By Israel Ginez, Eng-Mba, Gindustrez Trading Inc.
I have seen many times how some Principals do not understand or do not want to accept the full extent of a company in business such as the Representation structures.
This document will walk you through the organizational part of the business emphasizing that an Independent Rep is a business for profit as well as the financial implications when taking a new line, particularly if it is a new line with no sales in the territory (often referred to as a pioneering line) and how these conditions affect the contract.
Some Principals’ Approach
During the process of negotiation, various occasions I have heard Principals saying “It will cost you nothing to take my line as you are already in business, why should I pay for developing my line, you are still going to see your customers.”
This approach has two implications:
- The Organizational and
- The Financial
What I have been told can be also translated as, “You are some kind of freelance individual luckily located in the correct market I need for my product to sell and all you have to do is work for me and your compensation will come whenever sales appear, no matter the effort or the cost – that is your problem.”
This approach has in nature diminished the value of my service as a company and also as an organization.
The lack of understanding that a Rep is a Company in Business for Profit and the lack of understanding that the most important asset of a Representative is his time make the mentioned companies believe that, a services company (Rep) should work with less benefits than those that they would offer to their own personnel and of course any other service company they deal with. I wonder if they would make the same statement to a law firm.
In both cases, these two types of companies (the rep and the lawyer’s) we all sell our time, which is converted into a service. Structurally a Rep organization is no different from any other service organization, lets look at some of its characteristics:
- A Rep is a company: Generally speaking a Representative Organization has gone through the process of consolidating a company consequently is responsible before the law as of any other company.
- Company and cost: Similarly to any other organization in business a Rep has its own operational cost which ranges from the simple individual at a cost of $13.000,00 per month which a year is $160.000,00 (This value has been taken from “Developing New Markets with Professional Field Reps” MANA) to much more when considering the size of the company and its investment.
- For Profit: As any other company in business, Reps are working for profit and let me remind you, profit comes only after paying all cost and investment.
- No matter the size: The principle “a company in business for profit” applies to any Rep business without distinction of size, or nature of it’s operations. Each and every Rep company needs income to survive and it’s goal is to make a profit, otherwise such company will go bankrupt.
- Income comes from fair contracts: Yes, the function of a rep is to sell and earn their income from those commissions, but you get only what is written in your contract.
By using an example I am going to introduce simple financial calculations to show you how a new line will impact your company.
This exercise will introduce us to the concept of how much does a line represent to a Rep in terms of cost.
One of the statements I frequently hear from some Principals is, “You already carry other products, my product is not going to cost you anything”.
If we all agree that introducing a product into a new market can take from few months up to two years, we will have to determine the costs involved in the operation of the business and, particularly during the time when the Rep will not receive any income which is the developing phase (except when you have negotiated retainers – which in either case will not cover the cost).
Let’s assume 3 lines, a one-man sales operation, sales are equally divided among the lines and each line pays the same commission (10%).
Due to the nature of the business, the annual cost will be $160,000, plus expected profit.
Say profit is $40.000 a year (equivalent to 25% of the investment for that year).
Operational cost/line/year = 160k /3 = $53.333
Opportunity cost/line/year= 40k/3 = $13.333
Total = $66.667
The total income you are looking at, is $200.000; which divided into 3= $66.667 per line/year.
Now, how much do I have to sell to pay my cost and get me a profit of $40k/year?
Sales needed to make the mentioned income/line/year at 10% commission= $670,000.
Now let’s assume that we are accepting a new line (having previously 2 lines) and also lets assume a 1-year developing time.
What is the minimum period the Rep needs to work this line to recuperate cost and profit expected? Remember no revenue for ONE year is expected for the new line.
The result will depend on sales and commission. In this example, it will take more than 4 years to recuperate the investment in 1 line.
What is this example teaching us?
- To recuperate your investment, it always takes more than double the time of introduction
- Minimum expected sales per year should be >$700.000
- Hardly ever you breakeven on the second year
- The minimum initial time you need (that is the minimum contractual time) is 3 years (depending on the sales volume)
One of the errors many Reps make is not considering profit as part of the required income. The fact is that you can pay your operational cost but the goal of any company is to make a profit. But this concept sometimes is overlooked in the calculations due to the difficulty of determining a reasonable amount of profit and sometimes it simply had been not included.
Calculating a reasonable amount of profit.
When Profit is factored into the cost, it has also been called opportunity cost and it can be calculated taking in consideration the following aspects.
- How much can I make if I put my money in a bank
- How much can I make if I invest my money in stock or other funds
- What is the average profit for companies in similar business (niche)
Generally speaking, this information is available in the market and, that explains why I assumed 25% profit; but let’s dig a little more into profit.
If my investment, without me doing anything can give me up to 12%/year, then my operational profit should be more than that.
Let’s assume that the average profit a business in my area make is 20 to 30%.
With this information on hand I can determine what is a reasonable value for the expected profit.
So far, we have seen the two parts in the business and how they interact when it comes to determining a new line in negotiation.
Now that you have answered the organizational and financial questions, the next step is to put this knowledge to work in the negotiation stage with you Principals.
Negotiating a contract is not only determining what the commission should be. As you can see from these calculations, it is critical to reach an agreement on the length of the initial period.
The negotiation of the initial period has a particularity, which is; during the “Initial Period” there is no room for contract negotiation (it is a preset period) and, any breach during that time should be compensated accordingly in cash due to fact that you have invested in the new line. In a way, this is like loaning to your Principal a given amount equal to your investment.
Unless you have negotiated a retainer during the initial period, the initial period is solely your investment and it is the minimum time needed to recuperate your investment and the effort put into it.
In practical terms, what I regularly mention to my Principals is, if they want to cease the contract the penalty will be X thousand dollars per month as a cash payout multiplied by a Y number of years, which should be paid immediately.
The reasoning is that you have lost your income due to a breach and there must be a way to compensate that loss.
Bear in mind, what you are losing is a business opportunity that you have created, is not how much you have invested only, it is not how much money you have spent into it, is more than that, it is also the opportunities that you had turned away because of this product.
Should you fail to make this clear in the contract the Principal can take the business to his own any time, or do something unexpected that nobody can even predict and you will lose your investment.
I would summarize this analysis in a few sentences, which I hope by now you will clearly be able to relate to your own business.
- A Rep is a business looking for profit
- You should understand how much is your investment when you take a line
- If you want to survive, you must protect yourself with the proper clauses in the contract.
- The contract should clearly define the initial period and the amount of compensation in case of breach of contract.
It is also my experience that good Principals do fully understand the nature of these clauses. If a Principal cannot see or does not want to see this situation, don’t hesitate to walk away. You will find the right partner in business within those who can understand that a Rep is a business for profit as much as they are.