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Diseconomies of scale

With most large platforms continuing to run at a loss should advisers be focussing on smaller profitable providers?

The proliferation of platforms has seen an accompanying proliferation of companies and systems offering to help advisers select a platform, or two, or maybe three. At least one of these services has an eye on turning into a platform in its own right – the first real wrap of wraps.

Economics tells us that consolidation will follow a proliferation phase in a new market as firms shape up or ship out. Macquarie’s strategic exit last year signalled the start of this consolidation phase for many people but the pace has slowed now.

Novia’s recent hook-up with Aegon and declaration of its entrance into the hallowed halls of profitability has confounded those who thought that the privately funded platform might be next, and congratulations to them.

There was a time when the “financial strength” meme was a key part of competitive differentiation for product providers, especially in group pension business. That’s faded away in recent years and now IFAs wanting to do due diligence in platformland have a really difficult job. Funding of platform development varies massively from specialist monoline companies such as Nucleus and Novia through to megalithic providers such as Standard Life and Axa.

This was thrown into sharp relief recently when uber abacus-fiddlers AKG released some telling data on three of the largest platforms – Skandia, Standard Life and Axa.

These chaps have spent £225m injecting capital into loss-making platforms. Standard lead the pack with a £116m injection to cover a £130m loss (2007-2009), Axa chipped in £47m or so to cover losses in 08/09 and Old Mutual (Skandia’s owner) ponied up £62m to cover a £39m loss and presumably paint and fit new carpets in Southampton.

Now, it’s unfair to pick on the big guys, and I do have sympathy with the fact that introducing platforms to large life companies costs more than starting from scratch. I do buy the deep pockets argument inasmuch as platforms are large and complex software-as-a-service (SAAS) systems and have big demands for development.

It’s also important to say that the providers of capital to these companies have not shown any sign of tiring of supporting these strategically important developments.

I think these large firms, in their inefficient, imperfect, bureaucratic way, are doing the market a favour by show-ing the other big providers that it is possible to shift the model away from selling packaged products to the unwary to a more modern way of doing business. That’s as important as having vibrant, startup challenger brands in a market of this type.

But these sums really are quite large. The really scary one is Skandia, who have achieved massive scale and still have not turned a profit. That should be putting the frighteners on other insurers who think that achieving £20-£30bn scale will get them into profit. I suspect that the incremental costs to service assets under administration will be greater than these firms have planned for.

That’s not a counsel of despair – just a reality check on how much scale you need to achieve to justify a large centralised infrastructure.

The key question for advisers concerned about ongoing commitment to platforms is whether to trust a smaller provider who may be profitable now (or soon) but has all the scale challenges to come, or to trust a larger company that needs to refit their operation to work on slimmer margins? It is impossible to answer without a time machine – but IFAs would be well advised to track down what listed providers are saying to the City analysts about their plans and when they expect to hit profitability.

Mark Polson is principal of The Lang Cat


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