Inside magazine issue 12 | Part 03 - From a corporate perspective

Product profitability in Wealth management and Private Banking Unlocking profit opportunities with enhanced reporting capacity

In light of ongoing industry challenges, managing profitability remains a priority for wealth managers. Product mix optimization stands out as a key enabler for top and bottom-line improvement. To unlock its potential, best-in-class wealth managers are developing methodologies for monitoring and steering profitability across the product portfolio.In our view, given shift driven by MiFID II and evolution in clients’ expectations, Product Profitability should be top priority on the agenda of Wealth Management CFOs.

Pierre MassetPartner Corporate Finance & CFO Services Lead Deloitte

François GillesDirector Strategy, Regulatory & Corporate Finance Deloitte

Justin Morel de WestgaverConsultantStrategy, Regulatory & Corporate Finance Deloitte

Inside magazine issue 12 | Part 03 - From a corporate perspective

Profit in the wealth management industry remains under pressureClient wealth levels suffered significant decreases following the recession in 2007-2008 that led to significant declines in wealth managers’ Assets under Management (AuM) and profitability. However, despite notable recovery in AuM since then, wealth managers are struggling to recapture the high profit margins they experienced in the past. Indeed, as illustrated in Figure 1, pre-tax profit margins remained between 17bps and 19bps while AuM grew by approximately 70 percent between 2008 and 2015.

100

81 8417

14 17 1918 18 18 19

100 115 124 131 142 157 169 169

8478 77 75 77

82

67 67 6561 59 57 58

AuM (indexed at 2008)

Pre-tax profit margin (in bps)

Revenue margin (in bps)

Cost margin (in bps)

Figure 1: AuM and pre-tax margin evolution

Inside magazine issue 12 | Part 03 - From a corporate perspective

There are many reasons why wealth managers’ profitability remains under pressure:

• Clients have grown increasinglyconservative and price sensitive.Indeed, following the financial crisis,many investors have downgraded the riskprofile of their portfolio and moved intolow-cost, index-based products, beingreluctant to move back into the types ofhigh-risk asset classes, such as equities,that tend to carry high operating revenueand margins.

• Additional regulatory pressure hasconstrained industry development.In recent years, a number of newregulations have been introduced andhad a multitude of consequences forwealth managers, such as: – Reduced financial resources (lendingcapacity, deposit-taking capacity) to comply with new capital requirements

– Reduced product scalability due to additional administrative burdens

– Increased transparency on the types of services provided and the associated pricing

industry product offering and pricing model to change toward “under contract arrangements” with separate and explicit charges for advice requiring banks to distinguish the product manufacturing costs from distribution, sales, and advisory costs.

This shift raises a number of questions, which can be broadly broken down into three main categories: (1) pricing-related questions, (2) manufacturing-related questions, and (3) distribution and product mix-related questions. Figure 2 presents some examples of questions on the agenda of decision makers in each category.

To optimally manage their product mix, decision makers need financial reporting at product levelTo answer the questions raised by the ongoing shift in the product offering and pricing model, wealth managers are increasingly looking to understand the factors that contribute to greater profitability. With a view to clarifying which products add to profit margins and

• Intensified competition has pushedwealth managers to add evengreater value. The removal of bankingsecrecy in offshore centers such asLuxembourg and Switzerland, theautomatic exchange of information andthe recent developments in the FinTechspace resulted in: (1) a reduction in thecompetitive advantages of establishedplayers, and (2) lower industry barriersto entry. Intense competition andmore transparent product offerings(particularly on prices) have empoweredcustomers to compare offers fromdifferent firms. These developments havesparked greater competition and createda need for wealth managers to clearlydemonstrate how they add value.

Industry forces induce a shift in product offering and pricing model As the likelihood of returning to pre-crisis margins is remote, wealth managers need to reinvent and rationalize their advisory product shelf. Moreover, the greater transparency required under MiFID II will push the wealth management

Pricing

• How should fees be adapted inresponse to the market shift inpricing model?

• How can clients be provided withgreater transparency on productpricing?

• What are the key components ofproduct pricing?

• Are existing products correctlypriced?

• How to best price new products?

