Executive Summary
If there’s one thing that just about every financial advisor can agree upon, it’s that surviving the first few years in the advice business is very difficult. As a result, there’s a natural tendency for newer advisors to not be terribly picky about who they take on as clients, as getting any new clients that can generate any new dollars flowing into the business is often necessary for survival. However as advisers begin to find success, they have the opportunity to start building their practice with focused intent. For some, that means growing and scaling by hiring staff to support a growing number of clients. For others, that may mean remaining a ‘solo’ lifestyle practice and serving a (relatively) small number of (often highly profitable) clients.
But, no matter what a practice may look like, many advisors reach a certain point where the clients that helped them get off their feet early on are no longer a good fit… whether because they “can’t be serviced profitably” given new staff infrastructure, or don’t generate enough revenue to fit the more focused lifestyle practice, such that they can even become a drag on overall business results. In the case of no-longer-profitable clients who aren’t pleasant to work with in the first place, the solution is often straightforward. But what if they’re not unpleasant, just “unprofitable”? Which raises the question: How should advisors handle clients who they otherwise know they are helping and truly enjoy working with, but just aren’t profitable to serve?
In our 57th episode of Kitces and Carl, Michael Kitces and client communication expert Carl Richards discuss how to determine if a client doesn’t meet the profitability goals of a business, how to think about serving unprofitable clients who are otherwise a pleasure to work with and need good financial advice, and how to communicate with those clients when there’s no other choice but to let them go.
As a starting point, it’s important to first identify which clients are actually unprofitable for the practice. Accordingly, a common rule of thumb is to take the average revenue per client across the firm (by taking total revenues of the firm and dividing that number by the total number of clients) and then dividing that number by three. Since most advisory firms have overhead somewhere in the neighborhood of 30-40%, those clients who are generating less than about a third of the average revenue per client simply aren’t covering their slice of the basic costs of running the business.
From there, advisors can make a deliberate decision to designate a certain number of clients as “pro bono” and continue to serve them. But after those proverbial pro bono seats are full, there may be even more clients that now need to be transitioned. At that point, the best way to handle that conversation is by being candid and honest, and by explaining that, because of the level of service that’s being provided, the firm needs to charge a higher fee commensurate with the services it’s providing… and that it wouldn’t be in the client’s financial interest to pay the firm’s (new, higher) minimum fees. At that point, the advisor is communicating that they aren’t a good fit for the client (rather than the other way around, in a manner that could hurt the client’s feelings), and can best help by finding a different advisor who is!
Ultimately, the key point is that advisors chose this profession because they want to help people, but it’s equally important to acknowledge that advisors can’t help everyone… and that there are also other advisors out there who do great work, and for whom one advisor’s unprofitable client could still be a very good client for them. In other words, just because a client can’t be served profitably by one advisor doesn’t mean they can’t be served well by any advisor (as one advisor’s “C” client may still be someone else’s “A” client!). Which means transitioning clients who aren’t a good fit isn’t simply about “rejecting” them or leaving them to fend for themselves… instead, it’s an opportunity to help them find the advisor who will want to service them at the level they need and deserve, for the benefit of all!
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
Kitces & Carl Podcast Transcript
Michael: Well, good afternoon, Carl.
Carl: Greetings, Michael. How are you?
Michael: I'm doing well. I'm doing well. How are things settling for you back in the U.S. now?
Carl: Amazing. It's just amazing to be close to family. We were just talking about this today actually, we miss it. I had a conversation today with somebody from Scotland. She was in Scotland, I was here and the accent, and I was like, "Oh, I miss all of that," the kiwi accent, the Australian accent, and the Scottish and Irish.
Michael: They are wonderful accents. They are wonderful.
Carl: It's amazing. So, we miss a bunch of that but what we love is being close to our family and being outside so it's been amazing.
