Executive Summary
As the financial advice industry continues to move toward providing full-blown professional services rather than focusing primarily on product sales, advisory (advicery?) firms are increasingly experiencing similar stages of growth in their practices. From the initial stage of onboarding their first clients to the point of hitting a capacity wall and deciding whether to increase their headcount, and later to a threshold where an ensemble business eventually becomes an enterprise, advicers face many of the same challenges and opportunities along the way. Conversations around these commonalities often work their way into the broader advicer community, and one topic that frequently crops up is the concept of scale, which denotes a disproportionate increase in revenues over expenses (often because of increased efficiencies within the business), and is distinct from "growth", which involves a proportional increase in both revenue and expenses. Often, advicers whose firms are still in the early stages of development begin thinking about how they can scale their business, which begs the question: Are advicers worrying about how they'll scale their business long before scale is even an issue?
In our 140th episode of Kitces & Carl, Michael Kitces and client communication expert Carl Richards discuss how early-career advicers can sometimes get distracted by questions around how they can scale their practices, the issues they should really be focusing their time and energy on instead, and strategies they can use to identify what sort of business they want to build in the first place.
Advicer concerns around scaling typically present in a couple of ways. The first is based on the fear that, if the advicer introduces a new service, scaling it will be difficult because the margins are too low. Put another way, the advicer has a pricing problem and hopes that the economies of scale can correct for not charging enough. Another concern centers around increasing headcount, where advicers who don't want to hire and manage staff begins looking at technology as the key to achieving better margins while keeping headcount low.
The reality is that most advisory firms run profit margins around 25%, which means that the better way to increase profitability isn't to 'scale' margins by another couple hundred basis points but to grow the business and make the same profit margin on a larger number. In fact. worrying about scale can really be an excuse the advicer leans on to not do the next thing that would help move their business forward. Instead, an advicer's business would be far better served by prioritizing the most immediate problems, and more often than not this involves focusing on how to add more clients to first reach capacity, and then figuring out where to go next. Or put another way, is a major software upgrade really necessary for an advicer to serve their next 10 clients more effectively, or would the advicer's time be better spent re-examining pricing structures, marketing strategies, or service offerings?
The key point is that advicery (😊) firm owners may find it tempting to explore projects that keep them from addressing their most immediate problems. However, the most successful entrepreneurs are those who are able to quickly identify the most pressing issue they face, and solving for whatever may be blocking their progress/ And it's by focusing on doing the next hard thing that will ultimately be the most effective means of moving their practices forward and improving the trajectory of their bottom line!
Authors:
***Editor's Note: Can't get enough of Kitces & Carl? Neither can we, which is why we've released it as a podcast as well! Check it out on all the usual podcast platforms, including Apple Podcasts (iTunes), Spotify, and Stitcher.
Show Notes
- #FASuccess Ep 094: Crafting Your Optimal Solo Practice By Simply Charging What You're Worth, With James Osborne
- Kitces & Carl Ep 125: Scale Your Business, Leverage Yourself, Or Just Grow
- Salesforce For Financial Advisors
- Wealthbox
- Redtail
Kitces & Carl Transcript
Carl: Michael Kitces.
Michael: Carl Richards, III.
Carl: That's David to you.
Michael: David...
Carl: David Carl Richards, III.
Michael: ...Carl Richards, III.
Carl: Yeah, please.
Michael: DCR, DCR, III. I keep wanting to say DCF because it's just kind of cashflow. So I have to keep coming back to say DCR, III.
Carl: DCR, III. DCR, III.
Michael: DCR.
Why Worrying About "Scale" May Be An Excuse Not To Address More Pressing Business Issues [00:32]
Carl: Yeah. Yeah, what I've been having a lot of conversations about lately is places to hide. It's really, it's places to hide. And one that comes up all the time is this concern about, but will that scale? How will I scale it? I can't write a book because how will I sell 1000 copies or 10,000 copies? Or I don't know if I can open, if I want to develop that niche, because can I handle 100 clients? So, I wanted to get your perspective and just talk for a little bit about this idea of scale. Why do we get so worried about...? Why worry about scale when you don't have a scale problem yet? Have you noticed this problem? This problem...
Michael: I've noticed this problem a lot. I'm hearing it crop up a lot these days, and I think there's a lot here because frankly, I think it comes from a lot of different places. We use the same words, but we're talking about very, very different underlying problems. So, I see a version of this that is I'm worried about how to scale this because I know the truth is I'm going to be doing a lot for my clients if I roll out this new service, or try this new business model, whatever the thing is, and it's basically like, I'm pretty sure they're not going to pay very much and I'm going to be doing a lot. And I'm afraid that I won't be able to grow and scale it because it's going to be too expensive to build bigger. In which case, basically, I have some kind of business model charging fees value problem. Then I don't want to actually charge the right price. I want to charge a low price and then have the magical scale fairies fix it for me. And there's a version of having that come forward.
