401(k) record keepers near final stage of ‘consolidation curve’

Like many other fragmented industries, the 401(k) business is consolidating rapidly. That consolidation process, which happens in four stages, is driven by record keepers and retirement plan adviser aggregators.

The four stages are expertly explained in the seminal 2002 Harvard Business Review article, "The Consolidation Curve" by consultants at A.T. Kearny, which studied 1,345 mergers in various industries.

With 140 of the 190 transactions since the mid ’90s (see report here), 401(k) record keepers have led the way -- although there are still more than 40 national firms. Record keepers are a stage ahead of RPA aggregators, providing incredible insights about which firms will survive and which ones RPAs should consider joining.

Though closest to the airlines, the 401(k) industry is nuanced for three main reasons:
1.       Plans are sold, not bought.
2.       Fiduciaries oversee the plan but are not the primary user.
3.       Different entities must seamlessly partner.

Advisers are most like travel agents.

There are three distinct 401(k) markets that may eventually come together. Today, however, they must be serviced differently. Those markets are:
1.       Small to micro (less than $3 million in plan assets).
2.       Midsize to large ($3 million to $500 million).
3.       Institutional (more than $500 million).

Record keepers and RPAs tend to focus on one or maybe two markets.

Consolidation of defined-contribution investment-only firms, or DCIOs, and broker-dealers whose focus is not 401(k) plans will be driven by other factors. Many of their functions will be taken over by RPA aggregators and record keepers as they mature.

Let’s look at the four stages of the 25-year consolidation curve to see where record keepers and RPAs currently stand. Though 401(k) plans began in the early 1980s, we're starting with 1995, when advisers and smaller plans began to emerge.

STAGE 1: OPENING

Usually one entity dominates with close to a 100% market share (see Fidelity and Captrust), which quickly drops to three large entities, each holding a 10% to 30% share. First movers try to defend their advantage through scale, by creating barriers to entry, focusing on revenue over profit and perfecting their acquisition skills. Both record keepers and aggregators have already exited this stage.

STAGE 2: SCALE

Major players emerge rapidly, buying up competitors. The top three players enjoy a 15% to 45% market share, honing integration skills, core culture, retention and a scalable IT platform. Aggregators are still in Stage 2, but record keepers have moved into the next stage.

STAGE 3: FOCUS

After ferocious consolidation in Stage 2, survivors look to expand their core businesses aggressively and outgrow their competition. The market share of the top three grows to 35% to 70%, and there are five to 12 major players overall. This stage includes megadeals, and survivors ruthlessly attack underperformers, especially startups. Profit is key, as is avoiding all-out assaults on other major players. Record keepers are in the middle of Stage 3, with five dominant record keepers and 10 to 12 significant competitors.

STAGE 4: BALANCE AND ALLIANCE

The top three entities will have 70% to 90% market share and will focus on forming alliances as growth becomes more challenging. Survivors seek to defend rather than attack, looking for new ways to grow. They closely watch new regulations for threats and opportunities, careful not to be lulled into complacency.

The A.T. Kearny consultants concluded that a firm’s long-term success depends on the speed at which it rides the consolidation curve, with merger competency particularly critical in the middle stages. Slower firms will either be acquired or disappear entirely.

There are lessons for the DC market.

Record keepers are looking for new ways to grow, with less opportunity for acquisitions. Larger providers will focus on major deals like Wells Fargo by Principal and MassMutual by Empower. Global markets just starting DC plans might be interesting to providers, as are pooled employer plans. And some companies might even go fully bundled, using more proprietary funds and owning distribution to maximize profits and streamline service.

Most of the 15 RPA aggregators have either raised capital, are part of a larger entity or have sold to one, because they need capital to acquire RPA firms and build integrated IT platforms. For almost all of them, acquisitions are still the main engines of growth, and they are still in Stage2. But most are looking to develop the capabilities to cross-sell wealth management and benefits.

WHO WINS?

Aggregators that move fast through Stage 2, have a repeatable acquisition process, build a strong core culture and retain key talent stand to do well. Though each aggregator offers different benefits and culture, RPAs that chose the survivors will be better positioned, and wealthier.

Fred Barstein is founder and CEO of The Retirement Advisor University and The Plan Sponsor University. He is also a contributing editor for InvestmentNews’​ RPA Convergence newsletter.