In a previous blog post titled Is Sales or Better Client Retention the Best Way to Grow an RIA Firm?, we discussed the value of client retention. With a revenue structure tied to assets under management (AUM), a firm that grows its clients’ assets over time will therefore grow its own revenue over time, by increasing the AUM on which its fees are based. While there is nothing wrong with increasing AUM through new client acquisition, the costs of doing so may begin to add up and include:
- Marketing costs to build a client acquisition funnel
- Costs of “wining and dining” prospects
- Costs of hiring a new individual investment adviser representative (IAR) focused on new client acquisition
So, while focusing solely on acquiring new clients can increase an RIA firm’s revenue over time, there are many costs that are commonly not considered in the effort to gain additional clients. Additionally, new clients typically generate less revenue than legacy clients.
As illustrated in detail in Is Sales or Better Client Retention the Best Way to Grow an RIA Firm?, assuming a firm charges an average advisory fee of 1% per year and using Vanguard’s average traditional moderate portfolio returns, a client who is retained for up to 10 years may have a 41% increase in total cumulative revenue, while a client who is retained for up to 20 years may have a 114% increase in total cumulative revenue.
At the same time, an RIA firm, much like any other “subscriber-based” business, like a cable company or mobile phone service, will naturally lose existing clients over time for a variety of reasons, including:
- Clients deciding to manage their assets on their own
- Competition
- Clients no longer being able to afford asset management services
- Poor service
This phenomenon is known as client churn. In regards to an RIA firm, we often define client churn as follows:
For RIA firms with an AUM-based fee, we use AUM rather than the raw number of clients to determine churn. This is because any given client may have a different level of AUM. Let’s say an RIA has $50 million in AUM on “day one”. If there is an expected churn rate of 10% of the original $50 million in AUM over 10 years, the firm will lose ~$5 million of the original $50 million in assets over ten years, which is equates to roughly $500,000 per year. But as was detailed in Is Sales or Better Client Retention the Best Way to Grow an RIA Firm?, an average traditional moderate portfolio returns about 5% per year. Therefore, while the prospect of losing 10% of a firm’s AUM to churn per year may seem frightening, the remaining AUM will be growing at 5%. The point being, advisors need to be aware of churn, a factor for all subscriber-based businesses, but not terrified of it, because there are other forces working in an RIA firm’s favor, with the most notable positive force being the fact that the market tends to go up over long periods of time.
Now that we understand churn, let’s think of it in relation to growth. Many times, especially for small or newer firms, there exists a zero-sum situation as it relates to spending, particularly spending to increase revenue. Therefore, a firm that solely focuses on increasing revenue through client acquisition may be neglecting spending on client retention (i.e. minimizing churn). In this blog series, we are going to discuss some ways that a firm can implement a client success program with the goal of decreasing churn.
Decrease Churn, Increase Revenue
The ultimate goal of a client success program or strategy is to retain clients. To retain clients is to decrease churn. To decrease churn is to increase revenue. Even in industries where the revenue from a single client does not increase at an increasing rate, as is typically the case with an RIA firm’s AUM-based fee structure, the longer a client remains with a firm, the more revenue that client generates for the firm.
(Source: http://blog.marketculture.com/2011/04/26/part-1-understanding-lifetime-value-of-customers/)
In the above example from the MarketCulture blog, we can think of the terms on the right as representing the following:
- Acquisition Cost: Marketing and sales cost to land a new client
- Base Profit: Revenue received from the AUM-based fee on day 1
- Revenue Growth: Incremental AUM-based revenue received from appreciating market value
- Cost Savings: For RIA firms, we can think of this as AUM that may be added by the client over time in addition to the AUM initially managed (i.e. AUM which is acquired without new acquisition cost)
- Referrals: Revenue received in the form of savings from having had minimal or no acquisition costs to acquire new clients referred by existing clients.
- Price Premium: For advisory firms, this may not be wholly applicable, but we may consider this to be other non-RIA related services that some firms’ principals or IARs may offer clients in addition to and outside of the primary service of furnishing financial advice, such as accounting or tax preparation services, insurance, etc.
The concept that the longer a client is retained, the more revenue that client generates over time is fairly straight forward, yet investment advisers regularly do not fully appreciate how a client often becomes increasingly profitable over time. In contrast to the “seven year client,” the “one year client” is still forcing an advisory firm to recoup costs associated with the client’s initial acquisition. Additionally, a client new to an RIA firm has often not been with the firm long enough to have established both the trust and assurance that the advisory firm’s services are worth the cost of their reputation insofar as recommending the firm’s services to his or her peers.
Choose to keep those clients!
In the next post of this three part series, we will discuss actions that the principal of an RIA firm can take to decrease the churn that is both slowing revenue growth and decreasing profitability. When a firm chooses to approach client retention actively, as part of a strategy, rather than viewing churn as an inevitable and unalterable part of business-as-usual, that firm will have taken the first step in working to dramatically accelerate its growth trajectory.