Best Practices Crash Course: 3 Most Valuable Metrics

Michael Newsom wasn’t an immediate convert when he first encountered the Best Practices Study a decade ago.

“I’ll be honest—I was initially overwhelmed,” says Newsom, fifth-generation owner of W.J. Wheeler Insurance Agency in Bethel, Maine. “It’s cool to have good data, but if you have to work too hard for it, by the time you get it, you’re exhausted.”

That’s a common response to the Best Practices Study, a joint effort of the Big “I” and Reagan Consulting, Inc., which celebrated its 25th anniversary with the update released last fall. Since 1993, the Best Practices Study has aimed to help agencies measure themselves against best-in-class agencies, identify performance gaps, and better manage their businesses to address problem areas.

After switching to a management system that streamlines reporting and comparison with Best Practices benchmarks, Newsom now believes digging into the numbers is well worth the effort.

“Our participation in Best Practices has had a trickle-down effect where we never look at numbers in their absolutes anymore,” Newsom explains. “Now we ask, ‘Compared to what?’ That gives us a better picture of how we’re doing, and then lets us drill down into, ‘OK, what were we doing well that led to improvements? How can we keep doing that, and what are our roadblocks?’”

To help you begin the process of sorting through such a wealth of information, the 2018 Best Practices Study Update outlines the three most valuable metrics to target.

Sales Velocity (current year new business / prior-year commissions and fees)

According to Reagan Consulting, an agency’s organic growth is driven by four primary factors: exposures and rate changes, which are largely outside the agency’s control; and client retention and new business generation, which an agency can proactively manage.

John Merrill, vice president at Reagan Consulting, points out that even lower-performing firms generally report client retention rates around 88-90%, with Best Practices agencies coming in around 95%. “Retention rates are relatively steady within the industry,” he explains. “There’s not as much room for differentiation with a customer base that is consistently sticky industry-wide.”

That leaves new business generation as the single most important factor when evaluating organic growth versus your peers—and that’s where the sales velocity metric comes into play. “It’s great to talk about organic growth in general, but that doesn’t really tell the whole story as to whether or not you really have a sales culture,” says Tom Doran, partner at Reagan Consulting.

“If your agency’s growing at 6% a year and so is mine, but you’ve got a 15% sales velocity and I’ve only got a 10% sales velocity, what we know is you have a much more vibrant sales culture than I do,” Doran continues.

What’s a good sales velocity? It depends on your revenue category, but on average, Best Practices agencies clock in around 12-13%. This is Newsom’s favorite metric—“we can make big changes to the agency quickly by making dramatic changes to new business,” he explains. “Your sales velocity drives the conversation around your sales culture.”

For Newsom’s 10-employee agency, measuring sales velocity resulted in “figuring out we had to make some investments in a sales team,” he says. “We’ve developed some incentive tools internally for our folks who don’t have production, and we’ve invested in technology that gives our producers more feedback.”

Trey Starke, president of Starke Agency, Inc. in Montgomery, Alabama, agrees that of the four drivers of organic growth, new business generation is his agency’s top concern. His response: hiring young people and developing them.

“We’re not going out and raiding another agency and their book of business, because to be honest with you, the other agencies are not following Best Practices,” explains Starke, who notes that 6.5% of his sales velocity is driven by producers who are under the age of 35—a  significantly higher proportion than the 2% average among the rest of his revenue category.

According to Reagan’s research, agencies with particularly high sales velocities typically report substantial new business contributions from multiple generations of agency producers. “You don’t want to be too concentrated in one age group,” Merrill explains. “You don’t want to see all your new business generation in the senior category that could be retiring within the next five to 10 years.”

But especially in smaller cities, recruiting young talent can be easier said than done. “We’ve had zero luck with millennials sticking around,” says Cindy Widener Winn, president of Widener Insurance Agency, Inc. in Johnson City, Tennessee, whose youngest producer is currently 45. “We’re still looking for that magic person.”

In the meantime, Widener’s approach to maximizing new business generation relies heavily on cross-selling and account-rounding.

Because the agency’s business mix is about 45% commercial lines, 40% personal lines and 15% benefits, “we really work with our business clients on their personal lines as well as their employees’ personal lines, and then our personal lines staff tries to determine if they are decision-makers in any type of businesses that are local,” Widener Winn explains.

It’s a great example of a situation in which client retention and new business generation go hand in hand—the agency has a 96.2% retention rate, and Widener Winn says her existing client base is “where we get most of our new business.”

Pro Forma EBITDA Margin (pro forma EBITDA / pro forma net revenue)

Along with organic growth, profitability is the key driver of an agency’s value. Here, an agency’s pro forma EBITDA margin is an ideal metric because it “eliminates some of the noise” that gets in the way of an accurate evaluation of profitability, Merrill says.

“Looking at profit alone tells you almost nothing, because an agency may have bonused a lot of the potential profit out, or they may have all kinds of personal expenses running through the agency that they could discontinue in a moment,” Doran explains.

