Smart firms leverage staff to earn outsized income.
One million dollars has always been an aspiration for advisors, first as a top-line revenue hurdle and then as a personal income hurdle-a classic benchmark of financial success in the profession. In the 2007 Moss Adams study, which hits shelves this month, we saw the average income per owner for the largest firms beat the $1 million mark, a significant increase over previous years. To say that the largest firms in the industry are profitable would be an understatement. Their growth and financial success have enabled the owners to create significant personal wealth.
As you can see in Figure 1, the firms with more than $5 million in revenue in the Moss Adams study have progressively been growing income per owner-salaries, bonuses and profit distributions-to where it crossed the million-dollar mark in 2006.
As much as we marvel in the financial success, we also see important implications for the entire industry in terms of how firms are structured to achieve such results and how much of this profitability will be shared with employees. The first question is, of course: How did they do it? The answers are:
1. They hired a lot of people and made them productive.
2. They invited more partners to the table.
3. Their size gave them a strategic advantage.
The secret is in creating leverage, growing the partner group to foster further growth and using the firm's size advantage. Let's look at each in more detail:
One of the most critical factors contributing to the success of these market dominator firms is that they hire many people. While we have seen professional staff among market dominators increase by 29% over two years, we also have seen their dedicated management staff double, their support and technical staff increase by 25% and their administrative staff grow by 36%. The owners and other professionals in these firms are delegating, leveraging and focusing on where they can personally create the most value for the organization. (See Figure 2.)
The resulting staffing structure in a typical market dominator firm is quite different than we would see in other business models. The structure in Figure 3 shows a nonprofessional to professional ratio of 2-to-1, whereas in the other business models (smaller ensemble firms) we see a ratio of closer to 1-to-1.
This has resulted in strong professional productivity ratios for market dominators. Given the increases in support, administrative and management staff, revenue per total staff has declined 33.8%-to $260,400 in 2006 from $348,564 in 2004-while revenue per professional has increased 40.8%, to $719,330 in 2006 from $510,903 in 2004. It is interesting to note that the revenue per professional for mature ensembles, those with $2 million to $5 million in revenue, was $511,750 in 2006.
Adding partners is the second factor. On average, the market dominators have four partners, two more than the mature ensemble category. This ability to create a path to ownership is critical for the motivation of professionals and the culture of the firm. The owners of market dominators are not increasing their personal income by exploiting their staff and keeping the money for themselves; they are in fact inviting partners into the ranks to share in the wealth that is being created.
Thirdly, the market dominators are taking advantage of their size. By definition, this group of ensembles has more than $5 million of revenue; the median revenue in 2006 for the category was $8.6 million (see Figure 4). This scale is allowing them to hire additional staff and create specialization in roles, including dedicated management positions. It is allowing them the scale to create a meaningful footprint in their marketplace, which enhances their brand and ability to market and garner referrals. It is allowing them economies of scale to build systems and infrastructure that support a large revenue base and drop a significant amount of that revenue into the bottom line and into their wallets.
The implications of the million-dollar year are not just financial, of course. What also is interesting is the dynamic of the relationship between the non-owner professionals and the owners in these firms. The non-owner professionals are earning significant dollars in total cash compensation on an aggregate basis, far more than the owners (because there are more of them). (See Figure 5.)
On an individual basis, the non-owner professionals are earning over $150,000 per year in salary and another $40,000 in bonuses, easily putting them in the top 5% of incomes in the country. Still, fairness in compensation is always a relative question, and as a compensation consultant I can tell you that I have countless discussions with very highly paid employees that start with, "THEY make ten times more than I do ..."
This relationship between owner income and professional compensation is important because it defines:
1. The relative attractiveness of becoming a partner in an advisory firm. If partners make a lot more than the professionals, becoming a partner becomes very attractive and presents a career "trump card" that firms can use (wisely) to retain their best people.
2. The culture within the firm. At the same time, in the fragile culture of a relatively small firm, this "social inequality" creates some issues that can be harmful. The separation in income can create a separation in mentality and responsibility. Ideally, firms would like every professional to work like an owner and take ownership of every issue or problem. In reality, with so many degrees of separation in income, we may see a separation in attitude. This is why a career path to ownership is critical for the health of the culture of the firm and the motivation of the employees.
3. The ability of owners to sell their businesses to existing employees. Needless to say, a firm that generates annual income of a million per owner has a lot of value. That value is probably already out of reach of the financial means of potential internal buyers. How would they buy out $6 million, $7 million or $8 million in value per owner? This is why we see some of the largest firms enter into transactions with external buyers or financers to help realize or fund some of their value.
The cultural dynamics created by this increase in income are almost a royal problem-one everyone would like to have. Here are a few ideas to make clearing this million-dollar income hurdle a positive experience rather than a negative one (not just for the owners, but for the entire firm):
1. Define the path to partnership as discussed before. What will other people need to demonstrate to join the partner ranks? What will their financial contribution need to be if they are to enhance the income of the existing partners rather than simply dilute it?
2. Share the financial rewards of the firm with the whole staff. An incentive structure does not have to be complicated. It must simply make clear to the whole team how growth in the firm's profitability and financial success will lead to growth in each member's own personal income. It must also be clear that each member's financial success is driven by the same factors as the owners'. Firms that share the wealth in good years don't hear as many complaints that the rich are getting richer while the employees are doing all the work.
3. If you are hearing a lot of these complaints (directly or through the grapevine), take a look at the situation from their perspective. Are they being fairly paid for their role and contribution? Is the financial structure of the firm clear to them in terms of what owners are being paid for their job (in the same way any other employee would be) given their return on ownership/risk/investment? As an owner in a firm, you don't need to justify your compensation to employees, but understanding the differentiated rewards (the philosophy, not the amounts) actually helps employees see the big picture.
4. Make sure you have a performance culture that applies to the partners as well as the employees. Partners need to be held accountable to a defined level of performance that drives their compensation so employees can see that they are not just making a lot of money but that they have earned that income through their job compensation and their investment in the business. (For more on the topic of partner performance culture, stay tuned for my December column.)
The growth of the industry is undeniable, and the growth of market dominators is just one aspect of it. At this rate, we will see many more firms reach $5 million in revenue in the next two years, and thus we will have more firms generating more than a million per owner. If communication is open, if rewards are shared, if ownership opportunities and a clear path exist for those driving the business, if compensation is good for those who are supporting that growth and if the performance culture of the firm applies to the owners as well, then this level of owner income can be achieved without wreaking cultural havoc within the firm. As you grow your firm, and your personal income, think about the implications on your firm and your people to ensure you are doing good planning internally to make clearing that million-dollar mark a victory for everyone involved.
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.
