Client-Centric Changes

Will Revolutionize Brokers

By Abhijit Mukhopadhyay

The recent probes by New York Attorney General Eliot Spitzer into contingent commission practices and bid-rigging allegations have led to a myriad of regulatory, operational and pricing issues, all with significant potential impact on a broker's performance.

Top brokers have since decided to eliminate volume-based contingency fees and promised to make their processes and compensation deals more transparent.

While these steps might appease regulators, I believe a more fundamental change is necessary for the brokerage business to ensure sustainable profitability and growth in the long run.

As brokers can no longer depend on contingent commissions–estimated to be anywhere between 5-to-10 percent of a broker's annual revenue–to subsidize structural overhead and loss-making clients, every client relationship will need to stand on its individual merit of performance and profitability. As a result, brokers will need to adopt a client-centric approach to defining strategy and managing performance.

Another trend that also strengthens the above argument is the increasing popularity of fee-based compensation among insurance buyers. A November 2004 survey of broker compensation by the National Alliance Research Academy revealed that more than 75 percent of commercial buyers indicated they prefer to pay fees to compensate their brokers rather than having brokers accept commissions from insurers.

To accommodate such a change, brokers will need to develop a very different kind of pricing rigor and discipline than is required for commission-based compensation. Proper estimation and assignment of fees would require a detailed understanding of activities performed on behalf of clients and value delivered to them.

Since different clients have different needs and demand/consume different service levels, traditional one-size-fits-all business models will no longer be optimal. Brokers will need to implement segment-based business models that will allow more precise and optimal pricing decisions.

The above issues will have structural impact on a broker's strategy, business model, pricing strategies and client/underwriter relationships. To emerge as a leader, it's necessary to anticipate the true effect of these changes and act on them as quickly as possible.

Brokers who want to defend and strengthen their market position must seriously consider a road map that constitutes five strategic initiatives for creating sustainable value for their clients, shareholders and other stakeholders. Fundamental to these initiatives is an understanding of client economics and the desire to align strategy and operating model to maximize client value.

These initiatives will build the foundation for client-centric management of business strategy and performance byaligning client strategy, pricing structures and organizational capabilities to maximize client value. The five initiatives are:

o Build the capability to measure, track and analyze individual client and segment-level profitability:

Traditionally, revenue and market share have been the primary yardsticks of growth for brokers. All revenue was good, and one could produce a margin in excess of 20 percent without too much of an effort. If and when profitability is tracked, it is tracked by product lines or geographic regions.

Given that a significant portion of the margin has been contributed by volume-based contingency income–which could not be easily attributed to individual clients–client/segment-level profitability is typically not managed against or measured.

This needs to change if brokers want to acquire the right (profitable) clients and avoid the wrong (loss-making) ones, protect the right clients, make appropriate resource allocation/investment, and develop appropriate business models to serve various client groups profitably.

o Redefine client segments, develop segment strategies and realign operating models to optimize segment-specific profitability and service levels:

With the increased emphasis on the understanding and management of client-level cost structures and profitability, a one-size-fits-all strategy for servicing clients will be ineffective and unprofitable.

A client base must be segmented based on its economic values and needs. Furthermore, segment-specific strategies and operating models must be developed for profitable client-relationship management.

o Develop new pricing/compensation strategies in alignment with segment strategies, activities and cost structures, considering both clients and insurers:

As the fee revenue practice becomes prevalent in the industry, brokers will need to look at their business in much the same manner as professional services and consulting organizations view theirs.

Brokers will have to develop a cost-based estimating and value-based pricing structure to explain fees to clients and justify investments. This is a significant shift from the current commission-based management.

In addition, to compensate for the lost contingent commission income, brokers will need to find new sources of revenue. In particular, they should be compensated by underwriters for the legitimate services brokers provide to clients on behalf of insurers (for example–claim handling, premium accounting, etc.).

Brokers need to have a clear understanding and accounting of such services to negotiate an appropriate compensation structure with underwriters.

o Build process and information transparency to strengthen trusted advisory relationships with clients and underwriters:

While the need for regulatory compliance will be higher, brokers will have to demonstrate their willingness and ability to go above and beyond minimal compliance requirements to build–and, in some cases, rebuild–lasting trust with clients and insurers. Operational, technical and organizational changes will be warranted to develop a transparent operating environment.

Capabilities such as a complete view of the client, client benchmarking, and cost and revenue reporting at the client level will become standard operating expectations.

o Build the rigorous business discipline necessary for client-centric management of business performance and profitability:

Business performance management needs to transcend beyond traditional profit-and-loss statements to client or client-segment-centric performance. Performance goals and metrics need to be redefined to align with client strategies.

The operational infrastructure will need to support new capabilities, such as activity-based costing, time tracking, client satisfaction measurement, etc. Organizations should take an honest assessment of their capabilities and develop a practical road map for achieving their desired state.

Recent regulatory and pricing issues aside, the brokerage industry will continue to be impacted by underwriting and pricing cycles, shifting client and insurer expectations, specialization, channel innovation, consolidation and information sophistication.

To achieve sustainable growth and profitability under these conditions, strategies, operations and technical infrastructure need to be agile and innovative. The client-centric approach illustrates an actionable blueprint for achieving these goals in the current business environment. Brokers willing and able to execute on these ideas will successfully stay ahead of industry transformation and competitive threats.

Abhijit Mukhopadhyay is a director of financial services consulting with Fair Isaac Corp. in Chicago. He may be reached at 312-984-7116, or via e-mail at abhijitm@fairisaac.com.

Flag: Transformation Tips

What Should Brokers Do?

To achieve above-average growth and profitability, brokers need to break free of the traditional one-size-fits-all business model and adopt a more client-centric approach to developing strategy and managing business performance. This client-centric approach consists of five core components:

o Understanding client-level profitability.

o Aligning the business model to maximize client/segment-level profitability.

o Optimizing pricing strategies to maximize long-term growth and profitability.

o Building trusted advisory relationships with target clients.

o Creating and institutionalizing client-centric performance benchmarks.

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Client-Centric Changes Will Revolutionize Brokers

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