Investment Advisor Interests  04/29/2021 NAPA RSS Icon

How Investment Advisors Should Categorize Clientele

By Jon Talamas

How Investment Advisors Should Categorize Clientele

Have you segmented your client base according to financial or other criteria? If not, you may be missing out on an opportunity to optimize your firm’s performance.

Client segmentation—defined as categorizing your customer base by key factors in order to optimize service delivery and profitability—has become an industry best practice. But registered investment advisors (RIAs) may not be reaping the full benefits of this technique.

According to Fidelity research, 80% of advisors have segmented their client bases or are planning to do so. But only 22% link pricing and service to discrete client tiers. This limits the productivity and profitability gains to be had from this approach. To fix this gap, RIAs should revisit their segmentation goals and methods to make sure they’re truly benefiting from them. This article will provide guidance to that end.

Why Segment Your Client Base

Decades ago, financial advisors often did business with anyone they could sign up. Although large-practice bragging rights were satisfying, doing business with “everybody” meant serving too many clients who weren’t capable of paying adequate fees or were enjoyable to work with. But that was the least of it. With non-segmented practices, time and financial resources went to people ill-equipped or unwilling to benefit from them. Meanwhile, those who could appreciate and derive value from their services weren’t offered them. Result: RIAs spent too much time and money on the wrong clients and not enough on the right ones, leading to sub-optimal profitability. Enter client segmentation.

Dividing a practice into multiple tiers produced a better-managed and more profitable business. Fidelity identifies four specific benefits of this approach:

  • A more tailored business: Segmenting customers helps you provide services for each tier based on specific needs. The stronger the link between client preferences and service delivery, the stronger the firm’s customer satisfaction will be. The better the satisfaction, the greater a practice’s retention and profitability.
  • Optimal resource allocation: By matching client requirements with firm capabilities, clients receive support commensurate with their profit contribution and advisors become more productive because they spend less time with the wrong clients.
  • Better understanding of their practices: Once RIAs segment their business into tiers, they’ll know which clients are most important to their success and deserving of more firm resources.
  • Stronger business fundamentals: RIAs who segment their clients tend to be faster growing and have stronger financial metrics than those who don’t segment.

The Business Case for Segmentation

When it comes to client segmentation, the numbers tell the tale. According to Fidelity’s Advisor Community Segmentation Study, RIAs with client segmentation strategies had average assets under management (AUM) of approximately $2.6 billion compared with $1.45 billion for those without segmentation. The RIAs with client tiers also reported 74% growth compared with 63% for non-tier firms. They also strongly outperformed non-segmented RIAs when it come to the number of $1 million+ clients (28% vs. 16%) and mean annual compensation per advisor ($364,000 vs. $223,000).

How to Segment

Segmenting your clients isn’t a cookbook exercise; there’s no single correct recipe for allocating your clients into multiple tiers. But it should be tied to your practice goals and your desire and ability to precisely “slice and dice” your practice.

To start the process, think about your goals. Perhaps you have untapped advisor capacity you’d like to allocate to the highest potential clients. Or you may have service issues due to lack of advisor availability. Whatever your concerns, identify the goals you’d like to achieve through segmentation and attach evaluation metrics to them.

Next, decide on a segmentation methodology. You might base your scheme on a single factor—for example, client AUM or client profitability—and then assign cut-off points between tier levels. The benefits of this approach: it’s easy to create tiers and to allocate clients into them.

Alternatively, you might create a system based on multiple weighted factors, perhaps with primary, secondary, or tertiary criteria. Fidelity’s study found that 30% of RIAs used client profitability, 22% used client AUM and 17% used time and resources required to serve the client as their primary segmentation factors. Meanwhile 23%, 28% and 25% of advisors used the prior three factors as their secondary criteria. Future client revenues and product and service needs of specific clients were also used as both primary and secondary criteria.

Other common criteria include:

  • Demographic factors
  • Relationship with an existing top client
  • Shared philosophy/personality with the RIA
  • Ability and willingness to generate referrals
  • Tax sensitivity
  • Service preferences
  • Lifecycle stage
  • Career situation (employee vs. entrepreneur)

How might a weighted multiple-factor scheme work? Let’s say you decide your most important segmentation criterion is revenue generated per client. Your second most important is referral-generating ability. And your third and fourth criteria, which have equal value, are connection to a top client or clients and shared philosophy. Based on this system, a client who hits your ideal revenue target gets five points and one who doesn’t gets 1 point. Clients who can generate referrals get 4 points and those who can’t get zero points. And those who have connections to top clients or who share your philosophy get three points for each factor they fulfill.

After rating a client on these factors, tally the points and place each client in the appropriate tier. Clients with the highest points slot into Tier A; those with the second highest, go into Tier B; and those with the third highest total, join Tier C.

