14 May Freight Broker Organization Structures – An Evolutionary View – Part 1 (Cradle to Grave)
I’ve been working with freight brokers for over 10 years now, helping them revise their organization structure and align their compensation plans to support the goals of their business. While the number of different possible organization structures is almost limitless, there are a handful of very common approaches. These can be seen as the “base template” if you will, and then variations and themes can be developed off of these templates. There are also particular compensation structures that seem to naturally go along with the different organization structures, with some approaches allowing much greater flexibility than others.
As you start to consider different possible organization structures, note that your compensation plan and philosophy will affect your choices to an extent. Over this and the next several blog posts, I will try to break down the decision trees that go along with different philosophical choices for structure and compensation so you can more easily limit the number of options you need to consider (if you’ve ever bought white paint you know how daunting it can be to have too many choices…I’d like to help you NOT have that problem with your compensation plans!).
There is ONE universal compensation plan that does not depend on or affect your organization structure and allows you to change your structure, roles, responsibilities, and workflow pretty much at will, and that is a “salary only” plan where there is no incentive tied to individual performance. You could also have pretty much complete org design freedom if you did salary plus company year-end bonus. Neither of these approaches is affected at all by the structure or flow of work. An individual would earn the same amount if they were working cradle to grave or only as carrier sales (the salary levels might need to be adjusted but that is all). Consider the opposite extreme – the version that I consider to be THE WORST change to make… a 100% variable plan (no salary) aligned with cradle to grave brokers. GOOD LUCK doing anything different with your customers, your people, your teams, or your structure when you have this kind of plan in place. This plan is easy to calculate, easy to set up, and is the way many brokerages start out. But after a few years the constricting nature of the plan (you can’t move customers though it might be the best thing for the business) and some of the inherent unfairness shows up pretty clearly: have you “given” house accounts to new reps to get them started or do new (management sourced) accounts always go to your top producing rep leaving the others high and dry? And financially, there is no way you can recoup your investment in the business (new TMS, improved marketing, better IT support, etc.) without having the unpleasant and often unsuccessful “rate reduction” conversation.
So, let’s look at the basic organization structures. There are really only two approaches, with some variations on each: Cradle to Grave and Split Structure. This post deals with the first, we will address the Split Structure in the next post.
The most common first step is Cradle to Grave. One person calls new shippers, manages the relationship with existing shippers, calls trucks to negotiate rates to move the freight, and probably also does their own track and trace. When a new brokerage is born in a garage or unused bedroom, this is what the person starting the brokerage has to do. There is no choice as there is no one else to do anything. Pay is also 100% dependent upon what is sold (small business owners’ pay is almost always 100% variable at the start, and only with time, growth and stability do they reach a point that they can take a fixed salary out of the business). When a business gets a little size behind it, adds a TMS system, and has enough cash flow to provide financing, the owner will often seek out agents to provide an influx of new business. The agents get access to the TMS system and cash flow, while the brokerage gets the additional freight moving through the system to help offset the costs of the systems. Each agent added is just one more “node” in the network. For some people, the agent model is not as attractive as being a W2 employee and some owners don’t want agents or want some of each. While the agent model split seems to run from 40% – 70% of gross margin, it’s unusual for a W2 “internal agent” to get more than 30%. When you factor in the cost of payroll taxes on the commission, workers comp, benefits, etc., there is ample justification for the additional “share” going to management vs to the employee.
The next natural evolutionary step from pure cradle to grave is to add support resources. The broker working out of her bedroom does this when she hires her niece to manage the check calls. The broker working in his garage does this when his wife steps in and starts processing all the invoices. It’s the right thing to do to segregate roles and duties. One person cannot do every part of running a business and grow the business to any size. The first duties to get “handed off” are those that are specialized or clerical in nature. For the specialized roles, the owner will hire an accountant or bookkeeper, someone with an IT background to manage technology, a PEO for payroll, and a marketing firm to handle web design and SEO management. Clerical duties are easy to off load as well as the resources required are relatively inexpensive and the tasks easy to teach to someone else.
