The times they are a-changin’
The industry is evolving and savvy operators need to ride the waves of change to maximise the value of their business
The Market is currently in a state of constant flux. There have been significant changes over recent years and there have been winners and losers across the industry spectrum, with many lessons learnt. And it is these lessons that I have been asked to shine a spot light on.
At a recent presentation I attended in Phnom Penh two speakers spoke directly to this point of change. Firstly, Luke Fitzgerald from Mercer looked at all industry participants and profiled those industries that were experiencing significant changes now and had to adapt. There were very few market participants immune to the winds of change and that did not have immediate challenges to their business models.
As a financial planner from 1987 and subsequently a fund manager and professional service business owner, I have seen the evolution of industry business models in the ’80s to late ’90s to accommodate retail investment and superannuation products.
We entered into more personalised service delivery in the ’90s, which was enabled with the development of first generation masterfunds which further developed into second generation wraps and we now have the third generation of individually managed accounts and managed discretionary accounts.
Manufacturers or fund managers are being challenged by their failure to outperform market indexes, which has disenfranchised advisers and consumers. This is exacerbated by the many product failures and a heightened risk assessment of boutique or structured product offerings.
Fund managers have seen the creation of alternative products with lower fees – index funds, exchange traded funds etc as well as a diminishing distribution marketplace with increased institutional ownership.
Dealer groups are challenged by FOFA legislation and the inability to earn volume overrides on new business invested post July 2013 and legislative uncertainty in regards to vertical integration. Dealer values have fallen with a higher risk assessment given recent collapses and rising enforceable undertakings. Retail super funds offered by banks have seen their market share diminish in favour of industry funds, which in turn have seen their retention of funds under management challenged by the rise of the SMSF phenomenon.
Michael Drage of consultancy Nakodo, at the same Cambodian conference, showcased recent APRA statistics which showed the inflow and outflow of sector superfunds (see graph below). Professional service businesses, especially accountants specialising in SMSF, are being challenged by financial planners, low choice administration, legislative and industry specialisation requirements and low cost audit providers.
This is what was seen by stockbrokers, who were once able to charge one per cent full service with specialist research and access to initial public offerings. This business model has not only been attacked but the battle is now all but over; the winners being low-cost online services such as Commsec and E*Trade. Business models supported solely by transactional activity collapsed during and post GFC due to the rise of consumer knowledge and competitive pressure.
Super Sector Flows
The speed of development was so great over the last seven years that it was inevitable that government intervention would be needed as we saw perversions of growth and large scale product failures when the GFC tested the efficacy of the industry across all sectors.
The current battlefields are being fought in a number of areas. Price compression is being enabled by technology and we are seeing administration, audit and product managers struggling to maintain their status quo, as services are offered as commodity items with little perceived differentiation from low cost providers to high.
Advice businesses have not only had to evolve due to product and platform development but also rising consumerism. Their client’s needs are changing and their method of introduction and retention is changing with the rise of social media and calculator websites.
Mr Drage further illustrated the point showcasing recent Deloitte research which indicated that Gen X and Gen Y will hold 84 per cent of all super assets by 2030. Fifty per cent of Gen Y prefer set fee or hourly fee advice fees and 39 per cent of Gen X share the same preference. The current industry accepted practice of percentage of FUM is, and will continue to be, challenged. However the scariest thing from my perspective is the possible impact on practice values.
Mr Drage picked up this theme using IBISWorld research nominating the wealth management industry as having lost 2.5 per cent per annum revenue over the last five years, if you include the consumer price index over that period the average loss was 5.5 per cent per annum. If your business was generating $100,000 profit in 2007 and if your margins had remained the same your real profit is $75,000. IBISWorld expectper annum growth rates of 4.3 per cent per annum 2013 to 2018. If you deduct the current inflation rate of 1.3 per cent you are looking at real growth of three per cent. This is positive, but what is really alarming is potential future practice values.
|Year||Profit||Recurring Revenue||Multiple||Practice Value|
|2007||$100,000||$400,000||3.3 x RR||$1,320,000|
|2014||$100,000||$400,000||3 x RR||$1,200,000|
|2018||$100,000||$400,000||5 x EBIT||$500,000|
The first question is why we would change from the traditionally accepted recurring revenue valuation methodology to earnings before interest and tax for valuing financial planning businesses? The answer is multiple influences will precipitate this move as there will be significantly less fat in profit margins dueto lower administration and fund managermanagement expense ratio. If margins fall to accounting type levels and fees are charged hourly we could see even further falls in practice values. It is expected that 1.4 million small and medium enterprises in Australia will seek to sell in the next 10 years. This baby boomer trend will also impact supply in financial services and if demand stays constant with supply increasing we will see the price equilibrium move downwards.
The key lessons in this trend are, if you are thinking of maintaining the status quo, you have already lost and if you are thinking of going, go now. If you are looking to stay, you need to grow revenue and profitability with practice management improvements.