Is the financial planning profession doomed?

    I am convinced that independent financial planners will continue to be successful as a profession and that practitioners will continue to be richly rewarded for what they do-financially and otherwise. It is difficult for me to believe that a profession with such a significant impact on people's lives and futures will experience diminished success.
    That's why when I read the newly published report by JP Morgan Asset Management and Undiscovered Managers-Back to the Future: The Continuing Evolution of the Financial Advisory Business-revisiting the results of the much-publicized and debated 1999 Undiscovered Managers report on the industry, I feel divided. Not unlike its predecessor report, the JP Morgan analysis this year forecasts a future of a few large firms dominating the industry, with smaller firms facing a tougher time finding clients, higher costs and eroding prices-resulting in significantly fewer profits. While many of their assumptions are sound, I maintain greater hope for the future of this business.
    The Haves-as defined in the report-have robust client bases, are profitable and have the potential and resources to grow and evolve as businesses. They have strong long-term prospects and potentially great enterprise value. These firms make up 6% of the industry's participants, according to the JP Morgan report. Though most of these firms have more than $1 million of revenue, and many have over $3 million, the line drawn in the sand in the report is not one of size. The Haves and Have-Nots are defined instead by their prospects, their profitability and their positioning for the evolution at hand.
    I would agree that any firm that cannot grow and evolve profitably, and build enterprise value, is a marginal business. That doesn't mean they cannot generate an income and satisfaction for the owner(s), but these are not businesses that extend beyond the life of the owner. These are "jobs," not "businesses." We have to remember, of course, that not everyone in the profession is attracted to Wall Street riches; many are satisfied by a comfortable income that adequately supports their lifestyle in communities that they enjoy.

The Evolution
    Remember that the JP Morgan report is about the continuing evolution of the financial advisory business. We see the advisory industry evolving across many fronts:
    From "books of business" to "businesses"
    From a "revenue" focus to a "profit" focus
    From a "cost" mentality related to growth (people and infrastructure) to an "investment" mentality
    From an "individual" focus to a "team" focus
    From a desire for "more clients" to a desire for the "right clients"

    When we consider the ongoing debate of the importance of size-will small firms survive, or will a few large firms take over and dominate the industry-we will undoubtedly find that larger firms will be better equipped to deal with most, if not all, of the aspects of this evolution. My concern for the small firms is not that they won't survive, or that they won't create meaningful returns for the owners; my concern is that if they are not creating internal depth and continuity, they are not creating a business that can continue in its evolution beyond their own involvement. For them, their only opportunity to continue their evolution may be as an acquisition target for a larger firm-thus the consolidation described in the JP Morgan report. An important issue here for any advisor that cares about their clients is that they have a moral obligation to ensure continuity of advice to their clients should something happen to them. They have worked to create interdependency in the relationship and must be careful not to abandon their clients in their time of need. Building a business with continuity is not about greed; it is about client care.
    And the JP Morgan report does not predict that only large firms will survive. It does predict that 40 to 50 firms with $15 billion to $20 billion of assets under management will dominate, but that mid-size niche competitors will also flourish and that thousands of other small firms will continue to exist. They will just have to work harder in the evolution, and will likely earn less and have little transferable value in the process.

The Good News, As I See It
    The two fundamental assumptions behind the original Undiscovered Managers report were that the supply of clients will be quickly exhausted and that this will lead to price competition and erosion of margins. However, there is a lot of evidence to suggest that independent financial planners are just starting to make a dent in their potential client base and that this client base is continuing to grow.
    In a 2004 report on intermediary markets, Cerulli and Associates estimates that there are approximately 100,000 independent advisors and another 150,000 advisors inside full-service firms, banks, brokerages, etc. Cerulli also reports that there are more than six million households with more than $1 million in investable assets, and another 15 million households with assets of between $250,000 and $1 million (The Cerulli Quantitative Update: Intermediary Markets, 2004). Consider these numbers; this means that there are approximately 60 millionaire households for every independent advisor. This is close to the capacity of an advisor working with this size client. However, advisors obviously don't work with millionaires only. In fact, only 33% of the client base will typically consist of households with more than $1 million in revenue, according to The 2004 FPA Financial Performance Study of Financial Advisory Practices, published by Moss Adams LLP. So, including all these clients and both channels, there are 85 clients per current advisor-not nearly indicative of a shortage. The vast majority of clients requiring help in the future will not be the wealthy people, who large firms prefer to serve, but the average clients with assets under $1 million who the smaller advisors are comfortable handling.
    The large pool of new potential clients will ease a lot of the competitive pressure on the industry and significantly delay the time when the industry becomes a zero sum game, when one firm gaining a client means that another lost one.
    Data from the FPA Financial Performance and Compensation Surveys sponsored by SEI Investments, in which Moss Adams surveys hundreds of independent financial advisors, shows that in the period between the first Undiscovered Managers report in 1999 and its update in July 2005, advisory firms grew 145% on average, or 17% per year. In 2004, on average, advisory firms added 27 new clients and $12 million in assets. Of the 100 firms that participated in the survey during the entire period, no advisory firm reported lower revenue in 2004 that they had in 1999. And we have seen no fee compression across those years, even though some have predicted it for many years. As long as this growth continues, there is little danger of intense price competition and eroding margins.
    Where are the clients coming from? It appears that the majority of potential advisory clients have not been exposed to planning and advice yet, and many potential clients for financial advisors still are either self-directed or using a brokerage model. Research done by Cerulli Associates indicates that only half (49 percent) of all investors with less than $10 million of investable assets use an advisor (The Cerulli Report-Financial Planning: The Delivery of Advice and Guidance, 2002). We also can't ignore the fact that there is this huge bubble of wealth transfer occurring with the boomer generation, which is pushing liquid wealth into the laps of advisors who, regardless of their business model, will be swimming in business as long as they have an individual presence in their community.
    Yes, price competition will enter into the industry. However, severity of the competition is a different issue. In many service industries, quality and strength of personal relationships are much bigger issues than price. The segments of the industry that will experience more intense price competition are those where the service/product is:
    Standardized or regulated in terms of quality (tax returns, for example)
    Quality can be periodically and easily assessed or verified (e.g. investment management returns)
    Basically interchangeable from one provider to another
    I would also suggest that product-based industries (or product-based segments of this industry) are more susceptible to price competition than the relationship-based advisory model. The personal computer market, as cited in the JP Morgan report-where the industry grew at a rapid rate but still experienced consolidation, with the 30 providers in the industry in 1988 declining to ten today-is another example of this product-based, price-susceptible model that is forced into consolidation. But in the segments of the industry where trust and knowledge of the client are essential, price may never enter much into the equation. For example, take the CPA industry. For the routine tax returns, there is intense competition and a lot of price pressure. However, for the high-end tax and estate advice, CPAs rarely find themselves tangled in competitive proposals.

