Opportunities for Action in Financial Services. Hidden Treasure: Finding the Keys to Profitability in Wealth Management

Transcription

1 Opportunities for Action in Financial Services Hidden Treasure: Finding the Keys to Profitability in Wealth Management

2 Hidden Treasure: Finding the Keys to Profitability in Wealth Management Wealth managers and private bankers endured a watershed year in Many businesses reported their worst results in recent memory, suffering reductions of more than 50 percent in profitability. Some firms, particularly those with poor economics and weak business models, incurred major losses. Declines of up to 50 percent in the traded volumes of major markets crushed commission revenues. Securities prices fell significantly, too, diminishing the percentage fees that wealth managers levy on clients assets. Investors, dismayed with the performance of their holdings, often pressed for lower fees or sought advice elsewhere, with many ultimately moving their money to other institutions. These developments and the pressing need to improve profitability have highlighted the flaws in financial institutions traditional approach to wealth management. This approach, which sustained most competitors in the 1990s, has relied on only one service model for virtually all clients. Furthermore, it has generally been employed in an overly optimistic and imperfect way that has damaged the interests of both wealth managers and their most profitable clients. Let there be no mistake: the wealth-management and private-banking businesses remain highly attractive. When managed well, they regularly generate pretax returns in excess of 30 percent and those returns can sometimes climb to 70 percent. But wealthy clients constitute a fragmented market. Moreover, the quality of the service they receive and the performance of their investments varies widely. In today s

3 tough times, the wealth management approach of the 1990s increase the sales force and attract as many customers as possible is revealing its shortcomings. The solution lies in a highly customized approach to customers with distinct and appropriately priced products and services for each segment. Careful customer segmentation that adheres rigorously to stated account minimums should be combined with a renewed focus on managing clients for improved penetration and retention, and with discipline in pricing and cost management. This strategy will ensure that the business remains solidly profitable as it refines and aligns its product and service levels to customer segments. Casting a Wide Net Many wealth managers have stuck with their industry s conventional wisdom the more customers, the better by defining their target markets vaguely, designing a one-size-fits-all customer-service model, and then hiring a squadron of salespeople to pursue those potential customers. This approach is particularly damaging to wealthmanagement profitability for two reasons. First, few wealth managers adhere to their own stated minimum asset levels for investors. Minimum asset levels are set for good reasons. Clients who fall below those levels usually don t generate enough revenues to cover the costs of serving their accounts. Those clients also attract attention and resources that should be focused on wealthier customers. At one global investment bank and brokerage house, we found that more than 50 percent of investors didn t meet the stated minimum level of assets. At another top competitor, more than

4 two-thirds of investors didn t meet the required minimum. Those two firms, like others we have worked with, had many explanations for why they maintained and continued to attract accounts that fell below their stated minimums. Among the most popular arguments: these investors accounts have the potential to grow, these people provide great referrals, or these clients are due to inherit a lot of money. Our research shows, however, that if assets are not increased to the minimum level within the first year of service, only a tiny fraction of such accounts well below 10 percent ever reach minimum size and therefore can become profitable. At firms like these, the best customers the ones who meet required minimums are underserved and are subsidizing other accounts. Small accounts are not necessarily undesirable: they can be a good source of referrals, and some do grow into much larger accounts. But wealth managers need to be disciplined in tracking them and routing them to a more appropriate service model even another firm if they don t meet minimums within a certain time. There should, for example, be programs to encourage clients to place more assets with the institution so they can graduate from one service level to the next. The second reason for the damage to profitability is that wealth managers often use a standardized approach to their customers, offering all of them the same service model. This tactic can be costly and unsuitable. Again, it leads to the wealthiest customers subsidizing small accounts. It also means that providers are not well positioned to meet the differing needs of high-net-worth and mass-affluent clients. For example, the estate- and tax-planning needs of high-

5 net-worth clients differ greatly from those of massaffluent investors. In addition, high-net-worth investors frequently have very concentrated single-stock positions that require complex financial-engineering solutions. All too often, however, the unique needs of wealthier clients are ignored. Our research shows, for example, that when profitability in a typical wealth-management business is examined on a fully costed basis, 20 percent of customers drive 120 percent of the profit, whereas more than 20 percent of customers destroy value. (See Exhibit 1.) What is required to address this imbalance is a customized approach that matches service levels and costs to clients. It should steer clients who don t meet minimum asset levels to appropriate but less expensive customer-service models and suitably packaged products. For instance, the needs of high-networth and mass-affluent investors can be met in different ways: rich investors can afford and benefit from innovative hedge products and other alternative investments, whereas mass-affluent investors may be better off in principal-protected investments. Going for the Gold Farsighted wealth managers are breaking from tradition and capitalizing on current circumstances to prosper in today s challenging markets. They are differentiating their services and products more aggressively and segmenting their offerings to meet their clients needs more directly. At Merrill Lynch, for example, the Family Office Group serves investors with assets of $100 million or more. Private Wealth Services caters to those with assets of between $10 million and $100 million,

6 Exhibit 1. A Few Investors Generate Most Wealth-Management Revenues and Profits Percentage of revenues The 80/20 rule applies to revenues 40 80% of revenues Customer decile Percentage of profits The 120/20 rule applies to profits 120% of pretax profits Customer decile SOURCE: BCG wealth-management database.