Within a growing brokerage made up of W2 Cradle to Grave brokers, these resources will be added in much the same way a real estate or insurance agent does, developing into “pods”. The resource has a seat cost associated with them, and that cost is “charged” to the broker through a reduction in the commission rate (maybe it drops to 25%). Some brokerages that have W2 employees expect the broker to pay their support resources from their own earnings. If you are doing this…STOP IT IMMEDIATELY. Your W2 brokers are not collecting payroll taxes on the payments made to their support staff and (in addition to myriad ethical concerns – are you sure they are paying minimum wage? What if they pay their girlfriend more than their other helper?) this is a tax violation. If you want to operate your business this way, convert all your brokers to 1099 agents so they must set up their own business license and assume all legal and financial risk for THEIR employees. Instead, you, as management, will want to ensure all of your people are being paid fairly and legally and all the appropriate taxes are being collected on all payments. It’s not the broker that will be on the hook for any violations…you will be.
Ironically, I’ve seen many brokerages adopt this model but use a bifurcated compensation philosophy. The broker is 100% commission, but all operational support resources are 100% salary (with a salary charge taken out of the broker commission). This creates a very divided structure within the organization and frequently breeds resentment and complacency. The broker may be making a TON of money (I can personally verify that there are several of this type of broker out there with W2 earnings in excess of $1m), while the people “actually doing the work” are making fixed salaries in the $40k to $50k range. It’s not at all uncommon for me to hear lots of complaints from the support staff about how they are the ones doing all the work while the broker gets all the glory (and pay) and from management that the broker is complacent, not acquiring new customers, not growing, and not really trying very hard (because, guess what, in this system they don’t have to!). There are always exceptions, and I also know brokers in this set up that are working 80+ hours a week, never taking vacation (of if they do they are moving loads while on the beach), and generally running the risk of severe burn-out and a premature death. Owners often will express concern that they have become dependent on the “machine” like work ethic of these brokers but they know it can’t last. What happens when kids come along? What happens when there is an illness or injury? What happens when the broker just doesn’t want to do it anymore? Or…what happens if another company makes a better offer? How much of your business is “at risk” (and it’s not cheap to pursue a non-compete suit).
For all of these reasons, I’m frequently approached by companies looking to move away from this type of structure. Bear in mind though there is nothing wrong with a pod structure, where there is a leader and a group of support resources. Almost ALL outsourced freight management companies are organized this way (Account Manager + Logistics Coordinator + Logistics Support). But the REAL difference is in how they are paid (freight management uses very little or NO incentive pay – mostly salary), and how they deal with work that is outside of their pod. Will they willingly share resources, or won’t they? (And why is it even their choice?). In a more “corporate pod” model (vs the “independent pod” model of a broker and “his” support staff), the resources are more fungible and be shared or moved between pods based on business needs. Accounts may be moved from one pod to another to balance workload and ensure high levels of customer service. But, there is still a person or group of people who have primary responsibility for ALL aspects of a customer’s business (cradle to grave). This works really well for high-touch, high value freight that requires a lot of detailed knowledge and has high claim risk (TC, DOD, High Value/High Risk). Ironically it also works well for the managed freight world where most of the activities are automated because they are so repetitive. Freight comes in through EDI and is put on one of a few pre-negotiated carriers.
For those that want to have significant pay at risk for the pods, and yet maintain corporate oversight and management, it’s advisable to use a salary that is at least 50% of the total compensation at target (this “buys” you the right to change things around), and an incentive that is tied to a goal that can be raised or lowered when accounts are added or subtracted from the pod. It can be a commission still, where there is a fixed % of gross margin (usually) paid for the volume produced – the commission rate just needs to vary based on production tiers or goals, or it can be a pure goal with % of target incentive paid (no fixed mathematical relationship between production and pay). People in the pod get a different incentive based on their role.