The Bad News
    I see a number of challenges ahead, some articulated in the JP Morgan report, including that costs are going up and most advisors have weak alignment between what they deliver and how they charge.
    The trend discussed in the report that I believe will have a very immediate and significant impact on the industry is the fact that the industry is running out of professionals, and the cost of recruiting and retaining experienced advisors and planners is increasing very quickly. This will no doubt reduce profit margins, but the more dangerous impact will be slowing or even halting the growth of many firms and perhaps the entire industry.
    Let's look at some of the symptoms:
    Two out of every three firms that are looking to hire professionals in 2006 want experienced people, those who can manage relationships or even develop new ones, according to the Moss Adams 2005 compensation study.
    Only 17% of all firms are hiring out of college, according to the same study.
    Principals spend very little on training and developing new staff in a meaningful way, and almost none have formalized training programs in place.

What You Need To Do
    So what do you need to do? In my opinion, you need to:
    1. Define who you are and what you are about as a business. Create a unique value proposition for both current and prospective clients and current and prospective staff.
    2. Create an environment where motivated people will flourish. If you feel like you are spending a lot of time trying to motivate people, you probably have the wrong people.
    3. Get a handle on your economics and manage your financials like a business. The fact that the biggest differentiator between the Haves and the Have-Nots is their profitability, and as a result the resources they have available to invest in their own future, means that you need to understand what profitability is and how to monitor and drive it in your business.
    4. Better-align your pricing with the value you deliver. This is related to the comment above on business economics, but is equally related to communicating your value and differentiation (what are you all about) to clients. Working on a study for Schwab Institutional on pricing within financial advisory firms, we found that many have started to separate the cost of financial planning and are charging the client for the plan separately from the assets. To me this suggests that advisors, and in turn clients, are beginning to better understand the nature of the planning process and the value it brings.
    Bundling planning fees inside AUM fees has always seemed like a mistake to me-it confuses the client about what exactly they receive and where the value lies, as well as confusing the professionals about the exact economics of what they deliver. The fact that the two are starting to be separated suggests that they will be valued separately by the client and perhaps be subject to different dynamics.
    Investment management is a very competitive business and is subject to the intense price competition that the JP Morgan report talks about. Financial planning, on the other hand, is a very interpersonal service with very different dynamics. The relationships are not subject to the hire/fire performance carousel that investment mangers are subject to.
    Not unlike its predecessor, this new report from JP Morgan and Undiscovered Managers is ruffling some advisors' feathers. Once again, the business is getting caught up in its own defenses, arguing that the independent advisory industry is of too much value for any segment to be at risk of becoming obsolete. Upon the release of the report I had phone calls from press, advisors and industry colleagues to discuss it, and what trends we are seeing in the advisory firms with whom we consult. One reporter asked me if this was a "good report" or a "bad report." My response was that any report that makes advisors examine their profession, the industry, and more importantly their businesses, is a good report in my mind. Whether you agree with all of its assumptions and analyses or not, look at this report and ask, "If this were true, what would I do to build a better business to ensure I am one of the survivors?" Even if all the predictions in the report are wrong, having built a better business will only be to your benefit, after all. 

Rebecca Pomering is a principal in Moss Adams LLP and consults with financial advisory practices on matters related to strategy, compensation, organizational design and financial management.