This software is the heart of an advisory practice-so why are there so few options? (Hint: look in the mirror.)

    Here I am at a Greek diner near my office in Westbury, N.Y., sitting in a booth across from Bob Yacobucci, a 42-year-old programmer, who started his own portfolio management software (PMS) company in 1999. In an instant, ten years of covering PMS systems for RIAs crystallizes to form a clear picture of the gridlock paralyzing this part of the RIA world. Before you can say "cheeseburger, cheeseburger," I realize while talking with Yacobucci why the PMS market for registered investment advisors (RIAs) is paralyzed. I realize why so many advisors dislike Advent Software, and why financial services technology giants like SunGard Data Systems and The Thomson Corporation have not entered the RIA market with a PMS product.
    Before going any further, I want to say that my epiphany at the Greek diner should not be construed as a knock at Yacobucci or his PMS product. Portfolio Director sounds like an innovative application. Its interface is programmed in Java, and the application uses the Microsoft SQL Server database back end, which makes it different from any other PMS application being marketed to independent advisors. In addition, Yacobucci says he has made it easy for advisors to publish portfolio reports to their Web sites. So please understand. I could have been talking with any of the tiny PMS vendors when I had my epiphany and realized why the market for providing the mission-critical lifeblood application of an RIA is frozen in gridlock.
    Yacobucci had been asking me for more than two years to review his PMS software, but I'd been reluctant. By the time Yacobucci's software came to my attention three years ago, I had already been covering the advisor technology beat for seven years. I had already covered the meteoric rise of Techfi, which lit up the RIA world in 1999 with the first SQL-based PMS product, only to become so consumed by its growth that it failed to provide good service or support to its clients. I had by then already covered Techfi's purchase by Advent Software in June 2002 and Advent's subsequent decision to stop offering Techfi's products from the market. In short, experience had taught me to pause before covering tiny startups like Yacobucci's, to look at all the angles, and to be skeptical. So I've been slow to give Yacobucci's company any coverage in this column. But now Yacobucci had traveled all the way from Holidaysburg, Pa., and wanted to see me. We settled into the booth at the diner after making some small talk and I asked him some questions.
    Yacobucci said he had 250 clients. Earlier, he had told me that the cost of the software was $150 a month, $1,800 a year. I started making the calculation out loud.
    "Okay, so you have 250 clients each paying you $150 a month," I said. "Right?"
    "No," said Yacobucci. "We only raised prices on the new customers and not on the existing clients."
    "So you have 250 clients and each on average is paying you $1,000, right?"
    "Yes," he said.   
    "See, that's why I am such a pain in the neck," I said. "You have a business with six employees and revenues of $250,000. That's not a serious business."
    In this brief exchange, I saw the truth about the providers of PMS software to RIAs: The market mechanism for providing PMS software to RIAs is broken, stuck in gridlock. Advisors choose small technology companies to serve them because they can save money by doing so. Small companies like Yacobucci's offer their products at incredibly low prices. But small companies often cannot provide the solutions advisors say they want. Consequently, RIAs bemoan the fact that there are only two industrial-strength portfolio management software companies, Advent and Schwab, when in fact RIAs themselves have made it unattractive for qualified new entrants to try to serve them.
    In light of two recent developments of significance, it's time for RIAs to critically examine why viable technology companies are not trying to provide them with the central application they use to run their business. The two developments are Advent's decision to market its new SQL-based PMS product to RIAs with at least $1 billion under management, and the decision by technology giant Intuit, makers of QuickBooks and Quicken, to pull the plug on a one-year effort to enter the advisor PMS market. The strategic business decisions made by these two large technology companies indicate that something is wrong in the RIA world. Why aren't large financial service technology companies clamoring to provide RIAs-a growing market-their core application?

The PMS Challenge
    To understand the dynamics at work here, let's start by examining what RIAs expect of a PMS software application. RIAs want interfaces allowing them to download transactions from an array of custodians-Schwab, Fidelity, TD Ameritrade, Raymond James, Bear Stearns, Pershing, just to name a few. They want to be able to reconcile their data easily and clean it up when a stock split, dividend or other corporate action occurs that requires data scrubbing. They want elegant-looking reports and the ability to customize reports to show the data and graphics they want their customers to see.