Manufacturing

• How can product manufacturingcosts be optimized?

• What are the main drivers of thebank’s products costs?

• Which products are the mostexpensive to make?

• Which products are the mostscalable?

• Would it make sense to outsourcethe production of some products(make or buy)?

Distribution/product mix

• What percentage of relationshipmanagers’ time is spent on sellingand managing WM products?

• Which products are the mostexpensive to sell? What are theunderlying reasons (i.e., pre-, on- orafter-sale)?

• Which products are key drivers ofthe bank’s profitability?

• Are some products unprofitable?

Figure 2: Examples of questions on the agenda of decision makers

Inside magazine issue 12 | Part 03 - From a corporate perspective

the underlying drivers, best-in-class wealth managers are developing methodologies for reporting profitability across the spectrum of products.

The challenge, however, is that it can often be difficult to obtain a clear picture of product profitability:

• Tying back revenues to the underlyingproducts is constrained by complexaggregation methods across variousincome streams from fees, interestincome, trading and other sources.

• On the other hand, 50 percent to 70percent of wealth manager costs aretypically not directly product-related(e.g., client acquisition costs, relationship

management costs, overheads and other costs) and need to be allocated based on ad hoc methodologies.

• Moreover, the cost and revenue datarelating to services provided to individualclients is often difficult to consolidatefrom the various accounting andmanagement information systems thatcross different businesses and functions.Thus, the true operating earnings forvarious profit centers are often hard toascertain given complex, incomplete, orsometimes inaccurate cost and revenueallocations.

In light of these challenges, wealth managers often have to arbitrate between sophisticated models (based on bottom-up

Design

Objectives

Key challenges

Implementation Integration Maintenance and evolution

• Evaluate dataavailability and gatherbusiness inputs

• Define a revenue andcost allocationmethodology atproduct level

• Develop a prototype

• Define target solutionTOM

• Specify the reportingtarget solution

• Implement thereporting targetsolution

• Run the prototype ona recurring basis

• Test the implementedreporting engine

• Go live with the targetsolution

• Implement TOM

• Ensure the alignmentof the allocationmethodology withthe bank’s evolution

• Enhance the reportto cope with newrequirements

6–12 months

• Top-down vs.bottom-up

• Multiple reportingneeds

• Need forprioritization

• Availability andquality of data

• Complexity vs.reportingfrequency andspeed

• Integration inproductionenvironment

• Need to adapt tochange

• Need to managecomplexity

• Governance

Figure 3: Product profitability reporting capability development process

allocation methodologies), which are more insightful but require higher investments upfront, and tactical solutions (based on top-down allocation methodologies), which are less insightful but are easier to establish and maintain.

Developing a product profitability reporting capability means following a processRegardless of the type of model chosen by the wealth manager (sophisticated vs. tactical), developing a product profitability reporting capability usually means following a three-step process typically lasting between 6 and 12 months (see Figure 3):

Inside magazine issue 12 | Part 03 - From a corporate perspective

As shown in Figure 4, wealth managers may wish to follow a five-step approach as they identify and implement profit-enhancing strategic actions.

1. The first step is to leverage profitabilityreporting to identify areas of thebusiness where there is room forimprovement. This starts with a set ofqualitative and quantitative observationslisted and grouped into major functionalsegments that provide an assessmentof the current state of the business.Typically, a product profitability reportwill be assessed with reference to twomain dimensions:

• Product mix: Analysis of overallprofitability through an assessment ofresource allocation across products.

• Individual product P&L: Analysis ofindividual product profitability throughan assessment of resource allocationalong the value chain.

01 02 03 04 05

Assess currentstate

Develop a target state

Assess gaps Identify strategicactions

Develop a roadmap

Leverage product profitability reporting to identify profit-enhancing strategic avenues

Develop strategic vision of a future state by defining specific and measurable objectives

Identify gaps between the current and target states needing to be filled to achieve the vision

Identify areas of improvement corresponding to the possible gaps identified

Identify areas of improvement corresponding to the possible gaps identified

Figure 4: Recommended approach to identify and implement profit-enhancing strategic actions

1. Design phase: The key objectives of thedesign phase will be (i) the definition ofa methodology for allocating revenueand costs at product level, and (ii)the implementation of a prototypefor the purposes of producing a pilotproduct profitability report. The mainpurpose of the pilot report is as thecreation of a communication tool thatcan be used to validate the overallframework (e.g., product structureused, P&L structure used, etc.) and theproposed methodology with key projectstakeholders. Once the pilot report hasbeen formally approved, the projectteam in charge can proceed with theimplementation phase.

