The announcement from Merrill Lynch last week that they were cutting advisor compensation stood in stark contrast to a lawsuit filed in October by former Wells Fargo brokers, alleging that their practices had been impaired by association with the bank. While Merrill feels comfortable flexing their brand muscles by redirecting advisor cash flow back to the firm, Wells Fargo is accused of actually having negative brand value. These two situations highlight the dynamic interaction between investment management professionals and the firms they work for while demonstrating the significance of branding to build professional careers and advisory firm value.
An Ensemble Product with an Ambiguous Brand
A couple of weeks ago I was driving around Memphis enjoying the fall weather when I spotted a unicorn, or, more specifically, a Bricklin SV-1, decked out in fall colors. The Bricklin was an independently produced sports car with a small-block V-8 engine, two seats, a fiberglass body, and gullwing doors. Malcolm Bricklin debuted his eponymous car at a celebrity-studded event at the Four Seasons restaurant in New York in the summer of 1974. Despite the innovative nature and affordable price of the Bricklin, it wasn’t terribly quick (not unusual for cars of that era), reliable (the hydraulic pump for the gullwing doors would sometimes break if you tried to open two doors at once), or practical (it lacked both a spare tire and a cigarette lighter). Only 3,000 or so Bricks were sold in 1974 and 1975, and fewer than half of those are extant today.
Brand substantiates the value of goodwill and makes a firm worth more than simply a collection of broker books.
If the Bricklin were a metaphor for a cohort of RIA practices, it would be an “ensemble” practice. The company was run from Arizona but manufactured cars in Canada, shared taillights with the DeTomaso Pantera and the Alfa Romeo 2000, sourced its engine from American Motors and Ford, transmissions from Ford and Borg Warner, brakes that included parts from three manufacturers, and a steering wheel from Chevrolet. What Bricklin lacked was a compelling brand to pull it all together, so instead of projecting the image of a “best of everything” product, it came off as more of a Frankenstein.
Reading through the industry news of late, we’ve been thinking about the role of branding in the investment management industry. Branding is more than a firm name or logo, it encompasses the identity of an RIA such that the practice is elevated above the practitioner, with the potential to benefit both. As such, we consider brand to be more than tradenames or logos; it is a concept that substantiates the value of goodwill and makes a firm worth more than simply a collection of broker books.
Personal Goodwill and Corporate Goodwill
In the valuation community, there are techniques for determining whether a portion of a given enterprise’s goodwill is (in reality) allocable to one professional or to a group of professionals instead of the company. I’ll spare you the technical details, but suffice it to say that when an RIA matures to the stage that it can report a legitimate bottom line – i.e. that there are profits left over after covering both non-personnel costs and paying a market rate of compensation to all staff – then it has brand value that has generated a return on corporate goodwill. Profitability is evidence of brand value.
Returns to Labor versus Returns to Capital
When the C suite at Merrill Lynch decides to cut advisor payouts, they are shifting cash flow returns from labor to capital. Advisors probably feel like they are being devalued, and arithmetically they are. But what Merrill is also doing is testing their brand value. Can they enhance their return on corporate goodwill by retaining more client fees from existing brokers at the risk of either disincentivizing their advisor network or even running them off to other wire-house firms or RIAs? Merrill's opting to remain in the broker protocol can be seen as confidence in their brand to attract, grow, and retain an advisor network. Whether that confidence is misplaced or not is something we’ll be able to answer definitively in time.
Negative Goodwill?
At the other extreme, the Wells Fargo lawsuit suggests the possibility that negative brand value at the firm level can impinge on an advisor’s income. Two brokers are alleging that the string of negative publicity at Wells Fargo made it difficult for them to build their books of business or even to maintain the level of business they built previously. Investment management is a reputation business, and the lawsuit suggests that even association with a tarnished brand can impair a career. It’s an interesting lawsuit because in blaming the firm for advisor performance, it suggests that the advisor/client relationship is more significant than the client’s relationship with the firm – otherwise the advisor could mend the relationship simply by changing firms. Yet the lawsuit is basing the damage claim on the bad reputation of the firm.
Brand Value in the Independent Channel
Outside of the bulge-bracket broker channel, it is more common for personal goodwill and firm goodwill to overlap. There is a thread of conventional wisdom that suggests small RIA practices aren’t salable (i.e. don’t have enterprise goodwill). The reality is more nuanced, of course, but to the extent that the identity of a small RIA is really just that of the founder and principal revenue producer, then clients are difficult to transfer and the business is more difficult to transact. Building an RIA beyond dependence on the founder should be a focus of any firm wishing to build value.
Building an RIA beyond dependence on the founder should be a focus of any firm wishing to build value.
There’s more than one way to build brand value beyond the founder, as shown by high profile firms like Edelman Financial and Focus Financial. Edelman employs a highly centralized approach with uniform and templated marketing programs, and client service techniques. While Edelman has successfully built a large and profitable platform from this, the risk is that the secret sauce is vulnerable to being copied, and Ric Edelman is pursuing legal action against his former partner, David Bach, for just that. Focus Financial has employed a highly decentralized approach of acquiring cash flow interests in independent RIAs and then leaving their client-facing identities intact. You won’t find Focus’s name (much less the name of its founder, Rudy Adolf) on any of its partner firms, and thus individual firms (and Focus itself) are far less exposed to reputational risk from bad actors in individual offices. Besides this, Focus doesn’t base its business model on intellectual property that could be replicated elsewhere. What Focus lacks is a certain level of corporate identity and efficiency that comes from uniformity – we wonder how the Focus approach to branding will work over time.
In the End, Brand Value is Defined by Your Client
Much of the debate over the value of investment management firms can be distilled into one question: what is the value of a firm’s brand? More than "what’s in a name?", the question is an investigation into the relationship between client and investment management service provider. Do clients of your firm define their relationship as being with your firm, or with an individual at your firm? If you can answer that question, you know where your RIA is on the journey to building firm value.