Carl: Yeah.
Michael: There's a second one that I want to hear some of your thoughts around this. There's a second version of this that I hear come up where I'm really concerned about whether this can scale is code for, I don't actually want to have to hire, and manage, and rely on other people. And what they really mean is how do I keep growing this infinitely where it's only me? So therefore, I guess I need technology to scale this to the moon because in the purest sense, well, unless your problem is number one, you're doing a thing that's just literally not profitable and you're hoping that somehow the economies of scale fairies will come and save you. Most of us run reasonably profitable advisory firms. If you're charging a reasonable fee and doing a reasonable amount of stuff, a lot of our businesses end up somewhere in the neighborhood of 25% profit margins, plus or minus a little, and you get the income working in the business if you're a solo advisor or a main advisor in the firm. So you get the advisor comp and the profits and now suddenly you're taking 60% or 70% of your revenue. A peer said if I have a service business that's making a 25% margin, I don't have a scale problem. Get twice as many clients, hire twice as many people, and make 25% margins on a bigger number. You don't need your margins to get from 25% to 27% so you're scaling up better margins by getting economies to scale. If you look at the average billion-dollar advisory firm has the same profit margin as a million-dollar advisory firm. They don't find any economies of scale and there's no reduction in overhead when you get 10X as big. You just do the same thing with 10X, the people for 10X, the clients, and make 10X the profits because it just got bigger. You added more people.
Carl: How do I not add in with 10X the problems?
Michael: Oh, don't go there. That's another conversation.
Carl: That's just a little Carl lifestyle practice, little cute little lifestyle practice, Carl talking.
Michael: Yes. We can come back to that maybe on a separate episode because there is some stuff there. But, look, when you run a service business, growing and building up a service business is not complex. Hire more people to do work for more clients. And as long as the fees minus the cost of the people add up to profits, you're doing fine. So a lot of the discussions I hear about scaling, when I hear scaling, I think I need economies of scale because I'm trying to bring down my overhead costs to improve my margins. Your margins are fine. Just grow it and add people. If you don't want to do that, you're not talking about a scaling problem. You're talking about a, I don't want to hire, and manage, and rely on other people. And maybe that's because you don't want to hire, maybe that's because you don't want to manage, maybe that's because it's scary. If I bring in an advisor and my clients get to know them, and then they could leave, and then my clients might leave. So the easiest way to solve this is to never hire anyone and just have technology that magically scales me to the moon. Because I don't really have a scaling problem. I have a, it's scary to hire people in this business, especially other advisors. And I kind of want to be dismissed for that problem. It's a very real problem, but it's not a scaling problem. It's a relying on other people in an advisory business is scary problem.
Carl: Yeah. Well, and all of that is awesome. And I think about it from a slightly different perspective, mainly because I ran a lifestyle practice and I was going to use the word, the damn word. I was going to say and I'm damn proud of it, but I won't say that. I'll just say I was really proud of it because...
Michael: Way to not say it.
Carl: Yeah, I know, I know. Somebody gave me the term delightfully tiny last week, which I loved. So I had a delightfully tiny business, which is where I don't know if you're... The most common quoted thing back to me from our podcasts together is you're on vacation. It's just Thursday for me.
Michael: Yes.
Carl: That story.
Michael: Yes, that is the number one that I hear as well.
Carl: Yeah. And I don't know if it was Tuesday or Thursday, but I literally have people come up to me at conferences and go, "Hey, it's just Thursday for me."
How Advicers Can Determine What Kind Of Business They Want To Build [07:27]
Carl: So I'm a big fan of that. And so when I'm thinking about the scale problem, I'm talking about people who have 10 clients and they know they want 100. And they're thinking about developing this niche. And they're actually, like, the scale, I don't know if I could scale. I don't know if I could take care of, is actually just kind of a place to hide because it's really actually quite hard to go from 0 to 1. That's the hardest part, like, small experiments.
Michael: It's where you get your first clients, yeah.
Carl: Yeah. Small experiment. And first, and sort of metaphorically there, it might be your 11th, it might be a different niche, it might be whatever it is. From 0 to 1 is the hardest part. And so it's much easier to think about how hard, and design systems and be thinking and reading books and talking to people about going, "What is it going to look like when I'm at 100?" Well, you're not at 1 yet, metaphorically, even if you're at 10, let's focus on that. That's what I'm actually quite curious because I see that problem in the small-firm lifestyle firm. Let's just talk about that for a minute. I see that problem as a really interesting place to hide. And I do it all the time. We don't realize the value of just doing things that don't scale.