EBITDA is defined as earnings before interest, income taxes, depreciation and amortization, or “pre-tax income adding back interest charges, depreciation of fixed assets, and amortization of intangible assets. Essentially, it’s your pre-tax operating cash flow,” Merrill explains. “Pro forma adjustments are made to reported EBITDA to normalize earnings for items that are distortive to the operating profile of the agency, which commonly include non-recurring or one-time charges and personal or owner expenses running through the agency.”

Among Best Practices agencies, pro forma EBITDA margins average about 24% across all revenue categories, with high-profit Best Practices agencies closely monitoring what Reagan identifies as the four major expense categories: compensation, operating, selling and administrative.

“If I’m an agency owner and I’ve found that my profit is lower than I would like it to be, the question I have to ask myself is, ‘OK, where is the problem?’” Doran says. “The first step in solving the problem is understanding where the problem lives.”

According to Merrill, compensation comprises more than half of net revenue for most agencies: “Employee costs, including salaries and wages, bonuses, commissions and benefits, are always going to be the primary component of your operating expenditures, and typically the primary driver when you focus on profitability.”

Widener Winn agrees that the expense category that can “get out of control” is compensation. “You have good staff, and you want to reward them well—you want to give them raises, bonuses, etc.,” she says. “That is probably my biggest challenge.”

“I’ve seen hundreds of agencies, and I can tell you that 99.5% of the time when they’re missing it, they’re missing it because of compensation,” Starke agrees. “Everybody’s got a different model and a reason for it—‘This guy’s an owner and we can’t tell him we’re not going to pay him commission on $250 income accounts,’ or ‘We’re in Chicago and the salaries are a lot higher.’ You’ll hear every excuse you can think of.”

“There are a dozen things that go into the compensation question,” Doran agrees. “Do you have too many people? Are your systems not efficient? Is it taking you more people than the average agency to process business? Do you pay your producers too much? Are you paying market-level compensation to your people? You have to dive deeper into the underlying drivers to identify specifically where the issues may lie.”

But taking a closer look at your expenses by category is also an opportunity to discover where your agency may be unique among your peer group. At Newsom’s agency, for example, compensation expenses are higher than average because the business is employee-owned.

“Whether it goes into profits that are distributed to owners or whether it goes into their salaries or benefits, it’s all their money,” Newsom explains. “Everybody owns the company, and when you’re an owner, you get perks.”

Starke, too, says his agency “gets dinged on the percentage of our support staff based on revenue,” but believes his staff infrastructure feeds the agency’s high client retention rate.

“We also spend a lot more on education and training than our peers, but we know what we’re doing,” Starke adds. “That’s an investment we want to make in our business.”

Rule of 20 (organic growth + [1/2 x pro forma EBITDA margin])

Reagan has determined that in evaluating the valuation of an agency, growth is roughly two times as important as profitability.

Think about it this way: “If an agency is looking at a strategic decision where one direction is expected to add 1% organic growth to the firm versus an alternative direction that would cut a cost, it would need to provide 2% incremental pro forma EBITDA to break even from an agency valuation standpoint,” Merrill explains—assuming no crossover impact in each scenario.

This is where the Rule of 20 score comes in—it assesses an agency’s balance of growth and profitability, and whether or not the combination is leading to strong shareholder returns. Best Practices agencies average a score of 16-17, but a score of 20 or higher indicates that the agency is generating very high shareholder returns.

Your Rule of 20 score could be low for any number of reasons. Maybe you’re spending too much in one of the aforementioned expense categories.

Or “maybe your sales velocity is well below your peers and then you see your selling expenses are also well below. In isolation, you may think the lower expense factor which is contributing to higher profitability is positively contributing to the value of your agency,” Merrill says.

“However, you might not be adequately investing in your producers in a way that enables them to generate new business,” Merrill continues. “If you make an investment in some tools that will unlock production potential, it could pay off by driving new business and increasing overall agency valuation going forward, despite the increase in selling expenses.”

For Widener Winn, balancing profitability and growth requires keeping a close eye on sales goals. “You have to know what levels you’re wanting to achieve, measure them weekly, monthly and quarterly, and figure out what you need to do differently if it isn’t working out,” she explains. “You have to have goals and plans, and then review them and reinvent the way you’re going to strive to reach those goals.”

Reviewing reports on a weekly basis enables Widener Winn to identify where her staff needs to problem-correct. If a producer isn’t hitting their marks, for example, “sometimes you have to make the decision to terminate relationships, or reevaluate that employee to a service role,” she says.

Or maybe the issue is specific to a particular line—in that case, she might speak with the department head and help them come up with a solution. Either way, “hopefully we spot the problem long before it hits the long-term sales numbers.”

As Newsom puts it, “you live by two masters, right? An agency that isn’t growing at all could be super profitable, and an agency that’s growing like gangbusters could be losing money. The Rule of 20 just helps you realize you can’t neglect one of them. Long-term, you have to serve both.”

Jacquelyn Connelly is IA senior editor.

Get your copy of the 2018 Best Practices Study Update and start improving your agency today.