I’m not wild about team commissions, but sometimes they are the best transitionary choice away from the “broker take all” approach. But even here, your compensation strategy can allow or hinder flexibility depending on how you set it up. Take a look at these two approaches:
Option 1: Defined Split %. Team pool = 10% of gross margin: 60% paid to Broker, 30% paid to Carrier Sales, 10% paid to Track and Trace.
Option 2: Defined Commission Rate. 6% of team gross margin paid to Broker, 3% paid to Carrier Sales, 1% paid to Track and Trace.
Mathematically they are identical and will pay the same amount both in aggregate and to each individual. But what about when you want to add a 2nd carrier sales resource? Under option 1 you are going to struggle with how to accommodate this change (each now gets 15%?). Whereas option 2 allows you to start to split up the workload w/o raising costs. Carrier Sales 1 gets 3% of all loads she moves, and Carrier Sales 2 gets 3% of all loads he moves. You may want both tied to achievement of a team goal for part of their plan (such as team load count) so they work together to ensure all freight is covered (this could be a modifier on their individual commission). You could also pay them each 1.5% of the total team’s production if you wanted, to be purely egalitarian about it (but I’m guessing most won’t like that as one will work harder than the other). The point is Option 1 leaves you very few alternatives other than just changing the percentage share of the pool (as paying them both 30% of the total is NOT economically viable). Option 2 gives you some wiggle room to handle future changes – you are NOT backed into a corner with only one solution.
In all of the above situations, I would recommend having a tiered commission approach (below a level pays a lower rate, above a level pays a higher rate). Even if you only have ONE bar, you can now move the bar rather than changing the rate. The BEST way to do this calculation is to pay the higher rate only on the dollars above the bar (this is called a marginal commission plan) but this is nearly impossible if you are paying on collection. Philosophically, paying on collection often goes hand-in-hand with a 100% commission, quasi-agent model. Paying on shipment or delivery or invoice goes with a corporate model, where there is usually some kind of fixed pay (salary or hourly rate) along with the commission and much more management oversight in terms of extending credit to customers, setting payment terms etc. You CAN use a tiered commission in a “pay on collection” world, but you pretty much have to use a retroactive rate. Meaning, the rate is earned based on loads shipped or delivered within a month (a tier is reached) and then that rate is tied to all of those loads and paid when the customer makes payment. A given check for any broker will have loads with several different rates (as they delivered in different months), but most TMS systems can handle this just fine. What you don’t want to do, however, is use the previous months’ tier performance to determine the rate paid for loads collected in the subsequent month. This can create misalignment between performance and pay, e.g., I had a rockin’ good month in terms of deliveries, but my next month will be smaller in terms of collections because all my customers have 60-day terms and two months ago my volume was off. Likewise, if I have a down second month, the loads that gave me the high rate may end up being paid at a low rate because they are paid off the second month’s performance. You can see how it’s just problematic to not have the rate and the payment be attributed to the same loads. If you are paying commissions weekly (presumably using a flat rate and very low or no salary), you will have a little bit of a hiccup or one month of a double payment required to shift to calculating a rate based on monthly performance. Trust me, in the long run, it’s worth it.
In the next blog, we will look at how companies use the Split Organization model and some different incentive approaches that can be used with it (the sky is now the limit in terms of incentive options!). When you can clearly define and differentiate your roles, your compensation plan can be VERY directly tied to your specific objectives for each role. When you operate in a cradle to grave world, your commission plan needs to be very generic (% of gross margin) as it’s got to cover all bases in as simple a manner as possible.
Even though having two people doing the EXACT same job with one classified as 1099 and the other as W2 is an open invitation for an IRS and DOL to conduct an audit on your jobs and potentially hit you for back payroll taxes on the 1099 agents, many brokerages do exactly this.