A case study in cost competition

Company caps commission contributions

In a previous column, "The real competition in real estate," I wrote that I will be profiling various brokerage companies that pursue one of the four generic competitive strategies (per Michael Porter’s "What is Strategy?") in real estate. First up is Keller Williams Realty Premier Properties of Essex, Union and Morris counties in New Jersey.

(Note: I have no business relationship of any kind with KW Premier.)

The national Keller Williams Realty International franchise pursues a classic cost leadership (an effort to minimize operating costs to gain a competitive advantage) strategy, and KW Premier is a good example of how that strategy is implemented.

Porter specifically warns against this in his seminal book, "Competitive Advantage": "If its product is not perceived as comparable or acceptable to buyers, a cost leader will be forced to discount prices well below competitors’ to gain sales. This may nullify the benefits of its favorable cost position."

As we will see, the Keller Williams franchise model — of which KW Premier is an example — is built around achieving and maintaining cost leadership, while offering a product to the general agent population that is comparable to that offered by competing brokerages.

The company in brief

KW Premier is a franchisee with a three-county market area. It was founded in January 2005, and Howard Bunn and Cara Moxley are the two principal owners. In business for about five years, KW Premier has about 145 licensed real estate agents.

KW Premier was ranked No. 14 in profitability and No. 15 in profit-sharing in 2009 out of 690 Keller Williams offices. Within the Garden State Multiple Listing Service participants, KW Premier ranked second in 2009 with 383 units and more than $275 million in closed volume, behind Coldwell Banker Westfield, an NRT office that has been the No. 1 Coldwell Banker office in the New York Metro for the past 20 years.

KW Premier has an office in the towns of Summit, and a branch office in Short Hills. Its sales are mostly focused in Summit, Millburn, Short Hills, Maplewood, the Chathams and Madison.

The price

Arguably, KW Premier’s most compelling offering is its "100 percent split": After paying roughly $35,000 in total annually (commissions, royalties, etc.), an agent is said to have "capped" and is on a 100 percent split thereafter.

After that point, for all intents and purposes, the brokerage services are free to the agent. Prior to capping, Keller Williams charges 30 percent of the transaction as the price (i.e., a 70/30 split).

One could argue that even for the low-producing agents, a 70/30 split (with the agent keeping 70 percent and the broker keeping 30 percent) may be better than what they would be offered at some competing brokerages (with 50/50 or 60/40 splits), and the incentive to achieve higher production is very real.

For producing agents, KW is an extremely low-cost option, especially in a luxury market like the Summit, N.J., area, where the median home price is $885,000 and the average listing is $1.47 million, according to Trulia.

An agent who closes 20 transactions, for example, at 2.5 percent commission rate per side, generates $442,500 in gross commission income. For KW Premier, which caps at roughly $35,000 in commissions paid, it takes just over 5.3 transactions to cap out.

The remaining 14.7 transactions are at a "100 percent split" to the agent, meaning the broker does not receive any share of commission for those transactions. This amounts to the equivalent of a 93/7 split.

A competing brokerage offering even a generous 90/10 split costs the agent a total of $44,250, so in this example an agent with KW Premier would have paid out about $14,250 per year less.

For a truly superior performer who might do 50 transactions in a given year, the savings to the agent over going with the 90/10 split from a competing brokerage would be in excess of $80,000 per year — the equivalent of a 97/3 split.

Some low-cost brokerage models make up for the high share of splits they offer to agents in charging a variety of fees as profit centers. KW Premier does not, simply passing on the cost of overhead to the agents.

The product: core tradeoff

The main tradeoff that cost leaders have to make is in the offerings of the product: Everything that adds to the cost position has to be pared down, unless that results in a subpar product. Cost leaders are not necessarily interested in offering a superior product — merely an acceptable one, at the lowest cost.

