Size matters

When we published our recent paper, ‘No small change’, we generated some bizarre reaction in parts of adviser world. One anonymous commentator implied very foul language, indicated that disagreeing with him would be brave and referred to ‘grassing up dinner ladies’. The last comment rather lost me, but hey ho. These unpleasant remarks were addressed at an IFA who had the temerity to agree with our findings.

So lets go back to this apparently contentious issue – size matters.

Our hypothesis on this one is that RDR creates a much greater load for the adviser business to carry, in terms of regulatory requirement, research and operations. If one intends to run an independent, directly regulated practice (which may be IFA or whole-market restricted), the hurdles are much higher than they were. The requirements to demonstrate due diligence on all aspects of process and advice are onerous. This amounts to a core cost to the business in time and money.

The question we initially asked ourselves was how many advisers are required to amortise the cost of this load? In answering the question, we are looking at three issues:

• Profitability
• Quality of advice
• Succession

I will not dwell too much on the first. If anyone believes a non-profitable financial advice business is sustainable or desirable, please stop reading – we will not agree on anything. Our benchmark is a margin of >20%. Anything lower will not attract capital, and good businesses should attract capital; the sector needs to attract capital to survive and prosper; businesses need to be profitable to have a value.

The issue of quality of advice is crucial. If a solitary adviser is IT director, compliance officer, in charge of operations as well as advising on investment, pensions, protection et al AND conducting all requisite research, he is super human. IT CANNOT BE DONE!

As a client, why on earth would I trust my financial planning and investment needs to a jack-of-all-trades rather than a proper business where there are full-time experts on all key areas?

Finally, there is the issue of succession. I might live until I am 90. As my wife and I become old and probably infirm, our dependence on our adviser increases. Most advisers are of similar age to their clients. Long after they retire, their clients will continue to need financial advice.

Even if advisers are much younger, they may die, become disabled, leave the industry or emigrate. They may leave the industry because they fail to keep up with regulatory demands e.g. qualifications. I repeat, why as a client, would I take the risk.

I am sure many will attempt to run one/two man firms. They might survive for some years, but their income will drop. They will become uncompetitive because they will not have the resource of their better structured peers. They will probably lose clients, as clients will make informed decisions. Their business will have very little value as they with fail to achieve industry benchmarks that will become the norm.

We estimate that the minimum optimal business has three managers, five advisers, three paraplanners and a couple of administrators. This is an educated stick in the ground. It does not mean that a good business cannot be smaller. I doubt if it can be that much smaller.

A couple of other points:

1 We are assuming a certain amount of outsourcing. We expect an efficient firm to outsource investment research to Morningstar, FE or RSM or similar; we expect some compliance to be outsourced; we expect an outsource facility be set up for paraplanning, at the very least to handle high volumes.
2 We are not talking networks here. Whilst we believe that there will be successful forms of networks in the future, the days of the traditional network of self-employed IFAs, doing their own thing whilst being ARs of a firm, largely dependent on insurer and fund manager “contributions” to remain profitable, are over.

Ultimately, those who matter most, customers, will be better off in brave new, post-RDR world, because advisory firms employ professional advisers with specific competences in properly resourced practices. They will provide good advice at a sensible price, – good for staff, for shareholders or owners and for clients.

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18 thoughts on “Size matters

  • Are clients really that rational when selecting a client? Do they really think beyond the next 5 years when choosing an adviser?There is usually some trigger which prompts a need/desire for advice. A large % of that desire is fulfilled with the initial plan/solution (in perception if not reality). As a result I would argue that clients are still buying what’s in front of them, not the possibility of advice from the same business (if not adviser) in 20.years time. And they still have no idea or way of benchmarking or understanding what a ‘good’ adviser looks like, now everyone is at a new minimum qualification level and charges a fee.

    Some good, challenging, thoughts as ever though, Clive.

    Reply
  • Clive,

    Thank you for writing (and Fidelity for funding) this report. I was going to comment under your article in the pinks, but couldn’t be bothered after reading the trolls.

    Your report throws up a number of great points, not least the sustainability of the %AUM fee model.

    I will be using it to form the back bone of this year’s business plan.

    As part of a 2.5 adviser + 2.5 support staff firm I have “known” we are probably sub-scale for a while, without being able to articulate it as well as you.

    I also see big problems with the national model based on self-employed advisers. I think it is breaking down before our eyes. Whether or not those advisers will comply with the new “rules of the game” as employees with less say over the service proposition is one of the central questions of the next few years.

