In my last column, I discussed one offive competitive forces in the financial planning industry and how an analysis of this force can shape business strategy. The force—the threat of new financial planning industry entrants—depends on present barriers to entry and the reaction of incumbents. We found that new entrants bring additional capacity, but they also put pressure on prices, costs and the amount of investment necessary to compete effectively.

That analysis showed the strongest barrier to new entry is the high cost of taking existing market share from incumbents. However, financial planning practitioners have only captured a small portion of the overall market, so there's little need to compete for existing clients. Even so, new entrants increase competition, with a resulting downward pressure on prices: Smaller practitioners are generally less profitable. Bigger firms typically have more income per owner and per staff than smaller firms. This occurs because larger incumbents enjoy barriers against new entrants, which helps protect profitability. Incumbency and size are strong deterrents to new entrants, but less so to competitors moving up the food chain.

I concluded that a simple strategy would be to get bigger to attract and retain more profitable clients—a classic response. However, as we consider other industry forces, simply getting larger brings up new issues. This column explores the second and third competitive forces—the bargaining power of buyers and the threat of substitutes—and how you should think about them.

The Power of Buyers

In many industries, powerful buyers or customers capture value by forcing down prices or demanding more quality or service at the same price. Wal-Mart is the classic example of an extraordinary powerful buyer forcing its suppliers to cut costs. When do buyers have this kind of leverage?

• When there are few potential clients. Some potential client groups do have negotiating leverage. Surveys indicate wealthier clients often negotiate fees and services.
• When products or services are undifferentiated. Today, advisors seeking new clients who have never used a financial planner must compete against the ultra-low-cost investments and planning vehicles available via the web. When products or services are undifferentiated or commoditized, if potential clients believe they can find an equivalent product or service more cheaply somewhere else, they will usually search for the low-priced alternative. The only differentiators many planners have are the types and levels of service they can offer. The more advanced the service or the more specialized the advice, the less bargaining power a potential client has.
• When switching costs are low or nonexistent. For entry-level planners or those offering basic services, potential clients have a vast array of alternative information sources and competition. On the other hand, if the advisor can do a good job, the emotional cost of switching is quite high. Interestingly, many sophisticated clients spread their investment dollars among several advisors. However, the best firms attract a higher percent of their clients' assets over time with superior service and performance. Thus, clients with high earnings or substantial net worth are less price-sensitive and focus on reliability, quality and performance.
• When potential clients can produce the product or perform the service themselves. For many potential first-time clients, the availability of ubiquitous ultralow-cost products and planning tools means they can do it themselves.
  

In addition, potential financial planning clients may be price sensitive under the following conditions:

• They are average wage earners, have little excess cash flow or are otherwise under pressure to watch costs. These folks are unlikely to use a professional advisor in the first place.
• The quality of service or product is not controlled by a few firms.
• The cost of the product or service is small in comparison to other costs. For small accounts, this is the case, as price sensitivity is evident. On the other hand, individuals with substantial assets see the loss of principal as a high potential cost. Others may see the opportunity cost of missing the "big investment." These different investors will gravitate toward different ends of the advisor spectrum—either a strong orientation toward low-risk or high-return philosophies, respectively. Some firms can offer clients either or both styles, usually at a higher fee. Thus, investment specialization often commands higher fees from less price-sensitive clients.
• There is exclusivity in products or services—think hedge funds or other specialty products.
  

What does this analysis show us? You want to avoid potential clients with substantial buying power. One strategy is to offer exclusive or highly differentiated products and/or services. One way to do that is to become a recognized expert and establish a niche practice or provide specialized services.