From the September 2009 issue of Investment Advisor • Subscribe!

Formulas for Success: In The Absence of Value

Does your pricing strategy reflect your worth?

Traditional business wisdom holds that pricing becomes a factor when value comes into question. A combination of economic drivers has created a challenge for the financial services industry as firms seek to demonstrate their value and justify their pricing. Many advisors are reducing their asset management fees for clients whose portfolios are under water. Others are waiving fees applied to assets in money market accounts. Some brokers and custodians are discounting or eliminating charges or waiving fees to new clients on services for which they traditionally applied a markup. And in an odd reverse twist, wirehouse firms are virtually eliminating their override (the amount they keep) to "purchase" production from new reps by paying them 100% to 300% of their trailing 12 months gross to join their sales teams. Signs throughout all segments of financial services point to the difficulty of proving "worth" to clients and the consequent reshaping of financial terms.

Often these new discounts are wrapped in language that suggests the price change is because people have suffered, and this is the least the provider can do. While the less cynical might accept that at face value, those who expect their provider to make price reductions might also be thinking, "It's about time. You surely have not earned the money I've paid you so far."

Meanwhile, some firms are using "price incentives" to attract new business while keeping the full price intact with existing relationships.

Are You Maintaining Price Integrity?

Think about it. Years ago, the airlines decided to cut costs in the midst of deregulation and have never been able to get back to a pricing level that sustains profitability because consumers view a cheap airfare as an entitlement. The only way for airlines to rebuild profit margins has been to shift the burden of higher pricing to business travelers who tend not to plan so far in advance, and to reduce the traveling experience to a pillow-less, peanut-less, squashed-in torture.

The same is true in retail clothing. I accidentally wandered into a Nordstrom store this summer right in the middle of its Anniversary Sale. At first, I didn't realize what was happening because retailers have been experiencing an incredible absence of customers. On this day, the place was packed. I encountered an old friend of mine and made the wry comment "What recession?" She said that for years she has avoided going to Nordstrom until the Anniversary Sale or After-Christmas Sale. In other words, the value of the shopping experience and the quality of the clothes that Nordstrom tries to project year-round is diminished by seasonal reductions in price.

We also know of a number of financial advisors who've reduced their asset management fees, eliminated charges on assets held in money market funds, or given clients a price break for the first 12 months in order to get more business on their books. As in the previous cases, the reductions were not applied across the board but only to those who demanded their services for a lower cost or who were new to the firm.

An interesting parallel in each of these examples is that the most valued or loyal customers who have never complained about price are still paying full bore while those looking for deals are getting them. I have often argued against the logic of the 80/20 rule which states you get 80% of your business from 20% of your clients. When one accepts this premise as gospel, you wind up letting your best clients subsidize your lowest-value relationships. Further, because of the increase in volume with lower-value relationships, your costs tend to increase to support them. So a pricing strategy that drives volume may attract the type of clients you don't want to replicate, while disadvantaging those who are your favorites.

This price/value dilemma is occurring at a time when many in the advisory business are complaining that it is not viewed as a profession. It isn't obvious yet that other professions like lawyers, CPAs, and doctors are systematically cutting prices and promoting "lower costs" to select clients and prospects, perhaps because it is harder for the average person to do what they do. The exception to the price discounting trend might be laser eye surgeons, liposuction clinics, and breast enhancement specialists whose services are not regarded as critical to one's quality of life (I know, there is a contra argument here). In general, businesses reducing prices from pre-recession levels are those who deliver discretionary or elective services in a more competitive world.

But when one provides a service that impacts clients' lives as profoundly as financial planning, risk management, and investment advice, it seems that reducing the price to clients makes a real statement about the value you think you are delivering. It is an understandable temptation, however, as your competitors may be trying to buy market share or lure your clients with cheaper offers.

Consider this even bigger question: if you reduce prices today, when will you be able to increase them back to normal levels again? Like the department stores and airlines, will "low price" be your permanent value proposition?

Of course, the implications are great for an advisor's business. Lower revenue and profit margins caused by market shrinkage for those charging AUM fees are magnified by a further reduction in the actual basis point charge when advisors start discounting. Ironically, advisors are receiving less at a time when the amount of service they provide is going up. Will this too become the new norm?

Clients Have Options

The choices for price-shopping clients are manifold: use online financial planning and retirement calculation tools like Financial Engines; execute trades through a discount broker like Scotttrade, Schwab, or Fidelity; seek out a provider that actively promotes its "low cost" advantage like Vanguard; or discover advisors in your community who will deliver roughly the same advice for a lower fee in order to gain market share.

Alternatively, value buyers may seek out financial professionals who have worked with people like them or who are in similar situations (pre-retirement, sudden wealth, same sex relationship, business owners). These buyers may be sufficiently sophisticated to understand the relationship between price and quality, assuming you are able to demonstrate that to them. Others may view safety, soundness, protocols, and process as reasons to pay up in a marketplace where uncertainty and distrust prevail.

There is no easy answer to how one should charge for financial advice. Most advisors have the advantage over large institutional firms of hearing directly from their clients what they value or don't, what they are willing to pay or not. The challenge is not to ascribe the resistance of one prospect or client to all relationships: just because one says "that's too much," don't start whacking away at your price structure across the board in response.

A more prudent course involves defining your optimal clients in terms of those you'd like to replicate. Build a matrix that evaluates clients on more than assets. Include factors like how they came to you in the first place (seminar or referral, for example), where they live in proximity to your office, how they earned their wealth, where they work, what are their unique issues. You should be able to identify 15 to 20 different characteristics from which you can observe a pattern.

Evaluate what this group requires from an advisor based on emotional needs as well as the complexity of their financial lives. Ask them what they think is important enough to pay for, and help them grasp the necessity of a professional to guide them through their decision making.

Combined with understanding your costs for delivering the service and knowing what the market will bear, you should be able to develop a pricing strategy that is aligned with your value to the consumer. Keep in mind that you should not build a strategy around attracting sub-optimal relationships. Rather, stay focused on what your optimal client values, what pricing approach contributes a reasonable profit margin to your business, and what is sustainable over the long term.

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