnings to satisfy the returns promised to their investors. Privately held firms with no debt are in a much different position. In fact, they have a tremendous amount of freedom and can develop a strategy to capitalize on the soft market.
Playing Defense
During down cycles in business, leaders across all industries often turn to a strategy of playing defense. In fact, as a result of current U.S. market conditions, you can read about defensive strategies in the newspaper everyday. Playing defense often includes multiple cost containment strategies including headcount reductions, hiring freezes and the suspension of discretionary spending. The focus of playing defense is maintaining the current profitability of the business at lower revenue levels. The challenge with this strategy is implementing it while maintaining customer service levels and the ability to grow your revenues in the future.
This is especially true in our industry. We are seeing lots of defense being played in the insurance distribution arena: cutbacks in advertising, program development, new producer hiring, bonuses, profit sharing, professional education and professional development. The question that leaders must ask themselves is - While these cost reductions help maintain the profitability of the business, what effect does playing defense have on the firms' ability to create value in the future? For example, if an agency decides to cut back efforts with new program development, is it compromising its ability to drive growth in the future? Does eliminating or scaling back bonuses and profit sharing diminish the morale of employees and result in lower levels of productivity or customer service? If an agency stops investing in new producers, the lifeblood of a growing firm, where will future growth of the agency come from?
Playing defense isn't all bad and good expense management is a hallmark of a successful agency. However, there are opportunities to play offense in a soft market that will allow you to grow and build the agency in the soft market and beyond.
Playing Offense
An agency with a strong balance sheet (no debt, significant cash balances, etc.) is uniquely positioned in a soft market to play offense. For some, this is a difficult concept to grasp because playing offense likely means short-term dips in profitability. However, these short-term dips can translate into long-term gains, increasing the agency's revenue and profitability and value. Here are four offensive strategies to consider in the current soft market:
March On. Many agencies have developed detailed business plans that paint a clear picture of the future of their agency. Often, these plans are the result of intense thought and input at all levels of the organization, and are at the forefront of the minds of the employees each and every day. Would deviating from these plans create a disruption and distraction to the agency? If there is a lot of confidence in and commitment to the plan, why is a deviation necessary?
The insurance industry is like many other industries; it experiences cycles. As a result, many leaders in this industry are seasoned veterans and have seen both hard and soft markets. They know that the soft market will bring some short-term profitability challenges. The most successful have also built the business for the long-term, understanding that cycles come and go. The key to success is not to panic, but to keep executing and stay on strategy.
Compete. A soft market is a great time to compete for new business. Further, in this macro-economic environment, clients are feeling stress and evaluating their organization. Given these two factors, getting in front of a prospective client may not be as tough as it has been in the past. Therefore, agencies should seize every opportunity to interact with current or prospective clients. The agencies that do not play offense and show signs of complacency will face a strong challenge from those that do choose to be aggressive.
Invest. Continuing to invest during a soft market is the key to exiting the soft market as a stronger agency. There are multiple opportunities for investments, each of which can drive the growth of revenue and profitability in the long-term. Of course, the issue is that there may be a hit to earnings in the short-term.
As mentioned previously, new producers are the lifeblood of a growing agency. In fact, in evaluating agencies we feel that a Net Investment in Unvalidated Producer Pay (NUPP) of 1.5% - 3.0% of net revenues (or potentially higher) is a healthy level of investment in an agency's growth. Therefore, if an agency abandons this investment, their ability to grow in the future will likely be harmed.
There is also an opportunity to invest in your clients. This investment can take many forms, including adding or enhancing value added services offered to clients. Those that are playing defense will probably not be inclined to make these investments. Therefore, there is a real opportunity to distinguish yourself from some of your competition.
New. Another offensive strategy is to find new things to bring to market that will help you differentiate yourself. Are there new products or services that you can introduce? Are there new markets that you need to add that will allow you to pursue new clients or serve your existing clients better? Are there new hiring and recruiting strategies that you can utilize that will allow you to attract more talent?
Offense or Defense?
Each of these strategies must be well thought-out and planned. Aggressive spending without an eye toward the long-term benefits can be detrimental to an agency, especially if the benefits never materialize. If you decide to play offense, you must evaluate the returns of your investment in the form of increased revenue and profitability.
The market will improve and when it does improve, future success will be impacted by what you do today. Some of the best times to take a step forward are when your competitors are taking a step backwards. Those agencies that play offense and that are built for sustained revenue and profitability growth will be the ones that exit the soft market in a stronger competitive position with a higher firm value.