Transitioning Unprofitable Clients [01:38]
Michael: Awesome. Awesome. Well, welcome back. So, for our discussion today, we put the word out as we often do of what does everybody want to talk about? And we've talked in prior episodes about the dynamic of letting go of clients, letting go of clients that aren't a good fit. Life is short, it's time to move on from the “they pay us a lot of money, but they're just really unpleasant to work with.”
And, how do you let go of the... we used to call them PITA clients, pain in the...PITA is a nice acronym. How do you get rid of the PITA clients?
And, I think for a lot of us, like, those are pretty straightforward. Yeah, they pay us well, but it's not all about the money. Hopefully, ideally, we get our practice to a certain point where you can say, "my mental health is worth more than the incremental revenue from the next client, so I'm going to take the profitable but unpleasant clients and let them go."
So, we had a great question that came in that is the opposite scenario. The client that is a great client and a great person, but unprofitable.
And, it struck me, it really is a different context. Just the mental framework of “they pay well but they're a pain in the butt.” I know how to build myself up to say, "Look, this just isn't working and I'm going to feel so relieved when I know I'm never going to have to take a phone call from them again." That gets me through the awkwardness, the conversation.
But “I like you, you're nice people. I like working with you. I want to help you and I know my advice has positive impact, but it's just not profitable to serve you” is a really awkward conversation I think for a lot of us. It's sort of an extension of the minimum in this conversation, but it's even worse when you've already been working with them and basically have to say, “I need to stop working with you because you just don't have enough and pay enough.”
So, I thought it would be a great place to go for today's conversation of just how do you handle these situations where they're a good fit in all respects except there's just not enough revenue there? And I'm going to assume for a moment, this is not a, “well just raise the fee because they could afford to pay more.” I think we'll assume for this context they just really can't afford to pay you more or what your going rate is.
So, what do you what do you do? How do you handle this conversation?
Carl: It's a super good question. I think most of the people listening to this, just one of the reasons I love this little segment of the industry, whatever we want to call it, this little segment of people that we get to talk to is that most people got into this profession, if you will, because they're service-minded, they wanted to help people.
And, we've talked about this before that we never want to lose that, but it comes with some mindset things that can be problematic sometimes.
Michael: All right, “I like to help people and there's a person who's asking for my help, but I'm going to say no because they don't pay me enough.”
Carl: Yeah, it's tough.
Michael: I think we all get at some point. “There’s a business to run, children to feed, mouths to feed, etc”. Yeah, I get it at some level but when you get down to an individual, they're really nice people and I'm not making enough.
Carl: Yeah, so, a couple of things come to mind. The first is, should we assume for the scenario that they are literally not profitable or they're just not as profitable as we are now saying we're aiming for?
Michael: I think I would assume literally not profitable, but if you've got some thoughts around how should we be looking at profitability, I think that's a fair question.
Carl: Well, yeah, because that was where I wanted to start with this was, well, maybe you shouldn't get rid of them. Maybe there's something important there. Who says we all run around with these super cool S’s painted on our chest saying, “this is how we should do the bit,” and then well we had this come up a little while ago, maybe you shouldn't have a wait-list. Maybe you don't need to have a minimum.
The cool thing about this business is you can build any way you want, but if we assume for a minute that it's let's just say we brought on a number of these and it's this just came up this morning, actually, because it was tax year and a tax year in conversation with a bunch of really amazing planners in the UK. And they were all saying like “we just feel puffed.” The term I like to use is we just feel like we just got done with a month of being pecked to death by ducks. Nice people but so many demands so how do we deal with it? So, if there's literally like, “hey, I got to make a change to the business, how do you have that conversation?”
So, to me, the first thing that comes to mind is most of those situations are relatively simple. I guess you could create a scenario where somebody doesn't have enough money and a very complex situation but often when we're talking about those clients are relatively simple.
So, the approach I always took in this first meeting when we can back into you've been serving him forever but the approach I always took in the first meeting, and this comes up all the time because I think everybody deserves a second meeting.
