Executive Summary
As we enter the digital age, technology has been a driving force in putting pressure on many industries, taking any goods or services that could possibly be commoditized and driving their profit margins down to a sliver. In recent years, many have wondered whether financial planning may soon be impacted in a similar manner, especially given how software like TurboTax decimated the profitability of tax preparation services. After all, the commoditization has arguably already begun for some parts of the financial services industry, as costs have plummeted for trade execution and index investing and many software packages offer the ability to perform relatively sophisticated financial planning projections entirely for free.
Yet the reality is that financial planning itself may remain remarkably resistant to commoditization for the foreseeable future, for the simple reason that financial planning is incredibly customized and unique to the needs and complex circumstances of the client, and outcomes can still vary greatly depending on the expertise and the skillset of the planner (unlike tax preparation, where ultimately the outcomes are exactly the same because all clients and their preparers both have to follow the same IRS guidelines). In fact, arguably the greatest challenge in financial planning is not that services are so nearly identical from one planning firm to the next that the only competitive factor is price (as occurs in commoditized markets), but instead that the planning experience is still so different amongst firms that consumers struggle to determine which planner would be the best fit in the first place!
Nonetheless, the caveat is that for advisors who have linked the profitability and success of their businesses to a commoditized service, such as charging a fee just to gather data and do financial planning software projections, or charge an assets-under-management fee just to provide strategic passive asset allocation using index funds, the pressure is on to step up and deliver a greater value. Ironically, in the end that means not only is financial planning not being commoditized in a manner that makes financial planners irrelevant, but the reality may be that it's about to get even more competitive with more financial planners than ever, as an increasing number of advisors realize the components of what they provide have become commoditized and that they must step up to provide a deeper, higher quality of financial planning advice and services for their businesses to survive and thrive!
What Does It Mean To Be Commoditized?
Although it's a term that's often thrown around lightly, the true process of "commoditization" occurs when a particular series of goods become indistinguishable and undifferentiated from one another, such that they are viewed as being perfectly interchangeable with one another. By contrast, goods that have not been commoditized may have several points of distinction, from particular features and benefits to even more ephemeral qualities like brand. This is important because differentiation not only allows businesses to compete based on these qualities, rather than price alone, but also because it allows for a richer and more varied marketplace where there can be multiple companies that survive and thrive, each with their own particular version of the product and each with their own target audience of consumers who buy it.
By contrast, when goods are viewed as entirely undifferentiated and interchangeable, the only way to survive is to compete on price by trying to be less expensive than the competition... if possible. In practice, this can quickly topple businesses, as not every company can drive down its costs of production to provide the good on a cheaper and cheaper basis to undercut the competition. Only the cheapest producer survives in a fully commoditized marketplace. As a result, most goods and services are not completely commoditized, in large part because the businesses that provide them try hard to avoid this outcome, maintaining differentiation by any means possible.
Nonetheless, a great deal of commoditization does exist in many industries. For instance, many types of technology goods have been commoditized; while computer processors may remain competitive because of various processing speeds, more "mundane" parts like keyboards or power supplies or hard drives are often viewed as undifferentiated and interchangeable, where it's easiest to just purchase the cheapest solution. This is similarly true for many other products as well, from auto parts to construction materials to cleaning supplies. And of course, the term is commonly used for a number of financial markets goods that are similarly viewed as interchangeable "commodities" such as gold, silver, orange juice, cocoa beans, heating oil, and more. Notably, the concept of commoditization can apply in the service industries as well; for instance, internet and cable service has been largely commoditized (although the companies try to differentiate themselves with offerings like premium channels), and commoditization has also struck much of the airline industry, and even annual services like tax preparation.
What Is Being Commoditized In Financial Services?
In the broad financial services industry, many parts of the business have become largely commoditized in recent years, as evidenced by the strong downward pressure on prices for certain services. On the plus side, this allows consumers to get many services cheaper than ever; the downside, however, is that it's a very dangerous environment for companies that risk being made irrelevant if they cannot find a way to cut their own prices enough to compete.
For instance, the execution of investment trades has become almost entirely commoditized over the past two decades, driven heavily by the automation of technology and the rise of online brokers like Charles Schwab and E-Trade; as a result, executing a stock trade a few decades ago might have required the services of a bona fide stockbroker and cost $100-$200 or more, while in today's marketplace if can be done using digital tools for no more than 5% - 10% of that cost from a few decades ago... and in some cases, less, or even entirely free!
Similarly, the world of indexing has also been largely commoditized in recent years, a trend that began with Vanguard but has accelerated with the rise of Exchange-Traded Funds (ETFs). As a result, the investment expenses that must be undertaken to gain raw exposure to the markets just continue to fall lower and lower, as consumers simply buy whatever commoditized indexing vehicle is available at the lowest cost - since, by definition, the actual investments in the index would/should be identical.
Of course, the forces of commoditization have been playing out in other industries related to financial services as well. For instance, the rise of companies like TurboTax and H&R Block have drastically cut the pricing for tax return preparation (which posed a significant challenge to many established accounting firms); arguably, though, tax preparation was especially prone to commoditization risk, since the process is dictated by adhered to IRS rules and therefore everyone should ultimately end out with the same tax return results. Similarly, the rise of online services like LegalZoom has begun to put pressure on the cost for basic legal documents of all sorts, which again are typically identical or substantially similar for at least the majority of consumers (until the needs and situation become more complex for a select few).