And here's the other question. Why do you need to scale in the first place? This is another conversation I had last week with a consultant friend of mine. I was like, "Oh, but if I do that, if we do these..." We started doing retreats at my house for 10 to 12 people. And I was like, "Yeah, but then there's how many can you do?" And I was like, "I feel like I'm putting myself in a box because we get all in." It's like, "Let's put you in that box for a minute. What would it feel like if you did 10 of those a year, one a month for 10 months? And you had lovely people there and you had this deep... Do you like that box?" And I was like, "Yeah, but then I couldn't have..." "No, no, I asked you, do you like that box?" And I was like, "Yeah." "What if that's big enough? You don't have a scale. You don't need to scale." So I love the idea of like, James Osborne, one of our favorite little examples to hold out. James Osborne didn't have a scale problem. He got to 75 people and called it good. That's an option, too. Why are we even thinking about scale? If that's what you want to build, is it because everybody else is "doing it?" Is it because that's what all the cool kids do? Is it because that's what your MBA class said you should do? And none of those are bad answers, by the way. It's just you got to make sure, like, what's your answer? Where does your head go with that?
Michael: We're getting very negative on scaling.
Carl: No, scaling is awesome if it's what you want to do.
Why Advicers Should Focus On The Business Issues In Front Of Them [10:17]
Michael: Yeah. Look, I've seen a similar phenomenon to what you said as well. I actually remember a conversation a couple of years ago with an advisor who had reached out. We were doing a bunch of our tech writing, and I'm trying to remember his name. Well, I would anonymize anyways, we'll call him Tim. So Tim had done this giant Redtail versus Wealthbox versus Salesforce spreadsheet, comparing all the tools for which one he was going to scale with.
Carl: I'm only laughing because, of course, I'm going to scale.
Michael: Well, he had a spreadsheet. That's why he sent it to me.
Carl: Of course, I've even done that.
Michael: He wanted me to nerd out with him on his spreadsheet.
Carl: Yeah, we got to commission a study, hire a consultant likely, yeah.
Michael: No, no, he'd done the homework. So he reached out because he had this giant spreadsheet that was Wealthbox, Redtail, Salesforce and how it would scale with him for all the things he wanted to do as the business was growing big. And the conclusion he was coming to was, it probably has to be Salesforce to do it, just the depth of their APIs and flexible workflows. Particularly then there's a couple of years ago, at least Redtail and Wealthbox have built more workflows now. But at the end, they were really the only ones with deep workflows. And so he was pretty clear that the answer was Salesforce. And so I'd said to him, "Then it seems like you've got a conclusion, Tim, why are you emailing? What is your question?" You've sent me this cool analysis and a bunch of dialogue around it of how he was coming to the conclusion that it seemed like Salesforce was going to be the answer. It was like, "So why are you emailing me? What's the question? What's the problem?" He said, "Well, the problem is Salesforce is really expensive. I don't know if I can afford it." I'm like, "What do you mean you can't afford it?" It's like whatever it was, $125/month. "How big is your practice?" He's like, "I have 4 clients."
Carl: This, I don't know what it says about me that I am so intrigued by this story. This is a great...
Michael: This is true. This was a thread. And so like, "Tim, you need to go get more clients, my friend."
Carl: Use your phone.
Michael: Like, just, you need to stop this analysis because I can see you spent a lot of time on this, which means you're spending time on this, not going and getting your fifth and sixth clients. If you can't afford the CRM system you want to scale up, you're probably going to have trouble putting food on your table at some point here at four clients. It's like, "Look, I love the aspiration that you have..."
Carl: Yeah. Deep empathy for all of it.
Michael: "...but you're not solving the problem your business actually has today. The thing you need to solve today is how to inefficiently, non-scalably get the next 20 clients so that you get to a critical mass of revenue that your spouse doesn't tell you, 'You need to stop this and get a real job.' And after you get there, you can decide what comes next. And frankly, even once you get there, you don't need the depth of the fancy workflows that you're talking about. You need a basic CRM system. And after you get that, you need an assistant who can time-laboriously manually do a bunch of things for you because clients pay us a pretty decent fee and the business is profitable when you have staff and just keep solving that inefficiently.""And at some point, when you have, like, 20 people, and a 5% improvement in technology could save you an entire team member and like, $100,000 a year of salary, it will be really awesome when you start focusing in on tech that really scales you to the next level. But if you ddon'thave a dozen or a few dozen employees and a couple million dollars of payroll, you probably ccan'tget enough efficiency out of awesome tech to even say, make back the cost of your time to evaluate this. There is a point where the numbers are big enough that small changes in scale of really, really big numbers on the bottom line impact of your business. But you need a pretty sizable revenue line for a scalability improvement on that to have a material impact on your bottom line.
