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Generally speaking, when things leak, it’s not good. And when things leak slowly, it’s typically even worse.
Homeowners, know that a slowly leaking pipe or roof is about the last thing they want to discover. Car owners know that a slow leak in a tire can be the hardest kind to fix. And you don’t have to be a boat owner to know, as Benjamin Franklin said, that “A small leak will sink a big ship.”
Your financial services business is losing revenue and profits in the same way, through a wide range of seemingly small inefficiencies, poor procedures, misalignments, and human errors in your compensation system. These leaks are often written off as an annoyance, rather than a problem that needs immediate fixing. But over time, the losses pile up and reduce your bottom line.
Profit leakage – in this context – erupts from the unintended (or unnoticed) loss of revenue from your business and poorly optimized operations, resulting in a significant loss in overall profitability.
Statistics vary, but it’s generally estimated that every company, regardless of sector, experiences addressable leakage in a range of 1 to 5 percent of EBITDA. (Source: A Powerful and Effective Answer to Revenue Leakage)
In our experience, profit leakage is a considerable and often overlooked problem in the wealth management industry and has root causes that are behavioral, structural and operational. Behavioral causes stem actions that are induced, usually unintentionally, by the compensation, metrics and sales management program. Operational causes are often the result of business complexity and fragmented business processes. Finally, structural causes relate to the design of the business model and/or the technology tools that support it and insufficient or unreliable data to fuel it.
Each of these areas contribute to significant loss in revenues and profitability impacting the firm on a recurring basis and accumulate over time, if not properly addressed.
We’ve identified the following 25 ways in which your compensation system and procedures are likely allowing profit to leak out of your wealth management business.
When compensation and reward structures are not supporting your firm’s business strategy and performance objectives, this results in suboptimal organizational performance and therefore impairment of profitability. Failure to align the actions (and results) of the salesforce to the corporate objectives of your firm in a timely and effective manner is a drag on top-line performance.
Business units that are meant to cooperate will be more successful when there is alignment of measurement and reward. Bringing multiple compensation regimes into alignment across multiple lines of business is difficult, but critical to avoiding counterproductive activities and organizational friction. Aligned measurement and compensation makes execution smoother and ensures focus is on value creating activities.
Not measuring (or inadequately measuring) the profit performance of the compensation regime hides profit drains. Failure to measure compensation program performance is typically caused by lack of adequate data or the absence of organizational accountability for performance and compensation performance ROI.
Compensation program changes are often needed to enhance alignment with corporate objectives, to address shifts in the market and to respond to changes in the business or conduct of staff. Every day that passes between the decision to change the program and the implementation of the changes represents leakage through lost sales and service focus, decreased rep/advisor satisfaction, sales and service efforts contradicting company investments and operational burden. Compensation programs must be easily updated or replaced. Time-consuming requirements for custom programming or technical intervention is costly a warning sign that your compensation regime is not nimble enough to optimally support your business. Don’t accept when the capabilities (or lack thereof) in the compensation system stand in the way of rewarding for the right customers, the right revenue, or the right performance standards.
Firms that allow their compensation plans to become too complex over time ultimately find them becoming less effective – and then they swing back to a more simple structure. Focused and easily understood are the key design considerations. Overly complex plans make it difficult to be sure that everything is correct, and paid out appropriately to the right participants. The errors that spring from complex plans are themselves so complex that they can only be resolved by implementing time-consuming and costly manual adjustments.
The sheer number of plans in use is not, in and of itself, a problem. However, how these plans relate and how they are managed can be a problem and can cause considerable errors and excess compensation. Plans should be easily create, named, managed, understood and retired, as necessary. Poor process and oversight in plan selection, deployment and management can give rise to the wrong compensation plan or the wrong rules being deployed which results in compensation errors, reporting inaccuracies and contributes to significant leakage that can compound over time. A clean and organized user interface, logical workflows process and efficient oversight processes mitigate many costly errors.
Ideally a full and completely granular view into plan set-up, input data and calculations is available to business leaders, managers and advisors. A lack of this visibility complicates the process of finding and reconciling errors and resolving disputes. This wastes valuable advisor, front office and operations time and erodes trust which impairs revenue and adds costs.
Each discrete product (or security) must be associated to a classification that aligns with the compensation program. Frequently this means that several new products or securities may need to be assigned within the classification each day. While frequently supported by an automated process, a individual typically makes the ultimate assignment using a manual process, that often lacks proper decision-making and validation controls. Inconsistencies in product assignments can potentially have a large impact on compensation over time and can be very time consuming to correct. For organizations with multiple lines of business where products may be classified a number of times and in a variety of different ways, these errors have a habit of multiplying.
Where complicated layer split or sharing arrangements are required, it is not unusual for gross payout and/or minimum house rates to be inadvertently ignored when rules are set-up. This can result in over-allocations across multiple payees.
Packaged products have a tendency to cause complications in incentive compensation programs. The revenue and end customer information can be difficult to integrate and improper controls and poor communication between systems and complex fee payment structures can result in mismanagement of trailer-based revenues. Common examples are the mishandling of trailer revenue where they are meant to be rebated back to the end customer, or where certain asset types are to be treated differently in fee-billing. Incorrect fees payment can easily be processed, which can result in over-billing the customer and potentially overpaying the advisor. These often go unnoticed for extended periods of time, and their impact (both financially and reputationally) can compound.
In the case of some alternate investments, the firm receives both a sales commission and marketing fee, and must control how these are managed. Without proper classification rules and attribution processes, the marketing fee (which is frequently not shared with the rep) can get incorrectly lumped into the gross production number used for payout, thereby increasing the payout to the rep and cost to the firm.