Is Financial Planning Being Commoditized?
So given this context for what it means to be commoditized and the trends in the overall financial services industry, what is the outlook for financial planning in particular?
Overall, it's difficult to see how financial planning itself is in any danger of being commoditized in the foreseeable future. The primary reason is simply that the nature of customized, personalized and comprehensive financial advice is itself not conducive to being commoditized; to the extent every client's situation is different, and the circumstances for applying advice vary too, it's difficult for commoditization to take hold (although arguably planning firms still have a lot of room for more standardization of process and deliverables). This is quite different than a service like tax preparation, where TurboTax was able to gain momentum both because everyone must go through the process annually, and because ultimately everyone must follow and implement the exact same rules. With financial planning, though, the client needs, services rendered, expertise of the planner provider, and tools for implementation, are all so unique from one client-financial planner interaction to the next, the reality is that getting financial planning services in today's marketplace is actually the antithesis of undifferentiated and interchangeable! In fact, ironically the greater challenge for financial planning may be that the services provided vary so much from one firm to the next that consumers have difficulty identifying a good planner in the first place or knowing what factors to prioritize when making a choice; to say the least, this isn't a marketplace where the only difference from one planner to the next is the price for an identical service and outcome!
Notwithstanding the fact that financial planning itself isn't being commoditized, though, it's important to realize that many other services provided by financial planners or as a part of the financial planning process most definitely are becoming commoditized. For instance, as noted earlier, the execution of trading to the implementation of index portfolios is becoming rapidly commoditized; while few advisors still provide basic stockbroker execution services, this still puts a great deal of pressure on those advisors who provide little more than the implementation of passive, strategic portfolios, which can now be done for almost nothing from a wide range of online providers at an ultra low cost. Similarly, providing basic financial planning projections for retirement or other goals, accounting for a client's net worth and cash flow, or providing information on performance reporting, is also under commoditization pressure from a wide range of online computer- or tablet-based tools that are providing such information at little charge or entirely for free, from the RetireLogix financial planning "app" to the services of Mint.com to the more in-depth reporting options becoming available thanks to a wide range of "account aggregation" tools available for consumers. The end result - to say the least, there's no longer very much value in just gathering information and being able to report it back to clients the way that perhaps there once was.
Nonetheless, this doesn't mean that financial planning itself - the integration of these various points of financial data, client needs and goals, planner wisdom and advice, and subsequent implementation - are being commoditized, even though technology is certainly impacting many of the component parts. To the contrary, the opportunity is that as technology permeates the financial planning world, it will improve the planning experience and augment planners, not replace them, especially since ultimately the value of financial planning is about changing a client's behavior, and as human beings we simply don't feel accountable to change from a computerized commoditized service the way we do to another human being. On the other hand, the pressure is on for those who are masquerading as financial advisors without really providing valuable financial planning advice. If the goal is to get paid for just gathering a client's financial information, providing financial planning projections, executing investments and implementing passive portfolios, etc., the threat of robo-advisors is real, and business will not be sustainable as commoditization decreases the profitability of those services down to nothing.
Yet ironically, in the end the reality is that as we enter the digital age, financial planning is not only not being commoditized in a manner that would make financial planners irrelevant, but the reality may be that it's about to get even more competitive with more financial planners than ever, as an increasing number of advisors realize they must step up to provide a deeper, higher quality of financial planning advice and services for their businesses to survive and thrive.
Since successful financial planning is often about changing client behaviors, that aspect of financial planning will be difficult to commoditize. However, I concur with Michael that some aspects of investment planning are capable of being commoditized.
Too often financial planners tend to forget that it is a very complicated financial world out there. The vast majority of consumers (90% or more) need assistance in some form in navigating this complex world. Hence, the opportunity to add real value, in return for professional-level compensation.
Another good article, Michael!
Being also a CPA who started on the tax side and seen what has happened to a large portion of the tax planning/prep service, I still have strong concerns about how we as planning profession are/will “brand” our value and whether we can find the right combination of fee methods to sustain the holistic models that we know are so important – but may also be dismissed in the long term by consumers who 1) don’t really understand the value and 2) continually pushed by a society mindset that their services should always be either discounted or free. There’s certainly a lot more need for discussion and our own strategizing to get ahead of the curve in this area, and hopefully move outside some of the other “commodity” trends that have taken hold in the past! Thank you Michael for keeping this critical topic in sight.
Good comment Laurie. Here’s a question … if we become a true profession (i.e., endowed by law to regulate our peers), can we then take steps to ensure that consumers – 30% or more of whom currently believe the “financial advice” they receive is “free” – understand that professional advice delivers value?
Interesting scenario, Ron. Perhaps this step would give us an addtional tool or leverage in the proces. However we would need to figure out some more effective approaches to presenting our “value proposition” than has been done with other organizations – for example making greater use of the neuroscience research and other related studies about how individuals actually hear and respond to financial messages (many recent great resources in Michael’s roster here). Communications that have been tried in the past may have seemed “very logical and reasonable” to our industry, but have had little impact in real/practical application unfortunately. I’d love to wake up with a great lightbulb or “ah ha” moment in the middle of the night to share – will keep trying!