May 21, 2015

Is wealth moving to the freemium model?

Price is just one of marketing’s four Ps, but a critical one for obvious reasons. Among other things, price determines how much can be paid for distribution, it affects perceptions of quality and – clearly – has a big impact on profitability.

So what happens when a competitor starts offering a product very similar to yours… for free?

There are a couple of examples where that has occurred in wealth – the most prominent local one being ING Direct’s Living Super which we covered in an earlier Trialogue. It’s famous for being free – or appearing to be free. The default option (the free one) is invested 50% in cash which, obviously, has no fee attached to it. Of course, being a bank, ING makes a margin on the cash that can more than compensate for the lack of explicit fees on the portfolio.

Once a member of the fund, it’s pretty easy to change investment options from the basic offering (to one with higher allocations to growth assets, but with a fee) and purchase add-ons such as share broking. This is the freemium model at work – similar to the ‘in-app purchases’ you see in apps that are otherwise free (except my kids are unlikely to rack up a bill of $100 playing with my super account, unlike my iPhone).

ING has been incredibly successful, from a standing start, leveraging its direct banking brand into super despite not having any physical distribution. As today’s chart shows, FUM growth has been strong, recently cracking the $1b mark, making it the most successful truly direct super product available (most simple super products have generated the majority of flows through bank branches rather than online).


Source: Plan for Life

More recently, ‘free’ has arrived to challenge online broking. Trading costs in Australia don’t get much lower than $15 (most punters pay between $20-30 for a $10k trade). That’s pretty high, certainly much higher than what traders in the US are asked to pay (US$8 with mainstream brokers). So assuming the brokers haven’t been making abnormally high profits, how could this service ever be provided for free?

Robin Hood has answered that question by launching a zero brokerage business model. With shiny new technology providing fully automated STP execution, the marginal cost of each trade is tiny. This allows them to provide low costs to clients – but a presumably large upfront technology spend must make it challenging to offer their product for free.

Refreshingly, Robin Hood is completely transparent about their business model, being upfront with customers that it cross-subsidises the broking service by making a margin on any cash balances they hold, as well as any margin loans these customers take out. At its heart, this is the same idea as ING Direct Living Super, although they are perhaps more up front about it.

It remains to be seen whether this is a sustainable business model, particularly as margins on cash aren’t what they used to be. But following a recent second round capital raising, Robin Hood has announced it will launch with a free brokerage offer here (on US stocks, ADRs and ETFs).

So who is exposed to such a disruptive move? We think nearly all wealth firms are at risk here because of the opportunity to provide one service for free whilst making a margin elsewhere in the value chain. While this is not that different from the vertically integrated models, except there nothing is currently provided for free, there is a specific learning here that – for some customers at least – they are prepared to sacrifice margins on their cash balances in order to gain free services on other products or services.

Could platforms make money at 0bps? Beyond cash, there are a variety of options, including in asset management and life insurance. This assumes new technology and a new low-cost operating model (as Robin Hood shows, you don’t need all the bells and whistles if it’s free).

Could asset managers make money at 0bps? Sure – perhaps through securities lending, algorithmic advice, or a profit margin on cash balances. Or, more realistically, Macquarie is selling asset management for nothing to institutions already with their True Index range.

And what about advice? It’s half the value chain by revenues – could it really be provided for free? Perhaps, but it would have to be a much slicker operation than it is currently. And you would, of course, have to funnel customer funds into internal platforms and asset management products (which, it seems, is getting more difficult by the day).

There are some important pointers to consumer behaviour here. Even though they may be no better off in overall terms, there is a segment of consumers that like the idea of getting something for free in their left hand, and are prepared to fund that by having less in their right hand.

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