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Bundled Pricing Obscures Value Propositions for Investors

by Eric

As firms continue to deal with the financial crisis and respond to advisor and client demands for new and innovative products, they should think twice before they bundle and price services. I sense an undercurrent towards transparent, simple, pure, unbundled pricing in the future.

Financial services firms and advisors are under a lot of heat these days. Fee levels and transparency, fiduciary duty, advice, and product suitability are all in play for additional regulation. One topic about which I have not heard much yet, but expect to in the next five years, is the appropriateness of bundling.

Bundling, by definition, refers to the practice of selling two or more distinct goods together for a single price. It is used by sellers to maximize revenues. A simple example of bundling a razor with razor blades will suffice to show the benefit to the seller (and detriment to the buyer):

If constrained to unbundled pricing, the seller who wants to sell to both buyers must price the razor and blades each at $5. By bundling, the seller can price the bundle at $13 and make $3 more than he would have with unbundled pricing.

So, what does this have to do with financial services?

Investors today, knowingly or not, pay for three primary functions when they invest (to simplify, I am leaving insurance out of this discussion):

1. Access to, and investing in, the broad capital market (essentially, the cost to get beta)
2. A gamble to outperform the markets (the pursuit of alpha)
3. Advice

For most investors, the costs of all three of these very separate functions are bundled into one asset-based fee. Just as the buyers of razors above would have been best served by shopping around for unbundled pricing (thereby getting razors and razor blades for $5 each), investors may gravitate towards demanding unbundled pricing in the future.

Here is how that could look:

• Very inexpensive, beta products (index funds, ETFs)


• Distinct alpha products that will be pure (not closet index funds) and more expensive than beta


• Advice, separately priced, either via advice share classes or on a fee basis

This model will align cost, value, and price, will be more transparent, and will be better for the investor. However, it will be worse for the financials of asset managers. We see signs that this change is beginning. Scale is becoming more vital (Steven's blog piece on June 19), driving growth of low cost beta, and market share is flowing to low-cost funds and ETFs. Alpha-pursuing products are cropping up, and are clearly denoted as such. Financial advisors are flocking to fee-based models. Like most change in our industry, this will happen slowly, but it will happen. Progressive firms should be thinking about how to benefit from (or mitigate the risk that will come from) unbundling.