And, people would say, “well, what if you know in the first meeting that they're nice people but it's not a good fit, profitability-wise,” my thought was, you had the second meeting, and you gave them a roadmap and said, “here, go implement this. Here, a one-page plan for you. It took me an extra half an hour.” I don't have to say that, but internally, I know. And I treat those people as marketing.
And, what I found is they didn't refer people like them. They said, "Look, there's not much we could help with here. It's just not a good fit for what we do here but based on everything I heard, here's a couple of things you could do. You start paying off that credit card debt, save $25 a month at Vanguard, and, do this, this, and this. Max out your 401k,” whatever.
Michael: So, I get it when it's a prospect but what happens when they're already a client? I think that was the context for this question. Been working with them for years, not profitable. I feel like I need to let them go. Really nice people, don't want to let them go. I feel like I need to let them go. Really nice people, don't want to let them go. All right let's end down, we get stuck.
Carl: Let's extinguish all the alternatives, and then we will get to the really hard conversation because one of the other alternatives is to change your service model for that group of people.
I'm not suggesting and I'm just saying, "Hey, instead of contacting them once a month, we're going to contact you four times a year and we're not going to meet in person anymore." And you just say, “We've made some changes and let's just check in once a quarter, let's check in once a year, how about you come in for an annual update. I'm not going to contact you once a quarter, we're just going to check in once a year and if you need anything, email me.”
Michael: So, that at least says, let's take the marginally profitable clients, and maybe we can dial the service model back in a way that makes this not totally uneconomical for us.
Carl: Especially, if we're doing it in a way that's better than anything else they're going to get anywhere. It's what they need anyway. Maybe you're over-servicing them, maybe. So you get clear about that first.
I still love that business by the way. Wouldn't it be interesting if you could find a way to serve somebody for $100 a month or $50 a month even, a whole bunch of them in a service model, and have a planner, or a paraplanner that takes care of a whole group of them? I still think that's a really, really cool business to say, “Look, you don't meet the minimum to work with me. We've got a whole service model for that.”
I think that's a cool business and everybody I was like, "Hey, you can't do that." I just pull out my calculator and run the numbers real quick and like, "No, there's a way to pull that off." But let's get to the point and say great, that's awesome but I don't want to do that. I literally need to know how do I talk to somebody about this.
Figuring Out If A Client Is Costing The Business Money [10:07]
Michael: Or sometimes, you're just too low. The rule of thumb I would give as a good rough estimate for this of, where is this client just definitely too low that it's not going to be viable for you? Take the revenue you make, divide it by the number of clients. So, that is your average revenue per client. Take that number, divide it by three.
Most advisory firms (at least once you kind of get out of the early startup phase where you do everything in your chief cook and bottle washer) end out with overhead somewhere in the 30% to 40% range of their total revenue, just the raw operational staff costs it takes to run the firm even before you ever meet with anybody. It's about a third of your revenue. And so, if you take your average client revenue and you divide it by three.
Carl: You are saying as a variable cost?
Michael: Well, because our overhead is mostly fixed. We've got our staff, we've got our infrastructure.
Carl: So, if you add revenue, you're not necessarily saying that you add because you're talking about fixed costs. I just want to be clear about this.
Michael: Yeah. So, if my average revenue per client is $6,000, about $2,000 of my client expenses paying my staff overhead. So, if you are not generating $2,000, you could literally not see the clients all year if they are still not covering just the overhead of the client service administrators and the keep the lights on level of expenses because they still end out with service requests, their license in Orion that you pay an account for. Costs show up for them.
And, I know I see a lot of advisors like, “Well, I hardly meet with them so it's not that expensive.” It's yeah, but when you add up all the ones that you've got and you add up the time that your staff spends once or twice a year when they call because they need a service request, it actually adds up pretty quickly and the rest of the licenses that go with it.
