“Competitive forces are reshuffling,” the independent broker/dealers, but the 2006 FSI Financial Performance Survey of Independent Broker/Dealers finds an increase in revenue, the number of profitable firms, numbers of representatives, and margins, according to Philip Palaveev, senior manager at Seattle-based Moss Adams LLP, and research leader on this study.

Just how well the firms are doing depends largely, although not always, on their size and, you guessed it, larger firms often are able to use their economies of scale to their advantage. That said, not all of the firms need to be profitable. How’s that? Palaveev breaks the types of independent B/Ds down into four groups that have different characteristics:

1.Very large firms with $300 million to $400 million in total revenue, large numbers of advisors with average production of $200,000 or more, and that are applying a large amount of resources to building platforms that add value for reps.

2.Niche or boutique firms in which most of the advisors are CPAs, or work out of banks or community banks, and do mostly fee-based advisory business. These firms have made their mark by assisting “certain types of advisors to achieve success,” notes Palaveev.

3.Very large life insurance companies that have developed B/Ds to assist their career life agents in expanding into brokerage services for their life insurance clients.

4.Small-and nimble-independent B/Ds that cater to advisors who want a large amount of personal service from and contact with top management.

At the larger end, some of the B/Ds are run as profit centers of even larger companies but, particularly in the case of large life insurance companies, some B/Ds are run as cost centers, which can change the competitive picture by allowing for very small margins, so they can be more competitive, build brand with advertising, and plow more money back into the business. When you look at it that way, the numbers for operating profit margin by revenue size start to make more sense. The profitability sweet spot is not the largest companies-those with more than $100 million in revenue-they have only a 0.4% margin-in part because some of them are operated as cost centers. It’s the $17 million to $54 million niche that captures the highest margin of 3.1%, and then the $54 million to $100 million with a margin of 2.9%. However, the smallest class, with under $17 million in revenue, has a negative average profit margin of -3.0%.

Some other large firm-small firm differences turned up in the study: technology spending per rep increases with revenue size; firms with more than $100 million in revenue spend more than five times as much ($5,607 per rep) as firms with less than $17 million in revenue ($702 per rep), and as almost twice as firms with $17 million to $ 54 million in revenue ($2,597 per rep), or those with $54 million to $10 million ($2,834 per rep).

The highest operating expenses by revenue size were at the smaller B/D group: firms with less than $17 million in revenue spent 22% on operating expense, and the lowest average operating expenses (14%) were at B/Ds with $17 million to $54 million in revenue. Firms with $54 million to $100 million spent 19.5%, and B/Ds earning more than $100 million in revenue spent 17.2% on operating expenses.

The fastest growing segment of revenues is fee-based business, now the “number one business” of the independent B/Ds and a “significant determinant of their success and overall ability to grow,” says Palaveev. Fee-based revenue, as a percentage of revenue, grew to 17.6% of revenue in 2005, up from 10.2% in 2003 and 14.8% in 2004. Assets under management at corporate RIAs grew significantly, to $1.3 billion in 2005 from $1 billion in 2004. The larger the reps’ average gross production is, the more fee-based revenue they earn, with the highest grossing reps ($200,000 plus) reporting 25.1% of their gross revenue coming from fee-based business. The largest firms have higher numbers of sophisticated advisors “capable of introducing” the fee-based concept to their “more affluent clients,” Palaveev explains.

Across all the participating independent B/Ds, average total revenue was up to $112 million in 2005 from $100 million in 2004. The average number of reps per firm grew to 1,734 in ’05 from 1,037 in ’04. Operating profits were 2% in ’05, up from 1.2% in ’04, and a negative -0.3% in ’03.

There are significant challenges for the independent B/Ds, and Palaveev says the single biggest one is recruiting. B/Ds still need to balance recruiting large numbers of high-grossing reps and helping them build on their success, with thin margins, and high expenses on technology and compliance. In addition, in multi-rep branches, branch managers often are recruiting newer, lower production reps to replace mature reps who are nearing retirement. The challenge there is to help the less seasoned reps mature into higher producing, more sophisticated reps, whose revenues can actually replace the revenue of the retiring reps. Firms are spending an average of $800,000 a year on marketing to and recruiting reps, and that’s a big budget item when the B/Ds are skating on such thin margins.