An Incredible Opportunity

One of the most significant, but largely unnoticed changes occurring in the wealth management industry right now is that its most-widely used custodian, Charles Schwab, is in the early stages of creating an owner-operator model for some of its branches. Although it still has about 300 of its traditional, company-owned and managed locations, over the last three years it has also launched 24 owner-operated franchisee-owned branches.

While this might seem a bit counterintuitive (and no one would ever accuse us of being cheerleaders for any custodian, including Schwab), we think that, for the right person, getting one of these franchises is an incredible opportunity to make a lot of money without taking a tremendous amount of risk.

Why? Because the wealth management industry is on the verge of a seismic shift in what it costs to capture new clients, and this shift is going to make owning a Schwab branch very attractive.

Consider for a moment where the industry has come from: Twenty years ago, marketing in the wealth management industry was analogous to going fishing and waiting for the fish to jump into the boat. American workers were no longer provided pensions and were expected to fund their own retirements through 401(k)s. An entire generation of people suddenly realized that they needed comprehensive, holistic advice to manage their wealth, or in retirement they might wind up living in a cardboard box under an overpass. Consequently, many more prospective clients were trying to find financial advisors than the good firms had capacity to accept.

Demand for advice continued to grow during the following decade up until the 2008-2009 crash. Although many larger wealth managers began to emerge, the capacity that advisors had available to accept new clients was still exceeded by the number of them looking for advice. Thus, most firms did not have to spend very much on marketing.

However, if one looks at the industry’s current macro data, it is clear that this supply/demand imbalance is close to correcting itself. Billion-dollar firms are now commonplace and the relative rate of new client growth is much slower than it was only a decade ago. And while there will continue to be large numbers of new prospective clients, the demand for them will soon exceed their supply.

When a supply/demand imbalance corrects itself in any industry, it causes its economics to change significantly and quickly. This, too, will be the case in the wealth management industry. The costs of marketing and distribution will jump; in fact, in the not-too-distant future they will be most firms’ largest operating cost.

Now back to buying a branch: Schwab has been able for many years to attract extraordinarily large volumes of prospective clients to its branches. Although it initially created the branch network to attract retail customers who wanted to invest their money on their own, it soon figured out that many of these new clients wanted the kind of holistic, sophisticated advice that only independent fee-only advisors could provide. So it created a program in which it refers out thousands of them every year to independent firms, in exchange for agreeing to custody the assets at Schwab and a referral fee equal to the greater of 0.25% of assets or 25% of client revenue.

However, now that the industry’s new client supply/demand imbalance has been corrected, there will soon be significantly more competition for new clients. This competition will invariably make many wealth managers much more willing to pay more—in fact, a lot more—for referrals. Moreover, custodial branches will soon find that (savvy) wealth managers will soon volunteer to do whatever is necessary—sponsor branch client events, help fund local ad campaigns, underwrite branch employee training, etc.—so as to become a “preferred” firm for referrals. All of these steps will help branches grow faster while lowering their costs.

Thus, it appears that Schwab is now offering prospective franchisees the opportunity to own a branch right at the very point that owning one is about to become much more economically attractive. An obvious question is, given this shift, why Schwab would do this.

Our guess is that Schwab has concluded it has two core competencies—technology and branding—and like any successful organization, it wants to focus its energies on what it does best. And creating and managing hundreds of more retail branches is not going to move the needle when it comes to creating shareholder value.