A recent study reviewed in The Economist (Jan. 13, 2014) proved that competition was required to foster business success and progress. This makes sense. Competition is in many ways the “invisible hand” that Adam Smith described as key to capitalist success in 1776.
Few businesses or their leaders are geared to progress on their own. Instead, the gearing is built for achieving a certain speed and then cruising. That is why competition is an absolute requirement.
Competition is the spur or the whip required to overcome inertia. Otherwise, businesses tend to follow Newton’s first law that a body at rest tends to remain at rest unless prodded by some other force. In business, that force is competition.
However, we have a problem. We have a silent killer that evokes the fable of the frog in boiling water. At first the warm water makes the frog feel good and the water warms so slowly, the frog just feels better and better until the instance before death, when he realizes death is imminent.
In business, the most common riches to rags events occur in the tech world. One minute a company is on the cover of business magazines being touted as solving the world’s problems and a couple years later, its being sold for a dime on the dollar. Riches to rags stories absolutely do occur in the insurance world – for both companies and agencies. Cover story agency owners sometimes become mediocre producers in someone else’s agency.
Lack of Competition
One of the most important proximate causes of agency owners going from riches to rags is the lack of competition. They lacked adequate competition so they began following Newton’s first law of inertia. The industry’s wrong goal of profit, by itself, often exacerbates these agencies’ inertia.
Not only do they lack competition, but the owners are continually touted as being the best. Why do the best need to improve?
I’ve been in many agencies that set the standard for profitability. These are the best-practices agencies everyone looks up to. These are agencies with no future. They achieve profitability by eliminating growth expenses and hence, growth. The train wreck to which they are driving is blindingly obvious to everyone but them. The only unknown is exactly how far away the approaching train is, because identifying speed by sight in the dark is difficult. Night is a good analogy, because the human brain does not do a good job of judging catastrophes. The brain is built to judge frequency. When money has been flowing well for a long time, the brain is kind of useless at seeing the oncoming train because the train is a catastrophe. It only happens once. The agency owner will only see it once.
In our industry, and maybe others, we proactively exacerbate the danger. We do this by making cover stories of really profitable agencies and fast-growth insurance companies (the making of heroes of fast-growth companies is especially perplexing because fast growth of insurance companies is a hugely leading cause of insolvency according to A.M. Best). At agency meetings, especially private network meetings, high-profit agencies are exalted. In one organization, they even get the equivalent of a medal.
On the surface this is fine because the assumption is they worked to earn high-profit margins. But quite often, this is not the case. Sometimes it is, but I have analyzed the profitability of hundreds of agencies, and the profitability of the most profitable almost always have a nonreplicable business model. If they created that model, more power to them. But that is not often the case. Instead, the business model employed is sometimes a result of state-sponsored behavior that inhibits, and may prohibit competition. In other situations, particular microeconomic environments exist in which competition has been minimized.
For example, until quite recently, many Massachusetts’ personal lines-focused agencies reported fantastic results. The agency owners, having not owned agencies elsewhere, did not know the difference in Massachusetts’ auto rating laws/regulations that created their success. When rates are effectively the same, few high-quality aggressive competitors will innovate. High-quality competitors are not interested in an environment where their skill brings no rewards. This is why communism failed.
High-quality firms can deploy their capital and expertise better elsewhere. When high-quality competitors enter an insurance market, they usually do so with lower rates. This is especially true today where certain models absolutely result in lower legitimate auto rates (no major line has achieved more consistent loss ratios in the past five years than personal auto, and consistency is the key indicator of whether rates are being set correctly). When a competitor builds a better model resulting in lower rates, the existing competitors are eliminated. Hot tub to boiler in 36 months.
Agents lose because lower rates mean less commission and consumers shop more, also increasing costs. Lower rates mean less contingency income, too. Uniform rating, on a very rough basis, likely gave agents there 25 percent more profit on their auto books versus agencies elsewhere. They had little reason really to innovate because the competition was limited to the same price! Sometimes making the situation worse was that agents elsewhere looked up to some of the agencies’ profits thinking they should be able to achieve the same results. They couldn’t because they did not have price protection.
Another example is workers’ comp programs in specific states. These programs effectively create mini-monopolies. Agencies that are smart enough, capable enough or otherwise somehow grab one of these programs often have fantastic profit margins, but they cannot replicate the model into other lines or businesses because those areas have competition. I have seen dozens of agencies try to achieve high-profit margins mimicking these workers’ comp program agencies, and fail because they did not know a monopoly was required.
Absence of competition is another example. This does not happen often, but when it does, it is usually in a small, rural location.
Oil boom states are another example, not because competition is minimal but because business is so good for everyone, competition decreases.
A different cause of high profitability but with the same result of stasis occurs in certain microenvironments where contingency income is almost always high. For whatever reasons, an agency is located in a spot that is extremely profitable, but the companies’ rating area encompasses many less profitable communities. These fortunate agencies make money hand over fist without even trying, but they do not know they are not trying.
When agencies in any of these situations are touted, or they tout themselves, the key reason they are so profitable is never shared. Instead, these agency owners will often invest in wonderful value-added services and human resource programs. The cover story and the agency owners’ stories will advise these services are the key to their success, when in reality, this is a just a grand rationalization. The damage is done when other agents attempt to emulate these results without knowing they are not only putting the cart before the horse, but the cover agency’s horse is not really even the key. I have seen agencies ruin themselves trying to achieve impossible results.
Especially profitable markets can only be protected for so long. Inevitably, pressure builds to decrease rates, open markets,or a company will identify a microenvironment opportunity or the oil market will collapse. When this occurs, the incumbent agency is upset and unprepared. It has been unusually successful judged by profit. Now the rules change, and no one asked its permission. The normal human response is to fight rather than adapt, so from one throne to another, they quickly travel.
Newton’s first law is powerful though. That is why it is a law. If you have tremendous competition, you don’t have to worry about progressing. For these agencies, the best benchmark is not a profit margin or a growth rate. The best benchmark is progression.
I love watching the summer X Games far more than the Olympics because the athletes always judge fellow competitors by whether the competitor is helping the sport progress by developing new tricks. The goal is progression more than winning. That is why old tricks done well might not win as much as new tricks not completed perfectly.
When progress is your benchmark, not much else matters because with constant progress, you will get to the top. You will not make the mistake of aiming at impossible goals simply because you do not know the entire story. You will build your organization based on your specific situation because it is your specific situation that matters most, correct? Inertia will not happen. You will always keep raising the bar, and you will be raising the bar for everyone. You will be in control of the bar. Furthermore, by continually progressing, the competition will have to continually be trying to catch up.
Having goals of achieving best-practice standards is easy and wrong. More powerful but more difficult is a strategy of always getting better regardless of what industry best practices happen to be. If you are interested in a long-term program for constant progression, call me.
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