REPRINTED WITH PERMISSION FROM OCTOBER 4, 2014
This week Schwab made a cryptic press release that reminded me of the days of vaporware with Microsoft. In the old days, Microsoft’s pattern was to announce a “new” product offering, and then use that to establish a dominant market position. Other earlier market entrants would then soon die on the vine.
This week, Schwab announced that it is now going to be a robo-advisor. For those astute at PR, you’ll notice the pre-releases defining it as a robo-broker, not robo-advisor. Already, Schwab is trying to define and control the semantics and narrative.
To help our analysis, I think it is easiest to look at this from the vantage point of a long-short hedge fund analyst. We have two sets of “tickers”. On the one hand, we have Schwab and Vanguard. On the other hand, we have the new entrants of robo-advisors (“robos”), such as Wealthfront, Betterment, Personal Capital, etc. If we analyze Schwab against its peer group of robos, and assume they were all public tickers, which names would you go long and offset with an equal short? Would you be outright shorting the robos and going long Schwab/Vanguard now? That paradigm of analysis lends itself to one drawing a fairly easy set of next steps/outcomes.
Five points to consider as you set up your trade would be as follows:
Number 1. Schwab chose to do it internally vs. partnering.
Schwab is not an organization to make cavalier or light decisions. They move into a new space with a tremendous amount of forethought and analysis. Several of the robos have introduced business models to sell direct to RIAs via a private label option, so Schwab would have been an absolutely ideal enterprise customer (I have seen these PowerPoint decks). Yet, Schwab moved in the exact opposite direction. Rather than buy it, they chose to build it.
The fact that Schwab had the option to partner/license, and decided against it, is about a clear indication as any with regards to the systemic risk they considered as well as the risk to their brand of using an outside partner.
Historically, Schwab has integrated with partners it considered accretive and of benefit to its captive universe of advisors. They would not be opposed to integrating a vendor (TD does the same with Veo), and yet Schwab chose to not integrate. This decision alone shuts the door on any enterprise aspirations for the robos via a custodian, and it would be safe to assume that the other large custodians would follow.
It is our opinion that the direct to consumer model that the robos represented was rationale enough for Schwab to decide to go internally. Of note, when looking at the capital dedicated by the robos to build their platforms, it is fascinating to see how quickly Schwab came to market. Either a) it was a relatively affordable option to build it and/or b) they licensed software from another software provider with an air-tight service level contract.
Number 2. Schwab can price at FREE for a very, very long time.
This economic point alone should send a tremor through the robo space. Schwab’s offering of commission FREE ETFs already revolutionized an industry. Couple that alongside a FREE robo advisor and you have a very compelling value proposition. In light of FREE, and a comparable service offering, why would the consumer choose the existing robo-advisor relative to Schwab?
Schwab could subsidize this business for a very long time and their access to the capital markets alone is a competitive advantage relative to the robos. Ironically, some of the robos have decided to use Schwab’s ETFs as apart of the product mix. At what point does the consumer see this for what it is as well?
We believe that Schwab could obliterate the robo industry with one pricing decision (FREE) and one good ad campaign directed straight to the consumer.
Number 3. Is it now just Schwab and Vanguard?
It is interesting to see how market participants stack against one another.
Vanguard’s business in this exact same arena has been quietly building, and they too followed Schwab approach: do it solo. Neither company is positioning their advertising as an alternative to the existing robos. Why? In comparison to Schwab and Vanguard, the existing robos have virtually no consumer brand recognition. However, the robos are recognized in the advisor community, but as a competitive threat, not as synergistic to the advisor’s business. Therefore, the robos have successfully positioned the advisor community against them, not aligned with them. The advisor community alone could have been 1.6 million VARs (value added resellers) for the robos, but the robos chose against this option.
This begs the question, is this where the robo focus should have been from the start: enterprise sales?
Schwab and Vanguard do not need to define their advertising spend against the peer group of robos because, to them, there is no peer group for them to be concerned about. Schwab and Vanguard can message on price and value, which is a natural extension of their existing brands.
Consider this using the analogy of a Superbowl ad. If we gave all of the market participants a $5 million Super Bowl ad budget, who would succeed? Barring a clever sock puppet ad, the new entrants have no strong value proposition to sell to the consumer.
Conversely, Chuck Schwab is already a national brand, and all he needs to do is “offer his help” to Boomers nationwide for FREE.
Number 4. Is the robo play really an IPO play?
Looking at the numbers with regards to user adoption, we would argue “no”.
There is no social, or viral millennial effect occurring, and the robos are not engendering the millennial adoption the way that a typical “app” would witness.
Number 5. Is the technology proprietary?
If so, why are there so many market entrants?
The answer is that the technology is not unique, as it has been around for a while. The companies benefiting are the data aggregators, whose tech is in the background at most of the robos (Yodlee and ByAllAccounts). This is the classic “picks and shovels” approach we all saw in the dot-com boom/bust. Hence Morningstar's acquisition of ByAllAccounts for $28 million.
As evidenced by Schwab’s entrance, there are no barriers to entry, and the robos are not a technology play.
Only one person is benefiting from the entrance of the robos: the consumer.
Wealth management fees have now begun an unmistakable and irreversible trend down. That will continue for some time and the industry’s margins will never be the same.
Traditional advisors will be forced to consolidate into large firms and the robos will, inevitably, have to do the same. The implications for succession planning are strangely reminiscent of the dental industry…practitioners will be working longer as they try and find a way to sell their firms to a younger advisor.
Near term, given the VC capital already invested, we expect additional follow-on investments in the robos wherein the use of proceeds will be dedicated to marketing and branding. Look for more robo CEOs to be on CNBC advocating the value to consumers as a sign of this movement.
The other custodians will inevitably follow Schwab and Vanguard. The tech is easy to build, and they already have the branding in place. For them this is an easy accretive product addition to their existing infrastructure. For the custodians, the VC community just conducted a $200+ million of due diligence to help them validate whether or not they should enter the market themselves…but cheaper.
What can the robo-advisors do to survive now? Advertise. Advertise large. They need to create large national brands recognized by the consumer. Their reliance to-date with on-line advertising was sufficient, but it was not enough to create a defendable beachhead position with a well-known brand.
Lastly, the implications for the financial planning software companies is substantial. Here we may witness the most significant shift.
If the custodians offer a robo platform, firms like eMoney, MoneyguidePro, Naviplan, etc. will be hard pressed to define a value proposition to advisors. Their pricing is the first Achilles heel. These software providers may reposition themselves as enterprise partners to the custodians, but will be hard pressed to innovate given their legacy system’s infrastructure. If Schwab is at FREE, that is a tough number to match and compete against.
Finally, to return to our long-short analogy, we would recommend going long Schwab/Vanguard and shorting the robos. Watch the size of the Series C rounds and that will tell you who/how to determine and order your short list.