Winning in wealth management Strategies for building ...oportunidades.deloitte.cl/marketing/Reportes... · by its resilience in the light of the market turmoil in 2008. The model

Winning in wealth management Strategies for building profitablebusiness operating models

Audit. Tax. Consulting. Corporate Finance.

Contents

Foreword 1

About the research 2

Executive summary 3

Wealth managers in the profitability trap 5

Managing complexity to focus on profit 12

Winning business operating models 22

Transformation agenda 26

Conclusion 30

Key contacts 31

Contacts 32

Winning in wealth management 1

The financial crisis has provoked a major turning point for the financial services industry, changing the very basis ofcompetition from growth to profitability. At the same time, the industry has had to withstand significant regulatorychange and political pressure. Wealth managers now must deal with a short- to mid-term profitability trap, whichseriously challenges the entire industry. Our research will show that clear winners and losers will emerge.

Individual wealth management providers must focus their efforts on key profitability levers and transform theirbusiness operating models (BOM) to avoid being caught in this profitability trap, and to succeed in the changingcompetitive landscape. This structural shift requires a fundamental reappraisal of the strategic drivers of success inwealth management.

This report investigates the root causes of the unprecedented decrease in Swiss-based wealth managers’ profitabilityand explores differences in profitability and key characteristics among individual wealth management providers. Our research concludes with the perspectives on how to build and operate a profitable wealth managementinstitution.

To identify the key characteristics of “winning” wealth management providers, this report will answer the followingsix key questions:

Dr. Daniel KoblerHead of Financial Services Strategy Consulting

Foreword

• How has the profitability of wealth managers evolved over time?

• What are the key levers which have a direct influence on profitability?

• What is the impact of those levers on wealth manager’s profitability?

• Which business operating models are predominant in the market?

• What are the common features of “winning” business operating models?

• What are the main strategic initiatives focusing on business operating model transfromation?

2

This report summarises the results of a majorquantitative study based on an in-depth analysis ofSwiss headquartered and often globally active, wealthmanagement providers.

Our research goes beyond simple profit margin analysis.It also evaluates profitability drivers (financials) andprofitability levers (non-financials) and examines theirimpact on wealth managers’ value generation by meansof statistical analysis.

The empirical work is based exclusively on publiclyavailable quantitative and qualitative data for the periodbetween 2004 and 2008. The selected time periodallows for a comparison of Swiss-based wealthmanagers’ pre- and post-crisis profitability levels inorder to highlight the characteristics of “winning”players in both a bullish (2004-07) and bearish (2008)market environment.

The scope of our analysis includes 103 wealthmanagement providers in Switzerland, accounting for73% of the total number of players in the Swiss wealthmanagement market.1

About the research

Scope of this research

Wealth managerselection criteria

• Our analysis covers pure play private banks, foreign banks withwealth management operations in Switzerland, selected cantonalbanks, and asset managers with private banking activities.

• Wealth managers were selected based on:− Client assets in excess CHF 1bn.− Public availability of financial data and information.− Sufficiently granular private banking segment reporting.

• Institutions not meeting these criteria (e.g., small banks, smallercantonal banks and UBS/Credit Suisse) were excluded from theanalysis.

Client assets • Client assets are defined as the sum of private and Institutional assetsin discretionary mandates, assets under advisory and assets onlyunder custody.

• For reasons of simplicity, they are collectively referred to as Assets under Management (AuM) throughout this report.

Publicly availableinformation

• The information used in our research has been retrieved from company reports, SNB filings and FINMA reports.

• The data covers the time period between 2004 and 2008.

1 This research covers 103 of the total of 141 market players; as defined by “WealthManagement inSwitzerland”, SwissBanking Association[2009], p.11

The selected timeperiod allows for a comparison ofSwiss-based wealthmanagers’ pre- andpost-crisisprofitability levels …


Caught in a profitability trapWealth management providers are facing significantchallenges. The industry’s average profit margindecreased by 27% from 2007 to 2008. It is expected to recover in 2009 by a mere 3%–10% and is thenexpected to continue its recovery in 2010 and beyond.We expect many wealth managers to be caught in a short to medium-term profitability trap if no decisivecountermeasures are undertaken, because the financialmarket upturn does not fully compensate for theindustry’s hampered revenue generation. In addition,many wealth managers also struggle with an inflexiblecost base, which has an even greater negative impacton their ability to restore profitability.

Determine key profitability leversIn order to address the resulting profitability challenge,wealth mangers have to identify and address those key profitability levers which directly impact valuegeneration. By means of statistical analysis we havequantified the positive or negative contribution (in basispoints) of a pre-defined set of profitability levers to a wealth manager’s overall profit margin. Our analysissuggests that the following eight levers strongly driveprofitability in a manner that either adds value orreduces it:

• A clear focus on Affluent/High Net Worth clientsand an Institutional client base are very strongprofitability contributors in any kind of market.

• Producing & offering traditional products is verymarket sensitive and has to be managed very carefully

• Producing & offering market tracking productsis a significant profitability slayer, indicating that theindustry is facing a lack of scale.

