Consolidation is currently running strongly in our industry.
Why? Because in principle, larger firms ought to be able to use their size to invest in better propositions and utilise their scale to drive down costs, delivering better value for customers and ultimately better returns for their owners.
Private owners, private equity and public markets increasingly see that well-run advice businesses, often with their own in-house investment solutions, have high levels of recurring income, retain their clients and help to grow their clients’ assets over the long term.
All of these factors should lead to growing returns as businesses scale.
So why is it that in practice advice firm margins generally do not increase as firms grow?
According to the FCA’s 2019 analysis margins are actually greatest amongst firms with a single adviser, and they consistently decline as firm size rises. On average, firms with 50 or more advisers made a loss.
I would argue that a significant reason is that compliance overhead grows disproportionately quickly as firms scale. When a firm is small the principal’s values and livelihood ensure quality and compliance.
As the firm grows beyond the founder, systems and controls are typically used to try and maintain quality. The problem is that very often the design of these systems and controls are often decades old – at least in their thinking.
My observation is that many come from the production line mindset of the old ‘Industrial’ or ‘Ordinary’ branch salesforces, where quality control was ensured by reviewing weekly activity sheets submitted by salesmen.
I have heard those who operated in the industry in the 1980s refer to these as ‘Lie sheets’ on more than one occasion.
Like Ford, GM and Vauxhall production lines in the 1980s, these industrial processes rely too much on workflow and checking gates at the end of the process and not enough on building quality into the process so that the product is right first time.
In a vertically integrated firm, or where the ‘product’ is not just the advice but the actual portfolio itself, the financial driver to focus on the ends and rationalise the means at the end of the process will also be present, to a greater or lesser degree.
It is also true to say that technology has not always helped here. Often it has grown out of the ‘salesforce’ mentality with rigid workflow which is created by management, painful to follow and therefore easier to circumvent and fill in after the fact with post-hoc justifications (historically I have been involved with one or two of these systems).
Alternatively, vendors have sought to automate the adviser out of the process, with the latest ‘robo’ processes which while good at recommending specific portfolios, can not handle the complexity and messiness of human circumstances and the challenges of principles-based regulation.