by Tony Vidler
Financial advisers really need to invest more into their practices. Now. More money, more thinking, more strategy….more leverage. Even those who have been investing probably need to invest more.
For decades financial advisers have been able to to operate “lifestyle” businesses. It has enabled them to largely choose when they will work; who they will work with; and how much they will earn. It has cost little to run and required virtually no infrastructure that the adviser had to pay for.
It has been a pretty good business for many to be in really. There was no need for decades for the majority to think about capital issues, or to retain income or profits to reinvest. It was a cash machine that required no financial overheads of any consequence.
That’s changed though hasn’t it?
Compliance costs; software and hardware requirements; professional development and association fees and subscriptions; research…..these are all additional expenditure areas which have have gradually escalated in scope and volume over the last 10 years. For the typical adviser they now represent significant overhead that must be met before a single new client is engaged or a dollar of revenue is produced for the year ahead…and that is before we even get to items like professional indemnity insurance, increased consumer servicing expectations, increasing disputes & litigation and so on.
On the upside though is that the remuneration terms have remained reasonably constant and predictable in virtually all business lines except perhaps wealth management where the increasing pressure is to drive fees downwards. Margin compression in wealth management is worse than other business lines for financial advisers. For others, commission as a form of remuneration still dominates and provides some leveraging opportunity, as there is still significant consumer reluctance to directly pay from their own pockets using after tax income for the genuine cost of delivering advice in risk management and lending. Most consumers still remain relatively happy with commission as a form of remuneration for advice in those areas, and I suspect that will remain for a little while yet. After all, when you get right down to it commission is basically a “success fee” isn’t it? If the adviser can get the result that the consumer wants then the adviser gets paid well. If they do not get the result the consumer wants then the adviser has assumed all the delivery costs for a zero return. Consumers are generally pretty happy with the second element there in particular.
This leads to a situation where the majority of those most affected – the consumers and the advisers – are relatively happy with current arrangements. The ones who are not quite as happy are those who are trying to appease their own shareholders firstly with ever increasing profit margins (being the product manufacturers paying the commissions for successful distribution), and the political masters whose thinking arises from some idealogical position. That is, they frequently begin with conceptualising their own view of utopia and then try to impose the changes that will lead to it through regulation and rule-making, and that frequently has little basis in commercial reality. It is also frequently founded upon a Big-Brotherish attitude of “we know what’s best for you better than you do Mr/Mrs Consumer”.
So we are at an interesting juncture in financial services: enough of the politicians and bureaucrats from across the idealogical spectrum and across multiple jurisdictions & nations agree broadly on the direction and shape of the financial services industry of the future. What the actual industry participants want is rather a moot point. Changes will be made, and continue to be made, and re-made, until the idealogisits achieve their version of “good”.
Simultaneously, consumers have never been more empowered throughout history than they are right now. Their ability to access information rapidly, explore choices and a multitude of business models which may deliver a financial service or product, and transact in an ever increasing range of ever-more-convenient methods creates additional pressure on traditional business models. As an aside, I find it interesting that the politicians and bureaucrats seem oblivious to the fact that consumers have rarely distrusted them as much as they do currently, which suggests that there is a distinct possibility of an ever-widening gap between what consumers want and are happy with, and how the rule-makers decide to shape the future. Political consequences from some of the policies and agendas being adopted is a distinct possibility….and that would be a grand thing. When political agenda departs significantly from the electorates then there should be a change.
Where does this leave the adviser though?
Increasingly transient customers will come and go far more readily, together with increasing intrusion into how a business is run commercially from rule-makers who are increasingly disconnected from their constituency. And business operating costs will continue to escalate at a disproportionate rate to cost increases elsewhere in society.
That is a pretty bleak prospect for many, and certainly the joy of running a lifestyle business is dissipated. But, you know, this is all for the good of the country and all that….Consumers will be better off. Trust us. We know what we are doing….
The key to adjusting successfully and transitioning from a lifestyle business to a commercial enterprise which can absorb the increasing cost of client acquisition together with the increasing overheads is to create leverage everywhere possible inside the practice.
Without introducing leverage we are trapped by the amount of hours and energy each individual practitioner has, and the trend of increasingly transient consumerism. They are the two achilles heels of pure fee-based advisory work: the limitations of practitioner time, together with consumers array of lower cost alternatives and willingness to pursue them.
Today’s advisers have some time to adjust courtesy of the legal power of contractual rights to ongoing income streams. Renewals, trails, AUM fees…call them whatever you want…however the right to a residual income stream for providing ongoing service to clients whom the adviser sourced and introduced provides practices with the ability through (somewhat) predictable revenue (for a while at least) to introduce leverage through better work practices, better use of technology which costs less than labour does, delegation to lower cost workers both inside and outside of the firm, and so forth.
Reinvesting a reasonably high proportion of earnings into better systems, greater capacity, more effective marketing systems, growing good people in the firm in support roles and so forth needs to being now, if it hasn’t already begun. Those who fail to do so will have the same customer acquisition costs generally, but each additional customer will demand more of the practitioners time and energy which results in hitting full capacity at some point. And THAT just put a cap on personal earnings for the adviser together with minimising the likely capital growth of their business.
For advisers to have a business positioned to survive the challenges ahead they must build a business which no longer depends upon them personally doing all the marketing, managing, advisory work and client servicing functions. Instead of doing it all, and taking all the money from the practice because they were doing it all, they now have to leave more money in the practice – but build in capacity using that money to do the things that the adviser shouldn’t be doing.
It is time for advisers to seriously invest in their businesses if they want the business to survive and maintain a future capital value, and also to be able to provide the owners with a reasonable ongoing income. I still believe the pay-off will be absolutely worth it for those that do, though it may not feel like it for a few years.