Each year, InvestmentNews' benchmarking series looks at how top-performing firms rise above market conditions and industry competition to set themselves apart. This year's study — the InvestmentNews 2014 Financial Performance Study of Advisory Firms — is no different.
With the industry's continued, unprecedented growth in 2013, we developed a methodology to identify top performers by not only quantitatively measuring the financial performance of participating firms, but also measuring stress factors such as owner income and earnings before owner compensation. By doing this, we were able to isolate the factors that contribute to an individual firm owner's success and the impact it has on firm development.
Top performers represent the top quartile of a rank of more than 300 participating firms based on a composite of the following firm metrics:
Revenue per professional: The amount of revenue generated per client-facing professional at the firm. This is one of the most important, if not the most important, productivity metrics at an advisory firm.
Earnings before owner compensation as a percentage of revenue: Earnings before owner compensation, or EBOC, is represented as a percentage of revenue. This is a firm's operating profit margin before owners are paid traditional compensation, and a good measure of a firm's performance independent of its owners.
Three-year revenue growth: The rate of revenue growth, compounded annually (CAGR), over the past three years.
Pretax income per owner: Pretax income per owner is defined as the sum of operating income and owner compensation divided by the number of owners. To get a look at the raw performance of the firm, this measurement ignores the decisions that owners make regarding their own compensation.
Operating margin: Profits, or revenue, excluding all direct and overhead expenses.
Which activities defined the firms who ranked highest by these standards? Here are three trends we saw that made top performers stand apart from the rest:
Top performers are focused on revenue, revenue and revenue. When asked to describe their strategic emphasis over the past couple of years, top performers were more than 10% more likely to stress concerns over revenue growth and revenue quality (60% versus 49% of all other respondents). When it came to productivity, top performers were more focused on making their advisers — the direct generators of revenue — more productive than all others, who were more concerned with operations productivity than top performers.
And when it comes to revenue- and profit-growth initiatives, top performers were much more successful acquiring talent through inorganic means (e.g., buying or merging with another firm), and spent more energy hiring staff, formalizing referral relationships and integrating technology than all others. The ability of top performers to remain focused on results-oriented activity has a direct impact on the bottom line.
Top performers choose their clients In the area of business development, top performers were more likely to specialize their practice and home in on niche client bases, a strategy that often comes with natural boundaries once a business model is in place. The independent advice industry remains largely a referrals business, and top performers excel here, too. They are 11% more likely to have a formal client-referral process in place and 8% more likely to have a process in place with third-party professionals. Also, top performers recognize the value in carefully monitoring and shaping their client base. They are more likely to have required minimums (9% more) and measure each client relationship yearly for profit (5% more).
Top performers are astute executives. Owners at top-performing firms do more and take on more than their peers. The owners of the most profitable firms often are the most productive advisers, and this is reflected in the lower direct expense percentages their firms often pay in the form of salaries to nonowner advisers. Qualitatively, top performers more often focus their short- and long-term goals on capacity constraints (15% versus 10% of all others), which is described as “tweaking your current organization structure or service model to alleviate time limitations.” Top-performing owners can become caught up with finding new ways to make the most of their time.
Top performers often have larger support staffs and few advisers. But while “practicing” partners at the top firms are the best advisers in the industry, if top performers do not buttress their teams with adviser talent, owners can get stretched thin and firms can reach capacity. Robust administrative and support staff allows them to be successful but at some point, every successful advisory firm must facilitate growth by hiring strong professional talent that can be leveraged to increase firm capacity. If that doesn't happen, owners can become overworked and overtaken by the competition.