    There are possibly only two things you underestimated:

    1 The violence with which people object when you present them with unpalatable truths which threaten their livelihood…

    2 The willingness for many business owners to accept negligible profits in return for running their own business. As Phil Young says, people are not rational. I would suggest IFAs are even less ration than the average! So I expect the actual sizes of firms to remain lower than the 13 you suggest.

    Your next job is to update the Cerulli Associations 2011 survey!

    Tim

    Reply
  • Rational behaviour has rarely been applied in financial services by product manufacturers, advisers or their clients. If we had rational behaviour we wouldn’t have had the 2008 market crash, the RDR or for that matter, the first and second world wars. We have to work with what we have rather than what we believe is rational. Many advisers have chosen to run their business the way they do, idiosyncratically, rather than following a ‘commercial’ blue print. I prefer to celebrate that difference. Many advising firms may not be a business as Clive explains it, but it is a worthwhile way of adding value to the community. And it keeps a group of men in suits off the streets. A social good in itself in these times of overcrowded footpaths.

    Reply
  • I was unable to attend the meeting that launched the paper a few weeks ago, but had I been there I might have asked a few questions to get some clarity on several points.

    For example, the optimum firm size must surely have (as an assumption) an annual income level per adviser (what is it?) which needs to support the infrastruture that sits within the firm.

    There will also be an assumption about the make up of the income, such as how much from new clients (lots of advice and implementation) and how much from existing clients (advice and AUM). Newer and growing firms may require more in terms of admin and paraplanning than, say, a mature bank of clients.

    Without knowing the assumptions you have made it is hard to see how (or even why) you reach the ‘educated’ optimum size that you have. And optimum in what regard, biggest bang for your buck, or rather ‘greatest return on capital employed’ – what is your measure for optimum success – 20% profit?

    I posit that it possible to run a succesful and profitable firm significantly smaller than your ideal size, and that there will be many of them around. It may also be that they are not ‘all things to all people’ but specialise somewhat, as well as outsourcing more, as required.

    What you describe may be what an average firm, with average people, delivering average service to average clients, for average fees, (you get my drift) needs, but if you change from being just ‘average’ you can change the results too. The’ size is important’ that you refer to shouldn’t only apply to head count, but can equally apply to a number of other metrics too.

    Reply
  • Whilst I agree with the central tenet, I must take issue with the assertion that good businesses should attract capital. This seems to imply that growth is essential to survival.

    If a business is profitable, it does not need to grow, it can continue to make profit. It may expand or contract organically, but there certainly is no reason that it has to take on capital to expand. Not taking on capital has been a basic principle of my business for 15 years!

    Reply
    • Chris – an excellent point. Well made.

      Reply
      • Dennis, how we missed you at the launch! Of course, it is impossible to encapsulate 70 odd pages into a single article. You are quite right that the true measure is fee income, not advisers. Thus, an adviser producing £500,00 in fees is equal to three more typical individuals. However, there are good reasons for having several advisers (as you and I have discussed) around succession and range of competences. Regarding specialisation, you are on dangerous ground, as the regulator expects IFAs to cover all areas and you cannot refer, as any other profession can – a good reason for adopting restricted/whole market status possibly.

        On the issue of capital, I used the word ‘attract’, not accept. You may not employ external capital in your business – I don’t. However, you surely want it to be attractive, as one day you will presumably wish to sell it. It might be amusing to argue over a glass or two examples of IFA businesses that are viable and competitive, yet have no capital value, but it would be semantics. Importantly, as an industry or profession, if the return is too poor to attract capital, it will not be successful and will not have a future. New firms will require capital – more so in a fee-based market place, and we need the lifeblood of new young businesses.

        Dennis, your comments on averages are technically true, but naughty! The averages (or benchmarks) we are proposing are probably the levels being hit by the top 5% of advisory businesses today. I would say that you could be successful by being amazing in one area and below par in others. It goes without saying that to be amazing in all ………………… !

        Chris, I have had a look at your super website. You have a professional and operationally sound structure (sorry – I know that sounds patronising). Most importantly, your very first words in your “what we do” section are: Lifelong financial advice is what we are all about.

        Brillliant – and you have the structure to deliver. Lifelong planning means to 85 or 90, something the majority of firms will not deliver on as they do not have succession ( we have researched succession on a couple of occasions, and the results were not encouraging).

        A final point.

        Clients selected their advisers (or were sold to) in a pre-RDR environment. A lot more than remuneration has changed. There will be a lot of influences on clients, from every stakeholder in the game – regulator (insisting on a competitive market), providers, distributors, advisers, media and peers.

