When it comes to distribution costs, mid-tier mutual fund companies have traveled a difficult road in recent years. They pay the same as larger firms--and sometimes more--to distribute their products through wholesalers, but they don't see the returns on the investment.

Executives speaking last Wednesday at a seminar on distribution at the National Investment Company Association's East Coast Regional Meeting in Boston, said mid-sized firms are reevaluating budgets in response to the weak economy and will likely abandon some distribution channels, seek out larger firms to buy their companies, or develop less-expensive, Internet-based distribution models.

"In order to be a player that's going to survive, you need to be on the upper end," said Jim Alban, CFO of Sun Capital Advisors, a small-tier firm.

Spending More for Smaller Returns

That's partly because mid-tier firms are matching larger companies "head for head with cost structure," said Bob Kennedy, VP of marketing at BISYS Fund Services, but garnering and retaining "far less assets."

In 1999, tier-one firms paid their external wholesalers an average of $243,000 while mid-tier firms paid them $241,000, Kennedy said. In 2000, those figures rose to $318,000 for tier-one firms and $273,000 for mid-sized firms.

In addition, average production per dollar of wholesale cost has been dismal for mid-tier firms compared to their larger counterparts. In 1999, mid-sized firms lost $49 for every dollar they made in net sales through wholesalers.

"Something has to give," Kennedy said.

Some firms are already bailing out of distribution channels, Kennedy said. Mid-tier firm John Hancock, for example, recently pulled out of the 401(k) channel. "More will follow," he said.

Leveraging the Internet

Speakers at the seminar agreed many mid-sized companies could see Internet-based distribution as their most attractive option because it allows firms to reach brokers effectively without shelling out huge amounts of cash. "Travel expenses don't exist," said Kevin Nolin, a managing director of global sales and marketing at Orbitex Group of Funds. "And time and effort is basically zero."

Brokers, meanwhile, are used to using the Web for research and tracking daily data, so they will be eager to close deals over the Web, he said. In addition, said Frank Polefrone, a VP specializing in strategy at tech firm Access Data, the technology can help consolidate product offerings and deliver them in neater packages through various channels.

"Many consumers want just one contact for all products and investors are buying a lot of different products," he said.

Executives said e-wholesaling could amount to wholesale efforts via e-mail, or the idea could take the form of browser-based applications that enable transactions via the Web. Kennedy suspects firms will have widely adopted the method in some form within the next three years. Many, he said, are waiting to see what other companies develop. They don't want to build expensive platforms if cheaper ones will do.

"There's a big debate out there if there's any benefit to being first to market with some of these technologies," Kennedy said. "The mantra is to do more with less."

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