Vertical integration back on the 2014 radar
Australia’s wealth industry has become a vertically integrated place. The dominant for-profit business model since the 1990s – advice, platform, and asset management under one roof – has been further reinforced by much of the previous government’s regulatory program, intended or not.Is this the apex of vertical integration or could it go further? It always seemed odd that an ALP government appeared disinterested, but with a change in government, it’s possible that the impending Financial System Inquiry (“Son of Wallis”) could bring a critical focus to the issue. Equally though, it’s also possible to argue that the major vertically integrated players could do a better job of co-ordinating the moving parts of the value chain, and that vertical integration could have even further to run.That might be unpleasant to contemplate in an industry which has become tough for independents of all types, squeezed out of major categories (eg asset managers and diversified funds), or forced out altogether (most large independent planning groups other than SFG). The symptoms led to a commitment last November from the Assistant Treasurer to monitor the industry in the context of vertical integration. But it was a pretty narrow commitment around a competitive advice sector, and very much a distant priority behind the proposed FoFA amendments.
The interesting question is whether the causes of vertical integration, and resulting system impacts and risks, will be examined, rather than just the symptoms. If this is going to happen, it’s likely to be on the stage of the Financial System Inquiry, scheduled to report by November 2014.
There is no mention of vertical integration in the draft terms of reference. But there are a number of terms where the scope could allow for an examination, including:
– The current cost, quality, safety and availability of financial services, products and capital for all end users (1.3).
– Balancing competition, innovation and efficiency, with stability and consumer protection (2.1).
– Changes in the way Australia sources and distributes capital, including intermediation of savings through banks, NBFIs, insurance companies, superannuation funds and capital markets (3.3).
On this view it would be surprising if vertical integration didn’t get a run, for example in the context of concentations of financial risk in the system. Radical responses such as structural separation could potentially get an airing. Past financial system inquiries have resulted in significant reforms, and it’s likely that this government will be looking to put its stamp in the financial services industry as well. The for-profit players will be watching warily of threats to their business models emerging from this direction.
Vertically integrated players might also benefit from taking a closer look at the effectiveness of their model.
To the outside world, vertically integrated competitors – especially the big retailers – look like an all-conquering army marching in step as they crush every independent in their path. But take a closer look and it can look more like confusion, if not outright civil war.
Confusion arises around who is doing what. For example, it’s not uncommon to find similar activities being performed in different divisions of vertically integrated businesses. Given they don’t always communicate effectively (or sometimes at all), you can get left hand / right hand situations where one part of the business has a diametrically opposed view to another. Where that extends to investment views, for example, it’s a compliance disaster in the making.
While confusion is perhaps predictable, things get stranger when observing the organisational behavior of vertically integrated businesses. For all its economic power, many people working inside them don’t actually like working or collaborating with the other parts of the model. Financial planners resent being told which platforms they can or should use, as well as limited approved product lists. Platform managers resent pressure to allocate assets to the in-house asset manager. Equally, the asset managers feel they have to jump through even more hoops than external managers to compete. Given the internal tensions, perhaps the surprising aspect is that it hangs together at all.
So for the vertically integrated, while the Financial System Inquiry looms large, 2014 will also benefit from increased attention to organisational behavior, and how to best balance the power of the model with the human tendency to resist its imposition.
For those competing with vertically integrated models, some comfort. 2014 is your chance to make a fuss. But for all their firepower, the reality is that these models are less cohesive than they appear and have all the Kodak-like challenges of large firms coping with an industry in rapid change.