From the January 2008 issue of Research Magazine • Subscribe!

An Evolutionary Model of Change

Is there even one financial advisor in the U.S. who isn't aware of the increasingly intense focus placed on boomer retirement? Driven by demographics and the sheer magnitude of the amount of money in motion, the entire financial services industry seems to have recognized that boomers represent the most significant business opportunity of our careers.

To frame the questions that we will explore in this first of a monthly series of articles, let's review an interesting way to segment financial advisors laid out by Morningstar's David McClellan during last year's "Managing Retirement Income" conference. The industry is composed of:o Product sellerso Asset gathererso Investment managerso Insurance plannerso Financial plannerso Wealth managers

The behavioral "skews" of these financial advisor segments are as follows:Product sellers are transactional sales representatives. Their primary investment vehicles tend towards mutual funds, variable annuities and individual equities. They are mostly Series 7- and Series 6-registered as well as insurance-licensed. Their primary channels include banks, insurance broker-dealers and wirehouses. There are about 175,000 such product sellers and their average AUM per investor client ranges from $50,000 to $200,000.

Asset gatherers are relationship-driven salespersons who outsource the investment management function. The primary investment vehicles include mutual funds and separately managed accounts (SMAs). They tend to be Series 6- and 7-registered. Their primary channels include wirehouses and independent broker-dealers. There are about 95,000 asset gatherers and their average AUM per client ranges from $200,000 to $10 million.

Investment managers are analytical portfolio managers who do not focus their practice on having high client skills. The primary investment vehicles they use include mutual funds, ETFs, SMAs and individual equities. They often are Series 6- , 65- and 7-registered. They also favor the chartered financial analyst (CFA) designation. Their primary channels include IBDs, registered investment advisors and wirehouses. There are about 50,000 investment managers and their average AUM per client ranges from $200,000 to $10 million.

Insurance planners are sophisticated insurance salesmen who sell life insurance solutions. The primary investment vehicles they favor include life insurance and variable annuities. They often hold specialized insurance designations. Their primary channels include IBDs, insurance broker-dealers and wirehouses. There are about 37,000 insurance planners and their average AUM per client ranges from $50,000 to $3 million.

Financial planners offer comprehensive financial planning processes and are often fee-only. The primary investment vehicles they prefer include fee-based planning processes and software, mutual funds, ETFs and SMAs. Many are Series 6-registered and they favor the CFP designation. Their primary channels include IBDs, RIAs, and wirehouses. There are about 18,000 financial planners and their average AUM per client ranges from $50,000 to $3 million.

Wealth managers are members of high-net-worth teams who act as the investor's chief financial officer. The primary investment vehicles they use include SMAs, hedge funds and trusts. They hold various registrations, licenses and certifications. Their primary channels include wirehouses, IBDs and bank broker-dealer or trust departments. There are about 24,000 wealth managers and their average AUM per client is greater than $3 million.

A review of this segmentation should foster growing skepticism about one-size-fits-all solutions and product development. Different groups have different needs. Efforts to develop products that try to meet the needs of everyone often result in offerings that are relevant and compelling to virtually no one. When we look at a product, a process, an approach, a recommendation, an insight, it is important to ask ourselves, where does this fit? Who is this for? Is this really something for me?

Given this limitation, it is imperative that we identify what most, if not all, financial advisors may have in common before we start discussing the dimensions that differentiate products, processes and solutions. Only then can we make products that are more relevant to one specific FA segment or another.

A Change Management ModelThe first lesson that we may all share is related to the management of change. Evolutionary change is a model that holds great value for business and industry development. New products and new companies emerge from continuous evolutionary change. Many fail; some prosper. Even those who do well are replaced by other more successful, more innovative organizations. While we are familiar with this pattern as it relates to entrepreneurial and start-up ventures, it is important to note that it also applies to large companies.

For this article, we will describe an iterative three-step process for understanding and adapting to evolutionary change that is expounded by Eric Beinhocker in The Origin of Wealth: Evolution, Complexity, and the Radical Remaking of Economics. These three steps are: differentiation, selection and amplification.

