There are a number of forces, which will combine to recreate the wealth management Industry. These forces are so powerful that they may lead the wealth management industry in turn to transform the banking and finance industry.
One of the most interesting forces is the rise of third party intermediation.
Both demand and supply have driven the growth of third party intermediaries. Why do institutions welcome third party intermediaries even though they may, by doing so, cede their relationship with their customers?
There are several reasons.
Firstly, institutions realised over a decade ago that their costs were fixed and rising, while their revenues were cyclical and their margins were falling. The need to convert costs from fixed to variable has been on their agenda for a while.
Secondly, whether you or I like this or not, studies in the 1980s showed that the single biggest cause of poor profitability in an industry was a high level of unionisation. Little wonder then that institutions have been inclined to outsource the problem.
Thirdly, and paradoxically, financial institutions seem to vie to be good employers. They are in the vanguard of movements such as rostered days off, parenting arrangements and job-sharing. These are worthy causes, no doubt, but expensive. Institutions prefer to limit them to core employees and to outsource the rest.
Fourthly, institutions are sensitive to what has lately become known as bank bashing. The brand is paramount. Bank bashing happens mostly at the customer interface. This is perhaps another reason to withdraw from a contentious frontier.
Finally, management practices that made a lot of sense in the 1970s do not seem to work as well now. The management by objectives command and control paradigm has failed. It does not work well for managing people with high levels of discretion in the work they do. Neither does it work for people who have need to work together across organisational boundaries.
So, without going into too much complexity, we can argue that financial institutions have a big demand for third party intermediaries. So then, where does the supply of third party intermediaries come from?
Almost everywhere, it seems. Some are people who evolved their businesses out of life insurance agencies. Others are accountants looking for new revenue streams. Then there is a growing group of financial planners with specific professional qualifications. Their numbers are boosted by retrenched bank employees and people who simply want to work for themselves, rather than an organisation. There is no homogeneity in third party intermediation.
Some of them are completely independent, others are in tied agencies or are employees of institutions. However, even the most tied of them are more independent than a traditional bank employee. They have professional qualifications and skills that give them more options. They lack the loyalty of a bank employee of 20 or even 10 years ago. Once, each bank would have a few thousand people who thought of themselves as part of the management team. Today, I suspect, the great majority of people at the customer interface feel themselves to be in one way or another a third party.
Is the trend towards third party intermediation a structural one that is here to stay? Almost certainly, but not in its present form. Major factors militate towards change. In one sense, the genie is out of the bottle. Financial institutions will not find it easy to reverse the situation that they have created. End-clients have become increasingly accepting of intermediaries, although they are uncertain that they get value for money.
However, there are forces for change. The first is the limited capacity of intermediaries to absorb regulatory change. Privacy legislation and product and price disclosure will make big demands. These are compounded by changes to taxation. Intermediaries will need to commit substantial resources to understanding and responding to these changes.
The second is the required investment in information and communication technology, which has been described as a quantum leap every two to three years. If this cost has to be carried by institutions, will they create systems that bind intermediaries to them? The jury is still out on this. I suspect, however, that it will be difficult to make intermediaries dependent on any one technology.
Which intermediary model will prevail? The ability of accountants to combine financial intermediation with tax planning and accounting could put them in the box seat. But recently they have had enough to do just keeping up with the impost of tax changes.
What will the end-client want? Most would agree that end-clients are becoming more sophisticated and more involved in the investment decision. The financial press is becoming more informative. An intermediary who lacks true independence is likely to find this an increasing burden.
Who will own the customer, is a question also being asked. Will it be the intermediary with the relationship with the end-client based on understanding their needs and aspirations? Will it be the institution with the database? My response is that it will be whoever the end-client trusts. Whether individuals or institutions can develop the competence to earn trust is one of the great uncertainties that create the several possible futures facing the industry.
We are seeing a battle to shape the financial intermediation sector. None of the players appears to have a decisive advantage in market position or resources to commit. Nevertheless, the battle is being fought. The innovators with the will and resources to recreate the market may be yet to emerge.
IBM, in launching the personal computer, outsourced two major elements of the product — the microchip to Intel and the operating system to Microsoft. By doing so, it created two major corporations. Some say IBM gave away the farm. Others say that the computer would never have achieved such dominance otherwise. IBM itself is still a major corporation, after all.
Similarly, financial institutions seem to be outsourcing technology and increasingly, the back-office systems that technology supports. Meanwhile, they are outsourcing customer management. I do not think that anyone can yet predict the end game of this. Certainly, it will not be the same game.
Geof Johns is a financial services management consultant and market researcher.
