Where size doesn't matter

?Are the days of the small broker really numbered? I was interested, if not entirely surprised to read of Direct Line’s intention to enter the commercial insurance arena and sell products direct to SMEs. After all it has a great brand and a very successful track record in personal insurance, so why not commercial?

It is not alone. AXA has been growing its ‘commercial direct’ operation both under its own brand and via white labelling on behalf of others – most notably Lloyds TSB.

Allianz purchased Premierline in late 2006 to increase its presence in this arena, and Norwich Union and Royal & SunAlliance both have commercial direct operations.

There are plenty of others, including some brokers, which employ the same methodology of call centres and internet to attract customers. In all there are dozens of players trying to muscle their way into this ‘SME direct’ space.

So, should traditional brokers feel threatened? Will this go the way of private car insurance? I think not. And that’s not because these organisations are inept, misguided, and not good at what they do, I’m sure most are very good at what they do.

No, for me the reason that most, if not all of them are doomed to mediocrity if not outright failure is market size – the opportunity is not big enough.

Let’s look at the statistics. According to the DTI, in 2005 there were 4.4 million firms in the UK that employed fewer than 250 people. Of these, 3.2 million had no employees at all and, while making up 71% of enterprises by number, they accounted for just 7% of UK plc’s turnover.

A further 1 million employed fewer than 10 people, making up 24% of enterprises and 14% of UK’s turnover. That’s 4.2 million organisations employing fewer than 10 people. Not a very large pool of potential customers – particularly when you compare it with the number of people, cars, and households in the UK which, in contrast, all number in the tens of millions.

It’s also an extremely diverse group, with more than 11,000 different business classifications within it. This makes commoditisation of their insurance needs very challenging indeed.

Let’s make a couple of educated guesses around what this opportunity might actually be worth in total. Assume that it is the smallest SMEs whose requirements can be most easily packaged into a contract which can be purchased ‘direct’. After all, there is a limited need for tailored advice or a face-to-face meeting, and therefore more opportunity for a ‘one size fits all’ strategy.

So, if say 20% of SMEs which employ fewer than 10 people were capable of having their insurances relatively easily commoditised, that’s 840,000 ‘prospects’.

“I believe that it is a relatively small number of customers who will find the ‘direct commercial’ model sufficiently attractive in the long run to make it sustainable

Now further assume that 50% can be persuaded to ditch their current provider (80% of SMEs already use a broker so they’d be the biggest losers) then that’s 420,000 customers.

If they each spend £500 on their insurance – not an unreasonable assumption considering they are likely to be the very smallest businesses in the main – that’s a total of £210m in premium – not a bad split between two or three players.

But share this among 20, that’s only £11.5m each. Compare that to the UK commercial market size of some £15bn and you start to see how small this opportunity actually is.

Even if the average premium doubled to £1,000, a 5% market share would still only generate £21m in premiums – hardly earth shattering!

Moreover, these are all revenue numbers, from which claims, administration, and most tellingly, acquisition costs have to be deducted. I’ve made some pretty wild ‘back of a fag packet’ assumptions in reaching these conclusions which can quite easily be challenged, and I don’t have a crystal ball, so cannot predict with any certainty what will happen.

True, many SMEs will find themselves without the luxury of a broker on their local high street as a result of the current consolidation in the broker market.

Some may be tempted by the convenience of the internet. But overall, I believe that it is a relatively small number of customers who will find the ‘direct commercial’ model sufficiently attractive in the long run to make it sustainable for all the players who are currently investing so heavily in it.

So brokers should not despair when they read about fresh competition. But they should not be complacent either. Limited and inconvenient opening hours, a lack of investment in technology to make life easier for customers, and increasingly restricted access to competitive markets for the very smallest will inevitably lead to more defections by customers.

How many will defect to ‘direct’? That depends on how brokers rise to the challenge, and how many adapt to take advantage.

As a business grows, customers’ needs change and they will increasingly look for advice, which is the ace up the brokers’ sleeve. In my view there will be far more with burnt fingers on the ‘direct’ side of the fence.

Grant Ellis is chief executive of Broker Network.