Continuing our occasional series of perspectives from consultants on wealth management issues, here are authors from Simon-Kucher & Partners.

This publication has approached a raft of consultants operating in the wealth management sector to give their views about a range of challenges and opportunities for the industry in different parts of the world. A number of articles will be released in these pages in the coming weeks and we hope readers find them stimulating. The articles have been sought by this publication and also by Bruce Weatherill, of Weatherill Consulting, and also chairman of ClearView Financial Media, publisher of this news service. This article is by Simon-Kucher & Partners. The authors are Petra Knüsel, partner and head of UK Banking, and Alex Graham, a senior consultant in the London office.

The state of play
The success of the UK’s private banking industry goes back many centuries. So, unfortunately, does the current revenue model. At its core there are two sources of revenue: direct revenues from contractual fees, and indirect revenues that are opaque or completely unknown to the client.

The average margin of a UK private bank is around 0.8 per cent of assets under management.  This in our experience consists of the following:
1)    c.30 per cent from volume-based charges (e.g. custody fee);
2)    c.35 per cent from transaction-based fees (e.g. commission on brokerage);
3)    Less than 5 per cent from flat fees (e.g. account maintenance);
4)    c.30 per cent from "hidden” charges (e.g. FX surcharge, trail commissions).

The gathering storm
Recently, this traditional model has come under increasing pressure, leading to a decline in net margin. Clients are (rightfully) continuing to question the “value-add”, and demanding a more transparent view of fees charged. The continuous rise of execution-only options provides a further threat as investors choose the “do-it-yourself” option.

Although the decline of transaction-based fees has abated, following the financial crisis many banks have reduced transaction margins to remain competitive. To makes matters worse, investors continue to shift towards electronically traded funds instead of managed funds.

Furthermore, the Financial Conduct Authority’s plans to increase visibility and transparency, together with the Retail Distribution Review and the European Union’s MiFID 2 Directive, have brought trail commissions under greater scrutiny.

Client support and advice is usually free until a transaction is actually made. This leads to an inherent conflict of interest: the banker is incentivised to promote transactions regardless of the market situation or the client’s interest.

The new "three-part" solution
This traditional pricing model will soon be obsolete, and it must therefore be rebuilt. There are two principles which can serve as pillars for the price model of the future: Differentiation and transparency.

Differentiation is important because the needs of clients differ. A trader and a buy-and-hold client need (and value) different things. The same is true for “onshore” and “offshore” clients, and so on. In times of heightened competition, differentiation is vital to remain competitive.

How to differentiate? One approach already followed by some players is to separate service and product performance. Clients pay a fixed, explicit fee for a level of service that suits their needs, regardless of asset volume.

This leads to a three-part fee model:
(1) Service fee;
(2) Asset-based fee;
(3) Transaction-based fee.

The new service fee (1) covers all client-related services, such as account maintenance, reporting and assistance. At the same time, product-related fees, both for assets and transactions, are charged depending on the value provided, and therefore, fees such as advisory and safekeeping or transaction can be lowered.

Separating service and product also naturally leads to “Best Advice”, as revenues are less transaction dependent.

Packaged services can be built along the entire private banking value chain: current accounts, cards, payments, reporting, research, mortgages, financial planning and loans. Further value-added services are possible in wealth management and private banking.

And finally
Package fees enable banks to target various client segments directly. This benefits both sides: clients select the most attractive package, which in-turn indicates to the banker the level of service expected by the client.

From the bank’s perspective, a recurring service fee stabilises revenues and guarantees cost coverage across all clients.

In addition to greater transparency, customer satisfaction, and profitability, the “3-part revenue model” also provides superior flexibility. Prices can be more easily adapted to changes in market conditions, client needs or internal performance measures.

Differentiated pricing models are inherently fair, compared to models that only reward higher transactions or asset levels. The offering is fully transparent and can be communicated easily, and because it is based on value, there is nothing to hide.