Most of the post-Sandler debate on the UK mutual fund industry has focused on increased transparency, price caps and the issues raised by a new breed of low-cost, no-advice products. But I have been struck by the lack of discussion on what all this means for the future cost base of the industry.
My perception is that much of the industry has yet to move on from the short-term worries of: “How is this going to work?” to the longer-term issues of: “If this works, what are the implications and how are we going to manage them?” The Sandler review was clear about its aim to increase competitive intensity and achieve greater price competition. The implication is that the industry should be preparing itself for a world where revenues will be significantly lower. Unless participants have a game plan that will reduce their costs substantially (30 per cent is a realistic starting point), then Micawber's law is going to catch up with them.
Sandler suggested there are lessons to be drawn from the motor industry because its products have a high level of transparency. Resulting pressures on quality and revenue have transformed the end product and put huge pressures on revenues, as examination of the latest figures from Ford will show. The result is that the industry has had to become highly sophisticated about its cost management to balance the books and many companies which have failed to make the necessary changes have disappeared.
It is instructive to look at what separated the winners and losers in the motor industry. One important area of cost control was and remains the procurement of components. The less sophisticated approach, sometimes associated with the old British Leyland, was to seek quotes for components and buy the cheapest. This led to quality problems, significant expense and frustration for owners of the vehicles. As most of their vehicles used different components, orders were relatively small and this limited the cost reductions achieved.
The response, which was to place bigger orders less frequently, did achieve price reductions. But the increasing stockpile of components required more storage space and represented a more attractive target for thieving. Worse still, model changes would then require scrapping large stocks of components. The result was that the initiative was not achieving the sort of impact on the bottom line that management needed to secure the company's future.
If we contrast this with the sophistication of one of the survivors, General Motors, some things are apparent. First, it recognised that big orders secure big discounts. This is achieved by insisting at the design stage that different models share components as much as possible. Second, strict requirements are imposed on component performance, with failure linked to financial penalties and non-renewal of orders. Finally, the supplier is required to make deliveries at the same time as the components are needed so that stocks at the assembly point are minimised. All this is driven by a focus on end quality and overall costs rather than cost per item.
In the mutual fund industry, our key area of cost is not in the buying of components but in areas such as data processing. The British Leylands of our industry are focused on automation of the processes and can point to significant progress. But many chief executives have become increasingly concerned at the lack of obvious impact on the bottom line and those concerns are exacerbated by the reluctance of many of those involved to carry out rigorous post-audits.
Where are the future General Motors of our industry? The contenders have recognised the potential value of automation but have moved on to recognise that each of the many times that data is taken from one computer system and re-entered by hand into another, extra costs and errors arise. Furthermore, every new computer system means not only initial costs but also the substantial expense of maintenance.
To avoid these factors negating potential benefits, the focus is on designing new products to fit within the parameters of existing systems and on eliminating the amount of data that has to be rekeyed over the life cycle of a mutual fund investment.
What this has revealed is that one of the industry black spots relates to data flows from intermediaries to providers and back again, where automation is either non-existent or non-standard.
How can we progress along this strategically critical path? Chief executives must recognise that change will be driven by a comprehensive redesign of the data process flows, not only within their business but also to and from customers. Tools such as EMX need to be seen as a part of this process and not as something that can be bolted on. Installing technology that is not integrated into the data process flow will increase instead of save costs.
Redesign of data process flows requires companies to identify and recruit people with the mindset and experience to do this effectively. They need to integrate these skills with the existing knowledge and skills within their company.
Experience from other parts of the financial services sector shows this is not cheap and it takes time and significant amounts of top management attention to deliver results. It would be a mistake to assume all this can be left until the heat is on. Those who have already started are building themselves an advantage.