KW Premier is a good example of how a real estate brokerage has built all of its systems and offerings around achieving cost leadership. As the Keller Williams corporate philosophy states, "Keller Williams is designed to achieve the highest commission split possible within a full-service company and make a reasonable profit." …CONTINUED

The key founding principle of Keller Williams is the primacy of the agent. Its corporate belief statement is: "Real estate is a local business driven by individual real estate agents and their local image with their centers of influence. KW’s research showed that most agents care more about training than anything else."

Accordingly, attention and resources are spent on training. In fact, Keller Williams’ own words speaks volumes: "Goal: To be a training and consulting company that also provides the franchise system, products and services that lead to productivity and profitability."

It is fair to suggest that KW Premier is built around training, but in line with the cost leadership strategy, most of the expenses of providing the training are incurred by the national corporate entity. For example, Keller Williams University, Keller Williams Connect (the online educational system), MAPS Real Estate Coaching, Masterminds, etc. are organized by and offered through the national franchise on an a la carte basis. The local brokerage company incurs very little of the cost of training.

In the case of KW Premier, it pays for KW Connect for all of its agents, but the other offerings from the national franchise company are either free or paid by the agent.

But KW Premier plays a critical role in the training and leadership services. In speaking with managers, owners and agents of KW Premier, the element that they all stressed was the in-house learning opportunities that come from agent-to-agent sharing of best practices.

The agent-centric system of KW Premier means that most of the real costs of operation are paid directly by the agent — although usually not as a fee to KW Premier.

For example, technology investment is mostly the responsibility of the agent. To be sure, the Keller Williams model places heavy emphasis on technology. So, for example, every agent of KW Premier would receive:

–An agent Web site with free IDX (Internet Data Exchange property listings) and blog.

–Listings syndication via ListHub.

–A brokerage intranet with downloadable forms, documents and other useful items.

There are other minor technology-focused benefits, too. KW Premier charges a $10 monthly technology fee for the Web site, the blog and the brokerage intranet, as well as all of the materials.

However, when viewed structurally, it is fair to describe the technology offering of KW Premier as minimal, in line with the cost leadership strategy that it has embraced.

For example, the KW Premier company Web site is a subdomain of the Keller Williams corporate site, and is likely driven by the template of the main Keller Williams site. Some competing brokerages spend an enormous amount of money on the corporate Web site, as it is the gateway to the consumer.

But the agent-centric model, combined with cost leadership strategy, means that KW Premier chose to make a tradeoff here.

The agent Web sites are not standalone Web sites owned by the agent directly, but a subdomain of the main agent Web site at the URL: yourkwagent.com. For example, the Web site for Elizabeth Demaree in the KW Premier office is http://southorangerealestate.yourkwagent.com/.

An agent can purchase her own URL and have the Web site be at that URL, but the only thing she truly owns is the URL: the site, the content, the software, etc., are all provided by Keller Williams.

An agent who wants her own Web site, separate from the corporate platform, is allowed and even encouraged to do so. But that is at her cost. If an agent wants her own IDX search, or her own customer relations management platform, she pays for those out of pocket, directly to the vendor.

Photos, virtual tours, mobile technology, laptops and other technology are all the responsibility of the agent. Again, KW Premier does not charge the agent these fees; the agent buys them for herself, directly in the marketplace.

Virtualization is not only allowed but positively encouraged. On the one hand, it gives agents freedom to work from wherever they choose. On the other hand, it reduces rent costs for KW Premier. KW has decided that office space is not a real value.

Those who wish to have desk space can lease it from KW Premier at cost, according to Bunn, but unlike some competitors, the company does not regard desk or office rental as a profit center.

Staff support is minimal as well. For an office of more than 130 agents, KW Premier has two main employees on staff: the team leader and a finance/administrative person who deals with commission checks, billing, etc., along with an assistant for each of them.

An agent who wants other support — marketing, transaction management, personal admin, etc. — hires her own people. KW Premier might offer training on how to build your own team, but it will not pay for the members of that team.

There is virtually no marketing for KW Premier as a company. Company advertising goes against the core philosophy of putting the agent first, but it also reduces the marketing costs for KW Premier to nearly zero.

