Structural profitability erosion
Rising assets have resulted in increasing compliance and distribution costs, as well continuing pressure on fees due to a general market push towards transparency and comparability of services (MiFID II). Recent research has uncovered that many European wealth managers had to tolerate a decade of profitability erosion. Yet, only a few wealth managers took bold steps beyond cost cutting to build up new digital business with a measurable impact on net revenue growth. At Ross Republic we conducted a review of annual results of European wealth managers, confirming profit and revenue margin compressions, costs rising faster than revenues, and rising cost-to-income (C/I) ratios that go as high as 80% – although this depends on the market, e.g. in Germany, some private banks even have CI ratios beyond 90%. The introduction of MiFID II will have further significant implications on the operations, pricing, distribution, as well as product offerings of wealth managers, resulting in further rising costs and shrinking margins.
New competitive dynamics
Direct-to-consumer (D2C) robo-advisors are expected to reach $1.26 trillion in AUM by 2023. Similar model portfolio offerings as well as self-directed investing is currently getting a boost due to Covid-19: Digital brokers have made the markets more accessible and affordable for the average European investor to take advantage of the markets. For instance, only after a few months since BUX launched its investing app in Germany, it acquired 100.000 German users. Trade Republic, a fast-growing broker based in Germany, experienced similar customer inflows and recently launched zero-fee savings plans, including more than 280 ETFs and flexible investment amounts, starting at 25 euro. The plans can be initiated in just three simple taps in the Trade Republic app. BlackRock, the world’s largest asset management firm, is the strategic partner for Trade Republic’s ETF offering. Even though the assets under management of such new digital brokerage apps is small compared to the incumbents, the established players now have an opportunity to learn from the success of these new digital services and their go-to-market strategies.
Beyond direct competition from fintechs, wealth management services are further expected to become embedded in third party environments, such as personal finance management (PFM) apps or accounting services. Gusto is a prime example of such an embedded wealth management play. The software firm serves more than 100.000 businesses in the US, processing tens of billions of dollars of payroll. Lately, Gusto launched Gusto Wallet, a free app for employees to manage their savings, thus leveraging its large business customer base to win their employees as potential clients.
D2C digital wealth management services as well as the rising model of embedded wealth management shows that the go-to-market rules have shifted from linear distribution to seizing network effects that allow to acquire clients at low customer acquisition costs and aggregating services based on client needs.
As previously outlined in our article “How banks can unlock the potential of open finance” and discussed in our wealth management podcast, the adoption of cloud-native, composable architectures, independently deployable microservices and API-driven third-party integrations has replaced monoliths with platform-based stacks that smartly combine best-of-breed vendors. Such adaptive technology architectures can be highly tailored to fit the wealth manager’s propositions and business model. As cloud technology and interoperability lowers costs, wealth managers can manufacture their products at the lower marginal costs. At the same time, digital and embedded distribution channels unlock new sales interfaces at scale. The gathered data becomes a key resource to orchestrate highly personalised services, a key factor of differentiation in wealth management.
The winning financial services providers of tomorrow leverage technology as a key competitive advantage and enabler, rather than a cost centre. Digital transformation is about re-defining the end- customer experience, enabled, not defined, by technology. It is about pioneering new products and business models, as new technologies create new possibilities across the entire infrastructure stack. – Adrian Klee, Partner at Ross Republic
While modern technologies can improve operational efficiencies and enhance client relationships, the key is to leverage technology as enablers of new products and services, underpinned by new business models. While most wealth managers tend to evaluate new technologies mainly from an IT perspective, it is equally critical to look at it from a business model and strategic growth perspective. Thus, focusing on the latest tech trends, such as cloud or APIs per se is “almost the wrong focus and will likely not result in the desired ROI of such technology investments.”, as Ben Robinson, ex-Chief Strategy Officer at Temenos, highlighted in our recent podcast. “The key is to look at how to leverage the possibilities of new technologies to create business model innovation, new revenue streams or distribution models.”
New digital-era business models will emerge in wealth management
Legacy business models and operations of incumbent wealth managers are increasingly maladapted to some of the aforementioned shifts in the digital market environment. Mature industries impacted by digital transformation processes often result in
- a few winner takes it all players that aggregate demand,
- platforms that aggregate supply,
- as well as a long tail of direct-to-consumer niche players that focus on unique services or narrow target groups.
The transfer from a linear, industrial financial services value chain towards modular backends, open platforms and embedded financial services will gradually disintermediate the manufacturers and distributors of financial products.