Microsoft Opens Up

Remember the early days of Microsoft?  at war with Apple in the marketplace and in the courts – each one racing to dominate the personal computer universe – allegations that this one stole that but from the other one and so on.  Seems Microsoft won that early round by focusing on its Operating System and making it available to PC manufacturers all over the world.  Apple kept its OS proprietary and bundled it with its own hardware, relegating itself to boutique status.

But that’s 30 year old news.  When Steve Jobs came back to Apple he took the company in a dozen new directions, and changed everything. Not just Apple, not just business in general:  he changed the world.  We consume music today completely differently than we did at the end of the last century thanks to his Ipod and ITunes store.  The IPhone has replaced the camera as the most widely used image capture device.  The success of the IPad at least contributed to Microsoft’s decision to make its current operating system – which, by the way, is a bit of a disaster – touch capable.

After years at the bottom of the barrel, Apple is more profitable than Microsoft.  The two companies were in a dead heat in 2010.  But look at what’s happened since:


(The steadily rising red bar is Google.  The lion’s share of its revenue comes from its websites, largely via advertising.)

Today, Apple’s core business is not the Mac.  That bit of bundled hardware/software is responsible for only 13% of its revenue.  The IPad is 18% and the IPhone is 55%.  Apple’s core business is now in your purse or pocket!

Now take a look at Microsoft and where its revenue comes from:

70% of what they bring in comes from licensing!  Licensing what?  Well, Windows of course, but there are other things as well, notably, Microsoft Office.   In fact, in the fiscal year ending June, 2013, $16 Billion of Microsoft’s nearly $27 Billion in Operating Profit were generated by the MS. Office dominated Business Division.

Microsoft has a new CEO.  Satya Nadella took over for Steve Ballmer a couple of months ago.  Ballmer was a wild man (the bald guy):

And, he was very protective of Office.  He led Microsoft through a time when it – like Apple – held tightly to its products and property.  It was this protectiveness that enabled Google to gain so much so quickly.  They popped on the scene making their products available for free and also available for anyone to use and develop!

All of which takes us to this week, when Satya Nadella holds his first press conference.  He is expected to announce that Office 365 will become available for use on the IPad.  According to Charles Cooper at CNet, “The decision to make Microsoft’s cash cow available on a product sold by one of its arch rivals not only breaks with a long Windows-centric history, it also sends a signal from the new boss that more big changes are in store.”

The lesson from these tech giants is that the game is always changing, the bullseye is always shifting, and the nature of the business evolves.  Extinction occurs when we stand still and cling to what once was.

How To Do It: Step 9 – The Bottom Line

(This is an elaboration of ‘How To Rule The (Real Estate) World In 10 Easy Steps’)

Until you build your listing inventory, start generating leads and handling them effectively, add staff enabling you to do more and . . . in other words:  until you work through the previous 8 Steps, you really shouldn’t worry much about profitability.  There probably won’t be any.  But once you begin generating revenue on a regular and consistent basis, the ‘P’ word should become your obsession.

Profit is cash, profit is power, profit is longevity, profit is possibility . . .but mostly, profit is a measure of the success of your business.

Cash flow and profit are two different things.  You can be unprofitable and still have cash flow, and it’s been my experience that this is the case with most real estate brokers.  If you read these posts regularly you know I go on and on about how hard it is to make a true profit in the traditional real estate brokerage arena.  The question becomes:  if these guys are not making any money, how are they managing to hang on?  The answer is cash flow.  Cash flow is what you have in your checking account at the end of the month, after the bills are paid.

Profit is a paper calculation that tells you if your business is worth owning.

You get to it this way:

  • Gross Revenue
  • Less Cost of Sale
  • Equals Net Operating Income
  • Less Operating Expenses
  • Equals Profit/Loss before Taxes

The Profit calculation is:  Bottom Line (Profit/Loss before Taxes), divided by Top Line (Gross Revenue).  The answer is a percent.

The question is:  what is reasonable?  What should we all be shooting for?  There is no pat answer for that, not in the real estate business or any other business.  Before you can even begin to pick a target, you have to give definition to the process of arriving at the Bottom Line.  Let’s do that here, starting at the top with Gross Revenue.

Step one is to subtract ‘Costs of Sale.’  These are expenses that are triggered by the production of Revenue.  When you generate dollars to the top line, some get diverted to cover standard obligations that occur every time Revenue is generated.  The obvious one is Franchise Royalties.  You have a closing and the franchisee fee comes right off the top; in fact many offices have that Royalty check cut right at closing so they never actually deposit the money into their accounts.  Hawaii has a 4% Value Added Tax that applies to real estate commissions (I guess the Value Added is that you get to sell real estate in Hawaii!).  That’s a cost of sale.  Anytime we ‘split’ commissions with an agent, their portion is a Cost of Sale.  Why do we segment Costs of Sale  out from other expenses?  Generally,  because they are beyond our control:  they are an obligation that we cannot manage like we do Operating Expenses.

