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Here in part 2 of this series we begin to evaluate the question of whether the current commission structure is equitable for consumer and real estate professionals.

The risk versus reward curve is a fundamental principle in business. The simple explanation is that, as risk in a given transaction increases so does the reward. However, there is doctrine of “diminishing returns” where at a certain point in a given transaction, the amount of new risk does not have a corresponding increase in reward.

 It’s important to understand these concepts as we go thru the next parts of this discussion, because much of what I believe, is that the current commission structure was designed to reward real estate professionals for assuming almost 100% of risk in the real estate sales process.One of the questions I asked yesterday was “what are the standard elements of the real estate sales process”.  In the graphic below, I’ve outlined the process from both the real estate professional’s and consumers perspective, with the consumer having the more simplistic view, thus more likley to have a view that real estate agents do very little, and risk very little.

 As we examine the process from the real estate professional’s perspective, I’ll assign the level of risk and to what party that level is assigned.

1. Lead Generation (Risk ~ 100% Real Estate Professional) The traditional lead generation and distribution model is inherently flawed. In fact I believe that it may be one of the most inefficient systems in American business. This phase of the process is the most likely culprit in the perception that commissions are over priced. Consider the following scenario:

 

Broker X has 100 agents in his office, and his office serves approximately 10 zip codes with about 200,000 households. Only about 3 of the 10 zip codes have more than 4% annual turnover and are the target market of more than 30% of the offices agents. Each of the 30 agents that markets to those zip codes spends about $300 a month on marketing to those zip codes. Total markets spend $9,000. Lets assume that each agent generates 10 leads from their marketing efforts. That is a cost of about $30 a lead. If you apply the doctrine of diminishing returns, after a certain point, say mailing #10, any additional spend doesn’t have a corresponding increase in return. You could spend only a 1/3 of what was spent by the competing agents and still generated the same amount of leads.  Combined per lead cost, $10. Consider further that agents in that office only convert 1 in 10 leads to a listing, in the current model the cost is about $300 per listing, vs. $100 per listing in the combined model.

NOTE: Mary Jane has a better marketing piece and generates more leads than average and has a higher conversion rate from leads to listings. This effect can be incorporated into the model over time by applying best practices to marketing and lead distribution based on conversion rates. We learn from our mistakes.

This lead generation phase is where the Zillow’s and Trulia’s of the world are going to work on you. They know that there is an economy of scale to lead generation and by having brands generate leads instead of individual agents, the brands can maintain brand integrity, have better control of the customer experience, and mitigate the “top producer” effect.

This phase of the process is one of the most risk intensive parts of the process for the real estate professional. They must extend capital in the hope that they can generate enough leads, that conversion is just a mathematical certainty, without going broke.

2. Sales (Risk ~ 100% Real Estate Professional) The sales phase is the process of which the Real Estate Professional develops property specific proposals and invests mostly time and shared resources in an attempt to convert leads generated in the previous phase.  This is “time intensive” in the extreme. The risk here is mostly the value of the agents time.

The “risk” involved is almost entirely the agents to mitigate.

For example, should an agent not do his due diligence on the property or the sellers, or is “forced” to list the house at a price he knows it won’t sell, the agent is risking, not only his time, but his reputation and possibility a significant amount of money.

3. Listing Management (Risk ~ 100% Real Estate Professional) There is a common misperception that because the homeowner has entered into a contact with the agent he is somehow sharing the risk with the agent. Not True. The homeowner still has very little to lose if an agent’s marketing campaign is unsuccessful. Provided that the house is occupied, or rentable, the sellers risk is almost zero. This phase is typically the entry point for a consumer relationship. From a consumer’s perspective this would be the “Property Marketing” phase of the process. They would define it as the period at which they work with their agent to stage and show the house in a manner conducive to a sale.

Much of the “work” that agents do is in this phase. They must conduct an inspection; stage the home, setup marketing for the property, property photos, MLS entries, yard signs, flyers, postcards, mailers, open houses, etc. These activities too, must take place without any guarantee of compensation by the agent.

Tomorrow I’ll talk about Offer and Transaction Management phases and how agents mitigate risk for their clients. This is also important to understand from a communication phase with your clients.