Knowing that every financial advisor has a number of low-profit or even unprofitable clients, I often challenge the decision to maintain those relationships by posing two business questions: How many of those relationships are acceptable? Why are they acceptable? There are many variables that factor into client acceptance and retention, but to begin answering the question of how many sub-optimal clients are acceptable, it might be helpful to understand the economic implications of the decision. A good place to start is to understand what drives gross profit margin (not net margin) in a firm. Gross profit is the amount that is left over after fair compensation, which we refer to as "direct expense," is paid to all professional staff, including the owner. Gross profit margin is determined by dividing gross profit dollars by revenue. The optimal practice will consistently produce in the range of a 60% gross profit margin, meaning that for every $1 of revenue, the practice generates 60 cents in gross profit.
When an advisory firm's gross profit margin is declining or below an acceptable benchmark, the problem is typically caused by one of five factors: poor pricing; poor productivity; poor service or product mix; poor payout (?? la strategic partnerships); or poor client mix. One needs to maintain a reasonable gross profit margin in order to pay for the practice's overhead and produce a reasonable return for the risk of ownership (operating profit margin).
Client mix is a driver of gross profit and warrants examination. Obviously, every advisor has clients whose benefit to the practice is obvious. Some generate high fees; others are sources of referral; others are the children of good clients; and still others are positioned through work or inheritance to eventually become high-value clients. An analogy here might be a diversified portfolio. In combination, the basket of investments a client holds will produce an overall return, but what is the appropriate allocation of investment choices to achieve the optimal or desired return? This becomes the question for advisors: How many clients at each level is optimal or acceptable in order to maintain the appropriate gross profit margin which allows him to produce a return and reinvest in the business?
There are many legitimate, non-financially-driven reasons why advisors keep clients who are not currently profitable, just as there are many poor attempts to rationalize relationships that really aren't right for either party. The reality is that every professional service business has a combination of clients they like and don't like, from whom they generate a return and from whom they don't. I've never been a big fan of culling clients purely for financial reasons. I don't think it's necessary to make a profit on each individual client, considering that all relationships are dynamic and many exist for reasons not related to direct compensation.
Cost vs. Duty
Unless you have discovered ways to expand the clock without taking away from others, including yourself, each decision to accept clients who do not pay their way will inhibit your ability to serve everyone well.
When confronted with the dilemma whether to keep or accept a particular client, try processing the decision through the filters of duty: duty to the community, to other clients, to employees, to yourself, and to your business.
Duty to the community. How many pro bono or discount relationships can your practice absorb in order to help others who cannot help themselves? Many advisors have a legitimate sense of obligation to provide guidance without expectation of return to some segment of the working poor or to those unprepared for retirement or a health care crisis. Good business citizens recognize that using resources to aid others ultimately benefits their community. It's just the right thing to do.
Duty to your clients. Is it ethical and fair to expect your richest clients to subsidize your poorest clients? If all of your clients get the benefit of the same advice, who ultimately allows you to be so generous? Further, by spending time, energy, or salaries on helping those who are not generating substantial profits, if any, are you taking time and attention away from those who are paying your bills?
With respect to the not-so-wealthy, advisors tend to make two choices: 1) provide a reasonably high level of service out of proportion to the income received from these clients; or 2) delegate these clients to an inexperienced or low-level staff person or advisor. In the first case, you're doing what's right but probably sacrificing time that could be spent on others. In the second case, you're basically saying the clients are not worthy, but you want their fees anyhow. Either way, it's possible that somebody is getting cheated.
Duty to your employees. By clogging up your pipeline with so many unprofitable or marginal relationships, do you impose more work on others so that you can feel good about yourself? Who's handling those "C" and "D" relationships? Will the experience help your employees be better advisors or keep them in career limbo? Will serving your lower-end clients mean they have to compress more work into less time in order to serve them? What else are they not doing because they are serving those clients?
Duty to yourself. Nearly every advisor I meet complains about not having enough time to both manage their business and serve their clients; or not enough time to pursue their optimal prospects because they are too consumed by managing existing relationships. The tendency of entrepreneurs is to expand their workday to squeeze everything in, which ends up frustrating efforts to find a balance in their lives. How much are you willing to give up in order to maintain such relationships? Are you being fair to your family and to others who need and demand your attention? Are you willing to pass on taking larger, more complex clients in order to continue tending to the sub-optimal relationships or to free time for other personal demands?
Duty to your business. As a steward of your enterprise, no matter how big or how small, you must ask yourself this: Does having a large proportion of clients who consume resources and suck up time and profit impair your ability to invest in technology, processes, and people in order to serve all your clients well? The reality is that the advisory business is becoming more complex and more expensive to operate at all levels. While many may have come into this profession with the desire to help others, a failure to recognize that you have a fiduciary responsibility to your enterprise and the people you employ is a violation of a basic covenant of business ownership.
John Kenneth Galbraith used the term "conventional wisdom" in his book The Affluent Society to describe economic ideas that are familiar, predictable, and accepted by the general public. The "80/20 Rule" has become conventional wisdom and therefore acceptable to most in the advisory business. The rule is that it is acceptable to have 80% of one's revenue generated from 20% of one's clients. However, I find that this rule is less wise than it is conventional. It says that it is acceptable to have 80% of one's clients who are not in your sweet spot--it is acceptable to have 20% of your clients subsidize the 80% who are not profitable.
In having looked at thousands of financial advisory practices, I often see that the reason practices have costs rising faster than revenue is because they are continually investing in the 80% who are not optimal or helping their business grow. In what other enterprise besides a charitable organization are the vast majority of relationships pro bono?
Once an advisor moves past the survival stage on the course to self-fulfillment and personal financial success, he can afford to share more of his wealth (of knowledge and money) with others--but not at the cost of his other obligations. So perhaps this warrants a rule change: 20/80 instead of 80/20, or even better, let's follow the 50/50 Rule that dictates a more balanced commitment between the haves and the have-nots.
Unless you're able to live an entirely duty-free existence, your obligation to others is your master, but recognizing how to strike that balance means truly mastering your obligations.
Mark Tibergien, a principal in Moss Adams LLP, is chairman of the firm's Securities & Insurance niche. A nationally-known consultant to advisors, he is the co-author of Practice Made Perfect, available through the IA Bookstore. Readers may e-mail him at firstname.lastname@example.org.