Three key themes shaping the Australian wealth management industry – the “So What?” for financial advice businesses

In our last blog, we identified three key themes that we believe will strongly influence the Australian wealth management industry over the short-to-medium term:

1. Scaling up of the advice segment (and the competitive advantage it provides)
2. New demographics, regulation and technology enabling new competition (operating under different economics)
3. The unsustainability of an industry value chain very much out of kilter

What do these trends mean for owners of financial advice businesses? How can you expect things to change? We call this the “So What?”.

The importance of synthesis

Synthesis involves moving from a bare analysis of the data and evidence to address the question “so what does this mean for us?”. Without this step, even the most insightful analysis won’t lead to action. It’s even better if businesses can move from the “so what?” to the “now what?”, from “what does this mean for us?” to “what are we going to do about it?”.¹

In this blog, we’ll focus on the “so what?”, saving the “now what?” for our next piece.²

1. Scaling up and industry consolidation – what does this mean for wealth advice firms?

As noted in our last blog, the big firms are getting bigger – and different to prior efforts at aggregation, much of that consolidation is occurring around the advice end of the value chain, being driven by an aligned economic model.

So, in the advice profession of the future, all else being equal, size will matter.³

Like Touchstone’s “if”, there is much virtue in the phrase “all else being equal”: because not all scale will be the same. Scale that adds unnecessary complexity to businesses, or misalignment of economics or values, or service lines that core clients don’t value, will not support the types of scale advantages that will make the most difference.

So, what will it mean to be “not scale”? Obviously, all such businesses won’t simply disappear, just as suburban accounting or legal practices exist today, notwithstanding the scale benefits in those professions. But it’s unlikely such businesses will attract and retain the best staff; will be able to offer seamless advanced service offerings; build out multi-segment propositions; invest in technology and marketing etc – all of which means those practices will be valued at significantly less multiples and will likely over time struggle to grow in any meaningful way.

Given the current over-heated market for acquisitions in financial advice, there will still be a moment when these sub-scale practices will attract buyer interest at solid multiples, but this will surely dissipate over time.

Sub-scale practices will want to use levers to replicate the effects of scale (eg, outsourcing, pooled purchasing or technology groups, new technologies) and carve out defensible propositions that sit under the radar (eg, discrete geographical or demographic segmentation).⁴

2. Responding to new competition

We spoke in the first blog about the Golden Trifecta of inter-generational wealth movement, regulatory reform and new technologies leading to the potential for new advice models delivered by new competitors and embracing new economics.

We acknowledge that the significant demand overhang for financial advice and the likelihood that these new advice models will be initially directed at segments not currently important to most financial advice practices mean that, in the short term at least, the impact on financial advice profitability may be minimal.

But the experience of the evolution of robo-advice in the US demonstrates that even when these technologies fail to take off in a mainstream way, the effect of deconstruction of the financial advice offering and transparency of pricing will likely lead to margin compression over time.

If we take this US experience as indicative of what we might expect in Australia, then advice businesses can expect margin compression in the range of 10-20 bps,⁵ depending on the nature and scope of how the new advice models play out. A hit of this kind to most advice firms would be significant – how might your business respond?

For some advice groups, the chance to throw their hat in the ring with a larger group with a bigger play will be tempting. But for those that wish to remain independent, several issues arise:

• These supplier-cum-competitors may have access to adviser client data, operate critical advice technology, be important sources of business capital – how would your practice be able to respond to these types of supplier disruptions or threats?
• In all likelihood, any movement into advice by these groups would still require humans to deliver the advice – this would put more pressure on the limited industry talent pool⁷
• The nature of some of these offerings may enable highly targeted micro-segment offerings, cherry-picking the most profitable current client segments.⁸

What about other industry players?

How will other industry participants be impacted by these key themes? In a world where your clients are substantially larger with concomitantly increased purchasing power, you could expect even more margin pressure. Some level of competitive rationalisation seems inevitable.

How might you be one of the survivors?

• Back the winners, because they’ll likely win disproportionately – those groups with sustainable growth engines, powerful client propositions, aligned professional management and talent, etc
• Participate in advice consolidation in a way that makes sense to your proposition – the investee firms selected, the stake taken, the capital mechanisms used, the support provided, etc. All of these should be consistent with your overarching strategy, not opportunistically driven by what the market dictates
• If you do acquire, don’t overpay, especially for smaller sub-scale firms – even better, support the larger firms to become acquisition engines in their own right
• Think about how you can truly partner with these groups for a win/win scenario. If you’re introducing new advice models, work with advice groups in a way that grows the pie and helps them to build out better tiered advice models. Design better peer learning networks that are matched to your proposition as well as the genuine needs of your network (some ideas on that here: https://growthbydesign.au/community-by-design/)

Industry participants that use their competitive advantage – their intellectual property, their access to data, their capital strength – to positively partner with advice businesses will be better placed to survive the next wave of change in the wealth management industry.

Summary

For advice practices in Australia, the three key themes will likely have the following impact:

• Participate in the industry consolidation in some way or learn to live in a sub-scale environment
• Prepare for further margin compression to impact your practice as new advice models lead to greater price transparency
• Expect value chain disruption to lead to more of your suppliers becoming competitors, with implications for access to data, capital, IP etc.

Impact on advice margins:

How should advice practices adapt to meet these challenges? We’ll explore the “now what?” for advice business leaders in our next blog.

John Sullivan is one of the wealth management industry’s leading strategy commentators. He has been consulting to wealth managers, insurers, advisers, asset managers and many other industry participants, in Australia, throughout Asia, the US, New Zealand, South Africa and Europe since 1998. For the last decade, he worked with (and eventually led) Macquarie’s Virtual Adviser Network, where he worked closely with 100s of Australia’s leading advice businesses, helping them to grow – deliberately, strategically and sustainably.

¹ This is often the frustration of industry benchmarking, which will share the “what?” of relevant data and perhaps even the resulting insights but rarely helps businesses to understand what the implications are for their business, and even less help them to think about what actions they need to take in response.
² Much of this material is taken from the excellent book “Decision over Decimals” by Columbia University professors, Christopher Frank, Paul Magnone and Oded Netzer.
³ Just as it has done in other professions where large scale consolidation has occurred like mortgage broking or general insurance intermediation.
⁴ How big is “scale”? Let’s say sufficient to support a professional layer of management and corporatisation, so probably a minimum of $7M in revenues and $1B in funds under advice (FUA). With many advice businesses starting to pass the $5B FUA mark, this number will no doubt grow.
⁵ Calculating the impact of new advice models on US wealth management margins is not a simple exercise – this number is based on 20% compression, supported by a range of sources (eg, Oliver Wyman’s 2016 report “Winning at all costs – Cost management as key success driver”).
⁶ This is known as ‘value climbing’ and is a common phenomenon in the tech industry – for example, all of Lenovo, Sony and Samsung started as suppliers before they became OEMs.
⁷ It’s possible the New Class of Adviser envisaged by Tranche 2 of the DBFO draft legislation could be a circuit-breaker here.
⁸ Imagine a combination of AI-enabled tech, hyper-personalised data analysis, specialised access to global investment opportunities with highly incentivised Barrons Top 100 advisers, targetting the top 100 families without their own family office – how does even the largest HNW-focused advice group compete? How would it impact an incumbent HNW advice firm?