Hope is not a business strategy

I hope that the market goes up this year.

I hope that the market goes up this year. In fact, I hope it goes up a lot, and quickly too, because the sooner it goes up, the higher our revenue will be for the year.

But even if the market were to rise 50% in the fourth quarter it wouldn't do our firm much good.

Like many firms, we bill our clients quarterly, so the market"s level really “counts” only on four days: March 31, June 30, Sept. 30 and Dec. 31.

My point is that hoping for the market to recover isn't a strategy.

Hope is an emotion, and we can't run our businesses on emotion. Much has been written in the past few months about how to handle our clients given the devastation to their portfolios last year.

I would like to share a few thoughts about what last year's apocalypse means for us as managers of a business.

If your business is like most, you face about 30% less revenue than you thought you had just months ago.

Let's put that into perspective. If your business has a 30% profit margin, a 30% drop in revenue will produce a 100% drop in profitability.

That is called operating leverage, and it can really bite when revenue evaporates, which is why The Wall Street Journal quoted Robert Lee, an analyst at Keefe Bruyette & Woods Inc. of New York, as saying that he expects that the fourth quarter will “go down in the record books as the sharpest [ever] one-quarter decline in operating earnings for most asset managers.”

GROUND TO MAKE UP

There is an old saying in the industry: “Down 50 is up 100,” meaning a market that drops 50% will have to go up 100% just to get back to even.

That represents a lot of ground we need to make up.

So what should firms do?

Every organization wants to be around to celebrate the good times, once they return, but they have to be financially viable to do so. That means a focus on the expense side of the business and the cost of employees.

Whether your business is financial planning, wealth management, traditional investment counseling, open architecture or no architecture, your biggest expense is most likely people. It is tough to consider, but looking at a significant reduction in revenue means you either have to keep staff members and reduce their compensation or eliminate positions to bring the expense equation back in line.

In my conversations with hundreds of firms, I sometimes hear: “We've never had anybody leave the firm, because we pay our staff really well.” And in a great market such as we had, it is easy to have enough to go around.

Nevertheless, even if you have never had that thought about your staff, it is time to re-evaluate. Now literally thousands of very well- qualified people in this industry are looking for work.

This means very simply that compensation levels, like housing prices, have adjusted downward — so even if you don't eliminate a position, you should consider reducing the compensation for a given role.

Or, if you have any employees who aren't performing at the level you expect, now is the time to consider upgrading the talent level, which can probably be accomplished at a lower cost than you pay now.

It is also typical in our industry for most compensation to be of a fixed nature. But because the revenue in this business is so variable, it makes sense for associated compensation to be more variable.

For those individuals in your firm whose compensation is tied to client -revenue directly — portfolio -management, client relationship management and the business development team — compensation needs to match revenue realities. It may sound like a “broker model,” but it works.

Variable compensation reduces the operating leverage in the business. Everybody shares in the pain, and everybody shares in the good times.

It is automatic. If you are an owner, you no doubt understand that your compensation is variable because your take, after expenses, just got cut to zero courtesy of the market.

You may have no choice but to share the pain with your employees. Consider implementing a plan that reduces the level of fixed compensation in your organization for those employees who have client roles —and, to a lesser extent, staff as well.

Finally, don't give up. Hope isn't a strategy, but it does “spring eternal,” and that is a good thing.

M. Rush Benton is the founder and chief executive of WealthTrust LLC, a wealth management company in Nashville, Tenn.

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