Growth and Austerity

The economic story unfolding in Europe raises questions for all business leaders. Should we attack our deficits or should we fund our growth? While well-intentioned people can argue “yes” to either question, those in charge know that it is easier to write the slogans than it is to create the business plans to fix what ails us.

Despite all of the quick-fix rhetoric, there is no magic pill that can restore health instantly. This is true for governments. This is true for people. And it is true for businesses.

In our simplest minds, the choice seems obvious. Austerity causes pain. Revenues create pleasure. Why on earth would anyone choose to suffer if there is an alternative course? Thinking more deeply, however, our complex minds know that each action has a consequence, and no solution is entirely black and white.

Some combination of growing revenues, limiting financial leverage and managing expenses allows leaders to correct their missteps and steer in a new, successful direction. But the magnitude of the problem and our control over the levers dictate how decisively we can act. As much as we wish for new revenues, higher margin relationships and to grow without costs, the management of each of these levers requires discipline.

The average cost of running an advisory firm is rising faster than revenues. This is because of a pent-up demand for people, their need for higher compensation, rising regulatory costs and lower productivity.

In “Mission Possible III,” a recent independent study commissioned by Pershing Advisor Solutions LLC and developed by independent consulting firm FA Insight, we observed that the median overhead expense per client has been ticking up at a rate of 5.2% for the last several years (see Figure 1, left). Meanwhile the average overhead expense as a percentage of revenue is hovering around 40%. Of course, many firms are above average, which is not where you want to be.

Especially compelling, this analysis revealed where the expense dollars are going (see Figure 2, left). Thirty-five percent of total overhead goes to administrative staff, management, technical specialists and support staff. Other staff costs such as taxes and benefits consume 17% of the overhead budget, and office expenses take up another 20%. The rest is shared among IT costs, business-development-related expenses and a general catch-all called “other.”

These numbers affirm that we are very much a people business, no matter how many computers and smartphones we buy. Second, they affirm that with salaries, taxes and benefits consuming almost 50% of the operating outflow, advisors must continue to find new ways to squeeze out greater productivity. Bear in mind that these numbers do not include compensation and benefit-related costs for professional staff, which is counted in a category called “direct expense.” (More details on financial accounting within an advisory firm can be found in “Practice Made (More) Perfect.”)