In today’s dog-eat-dog world, there are a few two-word phrases that strike terror into the hearts of most business people. One is “tax audit”; close behind that is “price competition.”

Unless you’re a low-cost producer with megafactories in the Far East or a low-cost seller such as Wal-Mart Stores Inc. or Costco Wholesale Club Canada Ltd., few things will decimate a business’s bottom line more quickly than untrammelled price competition.

Historically, price competition focused on the manufacturing and retailing of products, in which economies of scale allowed players to build market share by cutting prices. Increasingly, however, it is creeping into the realm of services that don’t lend themselves to economies of scale and that historically have been immune to the ravages of price competition.

A recent conversation with a tax partner at one of the major accounting firms demonstrates this point. An American citizen, he heads his firm’s Toronto-based practice that completes U.S. income tax returns for American citizens residing in Canada.

In the past, because of the complexity of these returns, accounting firms could charge $5,000 or more to prepare one return. They could justify the fee based on the tax savings realized through the service.

A couple of years ago, one of the major accounting firms launched a new offering. Clients who wanted to save money could enter their data on a secure Web site, and the return was completed by a junior accountant in one of the firm’s offices in India or China. It was reviewed by a partner in Toronto and then delivered to the client — all for $1,500.

What had previously been a profitable business is now under assault.

Some financial advisors may say that while this might affect the accounting firms, price competition hasn’t made a big dent in the financial services business. For example, despite the best efforts of the media, ultra-low-cost options such as exchange-traded funds have not gained broad acceptance in the Canadian retail marketplace.

In fact, one successful and astute advisor told me that the only place in which he really sees price competition is in the brokerage channel, which has experienced pressure from discount brokers on commissions on stock trades. Escaping price competition with the discounters, incidentally, is one reason many investment advisors have shifted their focus to programs for which there is a fixed annual fee, which includes the cost of transactions.

Yet, despite all that, I believe a strong case can be made that price competition has already arrived at the top end of the market and is on its way into the middle market.

Conversations with advisors who focus on high net-worth clients make it clear: investment counsellors are competing for clients with $1 million or more by offering lower prices. Price competition is here in full force.

One advisor who historically has focused on his firm’s managed-money products has encountered increasing resistance to fees above the 1.25%-1.5% range (and, in some cases, the threshold is 1%). In-house wrap programs, which charge more than 2%, are simply not competitive vs investment counsellors. As a result, this advisor has gone back to his stock-picking roots, using his firm’s recommended list as the basis for his stock recommendations — both to achieve differentiation but also to get clients’ costs down to the magic 1% level.

Another advisor describes a conversation with a prospect with assets of more than $5 million, whom he had been assiduously courting for several years. When the advi-sor finally secured a meeting, the prospect showed him a statement from an international financial institution that was currently managing his money for 0.5%.

The prospect indicated that, although he might be willing to pay a bit more for a third party to provide oversight and diversification of managers, the absolute maximum he would consider paying for the advisor’s advice was 0.75%.

Now, we could get into a discussion about whether the client was really paying 0.5% — because his fees probably excluded trading and custody costs. And we could also talk about the risks of style concentration, and the benefits of diversification and objective selection and oversight of managers. That said, from the only point of view that matters — the client’s — he is paying just 0.5%. And that caps the amount he is prepared to consider going forward.

@page_break@Currently, awareness of and focus on cost is generally limited to the top end of the market, and advisors who focus on the mid-market might think themselves immune.

And although it is difficult to foresee the level of price competition for clients with $5 million in assets extending to clients with $50,000 or even $500,000, there is a clear pattern that shows that trends percolate downward, from the top of the market to the mid-market. Awareness of and sensitivity to fees at the top end of the market will inevitably spread.

Imagine this scenario. Your business is largely in mutual funds, focusing on mid-market clients. You open up the newspaper one morning and see an advertisement, or turn on the radio to hear a commercial from a discount broker, offering investors who own mutual funds the opportunity to get a 50% rebate on the trailer fees their advisors are paid. Although personalized advice would not be provided, investors could make use of online financial planning tools, access rigorously researched model portfolios of funds for investors with different time horizons and risk levels, and attend quarterly presentations by fund managers in their cities.

