Client Size

Q. I am just beginning a career as a financial advisor. As I grow my portfolio of clients, I can choose to focus on large clients or smaller ones. Do you have a perspective on which clients might be best to serve?

A. Most people think that large clients (or customers) are best. After all, they represent more revenue and are therefore highly sought after. However, as a practical matter, since you are a new advisor, focusing on landing very large accounts may be a real uphill struggle.

First, most high net worth clients will already have a relationship with an advisor. It could be difficult to dislodge them from that relationship, especially since we have been in an up market for a number of years, so the performance of the prospective client’s portfolio with his/her existing advisor has probably been fairly good recently.

Even if you find a client with a sizable portfolio that is ready to change advisors for whatever reason, chances are this prospective client will be looking for a new advisory with a long record of success. That can be a difficult hurdle for one just beginning a career as a financial advisor—frequently such prospective clients are just looking for someone with a few more grey hairs than you currently possess.

As a practical matter, it may be prudent to focus on prospective clients with more modest portfolios. However, this isn’t necessarily all bad. While we haven’t done this analysis for your industry, we have assessed customer profitability by size in a significant number of industries. Almost without exception, we have found that the largest customers are not the most profitable when viewed using a metric that encompasses profit per unit of effort (in your industry, such a metric might be fees earned per hour of work).

What we typically find is that small customers are less profitable because there are fixed costs associated with serving each customer. If the revenue you receive from a particular customer is small, you will have less volume over which to amortize the fixed cost. It is fairly intuitive that this would lead to lower profit per unit of effort.

Perhaps somewhat counter intuitively, we have also found that the largest customers may not be the most profitable. There is plenty of revenue over which to amortize your effort, however there are often mitigating circumstances that keep this revenue from falling naturally to the bottom line.

First, the largest customers are in a position to negotiate discounted pricing. Their volume is attractive, if won’t give them a discount, a competitor will. Further, since there is a large amount of money on the table, there is significant incentive for larger customers to push for lower prices.

In addition to negotiating lower prices, larger customers are likely to be sophisticated enough to demand a higher level of service. Of course, the higher level of service most often requires a greater level of effort without a commensurate increase in revenue. For these reasons, the largest customers may not be the most profitable.

On the other hand, mid-size customers lack the clout to negotiate the lowest pricing and enhanced services. However, they are also large enough to provide sufficient volume over which to amortize the fixed cost of serving them. This often means that mid-size customers can constitute a sweet spot where profit per unit of effort is maximized.

In your case, you may be constrained to working with smaller clients in the beginning. Our counsel would be to focus on smaller clients that have the potential to grow into, at least, mid-size accounts over time. Developing relationships with smaller clients who have the credentials and likely career paths that suggest the potential to build meaningful wealth over time may well be your most lucrative option in the long run.