The Pricing Conundrum: What's Wealth Management Worth?

Harriet Davies Editor - Family Wealth Report 20 June 2011

The Pricing Conundrum: What's Wealth Management Worth?

Both clients and service providers are being hit by falling margins and a lack of consistency on pricing in wealth management, causing the value proposition of wealth managers to be called into question. This needs to be tackled to improve the overall reputation of the industry.

Despite global wealth posting two years of consecutive growth, margins in the industry continue to be squeezed, while fees and charges often have no correlation with service or performance, according to the latest report from Boston Consulting Group. This is pleasing neither clients nor service providers, as wealth managers feel squeezed on the one hand and clients feel confused on the other. It’s also a business critical issue: statistics show clients are more likely to be unhappy with their advisor if they don’t understand their fees (source: Cerulli).

Undisciplined pricing

Indeed, according to BCG’s latest report prices tend to be too complicated for clients to understand. Backing this up are some astonishing figures from Cerulli Associates: in a study on wealth management fees some 33 per cent of surveyed investors didn’t know how they paid for investment advice, and 31 per cent thought their advisor or broker provided investment advice for free. Furthermore, the Boston Consulting report found many prices allowed for unguided discounted.

This lack of clarity hands bargaining power to the clients, leading to “significant variation in pricing and hence return on assets, even within narrowly defined client clusters,” says the BCG report.

While this may not sound like such a bad thing, it leads to a number of problems. Firstly, as the report points out, pricing is one of the key ways of increasing revenue margins. And with more advisors moving upmarket, as services to lower-end mass affluent clients become digitalized, this could lead to high-end wealth management becoming commoditized, “with commodity-like margins,” says Robert Ellis, a principal of Fast Track Advisors.

Secondly, it will leave clients feeling very dissatisfied when they find out their friends using the same firm pay a different price.

“Wealth management pricing schemes rely on secrecy, but just like salaries at work, eventually the truth will out,” says Ellis.

He adds that this will not only leave the client who is paying more feeling overcharged, but will also leave the client who is paying less feeling unsure of the value proposition they are being offered. The overall message to clients: pricing is random. And if pricing is random, what is the service really worth?

The value proposition

“Poor pricing discipline is a result of not having a strong value proposition. Consequently, advisors and managers often make their pricing decision on the marginal cost to serve. In other words, they look at the trading and platform costs, plus the advisors commissions or fee, and price at that level. This is often well below what other clients may be paying. They often do this because managers and advisors are commonly rewarded based on AuM, not profitability, when being evaluated for bonuses and sales quotas,” explains Ellis.

The same phenomenon also causes many wealth managers to accept clients with assets well below the stated minimum size. In his work in this field, Ellis says he has even come across firms which have an average AuM figure below their stated minimum - a figure he describes as being “more aspirational than realistic.”

In the past, BCG’s report notes, this method may have cut it, as wealth managers subsidized cost-conscious clients with those that paid higher rates, all the while fattening their AuM with both types of clients. However, this is no longer the case, as clients demand transparency on costs and new lost-cost business models are challenging the status quo. And as the “cost careless” clients dried up after the crisis, average return on assets deteriorated – a full 13 basis points in 2009.

What should firms be offering?

At the heart of the matter is a need for a transparent and logical pricing plan, the BCG report says, and this is linked to a firm’s value proposition. A fundamental rethink of a pricing schedule is a long-term strategy, but the report says more immediate changes could include limiting discounts and adjusting certain prices.

According to Ellis, a wealth manager’s offering is made up of three dimensions: products, delivery channels and client segmentation. It is this combination, along with pricing schema and brand perception, which determines the value proposition. Firms are then charged with the task of differentiating themselves on these dimensions, and conveying their value proposition to clients.

On the product side, a company differentiates itself on the menu of products and accounts it offers, while the delivery side reflects how a client is served.

“It may be a team or an individual advisor, online or in an office, self-service or the validation model, etc. The aspect of convenience also enters into the equation as well; I notice many firms providing cell-phone access to complex accounts where the size of the screen (too small) and the level of detail (too much) don’t match client expectations or reflect how they want to interact with the firm,” says Ellis.

On the brand perception side, many companies have taken a battering since the crisis, as trust – a key part of the wealth management business – evaporated. A strong brand imbues the client with feelings of security, as well as conveying a certain status. This offering, although intangible, adds value. This can be priced into certain firms’ offerings, especially those which have come through the turmoil largely unscathed. Some of the diversified firms, however, whose wealth management clients appeared to have been sacrificed for their investment banking divisions, have lost credibility and been forced to discount to bring in new business, says Ellis.

Client segmentation

Client segmentation is often touted as a way of increasing margins by delivering business more effectively, yet industry-wide surveys usually find the method is underused. A Cerulli survey last year found only 37 per cent of all financial advisors use a formal client segmentation process.

The key to doing it successfully is to find an appropriate measure for “worth”, and appropriate cut-off points for different segments, according to Ellis, who has analyzed the segmentation issue. His process uses net worth per household as a measure, as most households invest as a unit, and this also factors in debt levels and assets held across providers.

In terms of the cut-off points for segments, it is clear that ultra-wealthy clients will need different products and delivery channels to those that are wealthy, or affluent, and the critical point is defining at what level of wealth those needs change.

Ellis also says the use of sub-segments can improve service, taking into account clients’ ability and willingness to bear risk, their source of wealth, tax liabilities, advice dependency and what phase of the wealth cycle they are in.

Changing times

As an industry, pricing may not always have been at the fore – of discussion or marketing material, for example – apart from for specialized, low-cost firms. Wealth managers rarely publicize information about their prices. Recent research into some of the world’s most important wealth firms found that only 22 per cent offer specific information on their fees, while 10 per cent publish performance data for their discretionary accounts, according to the Geneva-based research firm MyPrivateBanking.

Wealth managers have traditionally preferred to talk about performance and service; however, both of these were called into question by the financial crisis. On the performance side, Ellis suggests firms “sit on the same side of the table” as the client, and help them pick products and managers.

But whether or not performance and service are up to scratch, pricing is now firmly in the spotlight and must be tackled. The wealth management industry has come under fire from both the mainstream media and regulators, with some articles even going so far as to suggest the whole industry is a “con”. Given this, service providers must figure out what they are offering clients, what it is truly worth, and how to deliver it profitably, in order to improve the overall reputation of the industry.

Register for WealthBriefing today

Gain access to regular and exclusive research on the global wealth management sector along with the opportunity to attend industry events such as exclusive invites to Breakfast Briefings and Summits in the major wealth management centres and industry leading awards programmes