What Industry Data Says About "Scale" [15:34]
Carl: All I really want to say is amen. I don't know if there's any more to say about it. That's exactly what I'm pointing to. It reminds me a little bit of this friend that was a doctor and then became a financial advisor. And he always tells this story that he'd have clients come in overweight and smoking, smokers, and they would want to argue and debate the merits of every different blood pressure medication. And he would say, "You still smoke." I think this desire, and I have deep, deep empathy for the guy we're calling Tim. I would do something exactly... The reason I found that story so fascinating is because I would do something exactly like that. And then somebody would go...
Michael: That's how we get you to make a spreadsheet.
Carl: Well, no, except for the "giant spreadsheet" that I just used. But it would be...
Michael: It was beautiful. I may go dig it up sometime.
Carl: Sure. But that's a perfect story, and deep empathy, seriously, for Tim as an example, because I can see, and we all tend to do that because you know what? The alternative is scary. Putting yourself on the hook for going from 4 clients to 5. It's way easier to think about Salesforce versus everything else, way easier. And so I think that to me is the amen, is like just put yourself on the hook for doing the thing that matters. You still smoke. Let's figure out how to stop smoking. Let's figure out how to go from 4 to 5 clients. Scale is beautiful if that's what you want. Let's figure out if you really want it. And guess when the time to do that would be, not at 4 clients. Maybe it would be at... Have the problem. That's the thing I love you said, too, about, do that inefficiently for a long time. Wake up one day and have the problem. You know what, I've got too many clients. So, anyway.
Michael: Yeah. But even there, I see I'm trying to figure out the tech to serve my... I'm not happy with the profitability of my firm. I'm trying to make some tech improvements to make the business more scalable. And then I'll get in the conversation like, "Well, tell me about your revenue, tell me about how many clients, tell me about how much staff you've got." Because I start doing all the numbers in my head that I think we've talked about in the past. Revenue per employee, and revenue per advisor, and revenue per client. And I can start mathing the business. And even there often... What comes to me as I've got a tech efficiency problem, I don't feel like we're using tech well enough because my margins aren't where everybody else's margins are. And the answer is like, "It's because you're undercharging your clients for all the awesome things you do."
Carl: Yeah. Yeah. Back to hard, back to... Oh, that's scary.
Michael: Yeah.
Carl: How do I have that conversation? How do I think about that? Yeah. These are just places to run, places to hide. And we all have them.
Michael: Yeah. But to me, just the weird effect to it is, again, I love nerding out on our industry's benchmarking studies is just there is no material difference in overhead expenses or profitability for firms at $1 million, $3 million, $5 million, $10 million, and $20 million of revenue. Maybe it gets better above that. We haven't had enough firms that are big enough at that scale that we can have a new category in the benchmark. He studies to see maybe there's a magic point of margin improvement scalability that comes. But the actual boots-on-the-ground numbers from the industry is that advisory firms don't magically get more profitable when they get bigger. They just get bigger. They remain profitable as larger enterprises and you get a profit on a larger amount of revenue, which means you do make more money as it gets bigger. But to me, there's even this grand irony that even amongst firms that are large enough to have scalability problems, they don't seem to actually manage to scale. They get bigger and they do more revenue with more advisors, with more staff, for more clients, and generate more profit. They do grow profitably, but we still don't actually find scaling showing up.
Carl: Yeah, yeah. Yeah. And I think, didn't we, we did discuss that in another episode. I just love where we landed with Tim and the giant spreadsheet. To me, that's the big question, is like, why are you thinking about this? What is it? Is it a place to hide? And then let's go do the hard thing, because remember, the people out there need your help, and they're not going to know you exist if you're just hiding behind a spreadsheet on whether to use Salesforce or not. So, love that.
How Advicers Can Get Clarity On Where Their Focus Should Be [20:40]
Michael: So how do you get clarity on the hard thing?