    With just a few clicks, advisors want to be able to upload their reports daily in a batch process that encrypts and stores client performance report data on their Web sites, so that clients can pull from personal folders whenever they wish. Advisors also want their PMS data stored on an SQL database, which would allow them to inexpensively write custom software programs integrating their PMS application with customer relationship management software and other applications, and allowing them to drill down in their PMS database from the portfolio level to the transaction level.
    Most importantly, advisors demand that this application be 100% accurate. Whether calculating time-weighted returns on stocks, a variety of types of bonds, mutual funds and other securities, reinvesting dividends or not, RIAs absolutely, positively cannot stand for any calculation errors. And the most sophisticated advisors want to be able to manage tax lots using multiple methodologies-first in-first out, last in-first out, average cost, highest cost, lowest cost and actual cost.
    To round things out, advisors want these features delivered through an easy-to-use interface that junior-level employees in their firms can use to generate reports, download data and perform day-to-day chores needed to run their businesses. They also want the PMS vendor to provide a toll-free support hotline 12 hours a day (between 8 a.m. Eastern time and 5 p.m. Pacific) five days a week, with the help desk manned by qualified experts.

Advent And Schwab
    Now let's assess the competitive stance of the two dominant firms providing PMS software to RIA firms, Advent and Schwab.
    Schwab almost single-handedly invented the RIA business in the early 1990s by creating the first mutual fund supermarket and establishing a division to serve independent RIAs. To provide better service to its advisor clients, Schwab built technology systems for them and in the early '90s acquired a then-tiny PMS vendor called Performance Technologies Inc., which made an application called Centerpiece. By the end of the millennium, Schwab had attracted about 70% of all the assets of independent RIAs using mutual funds to serve the high-net-worth investor market.
    For Schwab, its foray into the PMS market has been a blessing and a curse. It's been a blessing because it gives Schwab a competitive advantage. No other custodian can boast of offering an RIA the technological guts it needs to run its business-a portfolio management and reporting system as well as a back-office trading system and portfolio accounting system. Schwab truly understands RIA technology challenges because it lives and breathes it daily. It's in the trenches with RIAs, selling them PMS systems. And by the way, that just happens to also be a great sales pitch when Schwab is selling RIAs on custody services. Plus, Schwab can give away its PMS software for free to big advisors who are good custodial clients.
    However, offering its PortfolioCenter PMS system has also been a curse because it costs Schwab a lot of money to support and upgrade its software. Schwab now has about 5,300 RIA firms using its custodial service and 3,300 using Schwab PortfolioCenter. Schwab says 900 of its 3,300 PMS customers are not Schwab custodial clients.
    The economics of supporting RIAs that are not Schwab custodial services clients came to a head in February 2002, when Schwab announced that it would stop selling its PMS system to advisors that were not Schwab custodial service clients. This sent a chill through the RIA market because Schwab, which had long been accused of being heavy-handed with advisors, seemed to be pulling a major power play. RIAs that had trusted Schwab for both PMS and custody services suddenly became uneasy. If Schwab could impose conditions on Centerpiece users not using Schwab's custody services, what conditions might Schwab impose on Centerpiece users relying on its custody services?
    It was a PR nightmare for Schwab. Schwab eventually reversed its decision because the distrust it engendered threatened to harm its highly successful custody business. To this day, however, Schwab is looked on warily by many advisors who fear Schwab might use its tremendous clout to somehow strong-arm them.
    But what's been forgotten is that Schwab was simply trying to protect itself from a bad investment-providing a PMS application to hundreds of advisors who were not its custody clients. Schwab has a strategic reason for supporting the PMS needs of RIAs that are not its custody clients: It hopes to convert them to Schwab custody services. However, 900 advisors who now pay Schwab $1,650 a year for a single-user license to PortfolioCenter and another $600 for each additional user are probably not adding much, if anything, to Schwab's bottom line. That's why, when the bull market ended and Schwab was laying off thousands in early 2002, it no longer wanted to support PMS users who were not Schwab custody clients.
    When Schwab rolled out PortfolioCenter two years ago, it raised prices sharply. For advisors who did not custody assets at Schwab, the first-year license fee more than doubled, to $8,000 from $3,450. Schwab says it does not subsidize its PMS subsidiary and that its PMS unit must stand on its own financially. But the licensing fees Schwab makes on PortfolioCenter don't add too much to the financial services giant's bottom line. Just eyeball the economics of running Schwab Performance Technologies.