2. Implementation phase: The mainobjectives of the implementationphase are to (i) specify the reportingcapability target solution from abusiness, functional and technicalpoint of view, and (ii) implement thespecified target solution. This secondphase is considered complete whenthe implemented solution is ready tobe tested and released in a dedicatedenvironment.

3. Integration phase: The key objectivesof the integration phase are (i) to testthe implemented reporting solutionto ensure that it is consistent with thespecification, and (ii) to integrate thesolution into the wealth manager’sproduction environment.

It is important to note that the prototype developed during the design phase will typically be used to generate product profitability reports on a recurring basis throughout the subsequent phases. In this way, wealth managers can start sharing product profitability results after only a few months and thereby improve the extent to which the ultimate report may be used as a basis for action.

Steering product profitability and laying the foundations for future strategic decisions at management level The ultimate purpose of developing a reporting capability to track profitability at product level is to identify high-impact opportunities to invest, divest, and reduce costs where appropriate. Product profitability reports may uncover a broad range of opportunities that could be seized to increase profitability.

Inside magazine issue 12 | Part 03 - From a corporate perspective

2. The second step focuses on developinga strategic vision of the future state ofthe business. This phase often involvesmultiple functional departmentsacross the organization (e.g., frontoffice, operations, risk, compliance, andlegal) so that diverse, often conflicting,perspectives are taken into account andsignificant stakeholders are engaged.Setting specific and measurableobjectives during this phase is ofparticular importance because it mayestablish clear points of reference andguidelines throughout the followingsteps of the process.

3. The third step consists of comparingthe analysis of the current state of thebusiness with the target state visionand determining gaps that need to beaddressed to reach the target state.This step is crucial because it links theobservations identified in previous stepsto strategic actions in the followingsteps. Gap definitions need to be veryspecific and broken down by functionalareas as much as possible to helpinvolved parties identify the root causeof the issues.

4. The fourth step focuses on theidentification of possible strategicactions that may be executed toclose the gaps and achieve the targetstate. Strategic action selection isbased on specific objectives, potentialscope, timing, and required return oninvestment. Examples of high-levelprofit-enhancing strategic actionsidentified by wealth managers based onobservations made regarding productprofitability reports are presentedhereunder:

• Product rationalization andharmonization across marketsand segments

• Product standardization(e.g., decreased number of options/flexibility)

• Automatization/rationalization ofmiddle and back office processes

• Alignment of product distributionchannels with customer behaviors

• Frontline staff efficiency optimizationthrough advanced analytics

5. Lastly, the fifth step consists ofdeveloping a set of practical activitiesto be performed and milestones to bereached to effectively implement theinitiatives previously identified. The focusshould be on both quick wins as well ason long-term sustainable initiatives tomake profitability an ongoing process.The roadmap should strike a balancebetween complexity and risks versusthe magnitude of the transformation,and evaluate improvements againstthe transformation timeline. Clearowners and accountable partiesshould be identified and empoweredto enable effective delivery in line withexpectations. During this phase, thecreation of a “transformation summarydashboard” that tracks accomplishmentsagainst objectives on a quarterly ormonthly basis can help monitor progressand prioritize remediation actions asneeded.

Key takeaways

• Profit in the Wealth Managementindustry remains under pressure

• Product mix optimization standsout as a key enabler for top andbottom-line improvement

• Best-in-class wealth managersare developing methodologiesfor monitoring and steeringprofitability across the productportfolio

• In our view, given shift drivenby MiFID II and evolution inclients’ expectations, ProductProfitability should be a toppriority on the agenda of WealthManagement CFOs

In our view, given shift driven by MiFID II and evolution in clients’ expectations, Product Profitability should be a top priority on the agenda of Wealth Management CFOs.