From the October 2009 issue of Investment Advisor • Subscribe!

Formulas for Success: The Aftermath

Now is the time to shore up the foundation of your business

Granted, it's a little early to judge the lasting impact of the 2008 market cataclysm on the advisory business, but celebrating survival after this disaster--and getting to work shoring up the foundation of your business--may be the best course of action for advisors today. Not surprisingly, most firms had less revenue, lower profit margins, and fewer profit dollars this past year than in previous ones. As a consequence of a greatly diminished cash flow, owners of advisory firms also saw a material reduction in their personal income. One material consequence of lower cash flow is a lower relative valuation of their business. All firms were not impacted to the same degree, however, depending on the decisions they made before the market's precipitous drop.

Several industry surveys have released data on how advisory firms fared, and how they are preparing for future success. The first study to be released this year was produced by Moss Adams (and sponsored by my firm, Pershing LLC) and addressed the topic of compensation and staffing. FA Insight, Quantuvis, and Rydex are all producing data that supports similar issues. A few interesting observations emerged from the Moss Adams study:

1. Most firms did not panic by cutting staff precipitously, and thus have retained the capacity to grow.

2. Most respondents to the survey said they will use the layoffs in the broader financial services industry as an opportunity to selectively hire talent.

3. The smaller firms that cut back on staff and investment in their business are not as well positioned to get back on their growth trajectory.

4. Most firms have not adjusted their base and incentive plans yet to reflect the new reality.

5. Most missed the opportunity to make improvements in processes that would result in better productivity (they may have been slightly distracted by clients during this period).

The survey categorized the firms as "Opportunists," "Pragmatists," or "Mature." The Opportunists plan to increase their capacity through new hires--they are financially healthy and have the resources to invest in their business. The Pragmatists, a group representing most of the independent advisory firms, plan to remain cautious about spending money on anything, including hiring. The Mature group, which account for a small percentage of firms, generally had higher operating expenses to begin with and continue to look for ways to cut all costs including staff.

In other words, just like their clients, some advisors were prepared to weather the storm and others are now seeking shelter after their windows were smashed and their roofs blew off. Like natural disasters such as forest fires and floods, market downturns and recessions cleanse the earth and allow for new growth. In this case it appears that the stronger firms could emerge as market dominators and the weaker firms may have to seek them out as partners.

The Opportunists' Edge

General risk-taking principle says that the stronger your foundation, the more you can afford to lose. Although one could argue that those with subprime mortgages took big relative risks because they had nothing to lose; they had zero down in equity and a low payment, which basically meant they got cheap rent for a period of time. Advisory firm owners have a considerable investment in their enterprise, however. Because of narrowing margins, many were not able to retain enough capital during the boom market to fortify their foundation.

The Opportunists were disciplined about managing through the glory years. They rearmed themselves with people, technology, and dollars and kept their teams together during the worst of the problems. Now they are positioned to capitalize on the return of clients to the market and the movement away from wirehouses. Besides financial health, Opportunists distinguish themselves because they invested more in staff than their peer firms and, more often than not, have professional management in place to focus on opportunities while their technical and advisory staffs take care of client service.

What Now?

Mature and Pragmatist firms face unique challenges in the aftermath of the market meltdown. Mature firms must evaluate how to maintain profitability and perhaps begin planning an exit or merger strategy. The Pragmatists must decide when they will become Opportunists again.

The Opportunists have their own issues. How do they take advantage of market and staff movement without creating a negative client service experience or damaging their culture? How do they realign their compensation plan to encourage their associates to generate more business at a time of active market movement? If they open new offices, how do they ensure that their technology infrastructure and management is adequate to deal with the stress of a far-flung empire?

Let's break down these challenges into three major questions.

Whom Do I Want as My Client? The ACAT transfers reveal a lot of money in motion. While much of this appears to be going to self-directed accounts at the discount brokerage firms, advisors in both the independent broker/dealer and RIA business models are seeing a major uptick as clients fire their current advisors (many of these assets are coming from similar competitors, not just wirehouses). After having lost so much, advisors may be tempted to view opportunities in terms of assets and fees rather than considering client needs, compatibility with the firm, and a profitable relationship. A disciplined client acceptance process must be maintained for the future health of the firm. Leaders must remind their partners and associates who their optimal client is and restate a commitment to the firm's optimal client experience.

Whom Do I Want to Hire? Estimates predict that in the New York metro area alone, more than 80,000 people have been or will be laid off in the financial services industry. Meanwhile, independent financial services firms have been experiencing an acute talent shortage that will not abate as the demand from clients increases. The challenge is to select individuals who are experienced in the business and can adapt to your independent firm's culture. Assess a candidate's behavior toward fellow associates and clients along with their style of communicating and doing business. The opportunity for hiring talent is great--but the risk of undermining the character of an organization is also high.

How Should I Compensate Staff? Firms must also consider their compensation plan. According to the Moss Adams survey, many advisory firms still rely on discretionary bonuses instead of incentive pay determined by achieving performance goals. At a time when margins are squeezed more than ever and productivity (as measured by revenue per client and revenue per staff) is declining, the need to align the reward structure to the behavior you seek has never been greater. The incentives may be focused on client retention, client satisfaction, reduction in errors, and other factors--in addition to new business generation. Owners of practices must ask: "What behavior do I seek from my partners and associates? How do we measure it? How should we pay for it? How much of their compensation should be fixed, and how much should be variable?"

With all of the challenges in the post-meltdown market, Opportunists are in the catbird seat for sure. But unmanaged growth can be as bad, if not worse, than no growth at all. Checking and rechecking your firm's foundation will help to ensure the business doesn't collapse as you add new layers.

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