From the November 2011 issue of Investment Advisor • Subscribe!

Let Go to Grow

A groundbreaking study uncovers four critical strategies that let advisors get more by doing less

The trick to creating a successful independent advisory firm is exactly the opposite of what is taught by business schools and business gurus. Conventional management wisdom says great businesses result from great managers. My expertise, though, is in helping independent advisory firm owners build great businesses, and I know for a fact that on our end of the business spectrum, the conventional wisdom is flat wrong.

Most owner/advisors will never become great—or even good—managers in the conventional sense. They don’t necessarily have to be.

What they have to do is build businesses that create great employees, then stand back and let their employees help them grow the business they’ve dreamed of. To build a business that literally grows itself, advisors need to integrate four key principles—preparation, pay, perks and productivity—and let the system work for them. Each principle is essential to creating an environment that supports a firm’s employees to maximize their contributions to the success of the business.

It may sound simplistic, idealistic or even a bit new-age, but it’s the most practical business strategy that you’ll ever hear. I’ve spent the past four years conducting clinical research on advisory firms to determine what makes businesses successful. I published my findings in a white paper titled “P4: Building Great Businesses by Creating Great Employees.” 

One reason that the principles are not conventional wisdom is that getting information from small businesses is exceedingly difficult. For the most part, small businesses are not public companies, so their financial data isn’t readily available. What’s more, there is little incentive for most successful owners and advisors to participate in industry surveys—even if they do, they rarely take the time to look up actual figures or fail to understand them. Thus, they wildly “ballpark” numbers or unintentionally inflate or deflate figures.

Then there’s the problem of expenses and profits. Small business owners have an incentive to manipulate them, maximizing costs and minimizing the bottom line, which often skews a true financial picture.

One afternoon five years ago, I was thinking about “problem” employees in my client firms. As I thought about the small number of employees who have been problematic over the years, I realized that they all worked for the same firms—about half our clients, while the other half have never had any problem employees.

At first, I thought the problems might be next-gen employees. But, a quick look at employee rosters showed that “no-problem” firms had just as many next-gen employees as did problem firms. Next, I suspected that some businesses were simply better at hiring good employees than others. You might suspect this, too. But, when I looked at the data, I found a very different picture.

I regularly quantify employee performance at the firms with which I work, rating them from one to five, with five indicating a great employee and one a problem employee. To gauge a firm’s success at hiring great employees, I took the average employee rating at the end of the first year on the job for all the employees at each of the firms I work with. For the firms with no problem employees, the average rating was 2.90; for the firms with chronic problem employees, it was 3.54. That means the problem firms were significantly better at hiring good employees. So, better hiring didn’t necessarily lead to better employees.

Next, I looked at the average rating after employees had been on the job for four years (see Figure 1, left). Those good hires at the problem firms were down to 2.63, while mediocre hires at no-problem firms were up to 4.33. The problem firms were taking good employees and making them mediocre at best—and problems at worst—while the no-problem firms were taking mediocre employees and making them great employees.

I found striking differences in the way the two groups treated their employees (see Figure 2, below). For instance, 100% of the problem firms paid above-market salaries, while 84% of the no-problem firms paid market or below-market salaries. All of the no-problem firms communicated their firm’s goals to its employees; none of the problem firms did. Only 20% of the problem firms provided laptop computers so their employees could work at home; all the employees at the no-problem firms had laptops. All of the no-problem firms paid revenue-based incentives, compared with 0% of the problem firms, which offered profit sharing or performance bonuses. Of no-problem firms, 100% offered lifestyle benefits, which gave employees a flexible working environment to maintain work-life balance; only 20% of the problem firms did. And, while every one of the no-problem firms had an orientation process for new employees, only 20% of the problem firms did.

The bottom line was that instead of trying to hire great employees, the no-problem firms were creating an environment where their employees were prepared, equipped and enabled to help their firms succeed. The only question left was: Did it work? That is, were the non-problem businesses actually more successful? During the turbulent three years ending Dec. 31, 2009, the no-problem firms had zero employee turnover versus 34.6% at problem firms, of which 23.1% were terminated by the owner for poor performance (see Figure 3, next page). No-problem firms had 14% annual revenue growth (versus 3%) and 15% annual increases in owners’ income (versus -10%). During this rough economic environment, owners of no-problem firms worked an average of 31 hours per week (versus 54 hours), and 100% of their firms achieved their goals compared with 0% of the problem firms (see Figure 4, next page).

