TodaysAdvisor.com

  By Dennis Gallant, President of Gallant Distribution Consulting
    

       Prepared for SUCCESS METRICS and used with their permission.

    
Advisors Will Need to Align Their Practices With Their Clients

Moving forward, industry participants will need to increasingly focus on profitability, capturing client wallet-share and retaining clients. To succeed, broker-dealers and advisors will need to forge personal connections with their clients and embrace the concept of one-to-one marketing.

The concept of one-to-one marketing is emerging as a viable approach to address the varied needs in the marketplace and is slowly gaining attention within the financial services industry. One-to-one marketing focuses on providing products and services to the marketplace one client at a time. By better identifying and meeting individual client needs, these personalized interactions help foster greater client retention and other benefits include:

• Greater client wallet-share
• More profitable clients
• Higher client satisfaction
• Higher client referral rates
• Improved product offering because of richer client interaction
• Better differentiation by working to meet client-specific or unmet needs.

The concept of one-to-one marketing is not new, but its application to financial advice offerings is. Don Peppers and Martha Rogers, in their book, The One to One Future, touts exploiting CRM technology to provide personalized services to a large client base or mass audience. Today, CRM technology is being leveraged to tailor services to a few client segments, but one-to-one marketing goes deeper than current segmentation by focusing on individuals rather than groups.

The concept of one-to-one marketing has been employed within a number of industries, such as banking and pharmaceuticals, to help firms differentiate themselves in a competitive environment and by a handful of financial services firms, such as discount brokers and technology providers, but has yet to be effectively applied to the broker-dealer and advisor industry. The broker-dealer marketplace has all the necessary ingredients for one-to-one marketing to succeed: differentiation concerns, rising competition and access to large databases of client and advisor information. For broker-dealers, the implementation of an effective one-to-one marketing strategy would go beyond their clients and extend into their advisor bases as well. By better understanding and targeting both populations, broker-dealers will be better able to align products, services, and support with advisor practices and enable advisors to better serve their clients.

Effective one-to-one marketing for the advisor population would enable those advisors that want to change their practices to do so, while still fostering growth for those that don’t. In order to provide such personalized support, broker-dealers will need to provide individual advisors an unfiltered and candid understanding of their practices, their relative strengths and weaknesses, as well as identify their greatest opportunities to change or grow their practice. Providing these capabilities throughout a firm requires a new, more scalable approach to support that takes into account each advisor’s circumstances to ensure relevance for every advisor, both the 80% and the 20%.

Meeting the Challenge

To enable advisors to realize their potential, broker-dealers will need to provide personalized support that enables those advisors that want to change their practices to do so while still enabling growth for those that do not. Providing personalized support to a large number of advisors, in and of itself, presents a daunting challenge for brokerages as traditional approaches are either personalized or scalable – but not both. This challenge is further compounded by the need to help these advisors execute by enabling them to take specific actions to achieve their goals - making the task impossible for current approaches. As a result, new capabilities will need to be applied to the problem of advisor support if brokerages are going to foster change and growth throughout their advisor bases.

The 80/20 Rule

The 80/20 rule—the assumption that 80% of revenues are derived from the top 20% of performers—can be applied to most industries, and the financial service industry is no exception. Broker-dealers have always favored the top 20% of the advisor base, and with good reason: this small segment of the advisor force is the most profitable. However, the rising costs of advice delivery and the support required to assist advisors in shifting their businesses have forced broker-dealers to be increasingly selective regarding which advisors they support, exaggerating the 80/20 rule and skewing it to somewhere in the neighborhood of 90/10 at most firms, or even 95/5.

Belief in the 80/20 rule can be a self- fulfilling prophecy, and in some ways a vicious cycle, that increases a firms’ dependence on a few producers. With support almost exclusively being provided to the top 20% of reps, the remaining 80% are not getting the help they need to improve their practices, so few advisors emerge as top producers. With fewer advisors becoming top producers, the firm needs to recruit top advisors from other firms, increasing recruitment expense and further limiting the availability of support to emerging advisors internally. As fewer internal producers emerge, the firm becomes more heavily dependent on outside recruiting. The irony is that the focus on top producers is driven by the belief that they are the most profitable for the firm. However, emerging research shows that the rising costs of servicing high-net-worth clients are actually shrinking margins among top producers and wealth managers. In addition, attrition of top producers now has a greater impact on the organization.

The decision to focus on top producers is driven largely by rising costs of doing business. Before elaborating on the risks of concentrating exclusively on top producers, this next section will examine some of the escalating costs.


