Don’t be too quick to discount

By Vikram Barhat | September 19, 2011 | Last updated on September 19, 2011
4 min read

Emotions and advisory business are strange bedfellows and should sleep in separate rooms. A new study from PriceMetrix found that financial advisors who cut their fees during market downturns, a practice dubbed ‘sympathy pricing,’ are hurting their businesses over the long run.

The study focused on transactional equity commissions and found advisors not only lose money immediately, but also have lower average returns on assets than other advisors. Worse, they are unable to reset their prices as quickly when markets recover.

“As we’re seeing once again now, providing good advice to investors during volatile times is one of the most important services an advisor can offer,” said Doug Trott, president and CEO of PriceMetrix. “Clients pay for the advice and experience of their advisors; they do not expect a discount when market performance is poor, any more than they expect to pay a premium when market performance is strong.”

Advisors, he added, should be confident charging a fair price in good times and bad.

“There is a lack of confidence in their proposition and we used the term ‘sympathy pricing’ in the white paper, it could be better called ‘guilt pricing’ or ‘apology pricing’ as the markets go down,” he says.

The survey looked at seven million equity trades over a three-year period ending in June 2011. The average financial advisor cut his or her fees substantially during the market turmoil of 2008 and 2009. During this period, the average discount on commissions rose from 37% to 43%.

Advisors have subsequently raised their fees with the average ticket size increasing from $224 to $231. The price recovery, however, has been fragmented, as some advisors have been more successful than others in raising rates. Just 13% charge full price while half of all advisors discount their commissions by at least 30%.

“Many reps look at investment performance as the measure of their value addition,” says Trott. “It’s a very poor choice of a measure for value add because, of course, there is no control on the market.”

Consistent application of pricing strategy is one of the most important, and often overlooked, aspects of doing business effectively. The study noted that by a variety of measures, advisors who priced trades consistently over the three-year period ending in 2011 outperformed advisors who did not. Consistent pricers had a higher price to principal ratio (1.13%) compared to inconsistent pricers (1.04%). They also had a higher average return on assets of 0.76% compared to 0.71%.

“Advisors who price rationally and who demonstrate consistency outperform their peers,” said Trott. “Advisors should consider the value of their advice balanced against the value of the client relationship when they discount. Any revenue they may lose by offering a discount, they should get back, either through a referral to a new client or a greater share of the client’s wallet.”

Advisors who raised their commissions over the past three years actually improved their businesses and experienced less client attrition than advisors who did not, the report said.

While advisors as a whole reduced their average client load over the period, the data show that advisors who raised their prices by 25% or more lost fewer clients than other advisors with a decline of 6.1% versus 9.4%.

Further, average production increased 12% for the group that raised prices, compared to 9% for advisors who did not raise their fees. Advisors who raised prices saw a 10% growth in the number of households generating $2,500 or more in revenue compared to a 6% for other advisors.

“Raising prices does not result in significant client attrition, less revenue or fewer assets,” said Trott. “Rather, the facts demonstrate that advisor-client relationships can withstand repricing and that clients are willing to pay for trusted advice.”

The study reveals that advisors choose the price for a specific transaction for a number of reasons: what they believe the ‘right’ price is; rounding up or down to make a price easier to communicate; discounting to a price they believe clients are willing to pay or aligning price to compensation grid levels. Overall, the most popular pricing behaviour is to price a trade at a flat fee, a round number like $100 or $150. The most popular price for a trade is $100.

Firms should also work with their advisors to help them apply the new schedules, said Trott. For example, firms can establish minimum ticket sizes or reward good pricing practices. These steps can go a long way towards establishing and maintaining suitable pricing behaviour among advisors, he added.

“These are smart people and if they’re working for an employee firm, they’re earning 40% or 45% of the gross revenue as commission,” says Trott. “They have every economic incentive not to [discount], but they fool themselves.”

Vikram Barhat