Operating Expenses are the standard expenses you’d expect:  Rent, Utilities, Communication, Technology, Marketing and so on.  Your task as a business owner is to manage these items so that you get the biggest bang for your buck in each category.  Maybe you’re spending $500 a month  on Communication (mostly phones) and you find a new system that costs $400 a month without compromising the level of service and dependability you currently enjoy.  When you switch to the new system, you’re managing expenses.  Note, ‘managing expenses’ does not necessarily mean opting for the least expensive choice.  It’s about getting an acceptable level of service and performance for the least amount of money.  The biggest variable in the Operating Expense category is Marketing and as a real estate broker you must constantly be tracking your marketing dollars and evaluating the results they produce.  It costs less to Market real estate today than it did five years ago.  The effectiveness of the Internet to produce leads has given it center stage over things like newspaper advertising, and it is generally less expensive than older media.  It can require a greater time commitment from the broker.

Once we consider all of the standard expenses required to operate your real estate business, it’s time to examine the expenses we most often forget.  These usually have to do with compensating YOU for your contribution to the business.  It’s important to acknowledge that you probably have several functions in the company.  First, you’re an Investor.  You put up a certain amount of cash to have your company and keep it operating.  As an Investor, you expect a Return On Investment.  What’s reasonable?  You could have put your cash in a passbook savings account and gotten a secure 1 1/2% or so.  Or you could have put into very risky penny stocks and hoped to get 15% or more (if you’re very lucky).  Your real estate business falls somewhere in the middle.  I’d suggest you build in 5 -8% of the amount you have invested as Return on Investment.  If you have $100,000 invested in the company, you might expect, say, $6,000 a year as a return:  $500 a month.  Will you cut yourself a check every month for that?  In a perfect world, yes.  In a practical word, probably not.  But you will consider it when you calculate the profitability of your company or the result will be an untrue profit.

Your second role in the company is Manager.  You manage people, you manage expenses, you manage marketing:  You are a Manager.  What would you have to pay someone else to do all of the Management jobs you do in the office?  Don’t answer that.  Just remember that you are doing work when you Manage your company and it’s work for which you should be compensated.  Here’s where I’d fudge a little bit.  I’d build in about $3,000 a month for Management, regardless of whether you ever cut the check.  It’s probably less than you’d have to pay someone else, but it acknowledges the reality that there is a value to your time and expertise.

Your thrird role is probably that of Salesperson.  You do sell real estate and you should be compensated for selling just as you’d compensate any other salesperson.  This is a little tricky in Help-U-Sell because we have taken the revenue from set fee listings sold and allocated it to ‘The Company.’  We’ve decided that the Company generates listing leads through Marketing, the Listing Consultation should be a n0-brainier because of our great consumer offering and we manage our listings with office systems.  No Salesperson is required.  Therefore, you may choose not to compensate yourself for listings you take.  You may consider that to be a Management function.  But Buyer sides are different.  Here you really are functioning as Salesperson and you should be compensating your self just as you would any other Salesperson.  If you split is 50%, you need to allocate that amount to yourself every time you have a Buyer side transaction.  Here I’d suggest you do cut a check, but if you don’t — if you elect instead to ‘leave your commissions in the company’ — you need to allocate them to that amount you have invested in the business and consider them when you calculate your Return on Investment.  You’re reinvesting your personal sales commissions into the company.

Your fourth role is Entrepreneur or business owner but your compensation is not an expense.  It’s that elusive Bottom Line we’ve been talking about here: Profit.  What’s left after we pay all of the expenses including paying ourselves is Profit and it belongs to the Entrepreneur.  The Entrepreneur gets paid last:  after the Investor (you), the Manager (you), and the Salesperson (you).  If you look at your company’s financial health as I’ve outlined here I expect you’ll be depressed — especially given the economic climate of 2010.  However, what we’re talking about is a paper exercise that puts a measure on your company’s health.  Whatever you get is a starting point.  From there you can begin to do the two things that will improve your outcome:  Increase Revenue and Control Expenses.  So your bottom line is -3%.  Ok.  What are you going to do to get that to -2%?  and then -1% and so on.  The exercise has value all the time, but it’s probably most valuable during periods of great activity.  It’s at those times that cash flow is high and it becomes easy to assume we’re making lots of profit.  Evaluating your company like this is usually a sobering experience and can keep you from making poor decisions.

By the way:  there’s another payoff for the Entrepreneur.  It comes when the Entrepreneur exits the business, selling it to someone else.  The net proceeds of that transaction — after the Investor (you) recovers the money invested in the business, is owner’s equity.  It is the payoff for having developed the asset (the company) over time.

So what is a reasonable profit?  If you’re breaking even (no profit) but paying yourself as outlined above, you’ve  bought yourself a decent job with a possibly bright future if you plan and manage well.  If you’re making 3-5%, you’re doing ok.  If you’re at 10% or above (and you’re paying yourself as outlined), you are starting to have a business worth owning.