• Producing & offering extended services will, in thenear future, also be a key differentiating factor as thisrepresents one of the most powerful means ofovercoming clients’ trust deficit.

• Outsourcing single or multiple back officeservices, when planned and executed correctly, yieldsconsiderable added profitability and is an indicator ofoperational excellence in this part of the value chain.

• Maintaining an international footprint – in thecontext of a stricter regulatory environment –characterises a profitability cultivator in the near term.

• Running a proprietary trading function turned outto be a loss maker over the last two years.

The levers described above form an integral part of a wealth manager’s business operating model (BOM)which breaks down the structure of a market player’sorganization into its elements, covering the entirebusiness value chain (clients, channels, product/services,processes, organization and other elements). Depending on how a wealth management institutioncombines individual profitability levers to design itsbusiness operating model, it may achieve differentprofitability levels. For the Swiss market, profit marginsranged from 14bps to 54bps in 2008.

Winning business operating modelsOur analysis suggests that there are ten predominantbusiness operating models in the wealth managementindustry. The most successful of these is distinguishedby its resilience in the light of the market turmoil in2008. The model entered 2008 in a strong position,having already performed extremely well in 2007, when it exhibited an absolute profit margin of 58 bps(54 bps in 2008). This model also demonstratedattractive annual profitability growth of 6% (6%) in the period between 2004 to 2007 (2004 to 2008),respectively.

This most successful business operating model’s setupcan be described as follows:

• Internationally present (domestic and global onshoreas well as offshore) wealth manager.

• Focusing on Affluent/HNW as well as Institutionalclients.

• Offering custody, advisory and brokerage services aswell as discretionary mandates.

• Producing and offering traditional products (ownmutual funds, absolute return mandates, managedfunds portfolios).

• Outsourcing single or multiple back office services.

Executive summary

4

Our analysis found no evidence that either a strongfocus on client asset growth or the radical quest formore simplicity (equaling the simplest BOM setup) havehelped to achieve superior profitability.

We have observed that more than half of the wealthmanagement players in this study face serious challengesto sustainable profit generation. Their models are neitherrobust, resilient nor flexible enough for the new era.These players therefore have to expect below-averageabsolute profitability and continued negative profitgrowth in the near future, unless a strategic operatingmodel change is undertaken.

Eight strategic initiatives to escape theprofitability trapIn order to extricate themselves from the short tomedium-term profitability trap, wealth managers areforced to transform their current BOM.

Eight strategic initiatives which impact the identified keyprofitability levers act as catalysts of change:

Strategic initiatives

• Sales & Service Effectiveness.

• Improved Organizational Model Execution.

• Product Sourcing & Management.

• Product Profitability Management.

• Service Delivery Model Effectiveness.

• Proprietary Trading Reorientation.

• Operational Excellence in Back Office.

• On/Offshore Business Model Redefinition.


Ever since the outbreak of the financial crisis, wealthmanagers’ revenue generation has been severelyhampered by political and regulatory pressure, anunfavourable shift in private clients’ investmentbehaviour and a considerable trust deficit. Also, aninflexible cost base has prevented many market playersfrom fully absorbing the revenue shock. We argue thatwealth managers cannot rely solely on bullish marketconditions to restore their profitability margins. The industry will thus be stuck in a short- to mid-termprofitability trap if no countermeasures are undertaken.

Aggressive growth in boom timesWealth management has been a lucrative business inthe past decade. The industry saw the glory of growthand prosperity during the period 2004 to 2007, whichwas characterised by surging asset prices and growth in measurable wealth in the global financial markets.

Throughout these boom times, many wealth managersimplemented aggressive growth strategies andexperienced a surge in the volume of client assets. The race to capture asset growth was run mainly in thebelief that asset size was the most powerful driver ofprofitability.

Wealth managers in theprofitability trap

6

Consequently, revenue margins rose from an average108.1 bps in 2004 to 113.6 bps in 2007. At the sametime, the industry reduced its cost-margins from 73.1 bps to 68.4 bps. This heady mix translated intoattractive profit margins,2 which grew at an annualaverage rate of 9% over that period [see Figure 1].

From boom to doomHowever, the global financial crisis triggered a rapid andunprecedented decline in profitability. Our researchsuggests a staggering 27% decrease in the industry’saverage profit margin from 2007 to 2008.

Client assets held by wealth managers declined by 26%over the same period, reflecting the drastic assetattrition observed in the financial markets in 2008 (theSPI for example fell by 34% in 2008).

This reveals that the industry’s heavy reliance oncommission- and fee-based revenues has elevated its aggregate exposure to financial market cycles. In addition, high risk aversion on the part of investorsdrove down transaction volumes; further slashingwealth managers’ commission/trading income.

However, our data suggests that the resulting drop inoperating revenues was comparatively less dramaticthan the decline in the size of wealth managers’ client assets (19% reduction in operating revenues3 asopposed to 26% asset attrition). Revenue marginstherefore increased by 6% in 2008.

