Broker services under-priced

Industry watchers say that at many standard brokerages, clients are getting services at a discount, with many brokers charging even less, on average, than what it would cost to transact business at a discount brokerage.

Those studying the issue say there are a number of factors contributing to the problem. For one, business is booming and high volumes in the industry have driven profits, making efficient pricing less of a priority at many firms.

Second, the industry is highly competitive, leading many brokers to gravitate towards lower fees, either by caving outright to client demands for cheaper services. More subtly, some brokers will bundle administration services normally associated with unbundled services, streamlining advice, execution and maintenance of different types of advisory accounts which would usually come with different price structures.

Furthermore, clients are more cost-sensitive about their investments and the formulas used to generate commissions are complicated, with opaque structures that make it very difficult to explain to clients the commission generated by each trade.

Even if brokers were charging commissions that strictly adhered to their firm’s grid, Doug Trott, president of research firm PriceMetrix Inc., says “investor advice is too cheap. It’s too good a deal. And part of it is the reps are doing it to themselves.”

Based on a study of commission schedules from 13 Canadian firms and 20 U.S. brokerage houses, Trott says that brokers, on average, tend to discount their services by 40% with each trade. Roughly 10% of the time they charge even less than what a client would be charged at a discount broker.

Standard commissions, meanwhile, are only 30% higher than they were when the brokerage industry deregulated commissions back in 1975, despite that the average client’s service requirements have become exponentially more complex with the proliferation of portfolio allocation tools, mutual fund wrap accounts, separately managed accounts and structured products.

“We’ve improved the technology reps have, we have training requirements for them and we’ve increased compliance significantly. All of these things are at a cost that’s been extended to improve the integrity and the value of the offer to clients, and yet price hasn’t kept pace with inflation,” he says. “The alternatives that an investor has have broadened substantially, not just in terms of the number of stocks and number of mutual funds available but [also] the structures they can hold them with. That’s good. They benefit the end customer and the reps want to be in a firm that’s got a full suite of products so they can better serve their end client, but it’s too good a deal. The firms and the reps aren’t really getting paid for it.”

He says a large part of the problem is that brokers are still not great at talking about price with clients, setting expectations or reasserting their value proposition. Avoiding the issue, he says, can throw the question of price up in the air with every transaction, giving the client the opportunity to demand discount services time and again, throughout the relationship.

Another problem is that there is no reference price for services in the industry. “Without any reference, it’s hard for the reps to gain confidence that they are actually charging the right amount,” Trott says. “On average they discount 40% off. When was the last time you went into a Mercedes Benz dealership and said can I get that $100,000 car for $60,000? They’re going to tell you you’re in the wrong place.”

Similarly, he points out that no other goods or services providers, with the possible exception of those involved in Persian rug sales, are as consistently willing to barter and discount their services.

To address the reference price issue, PriceMetrix calculates commissions that ought to be generated by 10,000 sample trades at each firm it analyzes, using each firm’s own commission schedules, and then compares that number to what representatives actually charge for the trades.

The average full-price commission for the top firm surveyed — the firm with the greatest aggregate scheduled commission — was $329 per trade. The median price across the 11 full-service firms surveyed was $301, representing a premium over the old TSE schedule, set back in 1975, of just 20%. Even the top firm surveyed had a composite “list” commission just 31% greater than the 1975 TSE schedule. By comparison, the consumer price index has risen 270% since 1975.

Industry watchers, though, say the trend is creeping onto the radar of executives at dealer firms. Ian Russell, president and CEO of the Investment Industry Association of Canada, first raised the issue at the industry association’s annual conference in June during a discussion about efficiency and profitability. He says the unbundling of services in the industry is largely to blame for the problem.

“They’re providing advice to clients on a lot of complex product where the pricing model was probably designed for a simpler world,” he says. “Increasingly the products that are coming out, they could be wrap products, closed end mutual funds, tax specialized products, structured debt products, they all require a lot of time on the part of the broker to discuss with the client. It’s taking a lot of time and the pricing schedules probably do not reflect that kind of advice.”

Trott says several firms are addressing the issue by introducing principle-based pricing that charge straightforward fees based on the size of the trade. Several are also actively seeking advice and consulting to help them develop more efficient price schedules. He says statistics show that client attrition rates are generally not affected when brokers raise or lower their prices.

“You don’t keep clients by discounting and you don’t lose them by raising your price,” he says. “Clients don’t leave for price, they tend to leave because they haven’t had adequate communication with the rep or they’re unhappy with investment performance. We can show statistically that reps that raise their prices and reps that lower them have the same attrition rates.”

His manager of client analytics, Madeleine Cruickshank, agrees. “I think the firms we’ve worked with to introduce new schedules have been tremendously sensitive to the client retention issue. I think a lot of brokers have been surprised at how their clients respond positively to a price that can be easily explained to them.”

Filed by Kate McCaffery Advisor.ca, kate.mccaffery@advisor.rogers.com

(08/08/06)

Kate McCaffery