January 4, 2014

Why Financial Planning Can’t Be Offered to the Masses

As financial planning slowly and steadily builds itself as a profession, there has been an increasing focus on how to widen the scope of financial planning to reach more of the population. While some recent efforts to expand the reach of financial planning services may not be purely altruistic, there are many CFP certificants (69,000, according to the CFP Board), making it increasingly appealing for advisors to seek out new audiences to grow their businesses, rather than compete in the same bloody red ocean of their competition.

Yet notwithstanding that appeal, financial planners have struggled to extend their services. The promise of the web and the potential efficiencies of technology create the potential to bring down the cost of financial planning and make it more accessible to the masses. That’s the case even as planners find they may soon be in competition with the technology itself that delivers services directly to the public in the form of "robo-advisors."

However, the real inhibitor to extending financial planning to the masses is not about using technology to drive down the cost of delivering financial planning, but how to get new clients in the first place. That's especially the case given the small or non-existent budgets that most planning firms have for broad-based marketing programs.

So the real challenge in bringing financial planning to the masses is not about the cost to deliver it, but about the incredibly high cost necessary to get those clients in the first place. When we figure out how to bring down the cost to acquire clients, we will figure out how to truly bring financial planning to the masses. 

Defining CAC: Cost of Client Acquisition

In any business, the ultimate path from gaining a new client/customer to generating a profit from the product/service sold to them involves several costs, including basic overhead costs to operate the business and additional costs to produce the good or service itself.

Yet beyond the raw costs to produce and deliver a particular good or service, there are also costs to market and grow the business, or what are generally called "CAC" - Client/Customer Acquisition Costs. After all, if no one knows about the product or service, and/or they don't receive information that helps to convince them to purchase the product/service, there won't be any revenue generated. The nature of CACs vary by the line of business, but might include anything from marketing and advertising campaigns, to giveaways and free samples, to websites and marketing brochures, and so on. Generally, any cost that falls into the category of finding prospects, or helping to turn prospects into customers/clients, is part of the business' CACs.

In the context of a financial planning firm in particular, CACs would include the costs of website design, brochures and other marketing collateral, prospect seminars and events, and buying "leads" or paying for various lead-generation services. Less common CACs for advisors would include advertising and paying solicitation or referral fees.

The Impact of CACs in Practice

A business like financial planning presents some unique challenges. The service is intangible and difficult to explain, general public trust in financial services is relatively low and the price point (the cost of a financial plan) is not cheap. It can thus be very difficult to find prospects and convince them to actually become clients. In other words, financial planning is a world with relatively high client acquisition costs.

This challenge is apparent in numerous, subtle ways across financial advisory firms. Many firms have become resigned to the fact that since marketing is so expensive and relatively ineffective—you need to spend a lot to get any real benefits (i.e., clients) from it—that they just skip it altogether and rely on referrals alone for growth. In other words, the fact that referrals are the most common approach to growing a practice may have less to do with the idea that it's a "best practice" and more to do with the fact that every other method is just so darn expensive. That's the consequence of having very high CACs.

Yet that's not to say that marketing has no ROI at all. To the contrary, the fact that a small subset of mega-firms with huge budgets for marketing and branding still control a large portion of assets speaks to the fact that marketing can be successful. For instance, notwithstanding all their well-documented woes of recent years, wirehouses in the aggregate have less than 20% of all advisors but control nearly 40% of investment assets. Similarly, many larger regional RIAs are beginning to grow to a size where they can afford to invest more heavily in marketing—reaching the high CAC threshold—leading to a growing inequality in marketing between large and small firms. That trend was reflected most recently in a Schwab survey which found that advisors believed their greatest competition over the coming years will come from larger regional RIAs.

As a consequence of these CAC challenges, most advisory firms grow relatively slowly—lacking the capital to spend on high CAC marketing strategies—and often end up charging a higher price to make up for the fact that they have relatively few clients. In other words, if you "know" that you're only likely to get a couple of clients every year, there's little choice but to charge a relatively high fee or otherwise ensure that you generate a material amount of revenue per client. Other wise, it would simply take too long to build an economically viable business.

Unfortunately, the end result of these difficulties is that financial planning firms struggle to serve the middle class and mass affluent, not because it's expensive per se to provide planning but because the high cost to acquire clients leaves most planning firms undercapitalized. They're "stuck" with a relatively modest growth rate that necessitates higher prices simply to be able to afford to make a living.

Financial Planning in a World of High CACs

To understand just how insidious the problem of high CACs really is, imagine a world for a moment where the cost for a business to acquire clients was ultra-low, near $0. Financial planning firms would basically have an "unlimited supply" of clients available to service. That would raise the interesting question of exactly how inexpensive financial planning services could be.

As a starting point, let's look at what happens if we try to charge a very "accessible" price of $100/hour (which, notably, is lower than what many/most hourly planners currently charge under the Garrett Planning Network hourly model). If each meeting lasts for 1.5 hours, clients will be paying $150 for a "financial planning checkup" as needed. Let's assume the planner can only see four clients per day on this model (which takes six hours of planning time), with the remaining time each day set aside for other office-related work. This means the planning firm collects $600/day in planning fees, which is $3,000/week, and $150,000/year of gross revenue assuming a 50-week work year with two weeks of vacation.

Of course, someone has to do the planning work and be paid; we'll assume the planner makes $50,000/year, a very reasonable starting salary in most areas for a newly minted CFP practitioner who has no responsibilities besides seeing a series of clients day after day to advise them on their basic financial planning needs. In addition, we'll need to pay the cost for some basic office space in which to meet the clients, and some software and supplies; let's generously assume that all of these other expenses, including some part-time administrative help, cost the firm another $40,000.

So at the end of the year, the firm generated $150,000 of revenue, and $60,000 of profits, for a nice and healthy 40% profit margin. If the advisory firm could run the office a little leaner on cost (perhaps $20,000/year), and "only" wanted a 25% profit margin, the planning fees could be as low as ~$60/hour or $100 for a 90-minute checkup. (And bear in mind, we've seen advisors start their RIAs for less than $10,000.)

However, the catch is that operating this model requires an extraordinary number of clients. If the planner sees four clients per day, that's 20 per week, and 1,000 clients per year. In our magical world of ultra-low CACs, it's easy to get 1,000 clients per year. In the real world, it would be so expensive to do the marketing necessary to generate 1,000 clients per year that the entire business model would break down. Fees might have to be double, triple or more (and would necessitate a lot of upfront capital) just to have a chance of creating the necessary client volume.

In the second part of this series, we’ll address how this reality is playing out among robo-advisors and large RIA firms, and why a fiduciary standard could be a wild card in how planning can be made available to the masses.

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