        If I were an adviser, I would be singing from the rooftops that my business was not about me, but about a team of high quality advisers and planners; a firm that is financially strong and will be around to help them throughout their lives – long after I am retired.

        Reply
  • I broadly agree with your piece Clive but accept that we could all argue over some of the details. I think this is a major issue and there is already a lot of pressure on small firms to step up to the new regulatory requirements. That pressure will only intensify as the FCA starts enforcing some of the new standards. It’s not going to be pretty I suspect.

    There may well be some exceptions (as Dennis alludes to) but the exceptions won’t make the rule. These small successful survivors will be very well run smaller firms, not just your average.

    I am starting to see (dare I say it) polarisation of the business models within advisory firms. There are those adopting a financial planning approach (because it best addresses clients real needs) and those still trying to perform more basic advisory services (transactions or more limited advice) which in the medium to long term are going to come under more and more fee pressure I suspect. With the regulatory cost squeeze as well this doesn’t bode well for ‘small’.

    I take on board Paul Resnik’s comments too. Advisers have defied predictions of their demise for decades, however I think this is the start of a major shift in the forces shaping the industry/profession. Time will tell.

    Great piece.

    Reply
    • Brett, many thanks for kind comments. Much valued from industry giant! Like you, we would argue with the details. The point of the project is to start to create benchmarks. Those that are right today will probably be wrong in 12 months as the sector reacts to change from all stakeholders. We are keen to keep the conversation going so that all input to what will one day be relatively stable benchmarks, ratios and practices. Be good to natter over a coffee.

      Reply
  • I broadly agree with your piece Clive but accept that we could all argue over some of the details. I think this is a major issue and there is already a lot of pressure on small firms to step up to the new regulatory requirements. That pressure will only intensify as the FCA starts enforcing some of the new standards. It’s not going to be pretty I suspect.

    There may well be some exceptions (as Dennis alludes to) but the exceptions won’t make the rule. These small successful survivors will be very well run smaller firms, not just your average.

    I am starting to see (dare I say it) polarisation of the business models within advisory firms. There are those adopting a financial planning approach (because it best addresses clients real needs) and those still trying to perform more basic advisory services (transactions or more limited advice) which in the medium to long term are going to come under more and more fee pressure I suspect. With the regulatory cost squeeze as well this doesn’t bode well for ‘small’.

    I take on board Paul Resnik’s comments too. Advisers have defied predictions of their demise for decades, however I think this is the start of a major shift in the forces shaping the industry/profession. Time will tell.

    Great piece.

    Reply
    • Brett, many thanks for kind comments. Much valued from industry giant! Like you, we would argue with the details. The point of the project is to start to create benchmarks. Those that are right today will probably be wrong in 12 months as the sector reacts to change from all stakeholders. We are keen to keep the conversation going so that all input to what will one day be relatively stable benchmarks, ratios and practices. Be good to natter over a coffee.

      Reply
  • Are clients really that rational when selecting a client? Do they really think beyond the next 5 years when choosing an adviser?There is usually some trigger which prompts a need/desire for advice. A large % of that desire is fulfilled with the initial plan/solution (in perception if not reality). As a result I would argue that clients are still buying what’s in front of them, not the possibility of advice from the same business (if not adviser) in 20.years time. And they still have no idea or way of benchmarking or understanding what a ‘good’ adviser looks like, now everyone is at a new minimum qualification level and charges a fee.

    Some good, challenging, thoughts as ever though, Clive.

    Reply
  • I was unable to attend the meeting that launched the paper a few weeks ago, but had I been there I might have asked a few questions to get some clarity on several points.

    For example, the optimum firm size must surely have (as an assumption) an annual income level per adviser (what is it?) which needs to support the infrastruture that sits within the firm.

    There will also be an assumption about the make up of the income, such as how much from new clients (lots of advice and implementation) and how much from existing clients (advice and AUM). Newer and growing firms may require more in terms of admin and paraplanning than, say, a mature bank of clients.

    Without knowing the assumptions you have made it is hard to see how (or even why) you reach the ‘educated’ optimum size that you have. And optimum in what regard, biggest bang for your buck, or rather ‘greatest return on capital employed’ – what is your measure for optimum success – 20% profit?

    I posit that it possible to run a succesful and profitable firm significantly smaller than your ideal size, and that there will be many of them around. It may also be that they are not ‘all things to all people’ but specialise somewhat, as well as outsourcing more, as required.

