Profit margins at too many wealth management firms are being steadily eroded by service creep - that is, the continual addition of complex services to the client that aren't paid for.
This current arms race to expand the service offerings for bespoke services for ultrahigh-net-worth clients without commensurate compensation is simply unsustainable.
Indeed, the single biggest economic challenge facing wealth management firms who serve UHNW clients is right-sizing pricing in the face of increasing complexity for non-investment services.
Following the 2007-2008 market convulsion, client demand was inexorably reshaped, particularly at the very high end of the market.
There is widespread evidence that clients now value many non-investment service components at least as much as investment management, especially when performance expectations have been muted by low single digit returns.
LATENT DEMAND EMERGING
In the past, firms have traditionally lacked pricing power due to a fluctuating or uneven demand from client families. But while that dynamic has changed, firms have been slow to use this latent demand to modify their pricing strategies for non-investment related services.
What's more, these services can also be insidiously complex, and firms must become more disciplined and alert to how time and effort spend providing non-investment services can systematically erode their margins.
Currently, there are remarkable variations of fee arrangements.
Bundled asset-based fees predominate when investment and non-investment services are combined, but unbundling due to increasing client demand for non-investment services is also occurring.
Where firms use bundled asset-based fees, there are some clear clustering patterns or market rates for amounts less than $50 million under management, but almost all firms that use asset-based fees use uneven discounts above $50 million in assets.
While these discounts may be offered to gather assets, the markdowns are economically perverse as the needs of families with more than $50 million are predictably more complex.
QuoteFirms must demand to be paid for services rendered at a reasonable level of profitability.
Unfortunately, traditional bundled asset-based fee methodology socialized clients that they could get non-investment services for free. But firms must demand to be paid for services rendered at a reasonable level of profitability.
Many firms use an estimated price for non-investment services best described as a professional service firm time and effort pricing model where the firm takes a mark-up on their presumptive cost of staff time.
In the absence of any systematic cost-accounting models, time tracking systems, or other internal controls, this is, at best, imprecise. In fact, there is ample evidence that many firms are delivering many of these discrete non-investment services at a loss.
Notwithstanding these internal control weaknesses, negotiated, non-asset-based fees are, implicitly, inelastic - that is, impervious to the vicissitudes of the capital markets. They also more consistently recover the underlying costs, and, for strategic and planning purposes, are much more predictable presenting firms with a pricing opportunity.
CONVENTIONAL WISDOM WRONG
The conventional wisdom in the industry is that clients won’t pay such fees. But that assertion is largely unfounded.
With demand shifting, families increasingly rank non-investment services as high-value prerequisites in their choice of provider and don’t expect to receive something for nothing.
One notable pattern is single family offices disaggregating many services, shedding fixed costs for non-investment staff and technology functions to multi-family offices. These MFOs have an opportunity to set market prices for their non-investment staff functions and technology configurations.
WALK AWAY FROM PRICE SHOPPERS
Finally, firms not only have an opportunity to rationalize their non-investment prices, they must eschew families buying their services on price alone by simply walking away.
The definition of an attractive and actionable client segment in any service industry is one where a firm can acquire and retain a client over a full business cycle, and at a predictable and attractive price point.
Currently, there are no unique value propositions, just good ones—so it’s all about firms doing just enough to acquire a client family and then ruthlessly managing costs.
Sharper, more-disciplined pricing practices can get firms off this treadmill. Fortunately, improved pricing protocols and “best practices” are emerging.