Carl: I think you run small experiments. It's always the same, it's always the same. And how could I get some clarity on the hard thing? So, for instance, let's just play a little game. I'm relatively new in the industry. I've been in the industry, let's say 7 years. I've seen a lot of success. I've got plenty of clients. I'm trying to decide if I want to keep this delightfully tiny business, "delightfully tiny business," this wonderful lifestyle practice that's optimized for my happiness and my freedom, or if I want to scale to this next level. I don't know. Everybody tells me it's the thing we do is we grow and grow and grow. Well, how could I... Let's just run some experiments. The same thing we do with a client that comes to you and says, "I need $5 million and I want to retire on a sailboat." You would write that down and be, "Oh, that's really interesting. Thanks. I'll write that down. That's oddly specific. $5 million and a sailboat." But then you would suggest, "Have you been on a sailboat before? Hey, what if you went on a one-day?" And then, "Oh, did you like that? What if you went on a month? What if you went on a week?" You would run some experiments and see what you learn and you would run the smallest, I call the micro action, the smallest micro action you could take, and then actively look for disconfirming evidence. You have an opinion. Look for disconfirming evidence rather than confirmation bias. "Oh, you know what? I tried that. I really like it. I actually do want to grow. I think I want to open another office." "How could we think about opening another office? Could we bring on one more advisor? See if we could fill up that person's capacity." Just keep thinking about small experiments.
And on the lifestyle side, I would look for ways, like, I'm going to have this extra time if I think about this. We have a favorite lifestyle practice firm that we always talk about that he rides his bike 15 to 20 hours a week. "Do you like that?" "Oh, man, I'm bored to death." "Oh, is there something else, or do you want to devote that back to the business?" "Oh, no, I love riding my bike and being there for the kids and I love it. It's the coolest thing ever. Work just allows it." Cool. You start to get answers. And guess what? Don't be surprised, just like your clients' goals, don't be surprised if that sort of shifts and changes. And you're going to keep...and enjoy that process. That's never going to be done. I still can't believe at 52 how often I say to my kids, "Gosh, I wonder what I'm going to do when I grow up," because I just don't know. And sometimes I'm like, "Geez, I wish I knew. I wish I could just be a dentist." But that's not the life most of us have chosen as entrepreneurs that run financial services businesses. So that's how I think you get clarity on that. There are some analyses to do, of course, but just enough until you can take action and the new information will show up and you can feed that back into the spreadsheet.
The Trait Shared By Most Successful Entrepreneurs [23:48]
Michael: Yeah, to me, it just comes back to... One of the fascinating things about business ownership and entrepreneurialism to me is just getting clear on what the biggest problem is in the business that you actually need to solve, and then making sure you really truly are putting the time and energy there to solve it. And it's one of those things to me that when I started that, that seems straightforward and obvious. I problem-solve for a living, like, clients come in with problems and I analyze and craft recommendations, and try to help them solve problems. It didn't seem like it would be a big deal to have to figure out to problem-solve in a business for myself. And what I realized is it's really easy to get focused on something that's not actually the problem in front of you. Maybe because you're hiding as you framed it. I don't actually want to deal with the problem so I'm going to go tackle something instead. Sometimes I could just...you just have to pause for a moment to look and figure out what really is blocking the business from getting to the next level. I'm having fun on this CRM analysis, but do I really have a business problem? I not have the ability to serve the next 1, 2, 3, 5, 10 clients effectively because of my CRM? Or is it because I'm charging the wrong thing, or I'm doing too much for my clients for what I'm actually charging, or because I really need to just be focusing on getting new clients, which kind of sucks and is scary because they reject you a lot and it's really painful. What's the actual problem that you should be putting your time and energy solving? And to some extent and I find a lot of the most successful entrepreneurial business owners I meet, the thing that distinguishes them is how quickly they can figure out the thing that they actually need to put their energy towards, and how quickly they actually redirect their time, and energy, and focus there.
Carl: Yeah, super smart. I totally agree. It's so interesting. To me, it feels, I love using the term, it feels like a spiritual practice. It's that analysis in your body, conflict resolution, you're just like, tension. There's always tension there and learning to manage that tension. I think you're exactly right. The amount of time you spend, like, "Oh, darn, that was a giant waste of time and money." It turns out that wasn't the problem. And then realizing that's part of the experiment is like, as soon as I can find disconfirming evidence, as long as I can be comfortable living in the wrongness, I'm getting closer to being right. We often ask ourselves, it's like almost every day, "Wait, wait, wait, wait, what are we solving for? With that idea, what do we solve? Did anybody ask for that?" Like, "Oh, no, we should turn that into a podcast and do that." "Wait, wait, wait, wait. What are we solving for? Oh, you need more entertainment in your life? Can we solve that a different way?" That's the kind of conversations. So I think that's super smart. What are you solving for?
Michael: What are you solving for? Awesome.
Carl: Hey, Michael, that was super fun. Thanks.
Michael: Thank you, Carl. Appreciate it.
Carl: Cheers.
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