From the January 2010 issue of Investment Advisor • Subscribe!

Advisor Exceptionalism

The lessons to be learned from firms that stood out even amid the crisis

The stress testing endured by advisory firms over the last 18 months yielded an uncomfortable, and at times overwhelming, level of pressure for advisory firm shareholders and management. For an exclusive group of firms that we call "Standouts," however, performance improved as the heat was applied. With revenue growth running five to eight times higher than other firms and overhead expenses managed with discipline at 13 to 17 percentage points lower than their peers as a share of revenue, this elite group deserves close attention.

In November 2009 FA Insight released The 2009 FA Insight Study of Advisory Firms: People and Pay, a comprehensive human capital study conducted in the summer of 2009 that included highlights of the exceptional performance of this Standout group and how they leverage talent to outperform their peers. Sponsored by TD Ameritrade Institutional, the study provides firms of all sizes with extensive benchmarking data that is combined with prescriptive insight to ensure that firms make best use of their human capital investment.

What characterizes a Standout firm? The People and Pay study considered two leading characteristics to identify the Standouts from the 200 respondents whose surveys met our requirements--the ability to grow (firms were first ranked using revenue growth achieved between 2007 and 2008), and the ability to generate income for owners (annual owner income for 2008 was measured as the sum of owner compensation and firm operating income divided by firm revenue).

This combination of both growth and owner income provided a simple yet effective measure for gauging firm health and long-term sustainability. For purposes of analysis we grouped firms according to annual revenues:

o Operators--Firms with $75,000 to $500,000 in annual revenues

o Cultivators--Firms with $500,000 to $1.5 million in annual revenues

o Accelerators--Firms with $1.5 million to $3.0 million in annual revenues

o Innovators--Firms with more than $3.0 million in annual revenues

With equal weight given to both criteria, the top 33% of firms in each of our four stages of firm development were identified as Standouts--their results were nothing short of exceptional.

First, Control Overhead

In addition to greater revenue growth and owner income, Standout firms also performed markedly better in terms of AUM and client growth. Despite workloads peaking as clients demanded more of their advisors' time and attention, perhaps the most staggering achievement for Standouts was their ability to contain overhead expenses (See Chart 1: The Overhead Edge). By tightly controlling operating expenses, Standout firms achieved average operating profit margins that were 5% to 23% higher than other surveyed firms.

Having built a strong constitution during prior years, these firms withstood recent economic pressures and preserved performance through solid human capital practices. The results of the People and Pay study revealed the specific human capital practices distinguishing these Standout firms. In this article we highlight a few of their market-leading practices. Containing the cost of non-professional labor is at the core of Standout firm success. Let's be clear--it is unlikely that Standout firms are simply "cheap" when it comes to compensating their valuable talent. Instead these costs are managed in these three major ways:

Organizing People to Optimize Growth

Within any growing advisory firm, professionals must spend the bulk of their time in front of clients. To increase client-facing time, professionals must have confidence in delegating activities to their support team, which may include more junior advisors, technical specialists, client services staff, or administrators. Delegation frees advisor capacity to generate new relationships and better retain existing clients. Having a structure that enables delegation and leverages non-professionals is fundamental to maximize profit per client and new client growth.

The largest firms within the People and Pay study are a group aptly titled Innovators. Within this group of advanced firms, those identified as Standouts exhibited a median of 1.9 non-professionals per professional compared with 1.3 for other Innovator firms. In other words, the Standouts indicated a greater propensity to shift non-revenue-related tasks to a support team.

Dedicated management plays a key role in releasing capacity to grow, freeing in particular the time of professionals who previously managed the firm on a part-time basis. Furthermore, by providing greater supervision and support for non-professionals as well as professionals, dedicated management enhances individual performance management and, in turn, increases the efficiency and productivity of the firm. Dedicated operations management can streamline internal processes to drive efficiency and ensure each team member is effectively following policies and procedures to deliver the desired client experience.

Providing Training For All

For delegation to be effective, junior team members in particular must be trained to ensure competency within their given role. Standout Innovators, for example, are realizing the benefits of training across all position types especially for management roles and technical specialists (See Chart 2: At Best Firms, Training for All).

By prioritizing the training and development of less experienced staff, firms can build the skills of their people at an accelerated rate, enabling individuals to become more effective within their roles over a compressed period of time. To develop staff effectively, management must create a training plan that anticipates and fills knowledge and experience gaps. Monitoring is then required to ensure progress of each individual in accordance with the plan and to identify additional support that may be needed.

