Do you want to be successful? Our years of experience at Moss Adams consulting to top advisors and gauging the entire industry through our exhaustive research leads us to state the following with conviction: No matter what your definition of success may be, it involves people--hiring them, keeping them, and growing them. If you want to grow your firm, you first need the talent. We believe that independent advisory firms are as much in the business of recruiting and developing people as they are in the business of providing financial planning and investment advice. The development of a career track for all positions is perhaps more critical for the success of a firm than the development of any service capability. Recruiting and growing new advisors is also paramount to any referral relationship or alliance. Again, talent is the key ingredient for growth. But there's as big a challenge looming for all sizes and shapes of advisory firms: the client opportunities today far outpace the supply of talent available to advisory firms for servicing these opportunities. Dealing with that imbalance will make or break many firms over the next few years.
Before detailing how the best firms are already handling that challenge, let's look at the numbers. Moss Adams's research has found that in 2007, the typical independent firm expects to grow assets by 16.8%. In 2006 the typical firm grew by 25.7%. Over the past six years, advisory firms rapidly grew revenue and increased staff by taking on more clients and expanding services. Those firms with the strongest growth took the risk to hire staff in order to keep up with rising demand and as a result are now reaping better returns. These statistics, from the 2007 Moss Adams Compensation and Staffing Study of Advisory Firms, sponsored by SEI Investments and JP Morgan, speak to the rapid evolution of independent advisory firms. This evolution is really just beginning to take firms to higher and higher levels of success: financially, professionally, and personally for the owners. To get to those levels, though, you will need to find the right people for your firms, and as they grow in their capabilities, they will help ensure your firm's future success.
Where the Industry Stands Now
Moss Adams has conducted annual surveys of the advisory industry since 1994. From our vantage point it is remarkable how far the industry has come from a business perspective. The average revenue per advisory firm nearly tripled in the 2000 to 2006 period, increasing from $632,000 to over $1.6 million. With growth came the addition of many people. This year's 728 participating firms employed, on average, about twice the number of people as participating firms six years ago. Pre-tax income per owner increased as well during this period, rising 63% (see Chart 1: Growing Businesses).
History helps us put growth in perspective, but the future requires owners of advisory firms to develop the CEO inside themselves. Success has come in many forms to advisors. For some it meant generating more than $1 million in income per owner; for some it was growth, as close to 5% of the industry firms are passing $5 million in total revenue; and for others it came in the form of personal satisfaction from client service, wonderful relationships, and quality of life--developments that statistics fail to measure well. What we found in this year's Study is that recruiting and retention of people dominates the priorities of advisors today. This is reflected in our central report findings outlined below:
- Shortage of Staff--The industry today faces a severe shortage of staff: Nearly all of the largest firms are growing and need staff at every level and position. There is no clear external source for all the staffing needs, meaning that firms will have to train and develop much of their own talent. Improvements in productivity for existing staff must also be emphasized.
- Compensation Outpaces Revenue--As the demand for talent grows, the compensation of advisors is growing faster than revenues. Salaries for experienced professionals are outpacing the growth in productivity. Profitability is not threatened yet but the trend is dangerous.
- Productivity Is Critical--A key to profitability is productivity as compensation-related costs dominate the income statement.
- Million Dollar Benchmark--One million dollars of pre-tax net income per owner is the new benchmark for success. The largest 5% of the industry is generating this level of income now.
- Equity the Ultimate--Firms are starting to develop career paths that lead to ownership (i.e., partner status) for their best advisors.
- Solo Professionals Thriving--Despite the capacity limitations of the model, solo professionals are thriving and achieving high levels of income and an increase in average client size.
- Evolution Speeds Up--The progression from one stage of evolution to another is being shortened by the growth, challenging the management talent of the owners.
Short on Staff
Past a certain point it is impossible to grow without adding staff--at all levels and all positions. What we found in the Study is that the industry has a tremendous appetite for staff. Some chew them up and spit them out; the successful firms digest them. Firms anticipate an average 14% net increase in employees for 2007. Professional hiring will be particularly strong (we define professional positions as those primarily and directly responsible for client relationship management, advice delivery, or developing new business.). While nearly one in four firms hired a new professional in 2006, significantly more, 37%, expect to make a professional hire in 2007 (See Chart 2: Demand Surges for Experienced Talent).
The question many advisory firms are facing is a simple but challenging one: Where are these new hires going to come from? Talent shortages coupled with increased demand create a seller's market for labor, and advisory firms are feeling the pressure.
Dramatic Increases in Compensation
Demand is pushing up compensation levels and overall costs dramatically. Just since our last compensation survey in 2005, median compensation for a lead advisor, at $150,000, is up 41%. Average total compensation costs per firm are also up sharply, jumping 44% from about $580,000 in 2004 to $840,000 in 2006. Overall, advisory firms are hiring more, and they are paying more for each hire.
