Charles Schwab Corp. announced recently that it would eliminate trading commissions for retail investors, making Schwab the latest Wall Street broker to embrace the push to zero commissions.
But with $3.75 trillion in assets, Schwab is in a position to make such an aggressive move. Like other larger retail e-brokers, Schwab is capitalizing on its scale advantage, one that allows it to attract new client assets to its platform and strengthen its market share. But even as it slashes trading fees to zero, Schwab generates income in different ways: sweeping cash-balance deposits into investments that return almost nothing to customers, and by upselling customers into other, fee-generating services like wealth management.
Sounds simple, right? Not quite.
Today’s digital economy requires that firms like Schwab offer unique client experiences with both online and in-store capabilities and leverage the data accumulated by managing trillions of dollars of assets through value-creating insights. Professional services, especially, have become commoditized, leaving the upper hand to the large firms that achieve scale and simultaneously create a differentiated experience. The asset management industry, in particular, is experiencing steady declines in trading fees and advisory fees and is pushing for a winner-takes-all market. That is where one develops a disproportionately larger share of the market while earning marginalized revenues with only a slighted differentiated product or service.
Middle-market advisers have yet to catch on. They don’t always possess the same financial or people resources to compete at this scale, but must seek ways of reducing fees to remain competitive. What is especially concerning is that middle-market firms are not making the capital expenditures needed to compete. According to the RSM Middle Market Business Index from the second quarter, capex spending slowed amid a tight labor market, with only 39 percent of companies noting an increase in spending. What‘s more is that productivity-enhancing investment is being directed at basic efficiencies rather than around the necessary substitution of technology that larger firms are implementing.
According to Bloomberg, middle-market asset managers — defined as those managing assets of $250 million to $750 million — are charging 1.69 percent. By contrast, firms managing more than $5 billion in assets charge only 1.51 percent. These numbers are likely to go down before they go up. The long-term sustainability of advisory is at question if managers don’t adapt quickly and create a marginalized fee model. The tactics being used today simply won’t work in the new digital economy.