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Deja Vu

Oscar Wilde once remarked that “A fool is someone who knows the price of everything and the value of nothing.”  I think that lesson is being played out before our eyes in the financial planning profession, only instead of ‘fool’ in that quote, you can substitute ‘private equity firm,’ or ‘bean counter.’

Ever since I wrote the article telling stories about firms that were acquired, and the issues that the acquired advisors faced in their new workplaces, I’ve been looking a bit harder at the current consolidation, driven by an ever-growing flow of private equity money.  

The more stories I hear, the more I see, the more it reminds me of the leveraged buyout frenzy of the mid-1980s in Corporate America.  

If you’re too young to remember that era, it was a time when any fool could float junk bonds and buy viable corporations using the soon-to-be acquired assets of those viable corporations as collateral.  Then a bunch of bean counters would rush into the management ranks and cut everything in sight.  ‘Chainsaw’ Al Dunlap was a poster boy for this sort of thing, and his evisceration of the Sunbeam company, through a variety of acquisitions and cost cutting that slashed through fat, meat, bone and vital organs, ended in a huge mass of accounting fraud.

Not all of the outcomes were exactly like this, but what they had in common was new management that turned its attention to the numbers rather than to the products, the customers or the talent on staff.  Seldom did this end well, but of course the acquirers walked away from the messes they created with pots of money.  The postmortems often used the word ‘looting’ to describe the outcomes.

In the financial services world, I’m hearing stories that sound eerily similar.  The advisory firm is acquired, and the new owners turn their immediate and focused attention on the numbers.  What can we cut to generate more profits?  Why can’t advisors work with 200 clients instead of 75?  Of course, the people asking these questions have never actually worked with a client, and they don’t really understand the ripple effects of their budget cuts.  Their speciality is engineering profits.

At what cost?  The story begins when there are proposed cuts, many of which will impact (that is, diminish) the quality of client service.  But (the bean counters will argue) our retention rate is 95%.  Can’t we afford a little less of this expensive client service thing?

The first to object are the advisors who are closest to the clients, who see themselves as advocates for clients and client service.  If these client advocates persist in objecting as more budget cuts are enacted (and they usually will), then they will be encouraged to leave because they are ‘not team players.’  Of course, these are the most valuable members of the acquired firm, the people who have the best relationships with clients, and incidentally, the kind of people who can quickly find a new job anywhere else in the profession.

Now that the bean counters have gotten rid of the squeaky wheels, they can really go to work.  Profits soar.  But then they notice that client retention is not what it should be, and fewer clients from the newly-acquired firms are being retained.  Those lazy (remaining) advisors are the cause!  We should be paying them less or withholding their bonuses because they aren’t delivering as our forecasts projected.

I think you can see where this spiral is going, and I think we are in the very early stages of it.  I saw the same phenomenon back at the old IAFP during the mid-1980s, when the limited partnership collapse caused many of the companies (that were supporting the organization with unlimited funds) to go under.  The members who sold those partnerships were in distress, awash in lawsuits, unsure what to recommend to clients, dealing with the dual shock of a severe market downturn and a new tax act that eliminated the value of their tax planning services.

So what did the IAFP do in response?  Step up with additional guidance and service to its members, supporting new tools and finding sponsorship from companies that would be more appropriate recommendations?  Au contraire!  The executive director was compensated based on the profitability of the organization (you can snicker a bit at the fact that the IAFP was ostensibly non-profit), and his solution was to cut, cut, cut, every department, every service, anything he could get away with, which was a lot.  

Of course, I was a squeaky wheel during this process, and I actually drew an analogy for the management team and selected board members.  The story goes something like this:

The Campbell soup company is experiencing a period of reduced profitability.  What to do?  The company accountants, who will henceforth be referred to as the bean counters, came up with a brilliant suggestion.  Why don’t we cut out some of the chicken in the chicken noodle soup?  That way, we can save money and profits will go back up.

Sure enough, the strategy worked.  For a while.

But then the company noticed that its sales of chicken noodle soup were declining for some unexplained reason.  What to do?

The bean counters were ready with a suggestion.  Cut more of the chicken!

The strategy restored profitability.  For a while.  But then sales declined further.

I could go on with the story, but really what you need to know is that at the end, the company has cut out the chicken and the noodles, to the point where it is selling canned water, pretending it is soup, and sales are down around zero.  The bean counter solution provided short-term profit boosts, and eventually destroyed the profits altogether.  

I noted as I told the story that membership in the IAFP was already plummeting, because we basically weren’t offering anything more valuable than canned water.  After I left, the plummet continued, not to my surprise.  I warned them.

And now I’m warning the profession.  

Here’s a test.  When the new managers come in to reform the balance sheet, ask them what new services they think the advisory firm should be offering.  I guarantee that you will get a blank look.  What do you mean, services?  NEW services?  

That, at least, will get the business engineering team to look up from the numbers and see you for the first time.  It might even motivate them to look past you at the clients, but I wouldn’t bet on that.  

My best guess, as an amateur futurist, is that some of these aggressive acquirers are going to go through some unpleasant times, some will go under, and the profession as a whole is going to learn a very hard lesson: that the most valuable items on an advisory firm’s balance sheet are the staff talent, the client relationships and the service model.  Anything done to tinker with those things, and with their budget, should be done with care, and an awareness that they are the drivers of the retention rates that are too often taken for granted.  

I will also venture to guess that the PE firms will depart with bags of money, leaving behind what business management professors, using technical language, would call a ‘mess.’

But while that lesson is learned, another dynamic will play out.  Those smaller advisory firms that are wondering how they can ever compete with the emerging consolidated giants now have a strategy.  Just keep offering great advice and great service, keep your eye on client relationships and be welcoming and understanding when refugee clients knock on your door and tell you how the service level deteriorated at that office of a giant firm down the street, and how the advisor they had such a great relationship with over there (the squeaky wheel) is no longer there to hold their hands.  That advisor actually might now be working for you.

Offer those underserved refugees your best service, and I guarantee, while the private equity firms figure out this easy to understand, hard to learn lesson, you will do just fine.