More Than Keeping Score

An accepted principle in portfolio management is rebalancing–the process of restoring your portfolio to its original mix that was designed to meet a specific investing goal. Rebalancing is primarily about managing risk or reducing dependency on a particular investment. When parts of the portfolio have grown out of proportion to the benchmarks you set, you pare back those that have grown and direct investments to areas that have not.

The same principle applies to managing your business. Each facet of your enterprise–sales, service, human capital, technology, operations–requires an investment of time, money, management, and energy.

You periodically assess your operating performance, but do you apply this same rigor to your management decisions? For most business owners, it is difficult to have all elements of the business consistently performing at the optimal level, year in and year out. Some things go well and some things need work. Do you keep investing in that which is hitting on all cylinders, or do you reallocate to areas that need help?

I was struck by this recently when meeting with an advisor who had engaged a consultant to assess his people practices. One area of assessment was the comparison of what the owner thought was important and what the staff thought was important. The evaluation showed that this was a culture in which meeting client needs and new business development were the paramount values. However, the assessment also rated how the firm was doing in terms of developing and motivating others, fostering open communication, using financial data to make decisions, and thinking creatively. In these areas, the staff did not think the owner was living up to promises; the owner conceded these weaknesses.

But as the owner wrestled with the results of this process, he expressed concern over diverting attention to dealing with the aspects of his business that have been neglected. He was worried that the areas in which the firm was performing well–sales and client service–would suffer. “If I invest time and money in people development,” he said, “I will have to give up on something else.” That is a little like saying that if an investment class grew faster than the rest, it would make sense to continue investing in that segment rather than bulking up in areas that will help your overall return long-term.

Every business has finite resources, so the challenge is to deploy them in a way that moves you closer to your ultimate goal. Sometimes specific needs require big investments, and sometimes specific needs require incremental attention.

The notion that if you concentrate resources in one place it will cause another part of your practice to under-perform is an emotional flashback to the beginning phase of your business when survival was your overriding goal. However, for the typical advisory business with consistent, predictable income and a history of success, when something is working well it is likely that the enterprise is strong enough to endure a diversion of resources into areas that demand meaningful attention. Further, it is probably critical that resources be diverted where help is needed–or failure will become a self-fulfilling prophecy.

Benchmarking as a Management Tool

For owners and managers of advisory firms, it is critical to have a framework for making management decisions, for knowing when to rebalance the investment. Some use a concept called “best practices” as their measuring stick, which is a good starting point. But advisors should also use medians, averages, and their own best year as a baseline for evaluating operating performance. The key word is evaluating. The temptation, however, is to compare your business to this data as a means of keeping score. Instead of interpreting the trends and comparisons and using the information to determine areas for improvement, many will use the benchmarks for bragging rights. While we’re always pleased to meet the high performers, we have more comfort in the management decisions of those who stay humble and recognize they are not infallible.

Stuff happens in business. If being on top compared to your peers ensured superior performance in perpetuity, then GM would not be losing ground to Toyota, Sears would not be overshadowed by Wal-Mart, and the New York Yankees might translate their record-setting payroll into winning the Series, or at a minimum, the American League pennant.

What to Measure

Benchmarking provides business owners with both lagging and leading indicators. On the one hand, it’s good to know where you’ve been; on the other, it’s great to know where you are going. Almost anything you do in managing an advisory firm can be benchmarked–from client service and staff development to managing risk and measuring operating performance.

For the latter, the data provided in Moss Adams’s Studies of Financial Performance of Financial Advisory Practices is one good place to get benchmarks, but advisors should seek as many data points as possible to provide a framework for making sound decisions. (Disclosure: Moss Adams was my previous employer.) To evaluate operating performance, owners and managers of advisory firms should evaluate the following metrics (at a minimum):

• Gross Profit Margin
• Operating Profit Margin
• Revenue/Total Staff
• Revenue/Active Client
• Active Clients/Staff

These measures will provide insight into pricing, productivity, client mix, service mix, and expense control.

In addition, advisors should observe trends in operating expenses as a percentage of revenue, not just in aggregate, but line-by-line. This is a process called “common-sizing,” where every key category of expense is divided into total revenue and expressed as a percentage. When observed over a period of years, you can determine where the “creeper” costs are (those costs that get together at night and conspire to cut your throat).

The process of using benchmark data is linear: