Pricing advice for trust, sustainability and loyalty (Part 1 – pricing framework and context)

05 Sep 2023

From AdviserVoice - this Best Practice article is proudly brought to you by Bennelong Funds Management

Numerous studies have shown the price of advice is one of the main barriers to consumers seeking financial advice.

The importance of advice pricing

It sounds obvious to say that pricing can make or break a business, but in the case of financial advice it’s a particularly pertinent issue that remains one of the most debated and discussed across the entire adviser community.

There are several reasons for this.

Firstly, numerous studies^[1] have shown the price of advice is one of the main barriers to consumers seeking financial advice in the first place, and is one of the main reasons people switch advisers, or exit the advice system altogether.

Secondly, advice – and indeed financial services generally – has a longstanding trust issue with the community at large, and perceptions about adviser remuneration is undoubtedly a key contributor here.

Thirdly, from the adviser perspective, the cost to provide advice continues to rise. With the streamlining of red tape recommended by QAR yet to yield tangible benefits to advisers, the costs of the various inputs into advice (wages, rents, PI insurance, licensee fees, ASIC fees etc) continue to rise, and advisers face a difficult choice – either pass these increases onto their clients, or reduce their own margins, potentially undermining their long-term sustainability.

Coming from the other angle, advisers must also deal with two forces that effectively limit their flexibility with regards to remuneration. One is an overall consumer reluctance to pay an amount for their advice that comes close to covering the cost of providing that advice. The other, specific to life insurance, is the LIF related upfront commission cap of 60% (which was essentially locked in by QAR).

With this in mind, this article – the first in a two-part series – will seek to go back to first principles and offer advisers a way to consider and construct a price for their services that can both ensure their business remains sustainable, while building trust and loyalty with clients and prospects. The second part in the series will explore the mechanics of ‘how’ to charge, looking at different pricing methodologies and models, as well as addressing the all-important question of how to communicate your fees.

The starting point – your philosophy on price

Your philosophy on pricing your services is arguably the most fundamental business decision you can make. That’s because unlike the perfectly competitive marketplace depicted in economics textbooks, the market for advice has a key structural imperfection – namely the gap between what most consumers are prepared to pay for advice, and the costs incurred by advisers in providing that advice.

Advice practice owners must decide whether to price their advice from the inside out, or the outside in.

Pricing from the inside out means your starting point is what it costs you to provide advice (your cost to serve). After calculating your total cost to serve you can then add your desired profit margin to arrive at the amounts you need to recover from your clients.

Pricing from the outside in means starting with your potential clients, and what they are prepared to pay. This is a truly client centric approach.

To the extent that the two perspectives will result in entirely different numbers, they will actually drive your entire business model.

The first approach is likely to take you down a traditional, labour-intensive path. Many people will be unable to afford your advice, but the limited supply of advice (courtesy of shrinking adviser numbers) means there will be enough of a market to make your business sustainable. Under this approach you are probably deciding to prioritise a high touch approach to client care, which many will love.

The second approach will require you to build a business model that strips the cost of advice to the bone. This could require a more mass produced, low touch, modular approach to advice, which relies heavily on technology, virtual meetings, home offices, and outsourcing.

Each approach is as legitimate as the other, giving advisers equal scope to act in their client’s best interests and provide value for money, while remaining sustainable. But each approach is very, very different.

Pricing route 1 – inside out

The inside out approach starts inside your practice and involves setting your pricing by calculating the cost of every single aspect of you providing advice. This means forensically examining every single step in every single process in your practice, to calculate your ‘cost to serve’. You can then add a desired margin to arrive at the minimum price you need to charge each client for your advice (the minimum recoverable amount, or MRA).

A convenient framework to conduct this analysis is the one used by KPMG in research they conducted in 2021 on behalf of the FSC². In their study of advice costs, they broke down the advice process into seven key steps:

Identification of an advice need.
Meeting between client and adviser.
Preparing the financial plan.
Second client and adviser meeting (to present the advice).
Client signs the SOA.
Implementation of recommendation.
Regular reviews and ongoing service (for ongoing advice clients).

Calculating the cost of each step in this framework requires you to understand (a) how long each step takes and (b) the cost of the practice staff involved in those steps.

Estimating time taken at each step can be as simple as completing timesheets in excel, or as sophisticated as using workflow or accounting software to track the time taken on tasks.

The second dimension of this calculation is the cost of spending that time. This is an amalgam of business overheads (including, but not limited to rent, software, licensing fees, PI insurance, utilities etc) and then variable people costs, including salaries, training, memberships, workers compensation and other on costs levied at the per-person level.

A corollary of this analysis is that different categories of staff within a practice will have different costs – equating to different hourly rates. Advisers for example will generally cost more than paraplanners, who in turn cost more than administrative staff.

What does this look like in real life?

Based on their survey of licensees representing over 2,000 advisers, KPMG arrived at a cost to provide advice of $5,334.64^[3]. This is hardly surprising given how time-consuming parts of the advice process can be.

A study^[4] by Iress and Business Health for example, found that in 2023, the typical hours taken to produce key advice documents was as follows:

The previously mentioned KPMG survey^[5] found the average costs of practice personnel to be as follows:

Note the rates above are the actual cost of these personnel, not their charge out rate.

Problem number 1

Having arrived at an average cost to produce advice of almost $5,500, this means advisers looking to break even, let alone make a margin, need to be charging clients at least this amount.

But according to several studies, including those by Adviser Ratings, KPMG, and software provider Padua, the average advice fee is well short of that amount, meaning their initial advice is essentially loss making (making them reliant on ongoing fees to be sustainable).

Adviser Ratings found that in 2022 the median advice fee charged to clients in 2022 was $3,710^[6], an increase of over 40% on the median fee charged in 2018 but still well short of KPMG’s 2021 cost calculation.

A study by Padua^[7] found the loss on the initial advice was even higher, estimating the average initial advice fee to be only $3,315.

Problem number 2

The second problem stemming from the $5,500 cost to produce advice (a figure which doesn’t allow for recent inflation!) is the disconnect between that figure and what the typical consumer is prepared to pay for advice.

According to Adviser Ratings^[8], while nearly two thirds of the 1,200 Australians surveyed said they saw value in financial advice, the majority of those people (61%) said they were only prepared to pay less than $500. Just over one in five (22 per cent) said they’d pay up to $1,000 annually, while less than 10 per cent said they would pay up to $2,500 a year.

Of course, this disconnect doesn’t in itself mean that it is not possible to run a sustainable advice practice in Australia. On the contrary, it simply means the potential market for consumers willing/able to pay reasonable advice fees is more limited. Against a backdrop of falling adviser numbers, demand is still likely to exceed supply. And of course, if your chosen client niche is the high-net-worth segment, then ability to pay fees is unlikely to be an issue.

The other implication of this disconnect is that advisers are more reliant on ongoing advice fees to remain sustainable, and as such are less able to meet consumer demand for more ad hoc, episodic advice.

It is this disconnect which sees some newer advice practices basing their entire business on the second – more client centric – pricing route, being the outside in.

Pricing route 2 – outside in

The outside in approach means pricing your advice based on what consumers are willing to pay. Tied up with this is, of course, your chosen target audience. As mentioned above, if your target audience is high-net-worth clients, then their capacity to pay fees should mean you can afford to deliver a highly bespoke, high touch, labour intensive service proposition. But if you are wanting to bring advice to a more mass market, such as mums and dads or Millennials, then you will likely need to do so via a different, lower cost business model.

Taking a client centric lens also means recognising the widespread demand for piece by piece, or modular advice (limited or scaled advice by another name).

Various surveys have highlighted the latent demand for piece-by-piece advice, including 2021 research by Investment Trends, which found that while 11% of consumers wanted comprehensive advice, 38% wanted limited advice^[9].

One practice who adopted this client centric lens from the very start was Finnacle.

Case study: Finnacle business model supports affordable pricing^[10]

Driven by a vision of making advice affordable and accessible to young Australians, Finnacle founder Prashant Nagarajan and his partner designed their advice practice from the ground up. Having conducted three months of extensive client research before they even opened their doors, they recognised the needs of their target client for affordable, modular advice.

Shaping a business that could meet these needs in a sustainable way resulted in a Finnacle opening as an online-only practice, where clients become ‘members’, paying an affordable monthly fee to access personal advice in a progressive, modular fashion. These modules can include sorting your super and saving and borrowing for your first home.

Limiting face to face engagement strictly to video calls significantly minimises overheads, and their ‘just in time’ approach to administrative resourcing, a concept borrowed from the car industry, sees them outsource administrative work to a team of virtual assistants, allowing support to be dialled up or down – and paid for – according to need.

Adding a margin to your costs

Having arrived at a cost to provide advice, via either Route 1 or Route 2, you then need to decide the margin to add in order to arrive at your final price (fee) for your advice.

There are many approaches you can adopt here, including a flat profit margin of X%, or approaches based on competitive pressures (which may limit margins), or on what the market will bear (which may allow upside). The concept of the value of advice is intrinsic to your decision (and will be explored in a follow-up article).

According to 2023 Financial Advice Efficiency Report by Iress and Business Health^[11], the average profit margin across all advice practices is 27%, whereas as high profit practices were averaging a profit margin of around 60%.

Averages can of course be misleading, and the most recent Advice Landscape Report^[12] by Adviser Ratings found that smaller practices in particular were more challenged to remain profitable, creating a sustainability challenge with potentially adverse consequences for the accessibility of advice.

More specifically, Adviser Ratings found that in single adviser practices, just over one quarter (26%) were making no profit, and around 40% were making between 20% margin or higher. For practices with 5 advisers or more, the respective proportions were quite different, with only 11% unprofitable and 64% making margins of 20% or more.

In summary

The decisions about how to price financial advice are complex, and can quite literally drive the shape of a new practice, and determine the sustainability of an existing one. In this article we have explored the fundamental philosophical principles about how to price advice. We have provided a framework for calculating cost inputs, and provided a market context in terms of margins, average fees, and consumer fee tolerances.

In the next article in the series, we will explore the mechanics of how to charge fees, examining the different methodologies, consumer preferences, the quantification of value, and the market trends that are playing out. We will also look at how to communicate pricing in a way that builds trust.