Measuring Success

There are lots of ways to measure success in life.  I guess the most fundamental measurements have to do with happiness, satisfaction, fulfillment, a feeling of accomplishment and worth.  We all aspire to those ideals.

In the real estate business we measure success in two ways:  Market Share — which we talked about the other day (see previous post) and Profitability.

The important thing about Market Share is to recognize that it is both a goal and a process; or, as we said in the previous post,  both static and dynamic.  If we are aggressive and positive, we will never achieve our Market Share goals . . . because we will always be adjusting them upward!  The important thing is the process:  are we always growing our Market Share or expanding our reach into new areas?

Profitability is a different kind of challenge.  First we have to achieve it.  Then we have to maximize it . . . and we have to know when we’ve done that.  Then, if we want to continue to grow, we have to replicate what we’ve done in a new outlet.

Step one in any discussion of profitability in real estate is to define it.  This can be confusing because there are many people with strong opinions about it.  For example, your accountant wants to cram as much ‘stuff’ as possible into your balance sheet to minimize the bottom line and, therefore, your tax liability.  That’s fine; but that’s a different purpose.  Your purpose is to measure the success of your business, not the performance of your accountant, so you need to employ a different process, a different formula.

Start with Revenue – the top line.  If it comes into your office bank account as payment for the goods or services of your real estate company, it’s Revenue.

From Revenue, we deduct ‘Costs of Sale.’ A Cost of Sale is any financial obligation that is triggered by the generation of Revenue.  The best example I can think of is your Franchise Royalty.  As a Help-U-Sell member you pay 6% of your Gross Revenue on each transaction as a Royalty (well . . . it’s 5% through Dec. 2010 to help everyone get through the current difficult market).  The Royalty is triggered by the production of Revenue so it is a ‘Cost of Sale.’  If you have Buyer Agents on your team that you compensate by splitting commissions as a traditional broker would, their portion of the commission is also a Cost of Sale.  It’s Revenue you don’t have available for Expenses because as soon as it is generated it is sent somewhere else to cover an obligation.  What you have left after Costs of Sale is Net Operating Income or what’s commonly called ‘Company Dollar.’

From Company Dollar, we take the Expenses.  You have the hard expenses of Rent and Utilities, Support Staff Salaries, MLS Dues, etc. and you have the somewhat less fixed expense of Marketing.  Interesting:  at Help-U-Sell we approach marketing in a very systematic way so that, over time, your monthly marketing expense shouldn’t fluxuate much, becoming a nearly fixed item as well.

A couple of mistakes real estate brokers make when calculating expenses are not paying themselves for their production as agents and not paying themselves for managing the agents that work for them.  The result is an inflated bottom line — not an accurate picture of what’s going on in the office.  You have to think:  what would I have to pay someone to do what I do in the office if I ran away to Tahiti tomorrow.  Then, be realistic, crank it back down to earth and plug it in.  At Help-U-Sell, if you work with a Buyer and make a sale, you should compensate yourself (at least on paper) just as you’d compensate one of your Buyer Agents.  We consider that the Listing belongs to the company and that the system (not the agent) markets the listing, so the set fee you earn when the Listing sells can remain in ‘Company Dollar’ without an allocation to you, the broker, personally.

What’s left after we take out Expenses is Profit (or Loss).   It is a dollar amount but becomes meaningful when we convert it to a percent of Gross Income (or Revenue).  Take the bottom line and divide it by the top line.  What you get is your profit (assuming the bottom line is positive).  Traditional brokers often delude themselves about profitability by taking the bottom line an dividing it by ‘Company Dollar,’ but this is folly.  It’s not an accurate measurement of the success of their offices because it doesn’t take into account the huge splits they generally pay their agents.

How much profit do you have to make for your office to be ‘worth owning?’  That varies especially when you factor in the human elements we discussed in the first paragraph.  But here are some thoughts.  If you are Wall Mart, you’re probably happy with 3% -5%:  you make scads of money on volume.  If you Agnes’s Boutique, you probably need to see something more in the 20% – 25% range:  the risk is higher  for your small business and you are much more susceptible to market fluctuations.  In 15 years of profitability consulting for traditional brokers I never saw anything better than 4%.  I had some who tried to convince me they were making 10% or 12%, but they were usually running ancillary service Revenue through the company or not compensating themselves as agents or managers.  ‘Oh, I just leave my commission in the company,’ they’d say. ‘Uh-huh.’  Again, that’s fine.  It’s just not an accurate reflection of the success of your business.

My goal for Help-U-Sell offices is 15% – 20%, figured properly.  That’s a successful office and a good income.  It’s also very attractive when it comes time to sell your business — something you can do much easier than your traditional broker counterparts because you build your Help-U-Sell business on systems, not personality.  If you do it right (and the new ownership doesn’t monkey with it!) the business should continue to function long after you’ve gone away.




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