7 whereas the Wealth Management Group serves clients with holdings of more than $1 million. Financial institutions find it tricky to graduate customers from one service level to the next. To tackle that challenge, one North American bank recently installed a tracking model that identifies clients whose assets don t match their service category. A manager then intervenes and moves the client to the appropriate level of service. Although some wealth managers may shy away from that kind of interventionist behavior, such actions can ensure that clearly defined service models are linked to the asset levels and needs of investors. Managing Clients More Effectively Once wealth managers have designed a method for selectively targeting and attracting clients, the challenge is to retain those clients while selling them a broader array of financial products. Here it is important to note two points: Customer retention drives private-banking profitability. It generally takes years for an institution to recover its customer acquisition costs. On average, it costs much less to retain an existing customer than to acquire a new one. This fact provides a big incentive for private banks to keep their best customers happy. As wealth managers increasingly eye one another s clients, smart managers increase their share of wallet and maximize the profitability of existing customers. One way to do that is to create incentives that lead clients to invest in products that build long-term relationships products such as trusts, loans, and retirement plans. To that end, best-practice players focus on life events such as marriage, the birth of a child, or the death of a parent, which will change a client s

8 needs and circumstances and make him or her receptive to new approaches and products. A second technique for improving customer retention and profitability is cross-selling. According to our research, the typical wealth manager s cross-selling rates are 1.2 to 2.5 products per client. But best-practice players are achieving rates of 4 products per client by collocating experts, building teams, and running well-organized referral processes. Internal referrals are an underutilized source of new clients and can be a quick way to improve profitability. In many cases, wealth management businesses are part of much larger financial institutions and therefore have ready access to referrals from an existing captive customer base. Yet few institutions have systems in place to exploit this potential. The good news is that active internal referral systems can be implemented fairly quickly. Financial institutions should not be afraid to cannibalize their existing businesses. Retail banks, for example, can identify existing customers who qualify as private-banking customers and then transfer them to the private-banking division, thereby uncovering hidden gems in the customer base. It is important to design financial and organizational incentives to encourage such transfers. Pricing for Increased Profitability In today s challenging climate, clients are eager to find sound advice and willing to pay for it. Now is a good time for wealth managers to ensure that their advice is priced appropriately and covers its costs. Traditional commission revenues are highly cyclical and are under intense pressure from the decline in traded volumes. Many wealth managers are therefore moving to asset-based pricing to offset falling commis-

9 sion revenues. Such pricing better aligns the interests of the client and the manager and ultimately strengthens business. Still, commissions do generate more profits when volumes are strong, and some customers prefer to pay only when they transact. Our experience with clients suggests that there is tremendous value in building a disciplined approach to both transactional and fee-based pricing. If relationship managers or private bankers have too much autonomy in setting prices, customers often pay fees that are too low for the business under management. There is enormous deviation from standard pricing in typical wealth-management businesses where relationship managers have autonomy to negotiate prices with clients. (See Exhibit 2.) Simple tactics, like reducing Exhibit 2. Fees Are Randomly Scattered Across Accounts of Different Sizes Fees High Low Low SOURCE: BCG analysis. High Assets

10 the size of discounts, can have an almost immediate, positive impact on profitability. Controlling Costs As equity markets slow, managing costs is becoming more and more important to maintaining and increasing profitability in wealth management and private banking. Leading players are increasingly looking for ways to reduce their cost to serve without compromising service levels. Before costs can be eliminated, however, it is vital that institutions have a clear and complete understanding of their cost structures. A centralized investment strategy, for example, can reduce costs by eliminating the need for relationship managers to do their own research. In our experience, such a strategy not only lowers costs but also results in higher risk-adjusted returns. In addition, the back office provides opportunities to reduce costs. Several Swiss private banks, for instance, have merged their back-office operations while maintaining their distinct customer interface. This approach allows the banks to generate cost savings and focus more on relationship management. * * * Private banks and wealth management institutions have to make strategic choices as they face today s challenging investment markets. Approaches that were profitable during the bull market of the 1990s no longer generate acceptable profits. Improving profitability today requires rigorously adhering to minimum asset levels and aligning service levels with target customer segments. This approach needs to be supported by actively managing clients through

11 increased cross-selling and internal referrals. More disciplined pricing and careful cost management can also significantly improve profitability. When the markets rebound, those who have managed these issues well will realize the value of the hidden treasure in their wealth-management businesses. John Rolander Christian de Juniac Andrew Dyer John Rolander is a vice president in the New York office of The Boston Consulting Group. Christian de Juniac is a senior vice president in the firm s London office. Andrew Dyer is a vice president in BCG s Sydney office. You may contact the authors by at: rolander.john@bcg.com de.juniac.christian@bcg.com dyer.andrew@bcg.com The Boston Consulting Group, Inc All rights reserved.

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