Top Producer Syndrome

Transitioning an entire advisor force to an advice- and fee-oriented structure is a time-consuming and costly process. As a result, and in accordance with the 80/20 rule, firms are placing greater emphasis on their top producers and recruiting experienced reps because they generate more assets under management and service wealthier clients, which translates on average into higher revenues and margins.
Some level of focus on top producers is warranted. Morgan Stanley’s study entitled “U.S. Retail Brokerage: Flawed but Improving,” saluted brokerage firms for abandoning the “bums on a seat” strategy to justify fixed costs. These lower-end advisors had become a drain on profitability as fixed cost increased. Many brokerages have purged their lower producers, either through layoffs or by changing compensation structures to spur them to boost productivity or to leave. For example, within the last 12 months Morgan Stanley announced plans to cut its broker trainee program to 1,000 in 2006 from 2,500 in 2005, as well as cut underperforming brokers. Smith Barney trimmed payouts for lower-producing brokers to counter rising costs and reimburse the firm for cost incurred for advisors obtaining the Certified Financial Planner (CFP) designation. A.G. Edwards recently retooled its payout structure to penalize lower producing reps. This has had little impact, if any, on top advisors.

Many broker-dealers are recruiting advisors with $500,000 or more in production. Competition for experienced reps has accelerated and most major brokerage firms have increased efforts and incentives to recruit seasoned advisors in response. According to Morgan Stanley’s study, the cost for experienced recruits is rising, and packages for top producers can now be as high as 200% of trailing 12-months production—up from 80% to 120% a few years ago. Recouping these costs is challenging. On average, it takes a firm five to seven years to recoup its recruitment costs for an advisor producing $425,000 per year. To make matters worse, 10% of these recruits leave or are fired annually, exacerbating the economics.

The study questioned whether the cost and upfront compensation of top producers is actually as cost effective as driving growth via new or mid-tier advisors or if it helps operating margins at all. Either way, it’s clear that increasing advisor acquisition and support cost will begin to negatively impact broker-dealer profit margins with regard to their top producers. Unfortunately, the high recruitment costs have the additional consequences of shifting resources away from a brokerage’s lower- and mid-tier advisors—ultimately increasing the firm’s dependence on top producers by reducing the growth and contribution of the firm’s mid-tier and emerging advisors and creating a vicious cycle.

Although focusing on top producers and eliminating some support has helped improve some broker-dealer margins in the short-term, the long term viability of this strategy is in question for several reasons:

Increasing Competition for Top Producers – With every brokerage firm focusing on top producers, competition and cost for acquiring them will remain high and potentially rise. This means that the economies for growth via recruiting will become increasing unfavorable.

Retention Costs Increase – According to the Securities Industry Association’s 2005 Report on Production and Earnings of Registered Reps, which tracks 26 retail brokerages and nearly 50,000 reps, the overall registered rep turnover rate rose to 16.9% in 2005, with nearly half these advisors joining a competitor. With firms all vying for the industry’s top producers, retention efforts will need to increase. To maintain advisor satisfaction, brokerages will increase payouts and offer more support and autonomy, resulting in higher costs for the firms and lower margins.
Shrinking Pool of Candidates – Some experts predict a shortage of experienced reps within the next 10 years, as more top advisors begin to retire and exit the business faster than they can be replaced. The shortage is also partly driven by the longer lead times required to train a wealth manager and the reduction in new recruitment, training and support for mid-tier reps—who are tomorrow’s top producers.
Support Cost Rising – As firms increase their dependence on top producers, their cost to support them also increases. Top producers often require more sophisticated support and additional services to compete for clients. Services such as estate planning, trust, stock optimization, hedge funds, and real estate require expensive home office tools and personnel and are difficult and expensive to build. Ultimately this cost can diminish profitability for the broker-dealer, as well as the advisor.

To address these retention and rising support cost concerns, broker-dealers are placing greater emphasis on team practices. Advisors are also forming teams as they broaden services to address wealth transfer and wealth management. Most teams have functionalized roles among team members to address broader and increasingly sophisticated client needs with financial planning, estate planning, asset management and marketing/client development. Teams can be as basic as a two person practice, with one person focused on marketing and sales, and the other on managing client portfolios or can be a functionalized broad-based team of 5-10 professionals.