Carl: We don't want to go too deep into this, but look, if you've got a set of fixed costs and I add a marginal $200 a month...
Michael: They're not fixed. If I take a firm that has $500,000 of revenue, a million of revenue, $2 million revenue, $5 million of revenue, and $10 million of revenue, every single one has an overhead expense ratio between 30% and 35% without fail in every benchmarking study. The costs are never fixed.
We think they're fixed, but when you add enough clients, you end up hiring more bodies and the costs almost always move with you perfectly.
Carl: This will be fun and I think we will get a kick out so it's fine. So, let's just say, and I can't do it because I don't have a calculator. And this is now you know how you have...
Michael: You've got a calculator right here, man.
Carl: You know how you have Kitces Research?
Michael: Yeah.
Carl: This is Richard's Research, so just take this and put it in your pot and stew it. And so if you take two... how many? So, let's pretend, let's say $200 a month. Are we talking about clients below $200 a month or above $200 a month that are not profitable?
Michael: Below. You want an image, this client has $57,000 and they live off Social Security. And they're like your grandmother and you've been working with her for seven years and you don't want to send grandma to the wolves.
Carl: Then, if that's the scenario then I don't care what you say about profitability, you serve that person. My grandmother, are you kidding me? It's my grandmother.
Michael: Okay. How many of them are you going to take though before you run out of capacity in your business?
Carl: Let's say it's not your grandmother, let's say it's not my grandmother for a minute just because that would be too hard. We can't fire my grandmother, we can fire your grandmother.
Michael: All right. We'll take it off one step.
Carl: So, here's a couple of things, rather than getting into all that probability stuff which I would love to have another conversation about because there's a whole business model that I think is really cool there, but let's just pretend like it's somebody literally we just can't afford to continue to service.
Michael: Yeah, but just I hear a lot of questions about what constitutes not profitable because there's wide ranges. I just want to give people a rule of thumb that actually holds up pretty well, if you dig into the math of your practice metrics. Take your average client revenue, divide it by three. Anybody below that line is almost certainly not covering the raw overhead cost of the business because we as advisors tend to think if I only talk to them once a year, then the entire cost of the business is my one phone call and that's never, ever actually the case.
Carl: That is a conversation that I would love to have because I'm not sure I completely agree. So, we could have another conversation about that. But let's first let's just focus on this person. Here's the person and you just have to make a decision and I remember going through this. I had a couple of clients I just didn't like that I had to fire. That's the conversation that we talked about.
Michael: But those are the easy ones. I know how to fire “you pay well, but it's just not pleasant to work with you.” The “you don't pay well, and you're not pleasant” is pretty easy for all of us. This is the tough combination. These are nice people, we want to help them but it's not financially viable to do so.
Carl: Yeah. And if I literally can't make it financially viable once we've exhausted all those conversations, then I have to say, “Hey, we are making some changes at how we take care of"...sorry, "We're making some changes of how we do things here at Kitces and Carl Capital and it's no longer..."
So, here's the mindset shift. I had a friend who worked at Goldman back in the day, they had a $10 million minimum and there was a tax if they took anybody under that. They had to pay.
Michael: Interesting.
Carl: We lived in similar… it's like we lived in similar neighborhoods. It wasn't though. I lived on one side of the tracks in the neighborhood. He lived on a completely different side of the tracks, but we went to similar churches. In fact, we went to the same church and I was always getting asked for help by people who couldn't afford to pay much. And he was too, and somehow he managed to say no, and I was always managing to say yes.
And so, I asked him one day, how do you do that? And he was like, “look, it's just a disservice for me. It costs me money.” And so you're literally saying with the benchmarking studies that it literally would cost somebody money to take this client on? It costs me money.
So, he said, “The analogy I always think of is if I'm a knee surgeon and you've got something wrong with your shoulder. It would be a disservice for me to say, ‘yeah, I'll give it a shot. I'll give it a shot.’" And I think the mindset in my head has got to be if I continue to keep this person on the books knowing that I'm not going to service them because they're not profitable, I don't have the resources, I have to make a change.
