As financial advisors increasingly shift from their transactionally-based roots to providing ongoing financial advice (and being paid an ongoing fee for doing so), the value of getting a new client is changing dramatically. While in the past the “value” of a client was little more than the commission earned on the transaction they did, in a world where many advisory firms retain 95%+ of their clients, the lifetime value of a client over time could be as much as 20X that amount!
In fact, the lifetime value of an ongoing client relationship is so high, that advisory firms could arguably spend far more on marketing, business development, and (extra) services for clients at no cost, simply to accelerate client referrals, growth of the business, and to increase retention rates that further improve the lifetime value of the client and the economics of the business. Yet despite this opportunity, the typical advisory firm spends barely more than 2% of its revenue on marketing, and often charges separately for each “value-add” service (which can actually discourage clients from taking advantage of it!) to ensure clients are similarly profitable each and every year.
By contrast, the “robo-advisor” firms have been heavily focused on just reinvesting into the solutions they provide clients to stir word-of-mouth (i.e., referral) marketing and improve client retention, and are raising significant funding from venture capital firms that recognize advisory services are so profitable in the long run because of the high lifetime client value that it doesn’t matter if these firms generate no profits in the near term as long as the growth continues! Of course, most “traditional” advisory firms don’t have access to the capital that robo-advisors do, but the point still remains that perhaps today’s financial advisors could learn something from robo-advisors and their venture capital funders about recognizing the significance of high lifetime client value and how to (re-)invest in their advisory firms for long run business value and not just short-term profitability!
Understanding The Lifetime Value Of An Advisory Firm Client
In a transactional business, customers or clients have limited economic value to the business beyond the most recent transaction they conducted. While there is certainly some value to building loyalty to a business/store/brand to generate repeat transactional business, it’s generally quite difficult to do so unless your product becomes a regular purchase habit (e.g., Starbucks) or your repeat customers pay a very high price point (e.g., Mercedes-Benz).
However, in the context of businesses with recurring revenue – including most financial advisory firms, especially with the ongoing rise of AUM and now monthly retainer models for financial planning – the evaluation of client lifetime value looks quite different. As stable businesses providing ongoing services, with rather low retention rates, it suddenly becomes clear that a new client is worth far more than just the revenue they will pay in the first year; their value is the years, decades, or even lifetime (as many advisory clients literally remain clients for the rest of their lives!) of paying for services.
For instance, imagine an advisory firm that has a 95% annual client retention rate. This means that on average, the firm loses 1 out of every 20 clients per year, which in turn means that over time (if the retention rate remains stable) the average tenure of a client with the firm will approach 20 years. If the firm manages $1M of AUM for the client at a 1% fee, and thus pays $10,000/year for investment and financial planning services, then the lifetime revenue from the client will be:
$10,000/year x 20 years = $200,000!
Of course, the caveat is that the advisory firm must provide ongoing services to earn those fees, and there is a significant cost of doing business as a financial advisor. If the firm averages a 20% profit margin, then the anticipated lifetime profits from the client relationship will be:
$10,000/year x 20% profit margin x 20 years = $40,000
Notably, profit margins of an advisory firm may vary from year to year, and accounts themselves may grow or shrink (as markets go up and down, and clients either save more or withdraw to spend), so this (simplified) formula will not fully capture the nuances of client lifetime value, which could be modeled in a far more sophisticated manner. Nonetheless, the fundamental point remains: the lifetime value of an advisory firm client is significant. Very significant.
Marketing And Business Development For An Advisory Business With High-Lifetime-Value Clients
When the prospective lifetime value of a client is so high, there’s a lot of room for advisory firms to not only be successful, but to reinvest into their businesses to improve the situation further. For instance, if the firm can improve client retention rates from 95% to 97%, the lifetime value of a client skyrockets from $40,000 to $66,667 (which leaves a lot of room to invest into providing clients better services that can help move that retention rate by 2%!). If the firm can also run a little more efficiently, and boost its profit margins from 20% to 25%, the client’s lifetime value further improves from $66,667 to $83,333!
However, one of the simplest opportunities for advisory firms to grow themselves when the lifetime value of clients is so high, is simply to invest in marketing and business development efforts to bring on more new clients in the first place. In many industries and for many startup companies, the fundamental challenge is that if the acquisition costs to gain clients/customers are too high, the costs may overwhelm the lifetime value of getting the client, and the business model is fundamentally broken.
Yet when the lifetime value of a $1M AUM advisory firm client is somewhere between $40,000 and $83,333 (or more with favorable market growth that exceeds client withdrawals!), there is clearly room to invest into marketing. If the firm “merely” spends $10,000/year to obtain each new client, then the firm is dramatically increasing its value in the long run by “just” spending $10,000/year for clients with a $40,000 – $83,333+ lifetime value!
Notably, though, this is not what advisory firms actually do! The latest Investment News “Financial Performance of Advisory Firms” benchmarking study shows that the typical advisory firm spends only about 2% of its revenues on marketing! To be fair, 2% of all revenues is a much larger percentage when calculated against new revenues, but the math suggests that advisory firms still significantly underspend on new clients. For instance, a firm with $100M of AUM that aims to add 10% in new organic growth will add $10M of AUM, which at a 1% fee is $100,000 of revenue and with the above metrics will have a lifetime client value of $400,000 – $833,333… yet the firm is only spending approximately $20,000/year on marketing to try to obtain those clients!?
