[Ed Note: This is the first article in a series.]

Stewart Brand once pointed out that while fast moving trends get most of the attention, slow moving trends have most of the power.

What’s getting most of the attention in the industry now is consolidation. But consolidation has been going on and slowly building momentum over time. It is only now becoming visible because many deals that have been in progress for a long time are finally being completed.

While M&A is getting all the attention, a series of slower moving—but much more powerful—trends are profoundly changing this industry. And within less than a decade, wealth managers are going to have to have very different business models if they are going to continue to flourish. This is the first in a series of articles that will examine these forces and consider what they will mean for industry participants. 

The first of these forces involves adding new clients, since wealth managers are either adding new clients or they are slowly dying. Although existing clients stick around for many years, at some point they begin to consume their capital and the fees they pay decline. Firms that are not adding new clients wind up with economics that resemble depleting oil wells.

Unfortunately for industry participants, adding new clients in the not too distant future is going to get very expensive. Why? There is currently a disconnect between just how valuable new clients are versus the cost of getting them and (if you believe in the efficiency of markets at least over time), at some point that is going to correct itself.

More specifically, the present value (PV) of new clients is immense because they typically stick around (and pay fees) for more than 25 years. But the marginal cost of capturing them is a fraction of their PV. The disconnect exists because of a supply/capacity imbalance. The supply of people looking for comprehensive, holistic advice currently exceeds the capacity of industry participants—which expend 15x to 20x the resources for new clients versus established ones—to onboard them. Even large firms can only add a limited number of new ones at any time.  

Of course, at some point capacity will catch up with supply and when that happens, look out. Adding new clients is going to become very expensive.

Just how expensive? Well, consider the custodial referral channels. They are an example of a ferociously efficient market because legions of firms compete in them. And in those channels, wealth managers must rebate back to the custodian 25 percent to 30 percent of the revenue (over the life of the relationship) from referred clients.

This pricing signals that, once the supply and capacity lines cross, industry participants are going to have to spend a boatload more (on marketing, branding and sales) if they want to keep adding new clients. And if you are running a wealth management firm, consider for a second what your economics would look like if your effective net marginal revenue from each new client was 25 percent to 30 percent less than it is today. A lot of things in your business would have to change quickly if you want to have any hope of sustaining your profitability.

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