Nathan’s spreadsheet looked perfect.
His cost-to-serve model showed a team of six costing $520,000, generating $1.4 million in revenue, with a margin on every client segment.
On paper, the firm was thriving.
Day-to-day, however, Nathan was drowning.
His two senior advisers were maxed out. (One has been approached by an institution offering higher pay, fewer hours, and a much shorter commute.)
Client review meetings were being pushed back.
It was hard to find time to squeeze in new prospects, and even harder to determine how far existing workflows would be worsened if they engaged.
The team were good, but tired and had no time.
Nathan did what any reasonable principal would do.
He hired.
A new associate at $105,000, including on-costs.
His cost-to-serve model predicted that within twelve months, the associate would be looking after enough clients to be both productive and profitable.
On paper.
Here’s what happened in practice.
Nathan’s two senior advisers – the ones already at capacity – spent the next four months inducting, training and supervising the new associate. They attended meetings together. They reviewed files. They answered questions. They corrected mistakes.
The most valuable people in the firm were now spending less time on what made the firm the most money, i.e. client work, and more time managing someone who, according to the spreadsheet, was supposed to solve the capacity problem.
Revenue didn’t grow. It flattened.
The new associate left after eight months.
Better money and promises of less stress elsewhere.
Profits didn’t just exist on paper. They only existed on paper.
Nathan’s cash reserves were thin, remuneration conversations got harder to counter with offers from bigger firms, and the opportunity to buy an aligned accounting firm hadn’t gotten any further since a great whiteboard conversation with a prospective merger partner months earlier.
COST-TO-SERVE DOES NOT SERVE
Nathan’s experience is common.
He’s built a successful practice.
Advice firms can be excused for adopting cost-to-serve models as a primary planning tool.
They reason it’s simple, easy to build, and a common measure for business planning, not just for financial advice firms, but also accounting, legal, valuation, and engineering firms
Firms that sell trust.
Regardless of profession, firms that sell trust have to stop trusting the wrong tools.
They predict paper profits rather than real profits.
Regardless of whether someone costs $150,000 or a team costs $500,000, when that person or team is already overloaded, paper profits do not help principals make better growth decisions.
Worse, cost-to-serve models are fundamentally misaligned with the purpose of advice teams.
They focus on costs and margins.
But clients don’t care about your costs or margins.
Clients care about results.
Their outcomes.
Living better lives.
What is of value to them.
A model built around costs, not client value, is, at best, an inward-facing diagnostic being used to make outward-facing decisions.
WHAT COST-TO-SERVE MISSES
There’s another problem that cost-to-serve models don’t account for.
Adding new resources doesn’t just add costs.
It consumes existing capacity.
When Nathan hired his new associate, the model added $105,000 to the cost side and projected revenue on the income side.
What it didn’t model was the reduction in productive capacity of Nathan’s two senior advisers. The weeks of shadowing. The file reviews. The corrections. The management.
The firm’s most expensive resources became less productive precisely when the model predicted they’d become more profitable.
This pattern repeats in every growing firm.
As more resources are added, leaders spend less time on client work and more time managing a growing team that, on paper, should generate more profit.
The profits consistently exist on paper.
Less consistently, where they should be, in cash reserves, in remuneration packages, in savings earmarked for growth projects.
THE ALTERNATIVE: CAPACITY TO SERVE
A capacity-to-serve model starts somewhere that cost-to-serve models never go.
Client value.
What are clients willing to pay for the value they experience?
This is not a cost question. It’s a “worth” question.
It changes every decision that follows.
After client value, the next input is profit.
What profit is required?
In times of accelerated growth, what super profits are needed to fund the growth within capacity plans?
Then the model turns to capacity, the actual availability of every resource, full-timers, part-timers, off-shore, on-shore, off-site, on-site.
Not their cost but their capacity, their availability, their current and expected commitments.
Then it maps the types of work.
Existing clients, different propositions with different resource mixes, expected new clients, and with cost and capacity ramifications of potential new resources.
THE DIFFERENCE
Here’s the distinction that matters most.
Cost-to-serve models produce estimates of profit.
Capacity-to-serve models produce estimates of pricing.
Read that again.
Cost-to-serve sets expectations for earnings.
Capacity-to-serve sets expectations about what to charge.
These are the prices clients should pay, not only to generate the required profit but also to ensure the team’s capacity is managed.
One model is cost-based.
The other is capacity-based.
One model treats the team as an expense line.
The other treats the advice team’s time as the most valuable and finite resource.
If time and capacity are not managed, teams start drowning.
Drowning doesn’t start at the bottom but at the top.
That is, Nathan’s role.
The most valuable resource in the firm.
Nathan’s cost-to-serve model told him hiring was profitable.
A capacity-to-serve model would have told him his team couldn’t absorb a new hire without reducing the productive capacity of his existing team, and would have shown him what his clients needed to be paying before that hire made sense.
WHAT ARE YOU USING?
If your current planning model tells you what you might earn but not what you need to charge, it’s measuring the wrong thing.
If it shows healthy margins on paper but your cash reserves, remuneration, and growth plans don’t reflect those margins, the model isn’t broken.
It’s just not measuring what matters.
Jim
Photo Credit: Canva/mbp_teerapat/MAE-_RDd178