The Road to Profitability

“We know exactly what our revenues are per plan,” says Bud Pernoll, Bay Mutual Financial’s Senior Managing Director. The Santa Monica-based employee benefits advisory firm uses Quicken and QuickBooks programs both to track time spent servicing clients, and to create spreadsheets to determine revenues.

That, apparently, is far from the norm. Advisers, particularly those who serve the small to mid-size market, generally have not tracked profitability on a per-plan basis. “Most advisers are sales people first, and business people second,” admits Fred Barstein, President and Chief Executive Officer of 401kExchange in Greenacres, Florida.

In addition to not knowing per-plan profitability, most advisers do not know their hourly rate—i.e., they do not know their earnings per hour—says Charles Epstein, Founder of the 401K Coach training program, in Holyoke, Massachusetts. Knowing their hourly rates, he says, helps advisers to understand when it is best for lower-paid employees to work with clients. Traditionally, says Epstein, for the most part, the industry set the standard as to what was an appropriate “commission’ or fee to charge: for example, 1% for the first year and 0.25% thereafter.

Advisers, Epstein says, should calculate their overhead costs and what they need to earn on each line of business to be profitable. Additionally, for advisers to be successful, they need to know the minimum revenue they need from each new client, he says.

In a tightening market, there are signs that advisers are doing just that. There is a growing appetite for advisers to manage their practice like a business instead of like a practice, says Susan Theder, Managing Director of Segment Marketing at Pershing LLC in Jersey City, New Jersey. Top-tier firms already track profitability, she says, but now it is moving down to smaller ($500,000 to $1.5 million in revenues) and mid-size ($1.5 million to $5 million in revenues) firms.

Historically, advisers did not track profitability because there was little need to—just getting a new plan pretty much guaranteed profitability, note commentators. Plans generally demanded minimal support after the original setup and advisers were guaranteed a regular income stream from 12b-1 and other fees.

Tracking profitability, however, is more of an issue today because of the deflationary pressure on fees in corporate defined contribution plans, says Barstein, and the drop in asset values has exacerbated the trend. Having spoken to, and surveyed, thousands of advisers, he says, “Throughout the market, there is deflation in what the adviser can charge, so people are looking at profitability.” Further, he says, advisers now are expected to provide more services for the fees they receive.

Although, in theory, advisers can charge whatever they want, in reality, the market will only let advisers charge what the market will bear. In the last five to seven years, says Barstein, the fees advisers can charge clients on plans in the $10 to $100 million range have dropped significantly because of increased disclosure and competition and more sophisticated clients. Fees for plans with less than $10 million also have gone down, he says, but not so dramatically. Five to 10 years ago, says Barstein, wirehouse advisers would put a plan with $100 million in assets into A shares and earn 25 basis points, or $250,000, annually. Changes over time, however, have brought that down, and now the typical fee on a plan that size would be 7 to 15 basis points, excluding additional fees for education, special projects, and searches, among other potential services.

Additionally, when markets go down, for advisers getting paid through commissions, profit margins shrink, says Pernoll—something that is not necessarily the case for those getting paid by hard-dollar fees. Plan assets have lost value and, consequently, fees generated by those reduced assets are lower, yet advisers still need to spend money to service the plan, he says.

Determining actual profitability, however, can be tricky and must take into account incremental overhead costs. A first step is to track time spent on each client’s account, says Mark Temple, the Managing Director for Institutional Retirement Plans at O’Hanlon Michener & Douglas, LLC, a National Retirement Partners member firm in Slingerlands, New York. If advisers calculate the time dedicated to each customer, profitability evaluation becomes more objective, he says.

Advisers, notes Temple, tend to view customers as friends but, when you take the emotional factor out of it, he says, advisers may realize that some “friends’ are not actually profitable clients. The next step is to determine how much revenue each plan or client is bringing in, and compare the time spent servicing the client to the revenue that client generates.

Additionally, advisers should create benchmarks to determine average profitability per client, says Dan Inveen, Senior Research Manager with Moss Adams LLP in Seattle, Washington. For example, one benchmark would be to take total profits and divide by the number of clients. Next, track revenue generated by each client, matching that up with the time spent servicing and the expenses associated with that client, and compare those figures to the benchmark.

Available Tools

There are a number of products available to help advisers monitor profits. For example, client relationship management software products allow advisers to track time spent on each client and revenues generated by that client, says Inveen. The software, he says, can detail specifically what kind of workload a client is creating on staff and how that measures up in terms of the revenue generated per client. Popular client relationship management packages include Junxure and ProTracker Advantage, says Inveen.

