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. ¬≥Three-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."