In previous columns, I wrote about three of five competitive forces in the financial planning industry and discussed how analyzing these forces helps shape your business strategy. But why should you care about this stuff? The reason is simple: Strategy development for your firm is a critical part of positioning yourself to be more profitable and less vulnerable to competitors.

After reviewing two final competitive forces—the threat of substitute products or services and rivalry among existing competitors—I'll discuss what we're doing about them. As Bob Dylan sang in the 1960s, "The times, they are a-changin'," and if anything, things are changing faster than ever today.

Force 4: Substitution

This threat sneaks under the radar in different ways. Potential clients never see you because they find a less-expensive product or service elsewhere; they hire you, but also hire another firm because they don't differentiate between your products or services; or they leave you and substitute other products or services they get cheaper elsewhere. The threat of substitution is strong when the following factors are present:

• Products or services are undifferentiated. The array of planning tools and information on the web pits many advisors against low-cost investments and planning vehicles. When products or services are undifferentiated, potential clients will usually seek the low-priced alternative. The more advanced the service or specialized the advice, the less likely a client will substitute.
• Product substitution costs are low or nonexistent. Investors have a wide array of alternative products or services—front, back and no-load investment, insurance and annuity products. This is an issue for firms offering no- or low-load products.
• Clients can buy products or perform services themselves. Ubiquitous ultra-low-cost products and planning tools allow investors to "do-it-yourself." As technology advances and succeeding generations of investors become more technologically literate and proficient, techno-substitution for your services could become more prevalent. Watch out for firms using advanced technology to reach out to the tech-savvy. As millennials seek tech-loving advisors, your market share may shrink.
• Alternative products or services offer a more attractive tradeoff between price and performance. The better the relative value of an alternative, the lower the profit potential for planners working in that market. Here, the best business model is to provide advice only for a low fee or possibly offer products where the fee is buried so the client doesn't "feel" it.

What does this analysis indicate? Advisors should avoid competing on price, because someone always offers a cheaper product or service. One strategy is to offer exclusive or highly differentiated products and services. To do that, become a recognized expert and establish a niche practice. As I mentioned in the last column, this is a very different strategy from growing a large enterprise. If your strategy is to become large and attract bigger clients, those clients may be able to negotiate lower fees and demand more services. Before seeking bigger clients, carefully think through how you will deal with clients' expectations and lower profit margins.

Force 5: Existing Rivals

Rivalry comes in many forms: price discounting, new service or product offerings, advertising and marketing and service improvements. Price competition is most likely to occur when:

• Products and services are nearly identical, and there are few switching costs for customers. Advisors who lack personal relationships with clients are aware of this issue. However, switching costs are high for clients with personal relationships with their advisors.
• Fixed costs of products and services are high. Solo practitioners typically have low overhead costs. Larger firms must continually feed overhead with additional product sales or growing fee revenue and often compete on price.
• There is significant excess production capacity. At lower asset levels, there are more opportunities than planners. CNN recently reported the number of U.S. families with net worth greater than $1 million, excluding principal residence, may be as high as 8.9 million, but noted 61% of them said their approach to investing hasn't changed. They have someone they're sticking with. Even so, nearly four million may be willing to seek a new advisor. Moving up to the ultra-high-net-worth ($30 million or more) segment, survey firms think the pool has shrunk to less than 100,000 in the United States and Europe combined. In that rarefied air, price competition is assumed; virtually every firm I've talked with will negotiate at that level.

Competition occurs along other dimensions as well: product features and service offerings, ancillary services, reliability of performance and even brand image. This rivalry can be positive or negative, depending on whether competitors target and serve different market segments or use different mixes of products and services, pricing, features or brand identities. It's essential to understand the structure of the market you serve or want to serve.