NRP’s client relationship management (CRM) software allows advisers to track client revenue streams, says Temple. Since NRP focuses solely on ERISA advisers, he says, the software was developed specifically for advisers working in this space. The proprietary software tracks the time spent servicing each customer and tracks revenue earned per client. Advisers also can assign a variable as to the ease of interface with each customer, says Temple. This means that, in addition to straight profitability, users can factor in the complexity involved in servicing clients. Advisers, he says, can take into account site visits, face-to-face meetings, and whether or not the client requires a lot of babysitting. NRP’s CRM, says Temple, allows advisers to quantify hours spent on clients for travel, meetings, reports, conversations, etc., coupled with qualitative analysis that takes into account ease of interactions—i.e., you cringe or not when you see a client name appear on an e-mail or phone call—and revenue generated. This equates to profitability analysis of each client relationship.

SEI has a business assessment process for registered investment advisers (RIAs) that helps them assess their businesses against benchmarks, says Kevin Crowe, a Senior Managing Director with SEI Advisor Networks in Oaks, Pennsylvania. Leveraging data from a study of RIAs conducted by Moss Adams, it shows registered investment advisers where they are spending money, and what they are doing differently from more profitable advisers (those who take home more in revenue), he says.

Pershing also has a number of tools designed to help both registered investment advisers and advisers/investment professionals within a broker/dealer track profitability, says Theder, including a practice simulator that allows advisers to project future profits. After advisers are prompted through the simulator, says Theder, the program gives them profitability models and projects those results out five years.

HealthCheck is a Web-based business diagnostic tool that can assess 30 areas of an adviser’s practice, says Ray Henderson, a partner with Business Health Pty, Ltd, a Boston, Massachusetts-based consulting firm that provides services to the financial services industry. It asks the adviser a series of questions and measures the practice across a range of areas, including planning and client communications.

Once advisers know what they are making per plan or client they can make appropriate strategic business decisions as to whether or not to continue to service that client or plan, and at what levels. “With price pressure,” says Barstein, “advisers now have to see if it’s worth it, and maybe walk away if it’s not.” Advisers, he says, should price out the minimum fee they will accept and, if the client or potential client wants it done for less, the adviser can walk away.

Unprofitable Clients

Pernoll believes that, although it is not a “hard and fast’ rule, every client should be profitable. If it looks like profits on a particular plan are narrowing or there could be a potential loss, his firm speaks with the client to see what can be done to remedy the situation. Pernoll says his firm has walked away from clients if something was not worked out to maintain profitability (see “Breaking Up“).

Of course, say experts, there may be a difference between an unprofitable plan, and an unprofitable relationship. In defining a good client relationship, says Epstein, advisers have to look beyond just the dollars brought in. A plan could be a loss leader for other business from the client, points out Barstein. Or, he says, the client could serve as a great reference to get other clients. Furthermore, a plan may be losing money one year—particularly if it’s a new client—but it could be a profitable plan in the future.

Another reason to stick with an unprofitable plan, says Inveen, is that the work generated by the client may further the skills and experience level of staff so that the adviser can market itself to other clients in need of those skills and experience level. However, says Barstein, while there may be reasons to put up with an unprofitable plan or client, advisers should, at a minimum, know when they are losing money.

Profitability Potential

It is natural that advisers want their practices to consist solely of clients that generate income and are easy to deal with, notes Mark Temple, the Managing Director for Institutional Retirement Plans at O’Hanlon Michener & Douglas, LLC, a National Retirement Partners member firm in Slingerlands, New York. So, prior to taking on new clients, advisers should evaluate potential profitability. Once advisers learn what factors determine profitability, he says, they can weed out prospects unlikely to become profitable.

There are five factors that can determine future profitability, says Fred Barstein, President and Chief Executive Officer of 401kExchange in Greenacres, Florida. First is the level of account balances. If a plan currently has low account balances but salaries are high and deferrals low, there is a lot of growth potential. Second, review investments—for example, if a high percentage of assets is invested in employer stock that could mean lower fees, certainly for commission-based advisers. Third, consider the number of employer locations, and the time needed to visit those locations. Fourth, whether or not the client wants the adviser to act as a fiduciary, since additional risk is involved in being a fiduciary. Fifth, participation and deferral levels—if the plan already has a 90% participation rate, high deferrals, and most of the investments are in equities, there may be less upside revenue potential.

Illustration by Jonathon Rosen