This is the first in a three-part series on client profitability. In Part One below, we look at the challenges of growth and dispel three major myths about client segmentation. In Part Two, we present a case study of an advisory firm’s experiences with client segmentation.
Generally, independent registered investment advisors (RIAs) began as a small business. They focus on executing their value proposition, delivering a superior client experience and acquiring new clients.
Over time, as these small businesses typically grow larger and more complex, here’s what inevitably tends to happen. The firm has acquired a whole range of clients with varying needs and, yes, different levels of assets to manage. The principles have a multitude of competing demands on their time—after all, they are running a business. And their overriding concern—justifiably—is to give each and every client the highest possible level of service.
Challenges of Growth
While growth is good, it can lead to constraints in several areas of an advisor’s business. All too often, a firm’s most valued advisors may find themselves having to juggle multiple demands.
Trying to provide the same high level of service to everyone can make it difficult to focus on the more complex clients. There may be less time for business development. If the firm’s performance and growth begin to suffer, these conscientious advisors typically respond by redoubling their efforts and devoting more time to the challenge.
Advisors who confront this inevitable roadblock to growth with a more rigorous, strategic approach are finding that it can pay off by enabling them to:
- Return to their core offering
- Improve the client experience for all clients
- Free up time for key firm staff and
- Create a more profitable and growing business
Know Your Clients and the Cost to Serve Them
The 2008-2009 market downturn exposed what many advisors understood intuitively: The Pareto principle is alive and well in the advisory business. The idea that a small portion of an advisor’s clients typically accounts for a disproportionate amount of a firm’s profitability was confirmed by the 2011 RIA Benchmarking Study from Charles Schwab which found that 7% of a firm’s clients typically account for about 36% of revenue.
Yet as I worked with our RIA clients through this challenging period, many couldn’t tell me how much it cost to serve a particular client and which of their clients were truly profitable.
Most advisors try to provide the same level of service to their entire—but varied—client base. Too often, this allows the more demanding clients to consume the firm’s time, while the most important clients may receive minimal attention.
This highlights the tension advisors often feel between their desire to deliver the highest level of customer service to each and every client and the need to consistently improve the firm’s financial performance.
Rather than giving the same fundamental service level to all clients, advisors need to decide how to allocate their valuable, yet scarce, resources and structure their firm accordingly.
The Lessons From Looking at Client Profitability
By taking a close look at the makeup of a firm’s client base, advisors can begin to segment clients into sub-groups with similar needs. The goal is to deliver the appropriate level and type of service to each client instead of providing the same level of service to everyone.
Many advisors have discovered that segmenting their client base allows them to deliver the ideal client experience more profitably. However, we find that some hesitate to use this strategic approach because of concerns they have about segmentation.
Let me address the most common prevailing myths.
Myth No. 1: Segmentation is more about profits than clients.
“Not so!” say RIAs who have adopted segmentation. Advisors are generally attracted to the concept because they want to improve customer service for all clients.
The ability to view clients as groups with different needs and priorities provides advisors with a powerful tool. It can help prevent “squeaky wheel clients” from taking up too much of an advisor’s time and keep a firm’s smaller clients from “falling through the cracks”—not receiving regular attention simply because the partners are too busy with other relationships.