Non-cash compensation, in the form of health and retirement benefits, is also on the rise. Nearly three-quarters of firms now offer some form of defined contribution program. Benefits as a share of total compensation costs have risen consistently since 2002. The growing prominence of benefits is an overall indication of a maturing industry and is another sign of the increasing competitiveness of the labor market as firms use additional techniques to recruit and retain staff. In addition to insurance coverage and retirement plans becoming the norm, "perquisites" are also on the rise. Examples include flex time, complimentary health club memberships, and education subsidies.
The Key? Productivity
While the jump in compensation expenses could conceivably erode profits, most firms to date continue to generate strong returns. In most firms, labor is viewed as an investment rather than a cost, and the return on that investment is monitored in a deliberate way. Return on labor can be measured by dividing operating profit (return) into total firm compensation expense (labor). Labor costs are rising, so is return on labor (See Chart 4: Labor Payoff).
Firms are generating more profit per each dollar invested in labor, which to date has helped them weather the challenges of a tightening labor market. One tactic they are employing is an increasing use of non-professional staff to support the firm's professionals. The most effective firms are adding dedicated managers and technical specialists in order to best focus their advisors on revenue-generating client servicing activity.
Advisory firms are also responding to the talent shortage by using increasingly sophisticated compensation tools. Compensation packages are becoming more robust, as is evident in the increased use of defined-contribution plans and firm-wide incentive pools. Performance-based incentive pay motivates greater productivity from existing staff, and more attractive packages in general should help firms recruit and retain employees.
The Ultimate Staff Retention Tool
Aside from compensation, the ultimate retention tool is an environment that allows motivated people to flourish. This includes a proper job fit, a well-defined role and career path, a healthy culture that supports the firm's strategic direction, and opportunities for ownership or other long-term rewards.
A career path that potentially leads to ownership is present in only 19% of firms. However, another 25% are considering the addition of an ownership plan designed to provide employees with an opportunity to earn or purchase ownership. In addition, firms demonstrate greater tendency to grant ownership as they develop and mature, as illustrated in Chart 5. (See "What Color Is Your Firm" sidebar for evolutionary stage definitions.)
The Key? Productivity
While the largest firms are working on institutionalizing their human resources and capturing ever-higher levels of revenue, solo practitioners continue to be a common business model in the industry and continue to enjoy success. Statistics are not very good at quantifying the value of concepts like a high quality of life or the satisfaction from servicing clients, so our ability to measure the achievement of every type of practice is limited to what the numbers can tell us. Nonetheless, from what we can read in the numbers, being a solo practitioner continues to bring financial rewards.
High-profit solo firms (the top 25% based on pre-tax income per owner) typically consisted of four people (total staff count) compared to two for all other solos. For solo owners who are looking to increase the size of their businesses and their potential income streams, creating leverage through staffing in order to allow the practitioner to focus on revenue-generating activities is crucial. Successfully doing so enables these owners to service larger clients and larger numbers of clients. In return they are reaping significant financial rewards--high-profit mature solos earned $515,000 in pre-tax income per owner in 2006 compared to $182,650 for all other mature solos.
The ability to leverage is paying off for the largest firms and in 2006 we saw those firms (called market dominators) reach over $1 million in compensation. In just one year, owner income for these large firms jumped by nearly one-third (see Chart 6).
The Progression Continues
Together, these trends highlight the progression of the financial advisory industry as a whole and the continued evolution in the way advisory firms operate. The growth of advisory firms is a never-ending cycle of reinvestment in human capital and the infrastructure that makes that capital productive. As firms grow, so does their ability to manage and understand the cycle.
Based on observed trends, continued industry prosperity should be assured for the next several years. To capture their fair share of this opportunity, however, individual firms must remain diligent in applying best human capital practices. As firms grow, they reach critical points where investments in the business are needed and can compromise short-term profitability. Staffing and compensation practices play a significant role in the development of a firm. The chance for success only increases when firms take a deliberate, long-term approach to compensation and staffing--hiring purposefully, offering structured training and coaching, and rewarding appropriately through competitive pay, benefits, performance-based incentives, and long-term rewards.
Philip Palaveev is a principal who leads the market research for Moss Adams Financial Services Practices and consults with broker/dealers and RIAs on strategy, business planning, and compensation. He can be reached at Philip.Palaveev@mossadams.com. Dan Inveen, CFA, is a research manager at Moss Adams. Contact him at Dan.Inveen@mossadams.com. The complete study is available for purchase atwww.mossadams.com/2007advisorstudy.