    If you assume that the average firm licensing the software has three licenses and is paying Schwab about $1,650 for the first seat and another $1,200 for two more seats, Schwab is getting about $9.4 million in revenue a year on its PMS business. If Schwab signs up 50 new clients a year, it's another few hundred thousand in revenue. The company has about 90 employees. If you assume each one is making $50,000 a year, its payroll alone is $4.5 million. Add in the cost of employee benefits ($1.5 million), rent ($250,000) and all the other expenses that goes with running a company with 3,300 customers and 90 employees-utilities, travel, lawyers and all the rest-you have to assume Schwab is not doing much better than breaking even on its PMS business.
    PortfolioCenter is a strategic investment for Schwab, not a financial one. Advisors who are Schwab clients and who use Schwab's PMS system are paying a low price for their PMS application because PTI is not a division Schwab is trying to make money on. Schwab can afford to keep the price of PortfolioCenter software low because it gives Schwab a competitive edge in the custody business. That's one of the reasons why the market mechanism for providing better PMS solutions to RIAs is broken.
    Meanwhile, about a year ago Advent Software, a company advisors love to hate, rolled out a new, SQL-based PMS system called PortfolioExchange. Two months ago in this space, I noted that Advent was not interested in selling its very sophisticated new PMS application to the RIA market. That's because Advent is targeting large RIAs with at least $1 billion in assets under management to buy this software. For users of Axys, Advent's reliable but technologically ancient PMS system for small RIAs, Advent is charging tens of thousands of dollars to convert to PortfolioExchange. One advisor managing about $300 million with a long history of transactions was told it would cost $125,000 to convert to PortfolioExchange, for instance. Even a "small" RIA firm with just $100 million under management should expect to pay tens of thousands of dollars to convert to PortfolioExchange.
    Incidentally, if you contrast Advent's launch of its SQL product, PortfolioExchange, with Schwab's launch of PortfolioCenter, you see major difference in approach. When Schwab rolled out its SQL-based PMS system, it made upgrading free. Schwab rolled out the new software over a one-year period to limit disruption inherent in converting hundreds of transaction-history databases maintained in each of the RIAs using its PMS, but conversion was free-zero, zilch.
    Why? Because Schwab is not really in the advisor software business. It's in the RIA custodian business. Its PMS subsidiary need not make any money on the software conversions. Advent, meanwhile, a publicly held company, must make money on its software and services and charges tens of thousands for a conversion. No wonder Advent is not rolling out its new SQL-based desktop product for small RIAs serving high-net-worth individuals. No wonder Intuit concluded there was no money to be made in offering RIAs a PMS application and killed its offering after a year. Please understand that Schwab is not to blame for this. It's doing what's best for its business and, many would argue, what's best for its customers. Schwab is not evil or even devious. It's running its business wisely.

The Challenge To New Competitors
    Every once in a while, you open up one of the industry magazines and read about some new PMS application that is going to reinvent the industry. Four years ago, the buzz was around Interactive Advisory Software. Eighteen months ago, Intuit hit the market with PortfolioMinder. IAS is a good application that might yet succeed, but so far it has done little to effect RIA technology and it remains a secret to most advisory firms. Intuit pulled the plug on PortfolioMinder after it apparently figured out that this market offered little hope for the financial technology behemoth that makes Quicken and QuickBooks.
    We in the press need to be taken to task for being such suckers and telling advisors that almost every new application that comes along is good. And let's not even talk about those stories that talk about a start-up with the promise of transforming the industry. Attaining the age of 51, running my own technology business serving advisors for a decade and seeing so many promising technology companies descend into mediocrity or, worse still, come apart in tatters, has taught me that serving RIAs with technology is no mean feat.
    When magazines give glowing reviews of professional software, and most of the reviews in the trade press are favorable, it often generates a lot of buzz for these companies. But these are tiny start-ups we're writing about. Some have just a few employees. Such tiny companies usually cannot, overnight, create good service models that can deal with complicated issues like those inherent in PMS software support, and providing good service when you're doubling or tripling your business every year is a huge challenge.
    When start-up businesses grow rapidly, they are usually confronted with challenges that must be resolved by applying skills different from the founders' core competency. A programmer who was able to create great portfolio management software may not have the skills to market the company or manage its staff. A small PMS company-or any company for that matter-that has six or eight employees can often provide good software and good service to 100, 200 or maybe even 300 clients. But when a start-up grows beyond ten or 15 employees, the business can't be run the same way as when it had six or ten employees.