Classifying Unprofitable Clients As Pro Bono Work [17:48]
And, the other thing that I got really clear about, remember try to try to get really clear about was I do pro bono work. If this is over here, it's in this bucket, I do pro bono work. And it seems like it felt really messy when you start to think of those people who are clients of yours on the books as pro bono work. That felt really messy to me. I guess it could be a solution or you could say, “Look, this is my formal service.”
Michael: I know some advisors, they've done that as the solution. Particularly for larger firms where this gets, frankly, even more awkward where management says I have to take grandma and fire her which just gets so much worse.
So, one of the policies I have seen some firms implement are things like, “Look, everybody gets six pro bono clients. You get six clients that you can have regardless the profitability metrics of the rest. This is your good deed to the world. But you can't have 10, you can have 20, you can't have 30, you can't scale this up because you're going to actually blow up the practice economics. You can have six. You're not sinking the ship with six, we can handle six.”
And at that point, treat them like any other client, give them the full service. You don't have to dial them down, give them the full service. Just own it's basically a pro bono situation, or I call it pay what you can situation. You can charge your fee but it's not adding up to enough.
Make them a pro bono client in your mental record-keeping and own that, but also own you're not running a charity. So, if you're going to have pro bono clients, you have to limit how much pro bono work you do.
Communicating When Transitioning Unprofitable Clients [19:33]
Carl: So yeah, I think that's a possible solution but let's again, we've exhausted solutions now. My six seats are full. What do I deal with number 7 through 27? And I think the single best thing to do is just to be kindly honest. And the way to do that is to explain, “This is how much our minimum fee is. We set it there because that's how we run a business here and we have to.”
And look, “Do I have permission to be professionally candid with you? We got to have a relatively direct conversation. It's become clear to us. We set our minimum fee here for a reason. It's because after all, the overhead of running the business and the people that work here, we've got to have that much or else it just doesn't make sense for us.”
I don't like the word profitable in this conversation. I don't know why it doesn't feel good, but “I think it just doesn't make sense for us to do anything less than this and it would be bad advice for me to suggest that you pay that.” It's whatever, 10%...
Michael: I think that's a good...it's got a nice framing. “It would be bad advice for me to charge you what our going rate is.”
Carl: Yeah, “5% of years of your investable assets is my fee. That's not good advice. So we can no longer serve you the way we have been doing, but could we take a meeting and I want to get you all set up. Frankly, the reason our minimum fee is this is because we provide a lot of services and to be honest, you don't need those services. So, I can get you set up someplace else” and maybe set up the wrong word, “I can help you with a plan, one-page plan, that you can go implement somewhere else and I can even make a suggestion.”
I actually helped people open accounts at Vanguard. “Sit down, let me show you exactly how to open it. Let's open the account of Vanguard, let's get assets moved there, let's take care of that. I will help you with all of that.” We helped people who weren't a good fit. And I didn't have to do that often, but I remember doing it two or three times. And to me, that's the only way to do this. It's just got to be an honest discussion. We run a business.
And, I think most of this because it's even in my head. I'm stumbling through it right now. I feel it and I can feel this “I'm going to hurt somebody's feelings.” As I reflect back on those conversations, almost everybody understood, I totally get it.
Michael: They do usually know that they're not like the rest of your clients.
Carl: And, they're grateful for the help. And I just think everyone deserves that level of...dignity is not the right word but just we can treat people kindly in this process. And if it takes us an extra couple of hours to help them in that situation, we do it. And it's the same as the prospect that’s not a good fit. It becomes a form of cosmic karma. It also becomes a marketing. That person now clearly knows what your minimum is if you were kind to them.
