Managing Client Profitability, Pt. 3: Determining Your Firm’s Client Profitability

This is the third and final post in a three-part series on client profitability. In Part One, we looked at the challenges of growth and dispelled three major myths about client segmentation. In Part Two, we looked at a case study of an advisory firm that learned about its true profitability and solved its client capacity issues. In this post, we give you a step-by-step approach to determining your own firm’s client profitability. 

In my two previous blogs, I made the case for instituting a formal approach to client profitability in your advisory firm. By doing so, you can address some of the common challenges inherent in building a growing RIA practice, better allocate scarce resources to the right clients and prepare your firm to grow and perform more effectively. 

The next step is applying the concept to your own practice. At Schwab Advisor Services we developed a comprehensive eight-week program called “Managing Client Profitability” that we implement with RIAs who want to understand their firm’s profitability at the client level. You can use some of the steps from our program to do some fact-finding about your practice that can put you on the road to improving your own client profitability. 

Step One:  What does your practice look like today?
This first step can help you create a picture of your current client base and the services you provide. Advisors often tell me they strive to give all their clients the same high level of service. But upon further analysis of what they actually deliver and how and by whom it’s delivered, it is not uncommon to see that individual client experience may vary in terms of the level and types of services they receive, the amount of time they spend with their advisor and their fee schedule.  Sometimes the best way to find out how different clients are currently being served is to talk with your support staff.

Think about how you might categorize your clients into groups with similar needs. An obvious starting point is assets under management (AUM), and this criterion is often an accurate proxy for a client’s degree of complexity and specific needs. But consider other ways of grouping your clients such as: 

• The particular unique needs they have
• Their wealth life cycle
• The services you deliver
• How often clients want to consult with you
• The mix of team members that support your clients
• Who in the firm is primarily responsible for working with certain clients. 

The goal is to pinpoint the characteristics about your client groups that you find most accurately reflect client needs and your service offer. You can then use this as a filter to help divide your entire client “pie” into smaller slices comprised of similar types of clients (whether they are similar with regard to AUM, which principal serves them, or whatever standard you have chosen to use). 

Next, assign each client to one of the client categories you have identified (I suggest you limit your segments to no more than four or five.). 

In my last blog, I wrote about Trinity Wealth Advisors. When they went through their client profitability exercise, they saw that, generally, they could put their clients into one of four defined groups:

• High net worth clients with complex needs
• Clients with simpler needs
• Emerging wealth and referral sources
• Friends and family 

Step Two: What does it cost to serve your clients?
Now that you have created a way to view your client base more strategically—with an eye toward client need and the complexity involved in serving them—the next step is to align revenue and expenses associated with providing services for each client segment. Begin by listing the annual revenue generated by each client.  

Next, estimate how much it costs to serve a typical client in each of your segments. I find that few firms track their time, which would be the most accurate way to determine client profitability.  So here is a straightforward approach to estimating profitability.  

In most firms, salaries and benefits comprise about 75% of expenses, and most of that is devoted to client-facing individuals—advisors, portfolio managers, planners. Determine how many hours in a year are devoted to delivering service to a typical client by specific function and role (client meetings, meeting preparation and analysis, etc.). Then apply your respective salary expenses against those roles to get a better handle on the most expensive—and variable—part of your service offer—time.  

Finally, estimate other expenses, such as rent or mailing performance reports, and determine whether those expenses should be assigned equally or proportionally to each client group. This process allows you to reach a reasonably accurate estimate of what it costs to serve a particular segment so you can begin to get a handle on each segment’s relative profitability. 

This analytical process alone tends to open advisors’ eyes to how their business is really performing; they typically begin to see opportunities to change how and what they deliver to whom.  

It’s important for all of you analysts out there to avoid getting too bogged down in precision during this step. Your goal is to broadly allocate the expense of serving different client groups so that you can get a picture of your resource allocation and profitability.