For most advisors, analyzing the profitability of their business is something they’ve been intending to do: “I know I should do that – but I just haven’t had the time.” Yet when they finally do, many advisors have been surprised, almost shocked, to learn how unprofitable the bottom 50%, 60% or even 70% of their client base actually is.
The first step in analyzing a practice’s profitability is knowing how much revenue is coming in and where it’s coming from. Start by running a list of client households and the revenue each has generated over the past 12 months. If this information isn’t easily available in a report from your clearing firm or broker-dealer, you may need to run the list by client and then group the clients by household using the last name and/or address. Put the information into a spreadsheet. Combine revenue for each client in the household into one amount for the entire household.
Next, sort the households by revenue, greatest to least. Segment the list into 10 parts and calculate the revenue per decile. What percentage of your revenue is coming from the top 20%? According to the Pareto rule, those top two groups will contribute about 80% of your total revenue.
The second layer a firm’s profitability analysis is expenses. What does it cost you to do business, and what are the costs associated with serving specific clients? Expenses usually fall into three categories: Fixed expenses, variable expenses and time costs. Fixed expenses fund the existence of your business, including office space, equipment and utilities; variable expenses for certain segments of your client base – for example, special or additional services for top clients or niche clients
Time costs – the value of your time and your staff’s time – can be the most difficult to measure. You have time spent on running the business itself and then time spent serving clients collectively and clients individually. If 80% of your revenue comes from the top 20% of your client households, do those households get 80% of your practice’s total time spent serving clients?
COST OF CLIENTS
Compiling a spreadsheet to calculate the cost of clients requires a little more effort than the revenue analysis. You may need to review the past quarter or two quarters with your staff to arrive at an hours-spent figure for each client or household.
Another approach is to implement a client time-tracking sheet and ask staff to log time spent with clients on account maintenance, annual or semi-annual reviews, performance reporting and trouble shooting. You may want to track your time separately from staff time, as your “hourly rate” should be significantly higher. Assign hourly values for staff time and advisor time, and calculate the total time cost per client or household.
By subtracting the time cost of the client from the revenue cost for the same period, you can arrive at a simple profit/loss for each client. Sort your list again by the P&L column, and compare to your initial revenue analysis. Did some households drop from the top 20% and others rise up? What percentage of households landed in the red zone – those who are actually costing you to serve?
Now comes the more difficult (but incredibly valuable) part – deciding what to do with your analysis. Your first priority should be ensuring that clients in the top 20% of profitable households never have a reason to go elsewhere. Meet with your staff so they understand who these clients are and determine how they will be treated differently from other clients. That’s not to say that your other clients should receive poor service; it’s a matter of prioritization. For example, if your service standard for all clients is to return calls and emails within 24 hours, your top 20% of clients may get calls and emails returned within two hours.
Of course, further segmenting your client base, establishing service levels for each segment and adjusting client expectations may require additional considerations beyond the simple P&L.
Chris Kirby, Senior Business Consultant, Securities America Financial Corporation. Chris is a business consultant for Securities America's Practice Management Group and serves as a consultant/coach for the firm’s Business Consulting Service, helping advisors manage a more efficient, profitable and satisfying practice.