Where 401(k) advisers are on the industry consolidation curve

In their seminal 2002 Harvard Business Review article “The Consolidation Curve,” A.T. Kearney consultants Graeme K. Deans, Fritz Kroeger and Stefan Zeisel outline the four stages of consolidation most industries will go through as they mature over a 25-year period. Record keepers and advisers of 401(k)s are currently going through different stages of the consolidation curve.

Let’s review where they are on the curve and what we can expect in the future.

STAGE 1: OPENING

The consolidation curve starts with one company dominating, but drops off quickly with three to five firms enjoying 10%-30% market share. In this stage, companies must defend first-mover advantage by building scale, establishing barriers to entry and focusing on revenue over profit while starting to perfect acquisition skills.

Stage 1 really started for adviser-sold 401(k) plans around 1995 when retail mutual fund companies that distributed through advisers entered the 401(k) market.

Started by Fidelity (which sold direct) in the early 1990s, and followed by MFS, American Funds and Putnam, mutual fund companies used revenue sharing to shift record-keeping costs to participants investing in popular retail funds during a market boom, while tapping into a massive distribution sales force of 300,000 retail advisers.

Banks and insurance-company record keepers stuck with guaranteed investment contracts and stable value funds, their bread and butter, and were left out of the fray in the beginning.

STAGE 2: SCALE

Record keepers are about to exit Stage 2, during which major players emerge by buying up competitors (think Empower Retirement, MassMutual, Voya, John Hancock, Transamerica, One America, Newport Group and Ascensus), with the top three adviser-sold firms (Fidelity, Empower and Principal, in my estimation) enjoying 15%-45% market share.

Consolidation is brisk in Stage 2, with survivors honing acquisition skills, protecting core culture as they absorb others, retaining the best employees from acquired companies and building scalable IT platforms.

There are currently 38 national record keepers serving the retail 401(k) market, but only 20 have a chance of entering 401(k) heaven and surviving through Stage Three to be one of the “divine nine.”

STAGE 3: FOCUS

Focus is the key for Stage 3, as winners expand core businesses, shore up or shed weak ones, and organically outgrow competitors while scouting for megadeals. The top three will have a 35%-70% market share, with room for five to 12 majors.

Underperformers should be ruthlessly attacked in Stage Three and start-ups should be either crushed, acquired or emulated. The battle among the current 20 national 401(k) record keepers for one of the nine divine spots is currently being waged. There’s room for an additional three to four providers that have unique distribution capabilities like banks and payroll companies.

STAGE 4: BALANCE AND ALLIANCE

This stage is where airlines currently reside. Titans reign, with the top three enjoying 70%-90% market share (think American Airlines, Delta and United, plus Southwest and JetBlue) and looking to defend their positions while forming alliances.

Complacency and regulations are the primary dangers as Stage Four companies look for new ways to grow (baggage fees) while spinning off businesses in new industries (online booking). Companies reside in Stage Four, they don’t move through it.

So where are 401(k) plan advisers on the curve?

It’s hard to apply the consolidation curve to traditional broker-dealers, where 401(k) plans are a relatively small but growing part of their overall businesses.

So, let’s examine large retirement-focused advisory groups, known as the “aggregators.” CAPTRUST enjoyed prime position in Stage One, but SageView Advisory Group, NFP and the former National Retirement Partners quickly followed.​

Lockton Investment Advisors and Gallagher Benefit Services leveraged their insurance base to build retirement-adviser networks, and Global Retirement Partners formed as NRP balkanized after an acquisition by LPL Financial. Because Stage One emphasizes revenue over profit, access to capital is key, as is the ability to successfully acquire advisory practices.

There are currently 14 aggregators, with more likely to emerge from a group of between 50 and 75 “Tier 2” consulting firms, who are looking to leverage fixed costs and brand. Aggregators entering Stage Two of the consolidation curve will not only have to rapidly recruit or acquire and then absorb new advisory practices, they will need to start looking to purchase each other (Think CAPTRUST and Pensionmark, who announced a partnership two years ago.)

CUSTOM INVESTMENTS

Preserving culture will be difficult, as will retention of key employees. Along with building scalable IT, these firms must use their clout to get 401(k) plan and participant data from record keepers to create custom investments and cross-sell other services.

Expect between eight and 12 aggregators to survive in Stage Two, and move more rapidly through the consolidation curve than record keepers. Look for a large private-equity firm to buy an aggregator, using their capital and acquisition skills to aggressively grow faster than competitors lacking those skills.

Fred Barstein is the founder and CEO of The Retirement Advisor University and The Plan Sponsor University.

Related Topics: Mergers and Acquisitions