Dangers advisers may face due to record-keeper consolidation

Editor's note: This column was updated on Oct. 25 to clarify the lobbying that a group alluded to in the text, the American Retirement Association, does on behalf of financial advisers.

The 401(k) record-keeper industry is following the path outlined in the brilliant 2002 Harvard Business Review article, “The Consolidation Curve,” which predicts that fragmented industries go through four stages of consolidation over a 25-year-period. The process ends with three to five players controlling 70% to 90% of the market.

What are the dangers for advisers if this happens to 401(k) record keepers?

For perspective, let’s focus on the retirement plan adviser-sold market, which emerged in the early 2000s and includes plans with roughly $3 million to $250 million.

Record keepers are in the third stage of consolidation, which is aptly dubbed “focus.” That follows stage one, “opening” and stage two, “scale.” Stage three is epitomized by ferocious consolidation through mega-deals, with the focus on profit, expanding core services and outgrowing the competition. There will be five to 12 major players, with three to five of them controlling 35% to 70% of the market. They will look to crush underperformers while avoiding taking on tier one competitors, and to either emulate or buy start-ups.

In stage four, “balance and alliance,” the four to five leaders control 70% to 90% of the market. Because it's challenging to expand core services, they find new ways to grow and perhaps cut costs through efficiencies and technology, looking for alliances and focusing on government regulations.

What might happen in five years when the 401(k) record-keeper industry enters stage four?

There will be a lack of major investment in innovations, as there will be fewer competitors — and many of them will be forming alliances. Though costs might not increase, service and customization might decrease, and there will be greater competition for participant and ancillary services that advisers might also want to offer. The tier one record keeper’s consumer brand will only grow.

These larger providers will cater to larger RPA groups like aggregators, which are in the second stage of the consolidation curve themselves, and major broker-dealers, at the expense of smaller, independent RPAs. Getting these providers to share participant data will not be easy even for larger groups of RPAs.

More proprietary funds or money managers will be willing to pay a steep platform fee. Providers might try to sell directly, cutting out middlemen — much as airlines and hotels have been doing with travel agents and online booking websites.

Providers will focus on lobbying for laws that favor them over advisers, plan sponsors and participants. For example, if there's a federal mandate that all organizations of a certain size must offer a retirement plan, there will be less need for an adviser to sell it. And though there is a national association that lobbies for plan advisers, most of its funding comes from providers, money managers and broker-dealers, not advisers which can cause conflicts.

The prevailing record keepers will turn their focus to the smaller and micro market, through pooled employer plans and multiple employer plans. They will also offer participants services to institutional plans while almost giving away record-keeping services.

Resoundingly, RPAs should be concerned. But what can they do about it? The answer is complicated and nuanced, perhaps requiring further discussion.

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.