Hard floors related to commissions and fees need to be properly implemented otherwise they become a soft floor. Claw backs for violation of hard floors should be automated or at a minimum the subject of transparent workflow involving reporting escalation.
The compensation regime is typically used as a tool to manage discounting of services, or more accurately the profit impact of those discounts. Certainly other price and discount controls can be considered, however in the dynamic relationship management environment in financial services – and especially wealth management – compensation is frequently the first and last line of defense. Without adequate controls within the compensation system, rules may not be capable of properly stopping (or limiting) discounting behaviors resulting in potentially both loss of revenue and also additional payroll expense.
Expenses can only be recovered via a compensation system when they make their way into the system. In general, regular recurring expenses have a reasonably robust process related to their identification, set-up and reporting. As a result, they are generally captured properly and recovered via the compensation system. We do recommend at least an annual expense audit. Unfortunately, the one-time or infrequent charges, which can originate from a variety of sources, and in different formats, are easily overlooked. An email, voice message or even a scribble on a note pad are easily lost or misplaced resulting in lost recovery.
Unfortunately, the hard truth about payment errors is that firms are always told when someone is underpaid, but rarely told when they are overpaid. An accurate, rules-based, compensation system with strong reporting capabilities will significantly minimize these overpayments.
Transaction that are cancelled and rebilled can contribute to leakage. Typically this arises where the (re)processing doesn’t completely address ‘undoing’ all data that would have resulted from the existence of the erroneous transaction. The most common example is inadequate tracking of compensation or reward tier threshold impact. This can result in significant operation complexity or work to resolve it or can lead to potentially material compensation errors (i.e., overpayment).
A configurable tool that can accurately calculate and verify the fees being charged to the firm by their Clearing and Custody partners, firms are not able to easily identify incorrect fees, erroneous calculations, fees owed by advisors and/or where over-billing situations arise. For firms with multiple lines of business, the impact is magnified.
Unfortunately the data and reporting on mutual fund assets and revenues pales to that on many other financial products and services. Managing incomplete or inaccurate trail information just to support reconciliation to anticipated or expected revenues consumes valuable time. Additionally, a lack of clarity can result in incorrect allocations and calculations that can easily go unnoticed for months. At the root of this problem is asymmetrical information and the use of a variety of partial ‘fixes’ for that lack of symmetry. For example, fund holding and trailer information is commonly obtained from multiple sources – direct from the fund company, from industry data consolidation sources, in-house databases and frequently augmented through manual entry where there are delays in data availability.
Without the ability to apply adjustments (e.g., clearing fees or E&O charges) at the right point in the compensation process (typically gross vs. net), incorrect payouts and overpayment situations will occur.
Many expenses are collected and managed via offline processes either in the distribution network or finance department (e.g., Registration, FINRA & SIPC costs). These processes tend to be arms-length from the compensation system because many systems can’t support that particular type of expense. Many of these expenses should be borne, in whole or in part, by the advisors. As a result of the system disconnects, these expenses are at risk of being entered incorrectly or bypassed altogether.
Reviews of activity are required on a periodic basis. A compensation system that does not offer detailed audit tracking (and reporting) of changes makes it very difficult and time consuming to find, identify, and manage changes made in error. Additionally, poor audit reporting typically means that other functions – such as compliance and finance – have to rely on operations for investigations.
A system with automation gaps, poor tools for permanent resolution of errors or that relies on the manual upload of a number of files each day can expose compensation operations to highly variable peak loads. Maximizing data source integrations, rules based decision-making and processes to enable ‘one-and-done’ permanent problem resolution mitigate peak load variance and enable a consistent and optimized staffing model. This reduces volume based errors, unintentional omissions caused by uncertainty as to who is responsible and excess staffing costs.
Mid-period events, such as when a new rep is onboarded, challenge systems to support the proration of the related revenues and expenses. It can also impact how average and trailing production levels are determined. The resultant need for manual calculations and adjustments adds workload burden and introduces errors.
Billing and compensation systems should function symbiotically as they rely on information in each system to enable the other. When billing and compensation systems don’t “talk” properly, manual changes applied in one system are not routinely reflected in the other. For example, a compensation solution that cannot adequately track the metrics required by the billing team (such as waivers, thresholds, volumes, etc.), results in incorrect billing and compensation distributions.
Complicated termination procedures can easily result in overpayment of incentive compensation. For example, when there is a lag between when an action is taken (such as terminating a rep in the compensation system) and when that action should have been taken, this can lead to payout that incorrectly includes extra days of active time. Depending upon the effort required to correct it, these issues can sometimes go unnoticed (and not corrected) creating an overpayment to the rep and a loss to the firm.
By failing to properly control effective dates (i.e., not expiring rules on time), potential overpayments may persist for long durations and not be recognized. A common example is the failure to expire a ‘new recruit’ plan that pays higher than the ‘experienced advisor’ plan. The system should, at a minimum, offer reporting to highlight these conditions.
As these 25 points demonstrate, the ways that revenue and profit can leak out of your business is not merely metaphorical – it’s real.
Dated technology and poor business processes supporting your incentive compensation and performance management can hurt your bottom line. A modern, adaptable, technology platform and compensation solution that is flexible, and can be automated and integrated with necessary data sources and external systems, will ensure accuracy and give your firm’s management the opportunity to properly analyze the effectiveness of their salesforce and their compensation programs.
Contemporary compensation management technology, coupled with strong operational processes and a commitment to a robust data model, helps to prevent profit leakage. A system that fully integrates all steps in the compensation and performance management process is the best tool for helping to grow revenues and boosting your firm’s profitability.