Bigger Isn’t Better – Better Is Better

As the first few weeks of 2010 pass, business owners, executives, employees, and consumers alike are watching for emerging trends, which will test the accuracy of the 2010 prognostications posited by various industry experts.  While it may be too early to tell, there have been some signs, signals and even M&A transactions which point to industry consolidation and corporate restructuring among brokerages in the commercial real estate industry.  This is likely to continue throughout the year.

So my question is this – which CRE brokerage business model is better, brick & mortar or franchise/network? The current prevailing strategy associated with M&A transactions is for buyers and investors to disenfranchise independently owned, network member, CRE brokerages and covert them to wholly owned, corporate store entities, which are often dubbed “brick & mortar” brands.  The parties on the buy-side of these “deals” cite greater control and therefore better client service as two of their reasons for buying.

From my perspective, the current thinking outlined above incorrectly implies that “corporate store” CRE brands are better suited to service their clients than franchises and networks.  In today’s post, I will share with you why the CRE, brick & mortar brand model of old is broken, uncreative and non-scalable, while franchises and strong networks foster innovation, creativity, scalability and are positioned to deliver greater results for their clients.

There currently exist some great CRE brokerage brands.  Talented leaders stand atop sharp, seasoned, and knowledgeable industry experts who collectively make-up some well run brick & mortar brokerage brands.  It is the model in which these firms operate that is broken, and not necessarily the firms themselves.

Brick & mortar brands employ a model that operates with high fixed costs in a cyclical and unpredictable commercial real estate market.  Brokers who work for these firms often feel that they are giving too much (in commission split) for what they are receiving in return, the firm’s management team’s struggle to eke out profits in poor and mediocre markets, management’s focus steers toward survivability and earnings vs. client’s interests, and all stakeholders suffer – even the client.  CRE franchise organizations, and well run networks, by contrast, are not boot strapped by high fixed costs, can turn profits with regularity in varying market conditions, and this allows their focus and energy to be heavily weighted towards the client.  Additional benefits afforded to CRE networks and franchises, as compared to brick & mortar brands are as follows:

• Cost Structure & Focus:  Take into consideration the cost of running a national brick & mortar business with multiple leasehold obligations, high labor costs, the expense of creating brand recognition at the local, regional and national level, high IT costs, etc., and one can easily draw the conclusion that a predominant focus on size, breadth and volume is a survivability requirement.  History has shown that this frequently forces some national CRE brands to focus on recapitalization for survival.  Undistracted by high fixed costs, Franchisors and networks are, more often than not, run with inexpensive, variable, scalable, but effective cost structures, and their emphasis can be placed on innovation, creativity, marketing, and delivering results for their clients.
• Client’s Interests: In light of the high fixed costs mentioned above, it becomes cost prohibitive for some brick & mortar modeled brands to encourage fee sharing with competitive brokers.  The result is a preponderance of “double-ended” investment sales transactions, where the focus of a broker is more on finding the buyer independently vs. utilizing the brokerage community to assist – the result is nothing less than an effort on the broker’s part to earn a higher fee.  Franchisees and network members, whose businesses are independently owned and operated, on the other hand, operate with higher margins, can “afford” to put the client’s interests first, engage competitive brokers to shop listings to their buyers, split fees (some as high as 50% as we do at SVN as a matter or policy), generate organized competition, and ultimately a higher price for the client.  The latter approach is clearly in the best interest of the seller or client.
• Innovation: While franchisees and network members are both tied to strict brand standards, and some with codes of ethics, both are usually afforded tremendous, healthy independence with utilizing and developing technology, and processes, testing and identifying key vendors and developing the creative edge that client’s continually demand.

Bottom line – While large brick & motor CRE business models may look dominant at first glance, when you look under the hood, some represent organizations that cannibalize themselves from the inside out. Their constant need for investment capital requires them to be focused on short-term financial objectives which doesn’t afford them the ability to focus on the creation of long-term value through an efficient, client-centric business model. When all the dust settles, it will be the well run franchisors and networks who demonstrate the consistent ability to generate profits, and the ability to scale regardless of the economy that will prove to have the better business model.