As many of these practice functions or services have shifted away from the broker-dealer by allowing teams their own set of specialists, the stage becomes set for a team to breakaway from the home office. As a result, teams are in some ways a double-edged sword for firms. On the one hand, they can help retention because if a single team member leaves, the clients stay behind. And, if an entire team wants to leave, they often can’t agree on where to go. However, teams are less dependent on the home office and more able to move—so if a team believes it’s receiving little value from its broker-dealer, the whole team may jump ship along with their clients.

Further, teams are now an area of recruiting focus for many brokerages and the RIA market is also gaining some attention. Many advisor teams are considering leaving or have already left the confines of their broker-dealer and set up shop as an RIA, seeking higher payouts and autonomy. Service agent/custodians such as Charles Schwab, TD Ameritrade, Fidelity, etc., have stepped up efforts to attract breakaway teams and convince them that their broker-dealers are no longer adding value, while providing them with assistance and services to assist in running their own independent practice.

The focus on top producers is driven by a simple process of rationalization. Given limited financial resources, firms focus efforts where they expect the best possible return on their investment. In addition to some of the pitfalls of focusing on top producers mentioned above, it is important to remember that top producers themselves implement a variety of business models, which makes tailoring support a difficult endeavor.

Moving forward, adhering to the 80/20 rule will not actually translate into better margins or advisor retention unless the broker-dealer truly helps the top advisors run their businesses well. Even top producers and teams need support and assistance to help grow their businesses and create greater profitability and efficiency. At the same time, while appropriate support for top producers remains critically important, broker-dealers need to also invest in the other 80%.

The Other 80%

Broker-dealers often look at their advisor base in 3 groups. The top 20% or less of a firm’s top-producing reps receives the most support. The next 50% of advisor may have potential to grow their books of business, so support is very selective in hopes of identifying future top producers. The bottom 30% of the rep force is often considered either too new or too likely to be pushed out of the firm, so support is very basic, if it exists at all, at that level.

As stated earlier in this paper, rising costs and limited resources force broker-dealers to rationalize support in favor of the top producers—often the top 10% or 20%. Supporting the other 80% is too labor intensive and costly for most firms because most support services are not scalable. However, a number of factors are emerging that may change the attitude toward smaller producers and those with lower net-worth clients.

Competition for Affluent Clients: The market to service wealthy clients is quickly becoming saturated, raising concerns that there are not enough affluent clients to go around. According to Tiburon Advisors, there are an estimated 400,000 advisors and approximately 40 million households with $100,000 or more of investable assets. If at least three-quarters of these households use a financial advisor, the average advisor would only have 75 clients each. Using a 1% fee based on cumulated assets of $7.5 million the average advisor can only earn $75,000 in gross revenues. This forces the advisor to pursue wealthier clients; however, targeting wealthier clients causes the number of clients per advisor to decrease further since the affluent population gets smaller as you move up market. In reality, not every advisor can or should move up market because of the competitive environment or ill-matched skills. With limited pools of affluent investors and competition for them reaching a peak, some advisors and broker-dealers will find greater success if they shift their focus down market.

Retirement Income: Demographic shifts are causing advisors with less affluent clients to become more attractive and, because these clients are generally underserved, there is less competition at this level of the market. IRA rollovers are key to moving down market because they represent a significant infusion of assets into the retail marketplace as retiring baby boomers receive distributions from their retirement and pension plans. Rollover assets and retirement-income planning will make lower-net-worth investors more attractive to advisors and broker-dealers for a number of reasons highlighted below.

o Significant Account Size - Rollover assets can be significant in size and distributions of $100,000 to $500,000 are not uncommon.
o Looking for Advice - Mass affluent and lower-net-worth clients are seeking advice and advisors to address their rollover and retirement income concerns.
o Asset Consolidation - Retirement income planning requires clients to consolidate their assets with one provider in order to build a manageable income stream.
o Broader Products and Services - Retirement income will require a wide range of services and enable advisors to provide solutions for both sides of a client’s balance sheet. Advisors can drive revenue from banking and insurance products and these services often have higher margins for the broker-dealer than investment products.
o Asset Retention – Retirement income assets are stickier because retirement income plans are somewhat hard-coded and investors are unlikely to change.
o Large Population– There are an estimated 33 million mass affluent households with investable assets between $100,000 and $1 million and they control approximately 37% of total U.S. investable assets. Retirement income needs for these consumers is more pronounced and also happens to be very underserved by advisors, so competition is low.

Regardless of which level of rep a broker-dealer is focusing on, brokerage firms employ a number of strategies to improve an advisor’s practice and add value. The next chapter addresses strategies brokerage firms currently employ to assist advisors in building and improving their practices.