Practice Value

Pricing pressure continues to increase for advisory services. No matter how lean the operation, there is always the temptation to increase overhead since many times it's a quick fix to the wants and needs of the client base. But with increased overhead comes increased cost, and if you pass those rising costs along to your clients in the form of higher fees, your clients may start to find other firms more attractive. In this issue of PracticeEdge, we analyze the fee structures and pricing levels within the financial advisory marketplace to try and get a better grasp of what works and what doesn't.

Good News, bad news

One of the more interesting things uncovered by our research is that major fee reductions haven't actually taken place. However, we did find that advisors are being asked to provide more services and more attention for the same fees they charged up to four years ago. For example, the average number of services provided to clients was eight in 2005, as compared to six in 2004, yet the median fee slid slightly from 1% to 0.98%. Rising competition encourages advisors to reduce their fees or adopt more services to attract and retain clients. Both these actions can put a real squeeze on an advisor’s bottom line.

Also, while many firms struggle with the pricing issue, many best practices¹ have been able to increase their fees without losing clients. And while some may argue that this points to inelastic demand on the part of consumers, the truth may instead be that one should never count out the power of brand recognition. Many other industries carry examples of companies who can charge more than their counterparts and flourish. Advisors may do well to borrow a page from these companies and not attempt to compete on price and instead build your perceived value with their clients.

¹To identify the best firms in the industry, we applied a multi-criterion score model to determine the top advisory firms by examining four variables: size of firm, growth rate, profitability and range of services offered.

An important part of planning for your business is estimating both your costs and revenues, so you can understand what it takes to run a profitable practice. In the chart below we showed both the costs (expenses per client) as well as the revenue that would likely come from the fees you charge your clients.

The average RIA firm has about $3,000 in expenses per client, as opposed to the top firms which spend about $8,000 per client. To offset the costs of operation per client, the top firms’ average fees hover around 1.2% compared to the average firm’s fees of o.98%. Top firms tend to be more profitable than average firms because they have more clients on average and these clients tend to be more loyal, while average firms expend a good deal of effort attracting new clients, as their loyalty rate is typically lower. The top firms clearly don’t compete on price, and surprisingly, top firms offer an average of six services per firm, compared to the average firm’s eight services.

The average RIA had $394,904 under management for every client compared to $1,702,998 under management for every client for the best firm.

The lesson here is that the right mix of services, the amount of attention you pay to your clients and the size of client accounts play a big role in determining the appropriate fees for your business.

It’s important to resist the urge to reduce fees and compete with other firms based on cost. The value you bring to your clients can’t be measured in a five basis point cut. Instead, consider thinking about the other side of the equation—how can you add value and potentially consider raising your fees?

Shore up your client relationships: Make sure your clients are aware of all the elements and work that goes into managing their account. Have a good understanding of what is important to them so you can work on enhancing their loyalty to you. This will reduce the need to continually bring in new accounts to make up for lost ones.

Pricing methods: Utilize the most suitable pricing methods for the different types of clients served or for different categories of services rendered. Pricing models include AUM, hourly, project and consulting fees, as well as retainers. You may decide to be solely compensated using one of the methods above (i.e. AUM fees). Most firms however, typically use a combination of these models. Clients who are more high maintenance should pay more for the use of your time than those who need less attention.

Pricing levels: Check the viability and competitiveness of your current AUM fees, including breakpoints. A good start would be to benchmark your fees against other advisors using the AdvisorBenchmarking study, for example. Your breadth of services and caliber of clients are even more important determinants of your fees’ appropriateness.