What Advisory Firms Can Learn From Venture Capitalists About Growing A Business
Given this context about how relatively little advisory firms spend on marketing despite the tremendous lifetime value of clients, the recent efforts of the so-called “robo-advisors” to raise significant capital suddenly becomes much clearer.
For instance, why would Betterment have raised $35M in venture capital earlier this year, when it already has a working automated investment solution for consumers? Or FutureAdvisor raise $15.5M in a similar situation? Or Wealthfront raise another $64M last week, despite the fact that it hadn’t even begun to spend from the $35M it raised back in the spring?
The answer is the recognition of the companies (and their venture capital funders) that because lifetime value of clients in an advisory business is so tremendous, a firm can be quite unprofitable in the early years and still become tremendously valuable in the long run – at least, if it has enough capital to invest in marketing for growth, and enough cash to support the business and its staff until the cumulative revenue from clients turns the business to profitability. In other words, as long as growth can be sustained and compounded, cheap financing just provides the funds to reinvest for even more growth, making the whole enterprise more successful.
Of course, the caveat for the robo-advisors in particular is whether their businesses can maintain enough growth – with continued exponential compounding – to actually justify their rather lofty valuations, which for Wealthfront is now estimated at $700M despite the fact that at $1.5B of AUM and a 0.25% fee schedule the company still has less than $4M of revenue (and is certainly not yet profitable). In addition, it the robo-advisors cannot hold onto clients effectively when the next bear market comes, and their retention rate declines, the lifetime client value estimates may tumble dramatically, further exacerbating their woes. Nonetheless, while it remains unclear whether there might be “too much” capital flowing into too many robo-advisors, and whether their required growth to justify their valuations is realistically feasible or potentially signifying a bubble, the underlying point remains: what robo-advisors understand, that most traditional advisory firms seem not, is that the lifetime value of clients in the advisory business is so high that there is ample room and opportunity to invest heavily in growth for the future!
What Advisory Firms Can Learn About How Robo-Advisors Are Seeking To Grow
Beyond the fact that the lifetime value of clients is so high in an advisory firm – justifying (re-)investment in marketing and business development efforts for growth – the other notable thing about robo-advisors is the way that they are investing to attract new clientele. While the robo-advisors do conduct some outbound marketing efforts, the most significant investments they’re making with their newfound capital are back into their (technology) solution itself, trying to create something that becomes even more popular with existing clients and that can spread to new ones by word of mouth. In other words, in a manner remarkably similar to traditional advisory firms, they’re simply trying to offer great service(s) to their clients that increase their referrals.
Yet with the robo-advisors, their focus has been about adding new services and features to their existing offering, from the Wealthfront 500 tax-optimized US index portfolio, to the Betterment Retirement Income solution, without necessarily charging separately/additionally for it. The reason, as we can see from the earlier discussion, is that in a business with such significant lifetime client value, it’s often not really necessary to charge more for additional services! Especially if they can either accelerate growth by attracting more clients (increasing the number of profitable clients being added in the long run), or better serve existing clients and improve retention rates (increasing the lifetime value of the clients in the first place). The accelerated growth of the business that has strong lifetime value in the long run, and/or increasing the lifetime value of the clients, is reward enough for the investment.
Yet here, too, there is a notable departure in how robo-advisors are implementing the strategy, compared to traditional advisory firms. In the traditional advisor context, it has become increasingly popular to charge separately for offering (additional) financial planning services on top of AUM fees, rather than include it as one bundled package for a single AUM fee. The separate charges, especially in the early years, are often justified as being “necessary” because of the additional work that it takes to deliver planning to clients in the early years. Which may be true, but also misses the point; when clients have a strong lifetime value, it’s not necessary to be (equally) profitable in every year from the start!
In fact, the danger for traditional advisory firms is that by charging separately for each additional service, instead of recognizing it an opportunity for better (referral) growth and better client retention, is that charging separately can make clients more price sensitive, or worse charging separately for financial planning can actually discourage clients from doing it at all, leading to worse business outcomes! While the scenario would be understandable if advisory firms had severe client retention problems – where it just wasn’t reliable to count on a significant lifetime client value because there was little likelihood the client would stick around – the irony remains that advisory firms simultaneously have incredibly high client retention rates, yet still treat themselves as though they have little room to reinvest in their services and marketing to accelerate growth and improve lifetime value!
In other words, robo-advisors are focusing on building enterprise and lifetime client value (supported by their venture capital funders who understand the potential of doing so), while traditional advisors are focusing on maximizing year-to-year profits – a classic scenario of long-term versus short-term thinking, that will likely lead to some obvious differences in business growth and value in the long run!
So while the robo-advisors may ultimately face some challenges of their own – as their valuations demand tremendous growth and their low price point leaves little room for error in trying to grow and maximize client lifetime value – the fact remains that robo-advisors may actually be doing the superior job of running their businesses as businesses and focusing on how to really grow the value of that business in the long run!
The bottom line, though, is simply this: in businesses like ongoing advisory firms, with clients who have incredibly high lifetime value, it’s not necessary for a business to make the same profit in every year from every client. In fact, it’s not always even wise to try. So perhaps it’s time for us as traditional advisors to take a lesson from robo-advisors and their venture capital funders, and invest in our businesses for the long-term value, not the short-term immediate profitability!