The Internet is changing the way Americans educate and entertain themselves as well as the way they shop and conduct business, and the change visited upon investment advisors is particularly violent. Disruption plagues the investment advisory industry.
Disruption is dangerous in this industry. Independent advisors are so busy running their practices that they barely have time to analyze the shifts that are taking place in the financial services industry. Those changes are unfolding with such speed and are so massive and complex that even the small number of advisors who have the resources and vision to attempt to perform strategic business planning can become easily frustrated. But the success of your business is at stake.
Before the sage advisor can fashion solutions to the business challenges presented by the Internet, it's important to know what the problems are |
The purpose of this column is to take a step back and examine what's happening to the financial services industry and how it might affect your business. While this column has always focused on Web solutions, this installment is about problems. Sorry.
First, understand that with all the talk about how the Internet is going to change the world in which we live, your little part of the world is one of the first places to be affected. Like it or not, financial advisors are on the leading edge of the Net's progression.
To buy a car, clothing, or food, most people want to kick the tires, head to the dressing room, or squeeze the melon. Buying financial products online, on the other hand, makes sense. You don't need to taste stocks or bonds, the way you do a food or vegetable. You don't need to test-drive a mutual fund. You don't need to see, touch, kick, or smell securities you buy. The way you decide to purchase a security is by evaluating information about it, and the Internet is an efficient method of channeling massive amounts of information into people's homes and offices.
Also, try not to think of the Net as your enemy or as a weapon directed at you. The Net is more like a natural disaster or an explosion that has no target. Its shrapnel is hitting industries and companies indiscriminately. Financial advisors just happen to be at ground zero. Your house is in the direct path of the volcano's lava flow. The twister is coming through your backyard.
Naturally, this is frightening. Finding technology solutions requires technology expertise. The more money you have, the better your technology can be. Independent advisors, therefore, would seem to be at a great disadvantage in the Internet war. You don't have the budget of a Charles Schwab or a Merrill Lynch. You are financial experts, not computer experts.
Despite this, I believe the future is not as bleak as it may seem. In fact, I believe that independent financial advisors who figure out how to integrate the Internet into their practices can prosper enormously. If you do not embrace the Internet and address the disruption it will bring to your practice over the next five years, then you will probably have a much smaller practice.
Future columns, I promise, will focus on specific solutions, and there are many. A whole industry of Web-based services is about to come online. The first generation of financial Web tools was created for consumers because companies developing these tools saw a much larger market there. The next generation of financial Web tools will be for advisors. They will be expert tools created by business-to-business companies. For now, let's get back to the problems posed by the Internet.
The main problem is the radical shift in the competitive landscape that has occurred in the last couple of years. Independent advisors have had three basic competitors: other independent advisors, the wirehouses, and discount brokers.
The chance of competing with another independent has been pretty small since independent advisors are, statistically speaking, pretty rare. You have about 30,000 CFPs now, and many of them work for corporations and are not independent. There are 10,000 or so independent RIAs that are either state or federally regulated who are advising individuals. And you have 25,000 or so registered reps who are independent contractors at B/Ds. As a ballpark figure, my guess is you might have 50,000 or 60,000 independent financial advisors in this country now.
The main competition for independent advisors has come from wirehouse brokers. Like Willie Sutton said, that's where the money is. Merrill Lynch alone, for instance, has $1.7 trillion in customer assets. Salomon Smith Barney has another trillion.
The other major competitor you've faced has been discount brokers. They have been order takers. Since the orders placed with these brokers were unsolicited and didn't include research and recommendations, they were discounted.
This competitive landscape was great in the 1990s for independent advisors. The wirehouses were easy targets. They all sold house-brand mutual funds. Reps worked on a commission basis. In fact, these organizations were built on commissions and selling. By contrast, independent advisors could recommend any product and would find the best product for the client.
The discounters, too, were easy targets for an independent advisor. They gave customers no advice. While that's great for people who know exactly what they want, few people are like that. The discounters' customers were on the exact opposite end of the spectrum from yours, so you had great differentiation.