    What you describe may be what an average firm, with average people, delivering average service to average clients, for average fees, (you get my drift) needs, but if you change from being just ‘average’ you can change the results too. The’ size is important’ that you refer to shouldn’t only apply to head count, but can equally apply to a number of other metrics too.

    Reply
  • Rational behaviour has rarely been applied in financial services by product manufacturers, advisers or their clients. If we had rational behaviour we wouldn’t have had the 2008 market crash, the RDR or for that matter, the first and second world wars. We have to work with what we have rather than what we believe is rational. Many advisers have chosen to run their business the way they do, idiosyncratically, rather than following a ‘commercial’ blue print. I prefer to celebrate that difference. Many advising firms may not be a business as Clive explains it, but it is a worthwhile way of adding value to the community. And it keeps a group of men in suits off the streets. A social good in itself in these times of overcrowded footpaths.

    Reply
  • Clive,

    Thank you for writing (and Fidelity for funding) this report. I was going to comment under your article in the pinks, but couldn’t be bothered after reading the trolls.

    Your report throws up a number of great points, not least the sustainability of the %AUM fee model.

    I will be using it to form the back bone of this year’s business plan.

    As part of a 2.5 adviser + 2.5 support staff firm I have “known” we are probably sub-scale for a while, without being able to articulate it as well as you.

    I also see big problems with the national model based on self-employed advisers. I think it is breaking down before our eyes. Whether or not those advisers will comply with the new “rules of the game” as employees with less say over the service proposition is one of the central questions of the next few years.

    There are possibly only two things you underestimated:

    1 The violence with which people object when you present them with unpalatable truths which threaten their livelihood…

    2 The willingness for many business owners to accept negligible profits in return for running their own business. As Phil Young says, people are not rational. I would suggest IFAs are even less ration than the average! So I expect the actual sizes of firms to remain lower than the 13 you suggest.

    Your next job is to update the Cerulli Associations 2011 survey!

    Tim

    Reply
  • Whilst I agree with the central tenet, I must take issue with the assertion that good businesses should attract capital. This seems to imply that growth is essential to survival.

    If a business is profitable, it does not need to grow, it can continue to make profit. It may expand or contract organically, but there certainly is no reason that it has to take on capital to expand. Not taking on capital has been a basic principle of my business for 15 years!

    Reply
    • Chris – an excellent point. Well made.

      Reply
      • Dennis, how we missed you at the launch! Of course, it is impossible to encapsulate 70 odd pages into a single article. You are quite right that the true measure is fee income, not advisers. Thus, an adviser producing £500,00 in fees is equal to three more typical individuals. However, there are good reasons for having several advisers (as you and I have discussed) around succession and range of competences. Regarding specialisation, you are on dangerous ground, as the regulator expects IFAs to cover all areas and you cannot refer, as any other profession can – a good reason for adopting restricted/whole market status possibly.

        On the issue of capital, I used the word ‘attract’, not accept. You may not employ external capital in your business – I don’t. However, you surely want it to be attractive, as one day you will presumably wish to sell it. It might be amusing to argue over a glass or two examples of IFA businesses that are viable and competitive, yet have no capital value, but it would be semantics. Importantly, as an industry or profession, if the return is too poor to attract capital, it will not be successful and will not have a future. New firms will require capital – more so in a fee-based market place, and we need the lifeblood of new young businesses.

        Dennis, your comments on averages are technically true, but naughty! The averages (or benchmarks) we are proposing are probably the levels being hit by the top 5% of advisory businesses today. I would say that you could be successful by being amazing in one area and below par in others. It goes without saying that to be amazing in all ………………… !

        Chris, I have had a look at your super website. You have a professional and operationally sound structure (sorry – I know that sounds patronising). Most importantly, your very first words in your “what we do” section are: Lifelong financial advice is what we are all about.

        Brillliant – and you have the structure to deliver. Lifelong planning means to 85 or 90, something the majority of firms will not deliver on as they do not have succession ( we have researched succession on a couple of occasions, and the results were not encouraging).

        A final point.

        Clients selected their advisers (or were sold to) in a pre-RDR environment. A lot more than remuneration has changed. There will be a lot of influences on clients, from every stakeholder in the game – regulator (insisting on a competitive market), providers, distributors, advisers, media and peers.

        If I were an adviser, I would be singing from the rooftops that my business was not about me, but about a team of high quality advisers and planners; a firm that is financially strong and will be around to help them throughout their lives – long after I am retired.

        Reply

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