From the November 2011 issue of Investment Advisor • Subscribe!

November 1, 2011

The Touch of a Blacksmith

Managers must clearly convey goals and incentives to employees, not attempt to hammer them into the desired shape

Elite advisory firms manage staff with the same degree of care used in managing assets. They practice with a light and even hand, defining expectations and rewarding employees for good performance.

Back in the day before lasers, iPads and e-tickets, tasks seemed to require more physical strength. Horseshoes were forged by blacksmiths plying hammer and anvil. Fields were tilled by men controlling a plow drawn by powerful beasts. Even writers brandished a sharpened quill—or pounded the stiff keys of a Smith Corona.

One former colleague used a manual typewriter for most of his life, from college through his working years, to craft his reports, articles and books. Years later he still attacked a slim computer keyboard as if he were angry at the machine. Old habits are hard to change, including outdated methods of influencing behaviors.

Back when I was a kid, discipline and performance were governed by the physical mandate. Teachers controlled students with corporal punishment (at least the nuns at my school did). Parents used a switch. Employers hired enforcers to engage with underperforming workers. Mental therapists used electricity to stimulate a change in mood or actions.

Previous generations utilized fear and punishment to induce a result instead of encouragement and incentives. Baby boomers and their parents grew up under these conditions. While some have transitioned to a softer touch, others wield their personalities as if swinging a truncheon.

In business, moments frequently occur when managers must repress the urge to flex their muscles. Scare tactics and tough talk are still employed to influence an outcome, manipulate behavior or persuade. Subtlety and nuance are learned tactics, a style that hasn’t become second nature. It’s not uncommon to see talented managers who possess the keen mind of a surgeon—and the touch of a blacksmith.

Over the years, we have observed financial advisors who want their staff to suffer as much as they did on the way up. In the past, interns were given grunt work, not true learning experiences. Promotions and opportunities were held in abeyance until someone threatened to leave. Raises and bonuses were often paid reluctantly, as if employees were extorting money from their bosses.

A clue to underperforming advisory firms frequently can be found in their compensation plans. These strategies expose how firm owners struggle with people practices, rewarding the wrong behaviors and displacing active and effective management.

According to new studies on compensation and staffing, however, efforts around recruitment, retention and reward are becoming more enlightened and better aligned with what makes an advisory firm tick and what makes an individual flourish. Not all advisors are choosing the right approach, but many are blazing a trail, discovering how to translate the cost of labor into a consistent financial return.

The “Investment News/Moss Adams 2011 Adviser Compensation and Staffing Study,” sponsored by Pershing Advisory Solutions, revealed key market trends and techniques in how advisory businesses are refining their human capital practices to drive their firms in a new direction. Instead of using both the carrot and the stick to goad and beat their employees into submission, today’s firms are paying fairly and creating incentive and benefit plans that encourage the pursuit of excellence.

The elite firms identified by the study had 31% more clients, 54% more assets and 79% more revenue than the average firms. They also generated 6% more revenue per staff, 15% more profit and 49% more income per owner.

Why was their human capital process better? There were eight distinguishing characteristics that the study revealed:

  1. Clearly defined individual goals
  2. Clearly defined firm goals
  3. Documented job descriptions
  4. Awareness by employees of these job descriptions
  5. Defined career paths and organizational structures
  6. Awareness of opportunities by employees
  7. Formal training in place for staff
  8. Systematic performance evaluations

A comparable study produced by FA Insight, “The 2011 Study of Advisory Firms: People and Pay,” further validated these observations. As their report stated, “the quality of an advisory firm’s people is likely the single most important determinant for a firm’s long-term success.”

Both studies point out that the cost of labor represents around 80% of an advisory firm’s total expenses, so it is critical that owners not only spend wisely on talent, but manage the outcome in order to produce an acceptable yield.

What Gets Rewarded?

In addition to creating systematic processes for staff development and retention, successful firms implement a compensation program that not only aligns people with the strategy, but reinforces the right behavior. In addition, the compensation plan must be affordable to the business and in harmony with staff expectations.

To develop an effective compensation plan, first craft a compensation philosophy statement, details of which are described in my new book, “Practice Made (More) Perfect.” Creating this statement can help you define priorities: whether the team is more important than individual performance; whether to pay over, under or in the middle of market; and what behaviors you hope to encourage.

Your compensation philosophy statement provides a framework for choosing the structure of base pay, short- and long-term incentives, benefits and perquisites.

For example, you may wish to be competitive with the market on base and benefits, but provide more upside potential through incentives. You may decide to leverage team success instead of creating a star system. With these ideas in mind, determine how much you can afford to pay in aggregate, the amount of your fixed base pay component and how much to allow for a variable incentive component.

Incentive plans are usually tied to measurable expectations though there may be a subjective component to employee review as well. Depending on the role, incentives could range from 5% of the base salary to 50%. Jobs tied to revenue growth should be awarded a higher percentage of the base pay while service and management roles should garner a lower percentage.

The key is to know what you are measuring. Compensation plans that are too complicated and opaque do not reinforce desired behavior. Further, each role has different goals and different measures.

The financial advisory business is maturing. The current availability of compensation data from multiple sources allows both large and small firms to key in benchmarks to their compensation plans. While firms often dismiss these studies, claiming that the subject advisory firm is different or operates in a more or less expensive market, this data can provide an excellent starting point for understanding the relevant range of compensation for multiple jobs within advisory firms.

Well-informed and well-designed compensation programs, combined with thoughtful management practices, allow advisors to emerge from the dark ages in terms of their recruitment, retention and compensation practices. Withholding praise and pay may have been effective when jobs were scarce and technology was primitive, but now people have choices about where they work. Owners of advisory firms must apply modern management techniques to produce the optimal outcome: a finely crafted, strong and valuable business.

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