We frequently field questions from advisors on the topic of pricing. The questions usually start with, "How much should I be charging?" or more frequently, "What are other people charging?" To answer the first question-how much, or equally important, in what way should an advisor be charging-we have to understand a number of things about the advisor's practice:

What is it the firm is offering to clients? What is the value provided to clients?

How does the firm want to position that offering in its market? Does it want to be the low-cost leader? Does the firm want to charge similar fees or higher fees than other firms? How do the offering and client service experience compare with those of other firms in the market?

How much does it cost the firm to create the client service experience it promises?

Your pricing strategy should be the confluence of three factors: 1) the cost to deliver service; 2) the value of what you deliver; and 3) what the market charges for similar products/services.

Let's look at each of the three factors in turn.

The Market

Moss Adams gathers data on pricing and pricing trends in its annual study of advisory firms, and our data has shown that charging fees based on assets under management (AUM) continues to be the dominant pricing method for most firms, even among those that do more than manage assets. The preliminary findings from our 2008 study (the Moss Adams 2008 Financial Performance Study of Financial Advisory Firms, sponsored by Genworth Financial) indicate that 68% of firms charge at least 75% of their clients by AUM only, and 73% of firms charging an AUM fee bundle in other services for the same fee.

The method of charging clients varies somewhat based on the size and structure of the firm, though AUM fees dominate across all structures. (See Figure 1.)

For those firms that charged on the basis of assets under management, the median fees as a percentage of assets under management varied based on the size of the client, as you would expect. (See Figure 2.)

It is hard to tell by looking at this data exactly what services are included in the fee being charged. It's also hard to tell what level of expertise the firm employs in delivering those services or what charges the client is paying for that are outsourced by their advisor. Without knowing what is delivered for the fee being charged, advisors find it difficult to evaluate their own fees in the market. It's also difficult for consumers to compare one advisor's fees to another. Yet the most important information you can provide to clients in regard to your fees is transparency on what they are paying to whom and for what. If they are "comparison shopping," the information you need to be armed with is not just what your market competitors charge, but what is included in their fee. If you are charging more, do not start by lowering your fee. Start by describing the value you deliver.

Value

Which leads us to the next factor on the list: considering the value being provided to clients. This is certainly the most difficult thing to articulate and measure. In fact, your fees can contradict the message about your value. Take advisors who claim, "We are not in the business of delivering investment returns but delivering financial peace of mind." What does it say if those same advisors charge a percentage of assets under management, just like those who are in the business of delivering investment returns? At best, they are confusing their clients.

Granted, financial peace of mind is not as easy to measure and articulate, but it makes more sense to me as a consumer of financial advice if advisors say, "My job is to provide you with advice to help you achieve your life objectives," and then charge me based on either the advice they give me or their success in helping me achieve my life objectives. If they say, "My job is to manage your assets," then I would expect them to charge me an AUM fee. If they are both providing me with advice and managing my assets, I would expect to pay them for both of those services. If the two services are bundled together into one fee, I would like to understand the basis for both. Not so I can comparison shop, but because the fee I am charged tells me something about the nature of our relationship-it tells me what I am paying them to do.

Though we did not ask the question in our 2008 study, in our 2006 study (Moss Adams 2006 Financial Performance Study of Financial Advisory Firms, sponsored by JPMorgan and SEI Advisor Network) we found that 57% of firms charged separately for a financial plan, with planning fees ranging from $1,500 to $5,000 (though anecdotally I know several firms that charge five times that-or more-to take clients through the financial planning process).     Again, the question of what is included in the plans delivered for those fees will lead to different answers across the board.

In our 2006 advisor study, we did see indications that some advisors are considering switching their charging methods: More advisors said they planned to use fees based on AUM (49%), planned to use retainer/relationship fees (39%) or planned to use hourly/project fees (27%). Meanwhile, fewer advisors anticipated using commissions (29%), while 12% said they planned to move away from hourly/project fees. (See Figure 3.)

When it comes to aligning your fees with the value you deliver, the best thing you can do is ask yourself, "What is it I am delivering to clients? Do my fees align with it? If I say, 'This is what I do' and 'This is how I charge,' do the two make sense together, or am I charging one way for doing something else entirely?" Bringing these things into balance is just half the battle. The other half is properly articulating your value proposition to your clients. Educate them and make clear why they are better off as a client of your firm.