The benefits of formal training and development are extensive. Greater technical capabilities enable a firm to deliver more specialized advice, a necessary progression as firms grow and deal with more complex clients. Additionally, training enhances the ability to promote internally, which limits recruiting costs and supports the retention of high-caliber individuals. Furthermore, when hiring is required, Standout firms can recruit less experienced (and more abundant) staff because a framework exists to progress these individuals along an internal career path.

Using Compensation to Motivate

Across nearly all firm stages, Standout firms are better leveraging incentive compensation to motivate individual performance in specific areas. Standouts within the study's Accelerator firm group are particularly prone toward use of incentive pay across all position types (see Chart 3: At Best Firms, Smart Use of Incentive Pay). These Standout firms are linking the compensation structure of team members to achievement of specific firm and individual performance objectives that, in turn, are aligned with the achievement of the firm's strategic vision. In addition to incentive compensation, Standouts recognize that to motivate staff and ensure staff satisfaction, non-monetary rewards are also important. Chief among the factors Standout firms cited for retaining staff was the ability to create a collaborative work environment for staff. A focus on collaboration and other so-called "soft" people-related initiatives will drive the value firms deliver to employees and, in turn, increase loyalty to the firm.

What You Can Learn From Standouts

The four firm stages defined in People and Pay represent not just firm size, but also mindset and key operating characteristics.

Lessons From the Best Operators--Operators are typically staffed with one professional and may have one support person assisting them in delivering service to clients. Operator firm professionals wear many hats within the business, such as managing new and existing clients, technology, people, financial performance, and compliance. Delegation is minimal as the skill gap between the professional and administrative individuals is too great to release significant professional capacity.

A key consideration for growing Operators is to assess future organizational structure needs without compromising on the support delivered to your clients. When recruiting, consider positions that will bridge the skill gap between the firm's sole professional and existing administrative staff in order to delegate more non-revenue generating activities away from firm's owner-operator.

Lessons From the Best Cultivators--Cultivators are gaining momentum and beginning to build very solid foundations for the future. Organizing and supervising staff becomes more of a challenge as does determining how roles will work most effectively together.

A key consideration for Cultivators is to implement performance-based pay structures. At this stage a majority of firms (55%) fail to make incentive pay available to administrative staff and nearly half of all firms (47%) do not offer it to their professionals. The deployment of performance-based incentive pay can efficiently and effectively align the work behaviors of the firm's growing staff members with its overall strategic vision.

Where a firm does not have an incentive pay program in place, management should consider gradually introducing one by increasing the proportion of variable pay annually until reaching a balance of variable/fixed pay that is comfortable for both the employee and employer.

Lessons From the Best Accelerators--Accelerators are experiencing a dynamic phase of development. Firm owners must think quite differently about the way they work if they are to continue to grow to the Innovator level. Full-time management is likely as are multiple support staff and administrators. The firm is becoming more capable at leveraging talent and coordinating staff to deliver a consistent client experience. A key challenge is to develop staff toward more specialized skills, which will be necessary as the firm grows and begins to work with more complex clients.

A crucial consideration will be to dedicate a management team member to establish and oversee a formal training program for all staff in order to fill skill gaps. Only 39% of Accelerator firms offer formal training programs, compared to 66% of Innovators.

Lessons From the Best Innovators--Innovators represent increasingly complex organizational structures with the total number of staff more than double that of the Accelerators. These are mature firms that have established procedures for staff to create efficiencies and consistency in the delivery of the client experience. Aligning staff to strategy becomes even more critical at this size to ensure all resources are driving firm success. A key consideration for Innovators is to put in place a formal plan for succession of management and ownership. Just 47% of Innovators have developed a succession plan. The typical Innovator firm has three owners, but ownership tends to be highly concentrated relative to smaller firms. As a result, the affordability for internal successors to take a significant ownership share becomes a challenge. Larger firms will likely need to consider multiple internal successors. Owners must plan for the timeframe of the succession, the criteria for ownership, the level of equity to share, the value of shared equity, the equity model and how to best finance and transfer equity. Owners should consider professional support to ensure the plan covers all necessary succession considerations.

The Opportunity

In concluding, it's important to note that opportunity abounds across all firm stages for firms to better leverage their people to drive growth. This article, the first of the 2010 Human Capital Series produced by FA Insight in partnership with Investment Advisor, provides an overview of areas for firms to focus on. To further support the business decision-making of firm owners, the remaining series articles will delve more specifically into key areas of human capital management. Good luck and stay tuned for more insights into the best-performing firms in these pages and online at InvestmentAdvisor.com.

Click here to read all of Investment Advisor's People and Pay coverage.

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