In the weeks and months that follow, other discount brokers match this offering, mounting advertising campaigns inviting clients to move over their mutual fund portfolios. In fact, some offer clients with larger mutual fund portfolios rebates of an even higher percentage of the trailer fees.

For a client who has assets of $100,000 and bought the funds in the mid-1990s, a 50% rebate on trailer fees would translate into additional savings of $500 a year. Clients who were willing to make a five-year commitment to this discount broker would receive a cheque for $2,500, representing all five years of the rebate up front.

You might say this scenario is outlandish — and, perhaps, it is. But keep in mind that investors in the U.S. can avail themselves of exactly this kind of an offer from several leading discount brokers. That opportunity has prompted a significant number of investors to move their funds to discount brokers.

And this is a market in which trailer fees to advisors are generally half what they are in Canada, so the incentive to clients is half of what it would be here.

You might also consider the announcement this spring by one of the major Canadian banks that investors who buy the bank’s funds through its discount brokerage operation can save 0.5% on management fees. With that announcement, we have seen the first major move to give investors the ability to save money by stripping out compensation for the advisor.

Combine the U.S. trend toward trailer fee rebates, aggressive price competition at the high net-worth level and the first moves to give clients the opportunity to save fees at the mid-market level here in Canada and a strong case can be made that it is not a question of if we will see broad-based price competition but when.

When this happens, clients will have to make a decision about the value they believe their advisors bring them. In the scenario of an investor with $100,000 in mutual funds, he or she will have to decide whether the advisor brings $500 a year of value. For a client with assets of $200,000, the decision to work with his or her advisors costs $1,000 a year.

What will follow is the same kind of negotiation about advisor compensation on mutual funds that we currently see on stock trades — in which clients will say they are prepared to pay the advisor the same amount or a small premium to what they would pay if they dealt with a discount broker, but not the full trailer that advisors have historically charged.

With that kind of price pressure, we will see some advisors giving partial rebates on their trailers.

I recently did some research with investors that involved ETFs and other low-cost investment options. While many of those surveyed were familiar with these products, most believed that a good investment advisor or mutual fund manager could add sufficient value to more than offset the higher mutual fund fees.

But when I asked those who owned mutual funds about the possibility of getting half of the trailer fees, the interest level was much higher. Not all gave positive responses, but a significant number expressed real interest. (Also of note was that most were aware that their advisors were getting ongoing compensation on their funds and some knew the specifics of how trailer fees work.)

The difference in the minds of investors who were attracted by the rebate is that they could own the same funds, but at a significant cost savings. The question then became not one of how much value the fund managers were adding, but how much value their advisors were bringing to the party.

For advisors who focus on insurance and consider themselves immune to price competition, a strong case can be made that we will see growing transparency of advisor compensation in insurance. With that will come downward pressure on advisor compensation and the elimination of many of the commission “windfalls” that occur on large cases.

Clients may still take the insurance coverage they are now purchasing, but they will increasingly shop around and negotiate the level of advisor compensation.

This has happened in England and in Australia. It is only a matter of time before we see pressure from Canadian regulators to introduce greater openness in insurance compensation levels. And, with rising awareness will come competition on pricing.

Some advisors will say the scenarios I have painted are alarmist and that price competition of the kind I have described will never come to Canada.

My response is that these advisors may be right.

On the other hand, they may be wrong. And do you want to bet your business on this? IE



THE FIRST IN A THREE-PART SERIES ON PRICE COMPETITION.
NEXT MONTH: HOW TO PREPARE FOR AGGRESSIVE PRICE COMPETITION



Dan Richards, president of Toronto-based Strategic Imperatives Ltd., can be reached at richards@getkeepclients.com. For Dan Richards’ other columns, visit
www.investmentexecutive.com.