Is Bigger Always Better?

You don't have to be supersized to be profitable

Pump it up. That's the American way. Who has the biggest muscles at the gym? Who has got the biggest SUV in the driveway? (Well, at least before a fill-up required a mortgage.) Who has the biggest boat in the marina?

Yes, in the land of Big Gulps, Whoppers, Hummers and Shaq, big has always been in. But where bigness really thrives is business. Maybe it's because it's so easy to measure size in the corporate world — a dollar sign being such a transparent denominator. Top-line revenues, bottom-line profits, market capitalization — these are all ways that businesses define their worth and flex their muscles. In the financial-planning industry, reps love to flaunt their bigness, their success.

Big is powerful. Big is showy. Big is, well, big. But is big really better? And, more to the point, is big really worth it?

Take, for example, two hypothetical planning businesses:

Joe Glitzbomb & Associates: Joe works in 2,500 square feet of Class-A space in a high-rent suburb. He imported mahogany from Africa to trim his office. He employs four employees, including a marketing assistant who graduated from Harvard, a research analyst and two administrative staffers. Joe's office is wired with the latest servers, desktops and phones. He pipes in CNBC to flat screens in each office. His staff prepares and distributes quarterly performance reports for his high-net-worth clients. Merrill Lynch and Schwab both opened regional offices nearby; three other sophisticated financial professionals have been well established in the area for 10 or more years.

Charlie Frugal, CFP: Charlie serves his client base from a 1,500-square-foot office that he shares with a CPA. He employs an assistant who performs all his administrative duties, including customer support. He uses a premier broker/dealer to provide equities research, quarterly client reports, technology support and compliance functions. Charlie's wife, Nancy, prepares his books once a month. A single laptop and a combination color copier/fax machine/scanner serve all of Charlie's technology needs. His clients — while not as wealthy as Joe's — have been with him for many years and have built up substantial retirement savings. Charlie's only competitor is a new, independent financial professional who, so far, hasn't gained traction.

Without revealing how much revenue each generates, one could reasonably estimate that Joe's practice is much bigger than Charlie's. What if I were to tell you that Joe's practice generates $700,000 and Charlie's practice generates $300,000? Joe's practice is more than twice the size of Charlie's. Joe is clearly much bigger than Charlie.

But who actually takes home the larger net pay? Who, after all the overhead expenses have been paid, is making more money for himself? Is it Joe or is it Charlie? And who's happier?

Joe — probably rightfully so — feels he must invest (spend) in his business because his market niche is so competitive and his high-net-worth client base expects a certain level of pizzazz to accompany the advice he dispenses. Trouble is, Joe has overdone it.

Joe's scenario isn't entirely uncommon, either. In fact, as reported in the 2004 FPA Financial Performance Study of Financial Advisory Practices, economies of scale do exist for advisory practices, but relatively few firms achieve an improved bottom line on the way to being big. For most practices, the study says overhead expenses actually increase as a percentage of revenues up to the $1 million mark.

As a result of Joe's unbridled growth, his salary and office expenses exceed 50 percent of his top line. In addition, he wishes he could spend less time managing staff and more time with clients — as he used to do before he got big.

Charlie, on the other hand, keeps his office functional and efficient. He outsources (i.e., leverages) a good chunk of overhead to his b/d; as a result, these expenses are only 25 percent of his top line. “For solo practices,” according to the FPA study, “the key to keeping overhead down is leveraging the relationship with the broker/dealer or custodian.” Though he sometimes wishes he could grow his business more — primarily because he knows his practice will be valued by his top line — he enjoys spending time with clients and has built himself a solid nest egg.

So, who takes home the bigger paycheck? After subtracting a b/d haircut and the overhead expenses, Joe and Charlie take home approximately the same net pay. As to who is happier, we have to return to the original question, “Is bigger always better?” You be the judge.

Richard Hunter is the managing principal and CFO at Commonwealth Financial Network. He can be reached at [email protected].

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