In 2009, revenues dropped 9.5% and operating profit shrank seven percentage points to an 11% margin for the typical independent advisory firm, according to the second annual FA Insight study of advisory firms. The contraction was brought about by the once-in-a-generation market collapse of late 2008 and early 2009, during which advisors strained to counsel anxious clients while simultaneously managing costs to preserve profitability.
In contrast, firms are ready to grow in 2010. Revenue is on the rise. Advisors, having proved their value during a challenging time, strengthened client relationships and are positioned to acquire more of them. Significant hiring will take place for the first time since 2007, with the typical firm expecting to increase from five to six in staff size (see Figure 1, left).
While advisory firms are optimistic about their ability to grow, we wonder what the industry really learned from its recent experiences. The economic downturn revealed weaknesses where the old ways of doing business proved inadequate for many advisory firms. Under more favorable market conditions, growth comes with relative ease for most firms. Are firms making the necessary changes that will bolster growth under more challenging conditions?
Shareholders who are seeking to create a lasting enterprise and ultimately realize the value they have created must reflect on past experiences, challenge the old ways of doing business and build capabilities that will weatherproof their firms year after year, in good times and bad.
Actively planning growth, building scale and deepening business management capabilities can no longer escape the attention of owners and executives. Those firms that will succeed in creating sustainable growth irrespective of market conditions will systematically and thoughtfully plan for business success. For many firms, this discipline will require a departure from traditional business practices.
In recognition of this required shift in focus by firm owners, Growth by Design presents a detailed examination of how firms grow and, more importantly, offers considerations for how firms should grow. The study draws from survey data submitted from more than 200 independent advisory firms. To be included in the study, firms were required to have been in business for at least 12 months and report minimum annual revenues of at least $75,000. The input from these firms across a wide range of business topics yielded a rich source for analysis.
Growth by Design follows People and Pay, FA Insight’s inaugural study on how firms could best develop and manage people (see AdvisorOne.com for more on last year’s study). This year, Growth by Design moves from people practices to a special focus on two other important leading indicators of firm performance–marketing and operations. These two functions have important implications for how, or whether, firms grow. A strong marketing capability is needed to attract clients to the firm. A strong operational capability ensures the firm can efficiently and effectively service increasing numbers of clients.
It is one thing for a firm to effectively market itself, but it is quite another for the firm to ultimately deliver on its value promise. How a firm structures and manages its operations is essential for delivering on the firm’s value promise in order to retain target clients and attract more like them. Aligning the two functions with the firm’s strategic vision promises a smooth intersection between client supply and client demand, stimulating sustainable growth and building firm value as a result.
Performance Begins to Rebound
At no time since the independent advisory movement began to flourish in the 1980s has the industry gone through such a trying period as the past few years. A dramatic 19% slide in AUM during 2008 led to the severe contraction in revenues during 2009 which, in turn, directly affected owner income.
Owners took home less profit, as well as less compensation. The typical firm saw owner income per dollar of revenue fall from 50 cents in 2008 to 44 cents in 2009. Income per owner fell more sharply, declining to $366,200 in 2009 from $443,164 in 2008. Income would have seen an even sharper drop if owners had not reacted by reining in overhead expenses. Despite substantially lower total revenue, overhead expenses as a share of revenue were, at 41%, one percentage point less than the typical firm in 2008.
While owners clearly felt pain in 2009, signs of an emerging turnaround provided relief. Firms continued to add new clients through 2009, and as stability gradually returned to the economy, AUM jumped 20% for the year. The good news should continue as firm owners expect to finish out 2010 with strong increases in clients, AUM, and revenue, in particular, where a 16% increase is forecast. Projected 2010 staffing additions further suggest that firm owners are no longer fighting for survival; they are ready to return to the business of growth (see Figure 2, above).
Standout Firms Generate Income and Growth
Growth was always a priority for a group of elite firms in our survey, the industry’s “Standout” firms. For these firms, crisis represented opportunity as Standouts moved to capture market share from peers who were more focused on getting through the downturn with as little damage as possible.
In order to better understand what makes an advisory firm successful, Standout firms were distinguished at each of our four stages of development. Similar to last year’s study, we defined these firms according to two key criteria related to building firm value:
- The ability to generate income for owners
- The ability to grow (as measured by revenue)
Level of annual revenue defined firm stages. These stages included Operators ($75,000-$500,000 in annual revenue), Cultivators ($500,000-$1.5 million), Accelerators ($1.5 million-$3 million) and Innovators (over $3 million in revenue). The top third of firms ranking highest across both factors in each of the four stages of firm development were distinguished as Standouts. Both the owner income and growth criteria received equal weight.
By definition, Standout firms best demonstrated the ability to generate income and grow revenue, key factors that build value for firm shareholders. In 2009, depending upon the stage of firm development, Standouts relative to their peers achieved:
- 10 to 30 percentage points higher annual revenue growth
- 40% to 60% more owner income per dollar of revenue
The underlying drivers of this superior performance begin to emerge through review of other financial metrics. Again, the degree of outperformance by Standouts varies according to where firms are on the development spectrum, but the distinctions are clear. They include the following:
- 10 percentage points or more advantage in terms of overhead expenses as a share of revenue
- 2.4 to 3.5 times more profit per client, despite typically serving smaller clients in terms of AUM
- 16% to 20% greater productivity in terms of revenue per team member
The performance advantage translates straight to the bottom line, with Standouts registering operating profit margins that are 12 to 16 percentage points higher than other firms (see Figure 3, right).
Standouts’ ability to achieve greater efficiency, productivity, and profitability is not happening by accident. Neither is their related ability to build value in their businesses by achieving superior levels of growth without sacrificing income generation. It is this ability to create sustainable growth that we explore in detail in this year’s report.