The message of the data is clear: Businesses that prepare their employees to succeed by basing a significant portion of their compensation on the success of the firm; creating a flexible and supportive work environment; and supplying the tools necessary for employees to excel at their jobs, create great employees, who in turn create great businesses.

The good news for advisory firm owners is that the P4 principles are neither overly complicated to integrate nor very expensive, especially when compared with the high costs of hiring star employees, chronic employee turnover, low employee productivity and hiring a consultant to solve these problems. In fact, the increased growth of the P4 firms far exceeds any additional costs of implementing the P4 principles.

The P4 principles are basic, if not obvious, once firm owners can come to terms with the fact that it’s largely the structure of their firms—not recruiting, management or even the employees themselves—that determines whether or not their employees will be great employees. Because the P4 principles appear to violate conventional business management wisdom, most advisor/owners need to unlearn what they think they know about running a business. In fact, the difference between successful P4 firms and not-so-successful non-P4 firms is a willingness to try one or two of the P4 principles: Once they see the difference in their employees (and the decrease in their own workload), they’re convinced.

Preparation

The first and hardest P4 principle to implement is preparation: To create great employees, firm owners need to first prepare themselves to support the success of their employees, and then prepare their employees to be great. The first step is creating an owner’s mentality that focuses on building a successful business. Figure 4 shows the striking differences in the goals of P4 and non-P4 firm owners. P4 owners are focused on growing their revenue or growing revenue while working fewer hours (83%), while non-P4 owners simply want to take more income out of their business (100%). By focusing solely on the bottom line, non-P4 firms fail to reinvest in their business, particularly in the areas that create great employees. Notice that in the end, the non-P4 owners’ strategies proved self-defeating; not one of them achieved their goal, while all the P4 firms succeeded as their owners planned and a nice result was a significant increase in owners’ income.

The second step of preparation is designing a culture that fuels passion, purpose, growth and happiness—it’s about sending a clear message to the employees that their job is important, and that their firm and its owner stands behind them. This includes clearly communicating the firm’s goals, the role of the employee and the firm’s organizational strategy.

The third step is about giving employees the basic knowledge and skills to excel within that culture: how to communicate, to ask questions, to learn to do their jobs their way, to fuel personal happiness and to know what the goals of the firm are. Owners need to give their employees permission to ask for help, to take the initiative, to try new things and, yes, to make mistakes without adverse repercussions. What’s more, owners need to learn how to resist the temptation to manage (or micromanage), to be overly critical, to push employees up the learning curve too quickly or to insist that employees perform their jobs the way the owners themselves would complete the task. To create great employees, owners must let employees figure out the best way to do their jobs at their own pace and to maximize their contribution to attaining the firm’s goals.

As a result, owners will create an environment in which employees feel they can do their jobs their way, make mistakes and learn from them, come up with new and better ways to do what needs to be done and, finally, simply be themselves.

Pay

The single most powerful employee motivator is to tie a portion of their compensation to the success of the business (See Figure 5, left). The best way to do this is through revenue-based incentives (which are easy to calculate, easy to understand and eliminate the profit-sharing issues surrounding legitimate costs in small businesses). Compensation rewards that increase as a firm grows create a sense of ownership (in lieu of actual ownership) that is essential to maximizing employee contributions to a business’ success.

Additionally, these types of compensation arrangements eliminate the need to pay high salaries. Paying high salaries and high wages only motivates people for a short period of time. However, paying low salaries and low wages undermines employees’ abilities. How do you pay a fair wage? Connect wages to the overall success of the business. Great employees are built by connecting them to something greater than their own abilities. Revenue-based incentives are the perfect solution as the P4 firms illustrated.

Perks

There are a lot of benefits that employers offer to employees, from medical benefits to retirement benefits to lifestyle benefits. Which benefits really motivate employees? As shown in Figure 6, employers must offer medical and retirement benefits, but more importantly, creating a flexible work environment is a good motivator. Plus, it can be tailored to each employee’s needs and optimal work habits without disrupting the firm’s goals.

