RIAs Are in Margin Compression Survival Mode

Do you really believe that you provide value for your clients? Let me ask again from a different, more important perspective. Do you really believe that your clients believe you provide value?

When clients have the opportunity to look carefully at the services you provide for them compared to what they can get elsewhere for much lower fees, is your client service model attractive? From an objective external viewpoint, do you believe that your business, as it functions today, will be sustainable for the long haul?

The start of the year is our traditional time for self-evaluation and transformation, but due to changing consumer expectations, evolving technology and increasing regulation, some financial firms and advisors — if they are doing a really honest assessment — will see a somber reality.

It's very possible that the business model financial advisors rely upon today will not survive for long into the future.

We may eventually see a relatively small number of advisors who provide highly specialized services thrive. The services and counsel that some advisory firms congratulate themselves for offering to the mass affluent may be considered superfluous to the coming generation, who would just as soon manage all their finances online. By the time they really need nuanced advice, software may have evolved enough to provide it.

You may be thinking that, with the Trump administration taking office, your business model is no longer under siege. Think again. Just because Dodd-Frank and the DOL fiduciary standard may be reconsidered, the pressures on your bottom line will not be removed. Your clients are still aging and their children are still going online to invest. You'll still have a hard time finding a successor to buy your business. Investors in general will still suspect that financial advisors are not completely on the level.

These are the facts of our time.

Advisors and broker-dealers are already contending with margin compression, and there's no reason to think that pressure will ease anytime soon. Rather than reflexively trying to prop up existing cash flow, now's the time for thoughtful readers to consider their service model and align realities to it, rather than the other way around.

A more strategic approach is to first start by knowing your customer and understanding your value proposition. Then analyze your capabilities and align your resources with clients' service needs. In the future, the reality is that you'll improve your profit margin because you're exceptional at something, so figure out what it is and how to deliver it.

Understanding Change Through Three Lenses

At Strategy & Resources, we help our financial services and fintech clients look through three lenses of change: competition, compliance and consumer preference. We call these the "Three C-Drivers." We detailed these C-Drivers and dove into some industry trends in the December issue of Investment Advisor magazine. This installment in an ongoing series will dig into the changing advice model and what firms should be thinking about now.

Start by looking through the first lens. The competitive issues wrought by technology and automation — and the value, or lack of value, in investment management — will eventually drive the need for a change in business models. If you're really honest with yourself, you will see that the value you deliver is in providing personal financial planning and advice, not simply access to investments or management of assets. That advice has to be worth charging for to counteract the sinking price of pure investment management.

The second lens, compliance, is also driving this change. Although the brouhaha over the DOL fiduciary rule has been overplayed, in our opinion, it could nevertheless make some business models more difficult to sustain. Even if the regulations eventually go away (and even that would likely take a while), broker-dealers have already invested many millions of dollars in a fiduciary infrastructure. That may hold, and could also drive innovation as creative people work through whatever the DOL and the SEC may do to follow up.

The last C — consumer preference — is always the most important. What do your current and future clients want? Are you ready to deliver? How does working with you compare to working with today's uber-convenient, ragingly successful service providers?

(Related: Advisors, Amazon One-Click' Your Firm)

The Next Top (Business) Model

Are you positioning your business to proclaim that you're an advisor or planner but, ironically, still getting paid based on the assets you manage? If you are a financial services firm, are you just happy to keep the same old saw going? If so, you may be sending a message, both internally and externally, that your true value is in managing assets. Will your clients then decide that you're overpriced compared to a robo?

In a technology-enabled world, the value of your services does not lie in access to and management of investments. People no longer need a highly compensated professional to call in an order to a trading floor or build a nicely diversified basket of ETFs and mutual funds; investments and decently managed portfolios are a click away. Nevertheless, the industry's pricing and vision, as a whole, have lagged far behind consumer preferences and changes in today's perception of value. Too many advisors give away their most valuable service — individualized planning — by bundling it into their asset management fee, and thereby devalue their unique offering.

What's more, for many advisors, the AUM fees of their largest clients subsidize the more complicated smaller clients — say, the client with a blended family and a disabled child. This seems fair, unless you're the client subsidizing others. Changing your business model may help you get money for your true value, whether that be managing a large and unique portfolio or creating a strong and supportive estate structure for a complicated household.

There are three basic alternatives to AUM compensation to explore: hourly rates, project fees and retainers. All are already in use, and have advantages and disadvantages.

Alternative 1: Hourly Rates

This offers the advantage of ensuring that you get paid for your actual work.

To set your hourly fees you have to make sure that:

You have a true understanding of your cost of servicing accounts, including maintaining the office and staff, and can break it down into an hourly cost to ensure profitability.
Clients understand the rate, and agree that it's fair and provides real value, especially in comparison to paying an inflated investment fee.

It can be done: Look at the legal and accounting professions.

Alternative 2: Project Fees

This enables advisors to offer a menu of services and to scope out each engagement. The advantage is that clients know what they're getting and recognize its value. Once again, you need to have a good handle on your own costs in order to set prices appropriately.

You will also have to work with clients who want to bargain, and to define projects diligently in order to fend off what consultants call "scope creep."

It can be done: Consider the way management consulting and creative services professionals work and get paid.

Alternative 3: Retainers

This is the closest you can get to the traditional asset-based fee, but now the fee is visible, paid with a client's check rather than deducted from an investment account. Do your clients really know what they pay? Will they pay it to you directly? That's a question only they can answer, and you may go through some trial and error to get your retainer structure right.

It can be done: Think about the way PR agencies and corporate legal firms structure long-term relationships with their clients.

What Clients Value Most

Look at any survey of investors and you'll find that what they cherish about advisors is not their investment prowess (though they have to be competent) but their service. It is the way you show your clients that you understand their concerns and will help them meet their challenges, solve their problems and husband their wealth that engenders loyalty, not the mutual fund you found. To say to a client, "My advice is worth $400 per hour," you have to be able to articulate what's valuable about your services.

Most advisors can't do that — they've never even really tried. The best advisors can adeptly articulate their value, and they do it with classic marketing techniques.

We know, for instance, that successful marketing appeals to the heart first and the brain second. For example, one highly successful firm's website tells clients that they want them to feel loved; it doesn't mention investing until deep down — though it does mention tax strategies, which in its own way appeals to emotions. After all, who doesn't love to save on taxes?

Advisors who want to call themselves a quarterback or a coordinator, by contrast, are talking in clichés and abstractions — and clients will eventually begin to hear and think, "Oh, you get paid for doing nothing." So dig deep and spend some time figuring out what you really do, and how that creates a satisfying client experience.

It's up to you to define your business and align your services with shifting market demands. It may require a significant amount of soul searching, realignment and work, but in the long run, it will be worth it. Your passion and focus can take your business to its next level. It's time to get real, make a plan and spring into action.

— Read Forget Doubling Your Business: Why 10x Growth Is Actually Easier on ThinkAdvisor.