From the January 2013 issue of Investment Advisor • Subscribe!

Growth Gone Wild: 2012 Advisor Growth by Design Study

In the second article expounding the results of FA Insight’s 2012 growth study, the authors discuss when too much growth is bad growth

Illustration by <a href="http://www.shawnielsen.com/">Shaw Nielsen</a>. Illustration by Shaw Nielsen.

The great majority of advisory firm owners fixate on growing their businesses. It is a fundamental characteristic of their DNA. And why not? Multiple positive outcomes can be achieved as a firm grows and achieves greater scale. These aspirations, however, frequently overlook the very real risks that rumble beneath the growth trajectory and threaten to derail firms when growth goes wild.

Both in terms of recent history and objectives for the future, independent advisory firms are clearly in growth mode. In each of the last three years, the typical firm achieved double-digit percentage increases in revenue. As of this writing, client growth was expected to finish out 2012 at an annual rate greater than any year since before the onset of the recession.

In sum, 85% of firms report recently experiencing significant growth. Firms are far from satiated, however, as nearly as many (80%) hold strong aspirations for continued growth. About two-thirds of these firms are serious enough about growth to have defined growth targets and be actively managing initiatives for achieving these targets.

In 2012, FA Insight released “Growth by Design,” our firm’s fourth annual industry study and the source of data for this article. The 2012 effort takes a deep and objective examination of growth, with a particular emphasis on identifying a right way for firms to grow in order to realize economies of scale and build firm value. The study highlights growth’s virtues but recognizes the potential pitfalls associated with growth and provides considerations for overcoming them.

In this article, the second in the 2012 “Growth by Design” series for Investment Advisor, we examine the effects of growth, both positive and negative, in order to inspire firms that desire growth and better prepare them for taking full advantage of the growth that they achieve.

Caring for Clients Provides the Motivation

So what is it that typically motivates firm owners to put capital at risk, reinvest in their businesses and navigate the sometimes painful challenges that can result from growth? The answer may surprise many.

Those firms that indicated a strong desire to grow also shared their motivations to pursue growth (see Figure 1, left). Topping the list was the desire to better meet the advice and service needs of clients, with 27% of firms indicating this as their primary motivation for achieving growth. Taking care of clients ranked ahead of financial gains for shareholders, saving costs and realizing efficiencies.

Putting clients first is consistent with fiduciary obligations, but we suspect advisors also understand that the ability to better meet client needs is also good business. These firm owners understand that client sophistication is increasing and that deeper and broader advice needs are required to both attract and retain clients. Achieving greater size is a way to broaden capabilities, develop more specialized expertise and generally achieve a scale that can offer deeper and more customized advice and service delivery.

Benefits of Growth Are Widespread

Despite just a few factors surfacing as primary motivators, better meeting client needs chief among them, the actual ways in which growth can benefit a firm are widespread. The results in Figure 2 provide an interesting complement to what was revealed in Figure 1. Those advisory firms that reported experiencing significant growth cited a variety of positive changes as a result.

The three most cited benefits—increased efficiency, profitability and productivity—all relate to improved operating performance and are typical of firms realizing economies of scale. Improved quality of client service falls to a rank just below these three. Many other reported benefits are personnel related: greater career opportunity, reduced dependency on key individuals, improved management capabilities, greater succession choices and an improved ability to attract talent.

While they do not directly surface in Figure 2, other important benefits exist as well. Growing firms are better able to establish alliances with other professional services providers. With prospective strategic partners, scale conveys a depth of resources that increases their confidence to align with the advisory firm. As the size of the firm increases, so too does its ability to dominate a market and more readily attract prospects based on the perceived strength of the firm’s brand. Finally, and most importantly, firms that are able to sustain growth and maintain profitability have greater enterprise value.

Points of Pain

Despite the many potential advantages, growth does not always work out well for firms. Without the right practices in place, uncontrolled growth often results in damaging consequences. The reasons for this are varied. In many cases a lack of careful strategic planning or the undisciplined implementation of change will detract from the ability to take full advantage of increasing scale.

While the pursuit of growth and its associated positive impacts will continue to motivate firm owners, the growing pains commonly experienced are too easily overlooked. Uncontrolled, breakneck growth can blow out expenses and erode profit margins both in the short and long term.

This is not a challenge that is unique to advisory firms. In an interview with McKinsey & Company in 2011, Howard Schultz, the CEO of Starbucks Coffee Company, concluded that by 2008 the firm’s “growth had become a carcinogen.” Schultz went on to explain that the primary lesson he had learned over the years is that “growth can cover up a lot of mistakes.” In returning the company to growth, he vowed to make it a different kind. In Schultz’s words, future growth would be disciplined, profitable and for the right reasons.

Of those advisory firms that experienced significant growth, a notable 76% of them reported at least one negative impact as a result. For many firms, the unwanted effects of growth were related to people (see Figure 3, left). While growth can open up opportunities for a firm’s personnel, without a proper human capital strategy in place, growth can be counterproductive as our study results also demonstrate.

This result is not surprising given the organizational complexity that can arise with increased headcount, which necessitates that more time be devoted to managing team members and the firm’s organizational structure, particularly with respect to the coordination and completion of tasks. Participating firms most frequently cited difficulty in providing career paths for employees. This is most likely because of firms taking on more non-professional roles with growth and the fact that career paths may be less obvious and less linear among these role types.

Firms were also wary of increasing dependency on key individuals, the inability of management to keep pace and team members generally becoming overworked and stressed. Unrelated to personnel, firms also found their technology and operational infrastructure were typically challenged as a result of growth.

Sidestepping Growth’s Drawbacks

Growth is absolutely vital for firm owners genuinely interested in creating enterprise value. Not only does growth offer economic and personal rewards for shareholders, but career opportunities and job satisfaction for staff members as well as superior service for clients. Owners must appreciate, however, that there are often costs associated with growth and that only high-quality growth will result in the creation of value. Those firms that grow by design ensure that the potential landmines often associated with growth are avoided and long-term profitability is maintained.

Our “Growth by Design” research reveals that for firms to grow in a sustainable manner it is a function of how resources are deployed—not how much. Those firms achieving sustainable growth can be readily distinguished based on their discipline in business planning and management. This discipline supports efficiency and productivity and protects the firm from potential negative consequences of growth. Readers can look forward to a deeper examination of exactly how this is accomplished in our subsequent articles over the months ahead.

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