Today, decent, ethical individuals without extraordinary sales skills or investment acumen are thriving, while delivering a favorable value proposition to consumers and charging them reasonable fees and commissions. Unfortunately, that's about where the good news on advisors' compensation ends.

 A new study conducted for the Financial Planning Association by Moss Adams LLP of Seattle spotlights just how fragile advisors' recent prosperity is. While it's true that more advisors than ever before are finally able to operate financially viable practices, the margins of success are still so thin that relatively small increases in expenses or decreases in revenue could jeopardize advisors' income.     According to the study, which surveyed 703 diverse firms, total take-home compensation among group practitioners is highest at those fee- and commission-based firms that derive 75% or more of their revenues from fees. Typical owners of these group practices earn $135,794 in total compensation each, compared with $115,942 at fee-only group practices and $122,245 at commission-only practices.

 The numbers aren't as good as they sound, partly because the figures incorporate the firms' profits on top of the owners' base salary. Despite the brisk growth of many practices, the rise in operating costs is exceeding revenue growth, and productivity is lagging.

 Both the fee-only and commission-based models have their flaws from a business viewpoint. With fee-only practices, operating expenses and productivity typically decline rather than increase with the addition of principals. However, the study notes that fee-only or fee-based practices are more scalable than their commission-based counterparts, and most observers believe that fee-only practices relying on assets under management have far greater resale value than those that rely principally on commissions.

 Perhaps more alarming is the way advisors view their practices. Mark Tibergien, a consultant at Moss Adams LLP and co-author of the study, declares it is striking how many financial advisors claim they are not in practice for the money. "I know of no other industry where the practitioners are as altruistic, except perhaps the medical profession," Tibergien says. "Planners don't think of their practice as an investment."

 Despite this attitude, many practitioners are counting on the equity in their firms to provide a major source of their retirement funding. A primary reason why more than 70% of the 350 contemplated transactions Tibergien has consulted on fail to be executed is that the sellers realize the proceeds won't be sufficient to finance their retirement.

 Less than half of the advisors surveyed who plan to retire within the next three years have an ownership-transition or management-succession plan, even though 94% say they feel financially prepared for retirement. Tibergien notes that even if they don't plan to retire any time soon, advisors need a buy/sell agreement in the event of death or disability. This is particularly true for the commission-based crowd. In fact, the National Association of Securities Dealers prohibits the transfer of commissions from a deceased licensee who does not have a buy/sell agreement to a family member unless the beneficiary is licensed.

 Advisors' altruism may be admirable, but it's also a cop-out. Moreover, it can ultimately be unfair to clients, Tibergien believes because inefficiencies compromise service quality.

 The goal of providing financial advice without providing for oneself leaves advisors highly vulnerable to a downturn in the financial-services industry and could ultimately leave clients in the lurch. Tibergien can't imagine many advisors telling clients who own small businesses to run their business and personal finances in the same way they run their own.

 Despite the relative strength and stability of fee-only practices, Tibergien recalls seeing the fear in many practitioners' eyes in the fall of 1998 after a 20% stock-market correction resulted in a concomitant drop in top-line revenues. That bear market was one of the most short-lived in recent memory. But had it been prolonged, advisors of all compensation stripes would have had to address the thorny issue of business profitability.

 Fee-based practices, defined as those in which fees account for more than 75% of all revenue, have lower average operating-profit margins, 10.7% compared with 22.8% for commission-only firms. However, their higher revenue results in higher total compensation to the owners. The revenue gap is fairly wide, with the average fee-only practice recording $892,995 in revenue in 1999 compared with $227,689 for the average commission-only firm. Fee-only and fee-mostly firms typically are better positioned to involve more professionals in the practice, while the commission-based practices typically are one-principal firms. The study also found that for clients to be profitable for a fee-only firm, each client must generate $2,220 in annual revenue.

 One way to escape the profitability problem is to differentiate between owners' compensation and profits. ³Three-quarters of the planning practices have no value because they have no net operating profits," says Chris Dardaman, principal at Polstra & Dardaman in Atlanta. As Tibergien points out, this means controlling expenses, not necessarily cutting them.

 What makes advisors' precarious prosperity so tragic is that it doesn't have to be this way. "They make it through the survival phase, and enter the growth phase. Then they hit a wall," Tibergien says. "It's the resources question. Practices are attempting to become too diversified with limited resources."

 Diversification of services, sometimes known as lack of focus, may augment a young firm's top line in the short term, but it places a strain on resources that ultimately exerts a negative impact on profitability. It also attracts a more diverse array of clients and prospects, which lowers profit per client.

 Greg Sullivan, a partner at Sullivan, Bruyette, Speros & Blayney in McClean, Va., knows this situation all too well. Several years ago, after his firm decided to focus on asset management, tax planning and financial planning, it exited the insurance business, even though one partner, Pete Speros, did a strong insurance business. "It was the wrong image," he says, adding that Speros was able to develop a successful high-end insurance-consulting business.

 The Moss Adams study argues that the real advantages of multiprincipal firms don't materialize until firms have at least three principals. Adding a principal to a sole practice typically reduces revenue per staff person while increasing operating expenses per client. With three or more principals, "the revenue per principal and revenue per staff reverse their declining trends," the study says.

 For instance, revenue per client jumps from $2,269 at two-principal firms to $6,927 at three-principal firms. Why? Firms with more principals can spend more time with individual clients and provide more specialized services.

 But perhaps the biggest reason why small firms stay small is that they misallocate resources when they reinvest in their practices. The dilemma of how and where to reinvest is the most paradoxical problem confronting advisors trying to transform their practice from a book of business to a real business, and it's an area in which many small firms trip themselves. "They don't think about their unique business proposition," Tibergien says.

 For Sullivan's firm, tax planning helped differentiate it from local rivals in northern Virginia and appealed to the high-net-worth clients it was targeting. But the firm also made several internal management decisions that enabled it to grow its assets under management from $50 million in the early '90s to $750 million today. "We built it as a business and didn't worry about protecting our turf," Sullivan explains. "We vote on each other's compensation."

 Although he was the firm's top rainmaker, Sullivan ended up giving many clients to other partners. "You take a risk by giving them to other partners, but the clients ultimately are better taken care of," he explains. "Eventually, we all tap out. Besides, the clients begin to see you as more than one person. Today, if our firm lost the top one or two people, everyone else could step right in."

 Selecting the right type of client who can extract maximum benefit from a firm's core competencies is also critical to leveraging a firm's resources. Polstra & Dardaman transitioned about half its clients to other firms in the last year, giving up some revenue but streamlining operations.

 Tibergien cautions that although eliminating clients occasionally may be necessary for firms choking on volume, it's not a good long-term strategy. "Clients are perishable, and if you develop a reputation that you no longer take clients, you end up capping your growth," he explains. A better strategy is to create capacity that lets the firm add clients, albeit the kind of client whose profile dovetails with the firm's service offerings and can be served profitably.

 The three key figures for advisors to look at are: revenue per client, profit per client and profit per professional staff person. The difference between high-profit group practices and the average firm is almost $1,800 in operating profit per client.

 "The impact will be noticeable on their own quality of life and their ability to serve their clients," he says. "Too many people think building equity is the endgame. The endgame should be building a practice capable of serving clients, whether you are there or not. If you do all the things that make business sense, you'll have the option of walking away from a deal [acquisition offer] you don't want to accept."