The Changing Face of Robo-Advisors
“You must always be able to predict what’s next and then have the flexibility to evolve.” Mark Benioff, Founder & CEO, Salesforce.com
The success of many firms that are now household names was not guaranteed. As Salesforce.com founder says, they had to be flexible and continuously innovate to adapt to their changing market, new competitors and evolving customer base.
Paypal started out selling cryptography software before evolving into the peer-to-peer payment juggernaut they are today. Google thought they could make money selling pre-packaged search software until they developed AdWords in 2003 that now brings in over $60 billion in advertising revenue from across the globe. Even Salesforce.com, which never wavered from their software-as-a-service model, now generates 40% of their revenue from non-CRM software.
WealthFront has pivoted their business model towards greener pastures a few times already. They started out as a Facebook investment game call Ka-ching, then morphed into a kind of crowd-sourced investment manager, then finally switched to the robo-advisor format when that looked more promising.
They seem to have found their niche as they recently passed $1 billion in AUM, which puts them in the top five robo firms.
However, other robo-advisors will also need to adapt their business models if they are to survive the coming industry shakeout.
Market Pressures Force Innovation
We are witnessing this same fast-paced evolution in the online financial advice market. The first wave of robo-advisors once had the market all to themselves but now are at risk of being swallowed by a wave of new competitors, both large and small.
Even the term robo-advisors has become antiquated as their business models change and adapt like chameleons placed on different colored backgrounds.
Betterment launched an institutional product to become an outsourcer for traditional advisors who want an online presence. WealthFront is selling a direct-indexing service that builds client portfolios from an 80/20 mix of individual equities and ETFs to replicate a total stock market index with tax-loss harvesting opportunities.
Personal Capital claims they never were a robo-advisor at all. CEO Bill Harris refers to the company as a “digital wealth management firm”, since they use a combination of automated portfolio management with a light touch from a pool of young advisors who clients can contact if they want someone to hold their hand in case of market turbulence.
So what does this mean for the future of these digitally-enhanced, mechanically-automated, primarily online and sometimes partially human-powered advisory firms?
Where’s the Profit?
Profitability will need to arrive sooner than expected. VC-backed robo firms will find their AUM growth is slower than planned due to the rush of new entrants into the space.
The initial business model of most robo-advisors could be summed up in three words; volume, volume, volume. They believed that charging lower fees would help them attract enough clients and assets to become a dominant player.
Unfortunately, the financial advice business is not the same as social media, hailing taxis or texting. Venture Capital (VC) firms that had visions of home run success a la Facebook, Uber or WhatsApp will begin to beat up their respective robo management to find new ways to generate revenue beyond AUM fees.
Would You Like Fries With That?
Once all of the low-hanging fruit has been picked, the cost of every new client conversion will start creeping up. Selling new services to your existing base is a cost-efficient way to generate additional revenue.
The upselling strategy has been accepted by Personal Capital, the San Francisco-based digital wealth management firm run, who launched a new program that offers clients access to financial planning services for an additional 30 basis points.
Founded by CEO Bill Harris, of PayPal and Quicken fame, Personal Capital recently passed the $700 million asset level, making them one of the big four robo firms. Their management fee of 0.95% of assets makes them the priciest online advisor in the market. Add another 0.30% and you might as well just use a traditional advisor.
Robo firms like SigFig.com take upselling to another level. Their basic investment advice is free. They make money by recommending you to their partners, who are brokerage firms and traditional investment advisors.
SigFig does not even offer data aggregation functionality, which is standard for most robo firms. They only support pulling data from other brokerage firms. Also, their website provides no information or functionality without opening a brokerage account. I think prospective clients prefer to see some of what you are offering before taking that step.
I’m not sure how these guys will survive.
What Does The Future Hold?
The CEO of WealthFront, Adam Nash, believes that robo-advisors will revolution investment management in the same way that self-directed trading destroyed the commissioned broker model. If that is a valid comparison, then it is inevitable that many of the robo firms that have piled into the market will fail. Those that remain will be the ones that were able to adapt and change in order to survive.
While I cannot predict what will come next, it will be exciting to see how robo-advisors evolve and what their market looks like at the end of 2015.