John Lefferts' Blog

Tuesday, March 25, 2014

A Financial Services Blockbuster

On Friday’s of an era not too long gone by, after a grinding week of hard work, I recall looking forward to stopping by the local Blockbuster store to check out a DVD (or in an era long gone by, a video), pick up a couple pizzas and chill out with the kids for “Movie Night”. The greatest concern was whether or not the “new releases” had all been picked over which seemed to happen more times than not. Then on Saturday afternoon’s, we would look forward to hitting the local Borders bookstore to grab a book, magazine or even find the latest popular CD….ah, the memories. As we now know, DVD rentals have been replaced by streaming video, books by Kindle’s (or my wife’s fav the “Paperwhite”) and CD’s by various online services like Pandora, Spotify and others. And while 3-D pizza still looks disgusting, who knows what may happen in the future as this too may progress. Distribution models have and will continue to evolve as we see the new replace older outdated forms. But, of course, that doesn’t apply to the retail financial services business…says many a CEO “whistling through a graveyard”.

"Our dilemma is that we hate change and love it at the same time; what we want is for things to remain the same, but get better" -Sydney Harris

The retail financial services business is in the middle portion of a current phase of astonishing change ignited by the “great recession”. It’s been said that what we’re seeing now in this phase is more change than all the years combined since Glass-Steagall was first put in place over 80 years ago. And while we have observed industry trends trend towards independence, fee compensation, and witnessed a couple new distribution players hatching such as HighTower, Dynasty and Lion Street (my former firm), wires still dominate AUM, insurance continues to be distributed through support from the product manufacturers and financial advice is largely undefined (just ask the CFP Board) giving way to multiple forms with little looking like true financial planning. It’s hard to believe in this modern era that there continues to be leadership that thinks retail financial services distribution models are immune to this change and see what they want to see. It’s kind of a frog in lukewarm to boiling water thing to use a crude analogy.  I recall my former boss Kip Condron saying, “compensation drives all behavior” and I suppose that as long as the distribution food chain remains well fed under the current scheme, there is little motivation to rock the boat. But then, isn’t that what leadership at firms like Blockbuster and Borders thought until it was too late to make changes to survive?

When the “great recession” kicked us all in the gut in September of 2008, the business initially went into “survival of the fittest” mode downsizing, slashing expenses, deferring investment and doing anything to keep the business intact. Then around ‘10 when Dodd-Frank was first introduced, the following several years seemed to place firms in paralysis mode waiting to see what, if any regulations may change while the economy continued to sputter. Today in 2014 as we see an improving economy and visibility on where regulations are headed, one would think that there would be bold change by firm leadership to position for the future. This is seemingly not so while each intermediary lobbies to protect their respective turf holding onto the past as long as they can. I suppose this is what happens in a "mature" industry with aging leadership and too few disruptive up and comers. But the winds of change continue to blow and leaders not positioning for the future while clinging onto the good ole days are, in my opinion, soon to find themselves in the same circumstances as Borders and Blockbuster…up a digital creek without a paddle.

There are many drivers of change shaping the retail financial services business. But 5 biggies are currently unfolding that will force the hand of financial services leadership to to make strategic decisions that can no longer be placed on hold:

a) Invest in new distribution infrastructure to compete 

b) Let it ride (ie do nothing), squeeze out costs and watch it die a slow death, or 
c) Exit the business altogether. 

The 5 drivers of change forcing these decisions are:

1.    Regulatory Harmonization and shift towards a “Fiduciary Standard” with compensation disclosure and the elimination of differential benefits for recommending proprietary based products. I really don’t think status quo is an option. Everyone believes that at some point, we’ll all be held to a fiduciary standard. And RIA’s are na├»ve to think they can continue to escape supervision. As a preview of coming attractions, look what happened in the UK and Australia when they made similar changes…huge industry convergence and consolidation.

2.    Technological advancements from mainframes to the cloud. It almost pays to have been a laggard here since firms initiating a tech platform today can outsource hardware, software, maintenance, back-up’s, storage and to some extent disaster recovery through the cloud at a fraction of the expense many went to building “ball and chain” mainframe systems.

3.    Model convergence and shift from commissions to fees. This is not only driven by the potential for regulatory change, but by demand in the marketplace. And fee based comp is not limited to investments. Look to see it drift into insurance and annuities products as well. This harmonizing of compensation is occurring while business models are becoming more similar than dissimilar. In a couple years, it will be difficult to distinguish between what was once a wirehouse broker, a life insurance agent and an investment advisor.

4.    Higher demand with lower supply: The massive influence of the boomer demographic. No need to restate the boomer story as it’s been well told. We’re still on the front side of this influence while the peak year for their retirement will be in a decade during 2023. But as interesting is that while demand for financial advice is increasing, the supply of advisors is shrinking. Whoever cracks the code on this one is going to do very well.  

5.    Capitulation on the economics of maintaining a dated legacy distribution model. Recall earlier I mentioned 3 decisions leaders need to make; invest for growth, squeeze expenses out for a slow death or exit the business altogether (ie cut your losses). We’ve seen several European insurers pull out of the US retail business selling their B/D and distribution. Small IBD’s have given up the ghost as well. With the smoke beginning to clear on regs, the economy and the new economics of the business, I think you’ll see quite a few more in the coming year.

 2014 will most likely be a Blockbuster year for financial services firms. But whether it will be ‘blockbuster” as in a hit/bestseller sense, or “Blockbuster” the failed business model is yet to be seen. The one thing I feel confident about is that business as usual is a losing proposition.

“If you don't know where you are going,
you'll end up someplace else.” 
Yogi Berra

"Planning is bringing the future into the present so you can do something about it now"
-Alan Lakein