From the January 2008 issue of Investment Advisor • Subscribe!

January 1, 2008

Think About These

While taking stock of your clients, spend a little time on yourself

There's no doubt that an advisor already has enough going on, never mind adding 10 more things to think about. But as the year changes and I assess the big trends that have been impacting the advisory business since the turn of the century, I can't help but contemplate what these trends portend for the average advisory firm today.

One of the challenges of managing a business is the necessity of analyzing the firm and making plans about where to invest your attention. Even though it is an inexact science, we can probably draw some conclusions about where the business of financial advice is heading based on some essential observations.

I'm basing my observations on the following assumptions about the typical advisory firm. Most firms: are small businesses (even at $1 billion of AUM, the revenue level would qualify a firm as small); are owner-operated; have experienced rapid growth in clients and a meaningful increase in headcount; have seen overhead costs in general go up dramatically, particularly compensation-related expenses; have clients expecting--if not demanding--more without allowing for a commensurate increase in charges; and firm owners and staff are getting older.

Moreover, for most firms these trends will continue. So what do you think the future holds for your firm? The following 10 essential considerations have already begun to take root, with the potential to aggravate, and in some cases exhilarate, owners of advisory firms:

No. 1: Managing growth. According to Moss Adams, the average advisory firm has grown its top line by more than 22% annually. For many companies this rapid pace has continued over a sustained period of years. While growth provides the opportunity for staff development, increases in profits, more succession options, and an exciting atmosphere, it brings with it the potential for stress fractures. When an owner's span of control is stretched, quality, consistency, and effective leadership suffer. Often the firm's sense of purpose gets derailed as well because there is no time to inculcate new associates with the right way to do business, or for leadership to evaluate what's working and what's not. Unmanaged growth can be more dangerous to a business than no growth at all because of the reputational, financial, and compliance risk.

No. 2: Hiring professional management. As an owner, you will know your practice is at a crossroads when you do not have time to both serve clients well and manage the business well. For many firms, the business has become its biggest client and it has many moving parts: strategy, human capital, financial management, operations, sales and marketing, client service, and compliance. If you evaluated your business management by the same standards that your client uses to assess your ability to provide sound financial advice, how would you rate? Your challenge now is to decide whether to give up one in order to focus on the other. Advisory firms with professional management grow at a substantially faster rate than the average firm. With qualified individuals dedicated to a job, the outcome will almost always be better.

No. 3: Deploying technology effectively. Most advisory firms have plenty of tools but are not using technology to the optimal level. The lack of interface and integration, the failure to train properly, and having neither a plan nor a budget for acquiring software and hardware all contribute to the inefficiencies. Having made multiple steps forward, most advisors now need to take at least one step back to assess workflow and to determine how technology can be optimized to improve productivity and client service. There is a high likelihood that the solution will not be a proprietary creation, but better usage of what currently exists.

No. 4: Building value. Advisors realize value in their business through current income and capital gain upon sale. The vast majority of advisors are not contemplating the sale of their business anytime soon, however, so the key is to build a business to last. This means consistent repeatable income, sustained profitability, continuity of management and client service, and a systematic process for generating new growth. Business value in its simplest form is determined by dividing cash flow by risk minus growth (V = CF ?? [R -- G]). To build value, then, one should focus on enhancing cash flow, minimizing risk or uncertainty, and managing growth.

No. 5: Differentiation. Everybody uses the term "wealth manager," though their process, offering, pricing, and approach to client service varies. In some maddening way, the madding crowd persists in using this term to describe what they do. To dig a little deeper into an advisor's perceived differentiation, one hears things like "experience, depth of relationships, plan design, quality service, ethics." Frankly, those qualities are the basic threshold for being in this business. Real positioning comes from being known for something, having a recognized brand or technical superiority, or a unique way of generating new clients and serving existing clients. It's hard to separate from the noise, but with so many good competitors seeking the same clients, a growth-minded firm will need to resolve what distinguishes it in the marketplace.

No. 6: The talent shortage. The problem is acute. There is an oversupply of clients and an undersupply of qualified advisors. According to studies that Pershing Advisor Solutions commissioned from Moss Adams this past year, the need for 9,000 net new advisors in the next five years is predicted. When you add retirement, death, and disability to the equation, the actual number of new advisors increases dramatically. Growth-minded firms must position themselves as the employers of choice in their market and seek ways to recruit from non-traditional sources and invest in retention and development. Advisors who participate in the industry's professional associations will need to steer these groups back to the practical battles that will create more lasting benefits for the members, such as actively promoting this business to college graduates over other more "sexy" choices.

No. 7: Reinvigorating the sales process. The advisor has come a long way from when all financial service professionals were regarded as "producers." Unfortunately, the shift away from being known as a salesperson also resulted in a whole generation of advisors that is uncomfortable with the notion of business development. This lack of sales ability is camouflaged by the flow of referrals that comes into the firm based on the reputation of the founder or partners. Every business needs a growth engine. In professional services, this means having partners and associates who can create new centers of influence and attract new business to the firm.

No. 8: Managing profitability. While overhead costs are rising faster than revenues for most firms, this is mostly a function of investing ahead of the growth curve. The real challenge for advisors is managing the gross profit margin, the measure of profitability that occurs after separating direct costs related to professional compensation from revenue. As advisory firms experience more growth, they will need to retain price integrity, monitor and manage productivity of staff, improve client selection and retention, and avoid offering "one-off" solutions for which they lack expertise. It is important to know that minor changes in the gross profit margin will usually have a meaningful impact on the net profit of the enterprise.

No. 9: Redefining the service offering. Over time, client demographics and characteristics change. Typically, advisors attract clients their age or older, though that does not always have to be the case. What one may have regarded as an optimal client in the start--up or growth phase of the business may not be the optimal client going forward. If you were to identify the characteristics of your top 25 existing clients, what would be the pattern? If you were to acquire those top 25 clients today, what would your service offering be? What gets a business to one level is not the same as what will carry it to the next, primarily because of changing client needs, perceptions, and expectations. The question for every advisor today should be "Is my strategy still relevant?"

No. 10: The pricing strategy. As one's client mix changes, so too will the profitability of these relationships. Let us assume for a minute that all your clients are boomers who made it through the accumulation phase and are now in the distribution phase. Will it still be appropriate to charge an asset management fee? Will that still work for you if they are demanding more of your staff and you while drawing down principal? Will your pricing strategy communicate the value of your offering and reflect the economics of what you are offering? It is possible that there are always enough new clients coming into the pipeline to offset the income shift from older clients, but ultimately every business wants most clients to be profitable.

So as you ease into the new year and begin thinking about the adjustments you need to make to help your clients, take the time to reflect on your own business and its impact on your own pursuit of financial independence and peace of mind. Often, current processes are working and there is no need to change. But generally, every business must periodically make incremental changes in order to show marked improvements in how the business performs. These 10 things to think about should serve as fodder for your deliberations.

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