How to Compete with Online Advice: The Historical Lessons

Lesson Two: Ultimately, online advice will play an important role

Over the longer term, advisors should be cautious about dismissing technology-based advice. In his seminal Harvard Business Review article Marketing Myopia, first published in 1960, Harvard professor Ted Levitt explored how the railroad and movie industries, dominant at the time, dismissed automobiles and television as competitive threats when they first arrived on the scene. What rational person, they asked, would give up the comfort of established offerings for unproven new alternatives?

When faced with an untraditional competitor that offers an inferior product at a lower price, the first response is often dismissive. There’s a long history of established incumbents underestimating upstart entrants with stripped-down solutions:

• The legacy airlines initially scoffed at discount carriers like Peoples Express, but the failed experiments by these early innovators laid the foundation for Southwest Airlines and JetBlue in the U.S. and European discounters like Ryan Air, which changed the rules of the game for incumbents.

• At a time when IBM had overwhelming global dominance in the 1970s, it wrote off the small firms marketing personal computers.

• When Japanese imports entered the U.S. with a focus on low-priced cars, the big three automakers laughed at the thought that a country known for producing cheap transistor radios could pose a threat.

The financial industry isn’t immune from underestimating new price-based competitors – look no further than the yawns in the 1970s when Charles Schwab launched the first discount broker and when John Bogle launched index funds at Vanguard.

The real threat to advisors doesn’t lie in robo-advisors’ potential to steal clients by providing lower costs and promising better outcomes through disciplined diversification, regular rebalancing and automatic tax harvesting. In the short term, the risk of defection to online advisors by existing clients is generally quite low. Instead, the true impact on traditional advice will come in two other areas.

First will come downward pressure on fees. Some investors will read that online advisors charge 25 or 50 basis points and question the fees they’re paying. After all, everyone wants to feel that they’re getting good value – and even those with no intention of moving will look to reduce their costs. This was the experience with the aggressive cost cutting by discount brokers in the 1990s and 2000s, as some clients used the pricing by these firms as a frame of reference to renegotiate their fees. And this has been the experience in the real estate industry since self-help options were launched. Even people with no intention of selling their houses on their own have used the do-it-yourself cost to frame discussions on real-estate commissions – leading to broad downward pressure on real-estate commissions.

But perhaps the biggest change will be the image of traditional advice among the next generation of investors. Not that long ago, investors talked with pride about working with firms like Merrill Lynch, but with all the negative headlines and regulatory scrutiny of the investment industry, that perception of many traditional advice providers has been eroded.

Image and branding matters — we should not underestimate the “brand as badge” factor. The brands that people use make a statement about who they are. Apple is an obvious example of this, in which its appeal transcends its actual functionality and value. Auto brands like BMW, Lexus and Mercedes Benz are another example of this phenomenon. Today, this is one of the big challenges for the American auto industry — it has made huge strides in improving quality and its cars are competitive, but it still suffers from its image among many affluent and younger Americans of being outdated and un-cool. A warning sign for traditional advisors are initiatives like the one by Google to offer online advice as a company benefit, potentially positioning online advice as a superior option for younger, smarter, more discerning investors.

Lesson Three: What can be commoditized will be commoditized

Anyone dismissing these new online competitors ignores the first rule of the internet – what can be commoditized will be commoditized.

The travel industry has seen the decimation of traditional travel agents that dealt with the average American. Today, most consumers look to save money by making travel arrangements online. A key catalyst here was the decision by airlines and hotels to strip out the embedded commissions for travel agents, forcing agents to add a commission. Travel agents now have to add clear value to stay in business. One solution by some travel agents was to switch their focus to the corporate market, where it’s easier to demonstrate value by documenting savings on travel.

Another example of commoditization is how Amazon has disrupted the business models of traditional retailers, starting with bookstores and broadening from there. There are still some traditional bookstores that are doing well – but only those with a distinct market niche that have built a strong customer following.

The backers who’ve invested hundreds of millions in online advisors are counting on a similar pattern. And based on the track record of the founders and investors in these online offerings, they should not be underestimated. Here are some of the principals in leading robo-advisors:

How advisors can compete

Based on historical precedent, there are two strategies that advisors can employ to blunt the threat from online advice. The first winning strategy is to incorporate the best features of online advice into your own offering, no different than the moves by traditional retailers to integrate online retailing into their strategy. For example, Walmart’s online offering in the second quarter grew faster than Amazon’s.

We’ve already seen initiatives by some of the robo-advice firms to market their platforms to financial advisors. An article in Advisor Perspectives discussed how successful advisors will incorporate the key elements of online advice into their own offerings – things like more transparency on fees, clearer benchmarking of performance and integrating online tools into how advisors communicate with clients.

The second strategy is to focus your efforts in areas that don’t lend themselves to commoditization. A recent article outlined how professions such as medicine, law and accounting are seeing their work divided into two elements. The first element consists of things that can be easily automated – these are increasingly outsourced and produced at the lowest possible cost. The second element is things that rely on human judgment – and it’s here where professionals need to focus.

The last 20 years has seen a push by advisors to automate and standardize how they operate. And while operating efficiently will continue to be important, the big push going forward will be to personalize the advice and experience that clients receive, in a way that online advice cannot. Here are some examples of how advisors can provide personalized, customized advice that can’t be replicated by online robo-advisors:

There are two big traps when it comes to assessing new competitors. The first is to panic and overreact. The second and more serious is to be dismissive and underreact.

As you look at the new generation of online advisors, your response may be that they only appeal to kids in their 20s who have no money and aren’t material to your clients. While that may be true in the near term, history suggests that over time, new entrants will evolve and broaden their appeal to threaten incumbents.

It doesn’t have to be that way, however. If you’re proactive in expanding the value offering that you provide clients and have a laser focus on the areas in which commoditized players will have difficulty competing, the new generation of online players may be as much boon as threat to your business.

Dan Richards conducts programs to help advisors gain and retain clients and is an award winning faculty member in the MBA program at the University of Toronto. To see more of his written commentaries, go to www.danrichards.com or here for his videos.

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