The differentiation phase is characterized by the emergence of solutions in response to new, visible opportunities. Many of these solutions appear nearly at the same time, but there is no way to predict who will be the winners. The early days of evolutionary change from riding horses to driving cars is a good example. Initially, there were many entrepreneurial car companies as well as several power technologies such as steam, electrical, diesel and gasoline. Some entrepreneurs, like Henry Ford, failed early, but then achieved great success. There were slim odds of predicting the winning combination of technology and competitor during this time of great differentiation.

In the next phase, selection, the market picks the winners. To stay with our locomotion example, we no longer rely on horses for our daily transportation needs except perhaps in a few places in Pennsylvania. There are no steam-powered vehicles left, except in museums and scattered amusement parks. Electrical-powered cars were not the winning technology then, though they may become so in the future. Gasoline power overcame diesel power and Henry Ford and the Model T emerged then as a winning combination.

Finally, there are many ways to amplify success and this amplification is limited by the size of the market or market segments that apply. For instance, the assembly line amplified Henry Ford's success. In some situations where the market is large enough and the competitive advantages are based on network effects, once the market selects a winner, the winner takes it all. We have seen this pattern time and time again in the software application business. Yes, even there the success of the winner is amplified in both growth and profitability until it too reaches a limit.

As we consider the phases of this model for change, our questions include: Where does the retirement income industry stand? Are we still in a period of differentiation with many new products coming to market? Are we seeing market selection where the winners and the losers are becoming clear for all to see? Are we in a period of amplification where the winners gain most of the available business?

How to Get on the Winning Side of ChangeOur common challenge today is how to position our businesses and practices on the winning side of changes in our industry. Both manufacturers and distributors need to make hard-to-reverse decisions over the next few years. The constant worry in the back of our mind as we look at the various choices: How do we avoid dead-ends?

Dead-ends are reached more easily when one makes a single bet, implicitly through inertia or explicitly through silo-bias (i.e., using only the tools in your industry's toolbox). Dead-ends are also reached more easily when the industry is in a differentiation phase, when new offerings come to market frequently and one rushes to judgment too quickly. Many offerings look too similar to one another to justify spending our time on studying all of them carefully. In addition, various retirement income "religions" vie for our attention and we may already have implicit or explicit biases that frame our understanding of what we seek to evaluate. We may not see the relevant range of all the relevant products and processes before we start making hard-to-undo commitments to a specific business model, a specific "retirement income religion," a specific product or a specific software process.

Dead-ends are easier to avoid if one brings evolution inside. We can do this by using the power of diversification not only on our clients' assets to minimize risk and to optimize returns, but also on our own portfolio of strategies that we need to develop, focus on and become good at in order to grow our own business. We need to adapt or we will become marginalized.

As for the industry as a whole, the pace of new product introductions suggests that we are still in a differentiation phase, and that it is too early to identify the market's selection of winners and losers. Maps and segmentations of investor types, distribution models and industry silos help us identify the differentiated offerings that we need to focus on as we "sit between chairs," working our way from our traditional accumulation mindset toward a retirement income mindset.

Specifically we will keep four actionable mapping levels in mind as we explore our evolutionary landscape:1. Who is our customer and how is this customer changing?2. What do we do for this customer and how is what we do differentiated in the marketplace?3. How broad is our product/process inventory? Is it one-size-fits-all or do we differentiate our value-added by tiers of service?4. What is our current advisory business model and should it change with the market?

These are issues that practicing financial advisors may want to think about. It is a good idea to understand how our specialties and choices relate to the larger financial services marketplace in general, and the boomer retirement opportunity in particular.

Where can we find the type of information that will help us make changes and meet future challenges? It is my goal to develop such information as we progress in this monthly series of articles.

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Francois Gadenne is president of Retirement Engineering Inc., a Boston-based R&D company that designs insurance and investment products for retirement-income needs (www.IncomeAtRisk.com); he is a co-founder of the Retirement Income Industry Association.

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