December 3, 2011

A Business Model Structure to Help Advisors Manage Their Practices

In the RIA industry, the term “business model” usually refers to the various business model choices available to an advisor:  "fee-only vs. hybrid" or "establishing a new RIA vs. joining an established firm or "RIA aggregator".  Beyond this initial (and important) decision though, lies the world of business model design, a practice that can help both start-up and established RIAs manage their practices more effectively.

A "business model" is really just a depiction of what your RIA plans to do and how it plans to make money. (Yes, a deceptively simple description for a pretty complex undertaking.)  I don't handle raw complexity very well so my first reaction is usually to find some kind of framework that will add order to an otherwise complicated undertaking.  

A colleague introduced me to a book by Alexander Osterwalder and Yves Pigneur called Business Model Generation .  Th authors lay out a really simple framework that portrays the elements of a business model very effectively.  (Their blog is a great read as well.)  Based on their framework, I listed below the nine elements of an RIAs business model, along with some thoughts around each.  

Value Proposition.  Your value proposition is a fundamental element of your RIA's business model design.  It serves as a guide for decision making because delivering "value" profitably is the key to staying in business. (See previous post.)

Client Segments.  There are multiple client segments that an RIA may chose to target. Segmentation methods for advisors may be based on affluence, life stage, or other shared attributes like profession.  Beyond individual investors, advisors may seek to develop the capabilities to attract institutional clients.  After segmenting their potential market, advisors should then identify specific segments with needs that align with their capabilities and service models.

Distribution Channels. An RIA’s distribution channels include each of the methods that they use to connect with prospective clients. These may include client referrals, networking activities, promotional efforts, or prospecting activities. One additional channel that can easily be overlooked is existing clients. (i.e. determining if your firm is, in fact, a client’s primary or sole advisor.) 

Client Relationships. As a service-based business, establishing relationships that meet client needs and expectations is paramount to an RIA. The extent to which an advisor is willing to customize these relationships is a key decision. By establishing multiple service levels that align with pricing, RIAs can maintain more stability in their profit margins and build scalability within their business model. 

Revenues.  Determining the source(s) and the nature (e.g. recurring or non-recurring) of revenue streams is fundamental to an RIA's business model. Advisors may utilize a number of methods to charge for their ongoing services including: AUM-based fees, performance fees, or fees based on client net worth. Non-recurring revenues may include fixed or retainer-based consulting fees or hourly fees.

Key Resources. Think of these as your RIA’s “assets", both tangible and intangible.  Early on in an RIA’s life cycle, these typically include financial assets (cash reserves), human and intellectual capital (advisory team, client relationships, personal reputation, capabilities) and technology (both hardware and software). Over time, an RIA will add to these assets and will ideally develop additional intangible assets like reputation, firm culture and processes.

Key Activities. These step from the services that an RIA chooses to offer. Advisors may decide to provide investment management services or they may chose to utilize outside managers and products. Other decisions may include offering financial planning services, investment consulting, family office services, insurance or trust services. For each of these offerings, an RIA will have to assemble a combination of people (either staff or through partners), process and technology to support it.

Partner Network.  Partnership opportunities within the RIA industry are plentiful. Custodians continue to expand their service offerings to support advisors on their platforms. Innovative outsourcing solutions are being formed as well. And there is a rich set of specialist consultants available to help RIAs in areas like operations, marketing and technology.  Picking strong partners and incorporating them into their RIA's processes represents an incredibly powerful lever for most RIAs.

Cost Structure. An RIA’s cost structure is a combination of fixed and variable expenses necessary to deliver their services. This ratio of fixed vs. variable expenses should vary based on the stability of the business by limiting fixed expenses early in an RIA’s life cycle. As the firm matures and revenues stabilize, larger fixed expenses will become necessary.

What's next?  With this framework in place, advisors can begin to see how each of these components impact each other. For instance, if you are considering the addition of financial planning to your offering, this blueprint can point to each part of your RIA that may be impacted by this:  Partner Network (Can a new or existing partner help?) ; Key Resources (Do we have the human capital or technology support?); Value Proposition (Does this support/enhance/conflict with our promise of value?) 

Distilling down the various components of the business model will help investment practice leaders in a number of ways.  For start-up RIAs, these components can feed perfectly into a business plan.  For established RIAs, this framework will help leaders visualize their practice as a series of interrelated parts, guiding strategic decisions, pointing out areas for potential improvement, and ultimately adding some order to the chaotic world of entrepreneurial management.


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