Ten Reasons the Advisory Business is Unlike Any Other
August 5, 2014
by Bob Veres
A lot has been written about practice management in the investment advisory space. Many of the articles offer dark implications that somehow advisors are genetically endowed with poor business skills. The underlying assumption is that running an investment advisory business is just like, well, running any other business. You hire and manage people, you collect revenues from your clients, you create internal systems and procedures, buy software and IT services and market yourself to the community.
Just like everybody else, right?
In fact, the business dynamics that an advisory firm faces are so fundamentally different from a normal enterprise in the U.S. economy that any normal small business owner, dropped into your executive chair, would feel like she had been transported to another planet. The laws of business physics are different, the nature of the competition is different, the normal marketing principles don’t apply to you, and the advice you provide runs counter to every instinct of your paying customers.
To see how exceptional your business climate really is, let’s take a quick tour of some of the differences between an investment advisory firm and a normal member of the business landscape.
1. Your clients actually pay you less during those times when they need you the most.
In any normal business activity, more work is the consequence of more business and, therefore, more revenues. But think back to 2008, and you realize that your business, if you charge AUM fees, has it completely backwards.
When the markets tanked, AUM revenue tanked accordingly. Firms with a healthy 30% profit margin, whose aggregate client portfolios declined by 30%, suddenly found themselves living on a pay-as-you-go basis. Meanwhile, your docile herd of clients was stampeding in all directions. Instead of one or two phone calls a day, the phones rang all day long, as clients clamored for reassurance. You had to talk them out of making important financial decisions in a state of panic, keep them abreast of what was going on in markets you didn’t understand yourself, re-run their financial projections every couple of months and help them figure out how to adjust future spending expectations. One-meeting-a-year clients became every-two-week phone calls, and your planning software looked like it was going to wear out.
Meanwhile, your staff was working overtime to keep the ship upright during a year when you probably weren’t able to afford to pay bonuses, when the profit sharing plan didn’t kick in because there are no profits. In any other firm, working overtime means that the firm will be paying out generous bonuses due to the increased revenues.
There’s a management lesson here that doesn’t apply to most companies: Advisory firms that rely on AUM revenue have to be unusually profitable during the good years (i.e. when markets are going up), in order to be able to weather the inevitable market downturns.
2. You charge the same commodity that you happen to be managing.
Getting paid for portfolio management and financial planning work, and charging for your money management, puts you in a unique and uncomfortable position that most businesses don’t face. You have near-total access to your clients’ financial situation. You know how much they can afford to pay you. And then you determine your fee.
In what other profession is there a temptation to discount fees because you know that what you charge will be a stretch – or because you know, from your routine professional evaluation, that your clients are experiencing cash flow stress? On the other end of the spectrum, you know when your clients can afford to pay a lot more than you’re currently charging. Either way, there’s a temptation to lower or raise your own compensation based on your professional activities and understanding.
There’s a practice management lesson here. Doctors don’t look at a client’s ability to pay when they assess their fees, and I don’t know any plumbers who check your portfolio before they decide how much it’s going to cost to fix your frozen pipes. Advisors have to be capable of setting appropriate fee schedules for the services they provide, and ignore the temptation to discount or raise the fees based on what they know about the client. I know some advisors who refuse to discuss fees with clients at all; that becomes the job of the office manager, who isn’t privy to the client’s financial situation and is therefore not tempted to make adjustments.
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