The beauty of this approach is you can evaluate your client relationships based on multiple factors that are meaningful to you. It also allows you to consider quantitative and qualitative factors in one model. This provides a more realistic and useful picture of your client base than a single-factor financial model does. However, working with multiple factors requires that you have more client data on hand and more time to build the model.

Assess Tier Profitability

One of the key reasons to segment your clients is to see if there’s a disconnect between the resources clients consume and the profits they generate. To do this analysis, follow these steps:

  1. Calculate your firm’s return on assets. This is the revenue you produced last year divided by your firm’s AUM.
  2. Determine the total AUM in each client tier.
  3. Multiply each tier’s total AUM by your firm’s return on assets.
  4. Divide the resulting total by the number of clients in each tier.

The result of step 4 is how much profit a typical client in each tier generates per year. You may be surprised by the profit difference between your top and lowest tiers. If nothing else, this analysis will cause you to question whether you’re providing too much service to your lowest-tier clients and too little to your top-tier customers. Coming up with a more rational allocation is one of the main reasons to segment your clients.

Optimizing Service Delivery

Client segmentation not only allows you to optimize service, it also provides data to support your service model and pricing decisions. For example, an RIA that charges fees based on total AUM might provide financial planning for Tier A clients as part of its total service package funded by a percent-of-AUM fee. The goal is to recognize the value of clients in the top tier by encouraging them to take advantage of the firm’s financial planning capabilities. Doing so will likely generate positive results, making the Tier A clients even more valuable to the firm...and more satisfied with the service they receive.

Meanwhile, Tier B and C clients who need financial-planning work are charged an additional fee. This isn’t meant to penalize them, but rather to provide them with service and pricing commensurate with their financial sophistication, net worth and profit contribution to the firm. This practice allows you to offer the full menu of financial-planning services, but a la cart to ensure you are not limiting Tier B and C clients, but also not wasting energy that could be allocated to Tier A clients.

Segmentation also helps you to determine rational service delivery, communications and perks by tier. Tier A clients will typically receive the most robust support, while Tier C clients will receive the least. For example, a top-tier client might receive:

  • More in-person meetings
  • More outbound phone calls
  • A faster email response time
  • In-office vs. virtual meetings
  • Access to a “special” client appreciation event
  • More loyalty perks (e.g.: free financial-magazine subscriptions)
  • Free tax returns
  • Free concierge services (car-shopping or vacation-planning assistance)

Acting on Your Segmentation/Financial Analyses

After you finish segmenting your customer base, revise your policies based on what you discover. Here are some decisions you might consider making:

  1. Remove or deemphasize some or all of your lowest-potential clients
  2. Raise fees on clients who are unprofitable, but who may have redeeming positive factors (for example, a relationship with a top client)
  3. Add service support, advisor touchpoints or perks for your best clients
  4. Implement a campaign to uncover new assets from high-potential clients
  5. Assign your best advisors to your best clients
  6. Pair advisors with the least experience with lower-tier clients

The point is, you want to make sure there’s a strong linkage between what clients provide to the firm in terms of profit and what they receive in terms of service. Strive to right imbalances whenever possible.

At the very least, think about reevaluating how you treat your lowest-ranked clients. No solution will be perfect here. You could “fire” them, of course. But they might complain and spread negative word-of-mouth about you in the community or on social media. If you decide to keep them, consider reassigning them to younger, less-experienced advisors. However, C clients might not appreciate having to work with an advisor who only has a few years of industry experience. Switching them to a service package with fewer touchpoints (or with higher fees) might be a better option. Whatever you decide, make sure lower-tier clients understand your goal isn’t to punish them, but rather to give them a valuable and relevant service package. Leave open the possibility they can move up to a higher tier and receive more service as their finances grow. This will motivate them to make the right financial decisions.

Rethinking how you deal with your best clients will be easier to handle. Define in writing how you will augment their service package, touchpoints or perks. Then communicate the upgrade to them, ideally in person. Also create a plan for capturing additional assets from them, especially from those with significant assets outside the firm. Consider designing a marketing plan featuring more frequent calls, invitation to a client seminar or webinar tied to a relevant financial need and a robust client-review designed to assess whether they’ve effectively deployed their outside assets.

In short, by making these and other “rebalancing” decisions, you’ll produce a firm that’s firing on all its cylinders. Your best advisors will largely be matched to your best clients. And your clients with the least potential will receive the service they need without consuming excess firm resources. At the end of the day, an RIA with a well-designed client-segmentation strategy will be more profitable, more productive and better positioned to grow over the long term. If you haven’t segmented your firm yet, what are you waiting for?

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