Because I've seen the, I don't want to call it the Brooklyn way of doing this but I've seen that way, like “Hey, this isn't going to work anymore, sorry it's not a good fit. Tell me where to send the money.”
Michael: That's what I do for the ones that aren't nice to work with.
Carl: Yeah. Yeah. And I've liked that we've sort of processed through this, the nice ones to me, it's an honest discussion about the reality of the business and then a real effort to help them get set up in a way that frankly meets what they need, anyway. “Pay off this debt, save $50 bucks a month in the S&P 500 fund, keep funding your 401(k).” That's what you should be doing, anyway.
Michael: My approach to this is still at the end of the day, we've talked about this on other episodes of this podcast as well. Your ‘C’ client is still someone else's ‘A’ client, it happens really up and down the spectrum and even down to we'll call them just like very small account sizes.
Somewhere out there, there's a really smart, really sharp up-and-coming financial planner who does great work and knows their stuff and gives great advice and is struggling to find their third client and it would be a gift to everyone. They will service these clients more than you ever could or ever wanted to because they don't have a lot of clients. And particularly early on, any revenue coming in is good.
And so, just taking that mentality like your unprofitable ‘C’ client is still someone else's ‘A’ client. Even as you're talking about before, like that poor private banker of “I don't know what to do when I have to slum it with a client who's only got $3 million because our minimum is $10 million.”
It is amazing no matter where you are in the darn spectrum, your ‘C’ client is someone else's ‘A’ client, and your ‘A’ client is someone else's ‘C’ client. There's an incredible hierarchy in the industry. So to me, just if the client is not profitable, not viable for you, it doesn't mean there's literally no other good advisor in the entire country for whom this couldn't possibly be a good relationship. There are hourly advisors out there.
A good relationship is defined as they show up for the hour, and they pay for it. And one billable hour from them for the one client meeting a year may not be all that different from the one meeting you're trying to dial them down to except you're doing it as a sense of obligation, or pity, or something because you know they're not profitable but you're doing it, anyway. And for them, it's actually a good meeting, it's a good client, a good deal.
So, if you've got that angst, then find them a good destination. Instead of taking all the hours you're going to take to meet with them even though you shouldn't meet with them because they're not profitable, and not good for your business and consuming capacity for you to actually help the people that you can best help, take a little bit of that time you were going to spend with them, find an advisor. You can help them by finding the advisor that would be a better fit for them.
And, to me, then the conversation gets much more positive, which is look, "I've really enjoyed working with you over the years, but we've gotten to a point where I'm not sure we're the best fit anymore. Our minimum fees have been going up. I could not in good faith charge you those fees, because it's for a scope of services you don't need and it wouldn't be in your financial interest to do it. But I know another advisor. Her name is Jennifer, she's wonderful. I've spent some time talking to her, I'm really confident that she's able to help you and I'd like to introduce you so that you get the level of service that you deserve because I don't know if we can serve you the way that you need and Jennifer can. Would it be okay if I introduce the two of you?"
Carl: I love that.
Michael: And, just make it positive for them. “I'm going to help you get to someone that's better.” It doesn't mean we have to take the time to to find someone better but if you're thinking at all it's scary and challenging to find someone to refer clients out to, welcome to the challenge that every single client has because they got to pick this blind and they don't know anything about our industry that all of us know about how our industry works and how to actually vet who's going to do a decent job or not.
If you think it's daunting, then it's so much worse for your client. So, if you want to do something for them to help them like, do that work to help them find a better destination. And then it's a positive conversation. It's like, “I found someone who can serve you better than I can.” We got to swallow our pride to say that, but I found somebody who service you better than I can.
Carl: Fair enough.
Michael: All right. Well, thank you, Carl. This was an interesting one today.
Carl: Yeah. That'll be super fun to hear what people think about that. Thanks, Michael.
Michael: Thank you.
Carl’s “We can’t fire my grandmother, we can fire your grandmother.” was the laugh I needed today.