The financial planning business model has undergone a number of transformations since it was created in a room at the Chicago O’Hare Hilton in 1969 by a group of securities salesmen looking for a better way to market mutual funds. Their solution was comprehensive financial planning, which reportedly worked quite well until rising oil prices tanked the stock market in the late ’70s.
At this point, planners turned their efforts to recommending tax shelters — primarily oil and gas and real estate — until the Tax Reform Act of 1986 eliminated the deduction upon which those shelters were based. So planners switched to offering variable annuities, which offered tax-advantaged investing in the bull stock market that had started in 1982.
Then, the stock market made a major correction in October 1987, and planners turned to Modern Portfolio Theory to better reduce client risk with allocated portfolios — creating the asset management business model that the industry still uses today and transforming planners from salespersons into portfolio managers.
However, not everyone was quick to jump on the asset management bandwagon. Wall Street took a firm stand against retail asset management, petitioning the Securities and Exchange Commission to prevent advisors from charging AUM fees. But by the late 1990s, the lure of ongoing fees on growing portfolios proved too attractive, and even the wirehouses consented to let their brokers manage client assets.
Business schools tell us that this is the normal growth curve for new industries: starting as “mom and pop” businesses delivering a needed service, experimenting with various business models until they get it right. Then they experience great success until large corporations finally take note and move in, typically using their resources to increase quality and their size to drive down prices.
But financial planners have been spared such a corporate takeover for the past 15 years because digital technology has allowed them to increase their service quality. Instead of cutting prices, Wall Street increased them, leaving planners as the comparatively low-cost provider of high-quality financial planning and asset management services.
Unfortunately, Wall Street wasn’t the only industry to notice the success of financial planners’ retail asset management. Enter the digital advisory platforms (commonly called robo-advisors), which started providing asset management to retail clients at a fraction of the cost of independent financial planners — and undermining the current AUM business model of the independent financial planning industry.
At the same time, a flood of breakaway brokers has increased competition for independent advisory clients, creating a perfect storm of new market pressures. We believe that the independent planning world is already feeling the effects of both pricing pressure and more competition, and that it has already begun to transform its business model once again.
But unlike many observers, we don’t believe this is such a bad thing. In fact, it’s just what the financial planning profession has been waiting for. With AUM becoming a commodity, the focus is shifted to financial planning and other services. To continue to compete in this new business environment, financial planners will have to successfully articulate this new value proposition to their clients and prospective clients.
Problem is, most financial planning firms still seem to be finding their way. Our analysis of the current state of the planning profession comes from our Kaleido Scope Practice Management Assessment, an online questionnaire that gives advisory firm owners an overview of how their business compares with a well-run firm in each of six key practice management areas: management, human capital, finance, client service, operations, and sales and marketing.
Initially, we created the Kaleido Scope to give firm owners a quick snapshot of where their businesses are today and the areas in which they can be improved. In the short time the Kaleido Scope has been active, though, we’ve realized it’s a much more powerful tool than we expected. Not only do the results give us insight into individual firms, but by combining all the results, we’ve obtained a gauge to measure the independent advisory industry as a whole. Furthermore, because we’re seeing a steady, ongoing stream of results (rather than just a snapshot of the previous year, which forms the basis of most advisory industry surveys), the Kaleido Scope reveals industry trends in real time, as they are developing.
Profitability and Pricing
Two key trends that we’re currently seeing is that industry profitability is rapidly declining, while firm growth is beginning to decline as well. According to our data, two factors are contributing to both problems. First, firms are scoring very low in attracting new clients, which can be seen in falling client referral rates (down from about 36% to around 23% per year) and declining closing ratios on the new client prospects they do get (down from 70% to 50%).
At the same time, firms are scoring very high in client retention, with many losing only an average of 2% of their client base per year. While you might think that this is a good thing (and sometimes it is), when combined with the fact that those same firms are scoring very low in attracting new clients, it’s actually an indication of a problem. We believe that the inordinately high retention rates suggest that many of today’s firms are underpricing their services.
Pricing that is too low can create a negative image, as if your services are not as valuable as the alternatives. At the same time, many of these firms overservice their clients; that is, they continuously add services to meet the needs of new clients, taxing their resources and decreasing the quality of their other services. (We find that fewer high-quality services create a far better client experience.) Consequently, clients don’t feel good about making referrals, and the increased number of services drives up operating costs, hence the drop in profitability.
In our view, two causes underlie these disturbing trends. The first is structural. In our experience, most independent advisors approach building businesses backward, using what we call the “I” model — what services do I want to provide? — rather than starting with the services that clients actually need. Using this model, they launch their business starting with the services they can and want to provide to clients, and then try to attract clients who want those services. Doing this leads to having a whole lot of services — the “be all things to all people” model — or to simply adding services that are unprofitable.
The result is usually an ongoing series of quick fixes as firm owners attempt to meet the growing needs of their expanding client base. This leads to inefficient operations and confusion about what the business really is — among staff members, clients, prospective clients and even the owners themselves. This in turn leads to low referral rates, low closing ratios, high employee turnover, ill-conceived and costly new initiatives, and low profit margins and owner income. We’ve come to realize that many of the problems that advisors come to us to help them fix stem from these initial mistakes and the quick-fix attempts to correct them.
A New Vision
Consequently, many firm owners today are sensing client dissatisfaction with the services they provide (more often than not, the result of overservicing). That, combined with fear of the media-hyped online advisory platforms, is causing owners to panic and make knee-jerk attempts to solve the problem. We see many firms exploring ways to reduce AUM fees or adopt alternative revenue models (such as flat advisory fees), and doing anything they can think of to increase client service and revenues, including throwing money at new technology, marketing, recruiting and M&A — all without regard to their effects on the bottom line. Our assessment data shows that 87% of owners are making these changes without any clear plan or vision for what the resulting business will look like.