Apart from the company Web site — which is a free subdomain of KWRI — there is very limited advertising or marketing of any kind for KW Premier itself. The agents, however, spend whatever they see fit for advertising and marketing themselves. All property marketing costs are borne by the agent directly. …CONTINUED

Recruiting is done mostly through word of mouth, which again means the cost of recruiting for KW Premier is close to zero. The Keller Williams model of profit-sharing leads to this cost advantage in recruiting.

In the KW system, an agent who recruits another agent is paid a share of the profits generated by the recruit, all agents that her recruit brings into the company, and recruits brought in by those agents, and so on — up to seven levels.

This leads to some industry participants’ view of Keller Williams as a form of "multi-level marketing," which KW Premier denies.

But whatever it is, the profit-sharing model means that while the team leader takes an active role in the recruiting process, by incentivizing the agents themselves to do recruiting for KW Premier, the firm itself spends close to nothing on recruiting costs.

The fit and strategic competitive advantage

A hallmark of true competitive advantage is that the company is not afraid to share its methods. On that basis, Keller Williams has an undeniable competitive advantage in cost-positioning. The national franchise, all of its owner-managers, and all of its agents gladly share exactly how it is that the company manages to achieve its extremely low price, combined with an acceptable level of service to the agent-buyer.

The reason is that all of KW Premier’s activities fit together to create that cost advantage. It isn’t simply that KW Premier offers high splits. Its training program by itself is not an obvious cost advantage. The lack of expensive office space is not the cost advantage, nor is the low staff count, nor the lack of a truly robust and costly technology offering.

What KW Premier achieves is a totality of all of those factors working together to create the cost advantage: making the agent all-important leads to flexibility, which leads to not having to manage agents tightly, which leads to focusing on training, which leads to agents who don’t need as much handholding, which leads to low staff count, which leads to not needing expensive office space, and so on.

Combining profit-sharing based on recruiting, and the financial performance of the firm, reduces recruiting cost and incentivizes experienced agents to share best practices with less experienced agents, which reduces training costs. And so on. The entire system is geared toward cost leadership.

And this profile is merely a high-level look. There are dozens upon dozens of other detailed policies — such as financial transparency, where the brokerage opens its books to the agents, and the company’s "my listing, my lead" policy, very large market areas (three counties in KW Premier’s case) to maximize scale, etc. — that fit into the larger strategy that drives its cost leadership position.

Main strategic threat

Because KW Premier pursues the cost leadership strategy, the biggest threat is that a competitor will be able to offer a lower price while maintaining similar profit margins. Cost leadership requires that the company be the lowest-cost operator, not just one of many low-cost operators.

Given how many facets of the brokerage’s operation (from the national level on down) fit together to provide KW Premier with its cost position, this threat, while real, is relatively contained.

A secondary threat is that due to changes in technology, consumer behavior, or the like, the services offered by KW Premier fall below the "acceptable" line in the agent-buyer’s perception. That would require KW Premier to offer an even bigger discount (i.e., higher splits) that would wipe out the above-average profits.

The only defense against this threat is constant vigilance to ensure that the market’s needs are being met in a comparable or acceptable way. From the corporate level on down, the focus on new topics in real estate — such as social media marketing, foreclosures and short sales, etc. — is designed to ensure that the product remains comparable to the offerings of competitors, at least on a value-for-price standpoint.

Conclusion

The measurement of strategic advantage, of course, is in profitability.

While precise profitability figures are impossible without studying all of the competitors in KW Premier’s market area, KW Premier has been gaining market share from some long-established competitors.

Cost leadership works in real estate. There are tradeoffs, of course, but those tradeoffs are strategic and by design, in the case of KW Premier.

In the next part, I’ll examine a radically different strategy that actually offers a high level of service as part of a differentiation strategy — an effort to distinguish a service or product as different and better than that offered by competitors.

Robert Hahn is managing partner of 7DS Associates, a marketing, technology and strategy consultancy focusing on the real estate industry. He is also founder of The Notorious R.O.B. blog. You can reach him on Twitter at @robhahn.

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