Balancing lifestyle is increasingly important to employees these days. For little or no cost, a firm can create unique, flexible policies that can be almost priceless to an employee, while sending the message that their individual needs and creativity are important to the firm. Our research shows that offering the right perks increases employee happiness, motivation and commitment to the firm, while failure to provide the right perks creates a negative image of the firm in the minds of employees that can never be overcome, leading to poor morale and high turnover rates.

Consequently, “lifestyle” perks are one of the foundations of the P4 program. They form a collection of benefits, or perhaps freedoms, that allow employees to merge their working lives with their personal lives in a way that makes both parts better. The key to these lifestyle perks is an owner’s mentality that trusts employees to make responsible decisions about what’s right for them and right for the firm. It’s a mentality that shifts the owner’s role from parent-like rule-setting and monitoring to one of mentoring and trust. It sends a message to employees that says, “You figure out what you need to do to balance doing your job with having a happy personal life.”

The magic number of perks to make employees happy is six. It doesn’t seem to matter which six perks that employers offer, but by providing that critical mass, the owner has shown a willingness to let employees tailor their own work-life balance and trust that they will do so responsibly. Here are 10 lifestyle perks that owners should choose from: Flex time, open vacation, provided lunch, bereavement time off, family leave, time off for volunteer work, paid continuing education in personal interests, paid professional education, time off for further education, group discounts and sabbatical time off.

As I said, firms send a powerful message by offering at least six of these lifestyle perks: that they trust their employees to balance their lives and to do a good job. It is results-oriented management that leads employees to literally manage themselves. All of the P4 firms offer six or more of these perks, with flex time, open vacation and provided lunch being the most common, while only 20% of the non-P4 firms offer six. On the results side, none of the P4 employees abused these policies (and when a few people started to push the limits, the other employees quickly stepped in and told them to fly right); in a P4 firm, everyone is accountable to everyone else. P4 employees average 14.5 days a year out of the office, while the non-P4 employees average 19 days, or 24% more. And, 100% of the non-P4 employees ask for more vacation or days off every year. Offering lifestyle perks that allow employees to take responsibility for their own happiness makes P4 firms better, more successful businesses.

Productivity

There is probably no stronger message that a business can send to its employees than the quality of the tools it provides to get their jobs done. Today, that means cutting-edge technology and training to use more of that technology’s functionality. Obsolete or barely functional technology tells employees their job is not important and their time is not valued.

Today’s employees view their technology the way young baby boomers felt about their company cars: a clunker meant they were losers working for an unsuccessful company. The impact of providing technology and training is clearly seen in Figure 7. The P4 firms all provided laptops for their employees, hired technology consultants and maintained cutting-edge hardware for their firms (iPads, smartphones, big screens, etc.). What’s more, all P4 firms have a technology strategy that anticipates both the addition of new technologies and the replacement of old hardware and software as they become obsolete. In fact, 80% of the P4 firms actually set aside a “technology escrow fund” to cover the cost of keeping their tech current.

P4 firms also provide never-ending training on their software systems and platforms, resulting in P4 employees utilizing 90% of the firm’s software functionality versus only 20% utilization at non-P4 firms. The bottom line is that the cost of cutting-edge technology and training is minimal compared to the way it will make employees feel about themselves—and their firms: Employees of P4 firms rate their firm’s commitment to technology 4.6 out of 5, while employees gave non-P4 firms a 2.9 rating. That meant the P4 employees feel their firm provides them with essentially all the quality technology they need to excel at their jobs, while employees at non-P4 firms did not feel they were getting technology tools to make them more successful at being productive in their jobs.

Putting the P4 Principles to Work

Once the P4 principles are in place, most businesses virtually run themselves, with employees managing themselves and each other. Still, owners must make a mental shift from trying to manage their business to supporting their employees to be as good as they can be. It’s not about recruiting great employees. As we’ve seen, an unsupportive company can make problem employees out of good ones every time.

P4 is really about the realization that the success of independent advisory businesses—even those with only a few employees—is far more dependent on their employees than most people would suspect or than many owners would like to admit. Most importantly, if properly supported and motivated, almost all employees want to excel at their jobs and contribute to the success of their firms. In fact, P4 firms are a small business owner’s dream: Employees virtually manage themselves and each other, creating what I call “automatic management.” If owners enable their employees to be great, they send the message that they trust their employees. As a result, the research proves, employees will in turn make their advisory firms great, too.

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