In that environment, independent financial advisors prospered. But over the last couple of years, the competitive landscape has changed enormously, partly because of the Web. The discounters are becoming more like full-service brokers and the full-service brokers are becoming discounters. There are now a host of companies vying for your business: custodial options, marketing services, broker/dealers, software companies, and so on.
Merrill Lynch, for instance, is offering a service to allow its clients to trade online without a broker. Rather than continuing to lose assets to online discounters, Merrill created Merrill Direct (www.mldirect.com), an online discount trading site. In addition, Merrill last year unveiled Ultimate Advantage, a fee-based advice service that includes free trading online for customers. According to a survey of 400,000 online users by Forrester Research, the Web research and consulting firm, www.merrilllynch.com is now the No. 2 online brokerage site behind Schwab, and Merrill's is rated the top site for customer service.
The wirehouses know that the commission-based business model is a relic of the past. Ameritrade, for instance, recently began offering free trading online to some customers. Advice is going to be the only way to make money in the future because the transaction has been commoditized by the Web. This is one reason why colleges and universities accredited by the CFP Board to teach the course work prearing candidates for the CFP exam are reporting much more interest in corporate contracts from banks, wirehouses, and insurers (see "Inside the News," page 18).
Meanwhile, the discounters are are adding services to become more like full-service brokers. Look at the pattern: TD Waterhouse, the second largest discounter, has taken its "clicks and bricks" approach to a new level by opening a physical branch in each of the 50 states. It now has 170 branches nationwide and plans to open 25 more this year. Meanwhile, e*Trade is considering adding an institutional division to serve as a back office for advisors. Other discounters are also considering adding an advisor division. Schwab recently purchased U.S. Trust and rolled out a program allowing branch representatives to give specific advice about securities. All of the online discounters have Web tools that seek to replicate the advice given by an advisor.
While the Web has made discounters become more like full-service firms and full-service firms more like discounters, it's also spawned nontraditional competitors: companies like Yahoo!, Excite, Quicken, America Online, and Microsoft MoneyCentral. These companies are financial portals for consumers. They get huge Web traffic to use calculators or to look up stock quotes, mutual fund values, or portfolio values. They also sell banner ads to online brokerages.
In a report issued late last year, the staff of the Securities and Exchange Commission wrote, "Portals have become intermediaries between broker/dealers and their customers. A number of broker/dealers have entered into co-branding arrangements with portals, either paying a flat up-front fee or a per order 'connection' fee for every order transmitted by an investor who hyperlinks from a portal to the broker/dealer."
To compete against other independent advisors, wirehouses, discounters, and nontraditional competitors, independent financial advisors have to be willing to change. Take a cue from Merrill Lynch and Charles Schwab, which abandoned their old business models at considerable risk. They were seeing the competitive threat before you did because of the nature of their business. They are transaction-oriented, so naturally the threat to their businesses has been much greater. But as the lines blur between full-service firms and discount brokers, and as the Web tools replicating the services a financial advisor provides get better, the Web will have a greater impact on independent advisors.
Changes made by your competitors are daring. Schwab, for instance, has become by far the largest online broker because it cannibalized itself. It slashed its commission schedule, leading other discounters to do the same. The average commission of the top online brokers has fallen from $52 at the beginning of 1996 to about $10 now.
Merrill Lynch, too, employed what would seem to be a self-destructive strategy. It is offering $29.95 trading, ways to choose bonds and equities online, and tools for people who won't need a broker. Dean Witter and American Express have sites for self-directed investors and other wirehouses are likely to follow suit.
These large companies have embraced disruptive technologies. This approach to management has been promoted by Clayton Christensen, a professor of business administration at the Harvard Business School. Christensen, who previously consulted to Schwab, was recently hired by Merrill. He is the author of The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail.
To paraphrase Christensen, a fatal threat to your market share can begin as a low-quality, low-margin product that your customers don't want and can't use - yet. If you ignore these disruptive technologies, they just may grow in capability to meet mainstream needs. A disruptive technology can quickly develop into a competitive threat, dramatically transforming the marketplace and your business.
That's the problem.