Stop leaving fee-based dollars on the floor

One of the important trends among successful advisors over the past decade has been the shift from a business whose revenue model depended on commissions to one based on annual fees.

A recent research report provides important insights on getting the level of fee pricing right, one of the keys to making a fee-based approach work.

The big picture on fee-based business

At the end of December, the average advisor at US and Canadian full-service securities firms had 25% of assets and 37% of revenue in fee-based accounts; 80% of advisors had at least 5% of assets in fee-based programs.

Over the last four years, the typical advisor's fee-based assets are up 24%, at a time when non fee-based assets were down slightly. The average advisor opened just under 15 new fee-based accounts in 2010, up from 12 accounts in 2008 - over 80% of these accounts were with new relationships.

These are some of the findings from the most recent Insights whitepaper by investment industry software firm PriceMetrix. This report features data from 15,000 advisor books at a broad range of Canadian and US firms; these advisors worked with over 2 million investors representing assets of $850 billion (so an average account size of $400,000.)

Note that the firms PriceMetrix works with tend to be full-service securities firms, so the actual numbers may differ from advisors with other business models, although the overall trends should be.

What's driven the move to fee-based

There are a number of reasons for the growth in fee-based accounts.

Start with the fact that a fee-based approach leads to better alignment of interests. For investors it can reduce concerns about potential conflicts and whether a recommendation to buy or sell is motivated by the advisor's desire to generate a commission. Further it eliminates client anxiety about not getting a fair price if they don't haggle about commission levels.

For advisors, fee based-business escapes the commoditization trap on commissions and matches revenue and effort - good advisors provide ongoing, regular communication and advice to clients and a fee-based approach reflects that.

Finally, fee-based business provides predictable revenue. One of the key things that drives long term value in a business is "recurring revenue", the fact that once an initial sale is made, provided that you do a good job, additional revenue can be relied on. This is nothing new - Gillette built a great business based on giving away razors and then making money off razor blades.

For advisors looking to enhance the long term value of their business, recurring revenue is key - that's why some advisors who were historically transaction oriented have sat down with clients, shown them how much they've paid in commissions over the past few years and suggested a fee below the commission level clients paid in the past, foregoing some revenue for stability and predictability.

Getting fee-based  pricing right

Perhaps the most critical element to a profitable fee based business is getting pricing  right.

Three observations on pricing from the PriceMetrix research:

1.       Underpricing of small and mid-sized accounts

Average revenue from client households with assets of $500K to $1 million is two to three times that for clients with $100K to $250K. 

Even accounting for higher communication and service levels for larger clients, it appears that  advisors are either undercharging smaller clients or overcharging larger ones.

Here's the average pricing for accounts at different levels of household assets:

Household account size                         Average fee

< $100K                                                 1.68%

$100 K - $250K                                      1.60%

$250K - $500K                                       1.47%

$500K - $1M                                          1.32%

$1M +                                                     0.92%   

Takeaway One: 

Advisors need to scale pricing so that it's fair to clients of all sizes and to set minimum levels of revenue per household.

2.       Wide disparities in pricing for similar clients

Fees for similar accounts varied widely across advisors.

Here's the distribution of pricing to clients with assets of $250K to $500k in balanced accounts - note that the overall average price for this group 1.39%.

Average pricing:

Bottom 25%       0.81%

Next 25%             1.18%   

Next 25%             1.50%

Top 25%               2.08%

Of note, PriceMetrix didn't find any correlation between pricing level on the one hand and geographic location, other revenue from clients or success in winning new accounts on the other.  The only apparent variable is the advisor's business model and going in thinking on pricing.

Takeaway two:

Advisors need to be clear and consistent on their approach to fee-based pricing; as part of that, more attention needs to be paid to market pricing and what other advisors are charging for similar accounts.

3.       Getting initial pricing right

Once a pricing level is set, it is incredibly difficult to raise it - only 5% of advisors saw a meaningful increase in pricing levels with existing accounts. That means it's of paramount importance to get the initial pricing level on a fee based account right. To do that, you have to be crystal clear about your pricing going into client conversations - and be committed to maintain pricing levels across your book that are consistent and fair both to you and to clients.

Takeaway three:

You need to get initial pricing on new fee-based accounts right. As part of that, you have to be crystal clear on the value you're providing.

Two ingredients to building a fee-based business

There are at least two keys to making fee-based business the foundation of your business going forward.

First is to focus - the advisors who are seeing the most success are those who are adopting the fee-based model as the foundation of their approach. To make fee-based business a central part of your business, you have to assign this top priority.

The second is to effectively articulate what clients get for the fee they pay. A fee-based approach makes investors' annual costs absolutely transparent and requires clients to explicitly agree to pay that cost - in light of that, communicating your value is job one.

Here's a recent article and video that talk specifically to this point:

Watch Video Run Time - 3m 31s

Read Article 

And click here for the PriceMetrix report on fee and managed asset pricing:

http://bit.ly/m1kgu5

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