    When a business has ten employees, all the details about a company's product and processes for dealing with clients can be stored in human brains. The CEO and a few key employees know everything about the company and its processes, and can communicate on the fly with the entire staff and clients to keep the business running. But when a start-up grows to have 15 employees and hundreds of clients, communication becomes complex. Storing processes in people's heads no longer works. When you lose one or two key employees, important institutional knowledge about your business processes goes out the door with them.
    Tiny businesses, in order to succeed and become big companies, must get over this hump. Their processes for conducting business must be systematized, and cannot remain totally reliant on a few key employees. That's a big hurdle that most small companies never get past. In fact, few of them ever get to the point where their growth forces them to confront these challenges.
    In more than ten years of covering technology for advisors, I can count on one hand the number of software start-ups serving advisors that navigated successfully through this phase of growth. Albridge and EISI come to mind, and a few others are on the cusp of getting on this short list, such as Investigo and PIE Technologies. And this is when you examine the entire field of companies serving advisors with all types of professional software-CRM, financial planning, analytics and PMS. When you look at just PMS vendors who have moved from the start-up phase to become sizable companies, only Albridge clearly makes the list, with the possible addition of Investigo, and both of these companies are focused on providing an enterprise-wide PMS solution to B-Ds and their reps and not serving RIAs.
    Until a start-up surmounts these hurdles, relying on it for your mission-critical task, like portfolio reporting, seems chancy. Yet that is exactly what many advisors are doing when choosing a small vendor for a PMS system. Many are expecting tiny PMS start-ups to deliver great service and sophisticated technology at a low price. It's unrealistic.

Breaking The Gridlock
    So where does this leave RIAs seeking a PMS vendor? The great majority of RIAs choose the two big vendors, Advent or Schwab. A small minority, maybe 20%, choose one of the small vendors, such as Cornerstone Revolutions' PowerAdvisor, CapTools, Interactive Advisory Software, AssetBook from Major Technology, Financial Computer Support, Inc. or Portfolio Director. None of these vendors seem poised to break out of the pack and become the dominant new solution. Meanwhile, some advisors continue to pray for viable alternatives to Schwab and Advent.
    Breaking the gridlock may take a concerted effort. RIAs could organize a technology co-op. Much the same way as a group of about 50 advisors banded together about five years ago to form a trust company, National Advisor Trust Company, that could serve their niche, RIAs could band together and marshal their resources. They could choose one start-up vendor that holds promise and come up with a list of features they want and a schedule for getting them, and agree to move their PMS business to the vendor if it meets specified goals on time.
    Another possibility is that advisors will be forced to spend more on PMS by Advent and Schwab. Most RIAs are paying $3,000 or less annually for their PMS software, which is pretty low when you consider it is the core application they run their business on. A study by Moss Adams, a prominent consultant to advisors, recently found that firms with $250,000 or less in revenue had budgeted $1,000 in 2005 for software expenditures, while firms with $250,000 to $1 million in revenue had budgeted $5,000 for software expenditures. Those with revenue of $1 million to $5 million had budgeted $22,000 for software expenses. Advisors I know who are managing $300 million are paying about $3,000 annually for their PMS system-the lifeblood application of their business. This does not make sense and does not work in other industries.
    When you compare what advisors spend to run their practice's core technology to what a doctor spends, the strange economics of advisor PMS systems is obvious. A physician friend of mine is in a group practice with six doctors and they recently priced a new recordkeeping system, which included scanners and tablets as well as software. Price: $100,000-half of which would be for software and the other half for hardware. The software costs amount to about twice the entry price of Advent or PortfolioCenter for an office with six professionals.
    To put it all together, RIAs have high expectations of their PMS vendor, are incredibly cheap about spending on technology, and the competitive framework among vendors is not allowing capitalism's great strengths to serve up new solutions from larger vendors. There is no money in it for them. The RIA PMS market is stuck in gridlock, with no signs of it breaking up anytime soon. Sorry, but that's what I'm seeing.

Andrew Gluck, a longtime writer and journalist, is CEO of Advisor Products Inc., a Westbury, N.Y., marketing company serving 1,500 advisory firms.