Cost

For the most part, the third factor in your pricing is an accounting exercise, and I would say this exercise gives you the minimum floor you can charge clients to break even. This is not a way to assess your value; it is just a way to assess your costs, which should in turn define the minimum pricing level. For most advisors, examining the economics of their client relationships and making conscious decisions (instead of unconscious ones) about working with clients who are not profitable is a necessary and positive step for the business.

To assess the cost of serving clients, you need to assess and allocate costs in three categories:
1. Fixed overhead costs, which are equal across all clients or segments
2. Variable overhead costs, which differ by client or segment
3. Time costs, which vary by client (or to simplify, vary by client segment-A's, B's and C's, for example)

To begin with, identify your fixed costs-support staff salaries and overhead expenses that are about the same for every client (paper clips, reception, rent-unless you really want to dice it finely). Then allocate these fixed costs by taking total overhead and support salaries and dividing it by the number of clients to determine your cost per client. Think of profit as a cost in this exercise and build in your required profit margin.

Example:
Fixed Overhead + Support Salaries = $500,000
Number of Clients = 250
Fixed Cost Per Client = $500,000/250 = $2,000
Desired Operating Profit Margin = 25%
Required Fee to Cover Fixed Costs = $2,000 ÷ (1 - 0.25) = $2,666

Next, identify your variable overhead costs, which are not the same for every client. For example, perhaps you do an event for "A clients" and a newsletter targeted at "B clients."
Example:
Investment in Event for A Clients = $5,000
Number of A Clients = 25
Investment in Newsletter for B Clients = $10,725
Number of B Clients = 165
Required Fee to Cover Variable Overhead for A Clients = $5,000/25 = $200
Required Fee to Cover Variable Overhead for B Clients = $10,725/165 = $65
Required Fee to Cover Variable Overhead for C Clients = $0

Lastly, identify your time costs by client or at least by client segment. The best way to get the most precise data is to have the individuals whose time was not included in the support staff allocation track their time to see which clients are requiring the most of this resource. However, this is not a popular option for most advisory firms, so I will suggest a method that is less precise but perhaps less painful. If you have segmented your clients (A, B, C), define the time required for each level of staff for the desired client experience you want to deliver to the typical A, B and C client. Such a strategy might look something like Figure 4.

Then assess the cost (to the organization) of the individual(s) providing this client service. I am not suggesting you need to charge clients hourly, but I am suggesting you need to know what an hour of every employee's time is costing you so you can assess the cost of delivery to clients.

For simplicity's sake, let's assume we have one employee (if you have more than one, you would just repeat this exercise for each). (See Figure 5.)

So to "break even" on the cost of this employee, we need him to generate $375,000 in revenue from client-facing activities. This employee is not going to spend every working hour with clients, of course. Let's assume he spends 2,400 total hours working during the year. He is going to spend 200 hours on vacation, 60 hours in continuing education and 60 hours on paid holidays, which means he is in the office 2,080 hours in a year. Of that, he might spend 280 hours developing business, 300 hours training and developing staff and 300 hours on other firm/management responsibilities, which leaves 1,200 hours for client work. This tells us how much revenue we need to make for every hour this individual spends with clients:

Example:
Target Revenue (see above) = $375,000
Number of Client-Facing Hours (see above) = 1,200
Hourly Cost: $375,000/1,200 = $313/hour

Again, this is not a rate that needs to be charged directly to clients, it is just an amount that needs to be captured in the fee you are charging. If we combine this with Figure 6 that describes how many hours will be spent with a typical client in each segment, we can see what the time cost is for the typical client in each segment. (This assumes that we only have this one employee. If you have more, you would look at the proactive and reactive time for each segment at the different hourly costs of the individuals involved.)

Now, to get a sense of the total cost per client in each segment, we take the sum of the fixed, variable and time costs we calculated for each segment. (See Figure 7.)

This tells us the total cost-the minimum fee-per typical client in a given segment. The minimum fee would, of course, increase or decrease for specific clients if they require more time or variable cost than the typical client in that segment.

For most firms that struggle with profitability, the key to their struggle is in their pricing. To truly understand where their pricing should be, most firms need to get a better handle on 1) the market; 2) the value they deliver; and 3) the cost of delivery. If you understand your economics, you can set prices at appropriate levels. Then you can convey to clients a clear message about what is being delivered, the value of what is being delivered and how that is reflected in the pricing of your services.

Rebecca Pomering is a principal of Moss Adams LLP and practice leader for Moss Adams Business Consulting.  She consults with financial advisory practices on matters related to strategy, compensation, organizational design and financial management.