2 Profit margin equals thedifference betweenrevenue and cost margin;revenue margin denotesthe ratio between totaloperating income [netinterest income,commission and feeincome, net tradingincome and other ordinaryincome] and total clientassets; cost margindenotes the ratio betweentotal operating expenses[personnel and otheroperating expenses] andclient assets

3 Our research suggeststhat Swiss wealthmanagers’ operatingrevenues totalled CHF 49.6 bn in 2008 ascompared to CHF 61.3 bnin 2007. This correspondsto a decrease of 19%

= CAGR 2004-2007

Source: Deloitte Research [2009]

= One-year growth rate (2007-2008)

* Client assets are calculated according to the strictest definition, namely client portfolio holdings in domestic branches

** 2009 estimates are calculated based on figures for the first half of 2009. Due to limited availability of public data, a restricted sample of wealth managers has been considered for this estimation

Client Assets (CHF tn)*

+16% -26%

–

+9%

Profit Margin** (bps)

+28% -2%

Revenue Margin (bps)

+2%

+6%

Cost Margin (bps)

-27%

Figure 1. Average profitability of Swiss wealth managers

0

2

4

6

20082007200620052004

4.1

5.454.4

3.5

0

50

100

150

20082007200620052004

120.9113.6109.3107.4108.1

0

25

50

2009E20082007200620052004

37.0

34.0

45.2

33.141.537.435.1

0

50

100

20082007200620052004

87.8

68.467.97073.1


Many private banking clients have seen theirinvestments decline. In consequence, a significantnumber of these automatically slid into moreunfavorable fee schemes.4 This side-effect protectedwealth managers’ revenues from shrinking even further.

In addition to declining revenues, costs did not developfavorably. In the pursuit of asset growth, many wealthmanagers expanded their presence to internationalbusiness locations.

Some established booking centers, others local onshorebusiness and many expanded their range of services,such as complex products offering. These undertakings,combined with the decline in the size of wealthmanagers’ client assets contributed to the 28% increase in cost margins between 2007 and 2008.

4 Private banks often chargetheir clients periodic feesas a percentage of theassets held in theiraccounts. Typically, thehigher the size of theassets held in an account,the lower the percentageused to express these fees

Focus box 1: Asset growth alone does not equal profitability

Prior to the market turmoil, the industry considered asset size and asset composition as the most powerful value drivers. As a consequence, many wealth managers focused strongly on acquiring new offshore clients and invested heavily in theirinternational presence. However, our research suggests that banks with particularly aggressive asset growth between 2004and 2007 did not exhibit significantly higher profitability in 2007 [see Figure 2]. On the contrary, wealth managers withaggressive asset growth faced a lower absolute profit margin and profit margin growth compared to players with low ormoderate asset growth. Chasing growth therefore captured headlines but – even in booming markets – did not necessarilyresult in higher profitability. Further analyses indicate that aggressive growth strategies on average resulted in a simultaneousdecrease in both cost and revenue margins, revealing a trade-off between asset growth and profitability realization.

Figure 2. Asset growth and profitability

No correlation between AuM growth and absolute profit margin

120

100

80

60

40

20

0

Profi

t M

argi

n 20

07 (b

ps)

Profi

t Mar

gin

CAG

R 04

-07

(%)

-30% -10% 10% 30% 50% 70% 90%

AuM CAGR 2004-2007 (%) AuM CAGR 2004-2007 (%)AuM AuM

Weak correlation between AuM growth and profit margin growth

50%

30%

10%

-10%

-30%

-20% 0% 40% 60% 80%20%

R = 0.085

R = 0.02

Source: Deloitte Research [2009] based on company data [N=103]

Caught in the profitability trap Despite recovering capital markets – there has been a 23% increase in market capitalisation betweenDecember 2008 and December 2009 – we argue thatin the short- to medium-term the wealth managementindustry’s profits will remain significantly below therecord levels seen in 2007. We expect profit margin for2009 to be between 34 and 37 bps. This implies a raise of around 3-10% and puts the industry back onthe profitability level of 2004 [see Figure 2 & 3]. Even though asset revaluation will continue to have

a positive effect on wealth managers’ asset based feesand indirectly on commission incomes, several distinctfactors in the market [see Figure 3] are impeding wealthmanagers from fully restoring their historic profitmargin levels. We therefore expect many institutions tobe caught in a short- to medium-term profitability trapif no swift countermeasures are undertaken. First, thehindering factors will put additional pressure on manymarket players’ future revenues. Second, they willhamper wealth managers from re-shaping their costbase in order to accommodate their revenue challenge.

8

Costs

Pressure onoffshorebusiness

Unfavorableasset

allocation

Trust deficit

Increasingregulatory

costs

Limited effectof short-term

measures

Restructuringcosts

• Increasing regulatory pressure

• Introduction information exchange standards in tax matters

• Tax amnesties

• Clients maintain risk averse strategic asset allocation

• Continue to avoid high-margin services

• Clients switch providers more easily and commit less often to fiduciary business

• Clients seek external advisors/exhibit parts-buying behaviour

• A stricter regulatory environment is likely to cause extra costs in the mid term

• Short term cost savings, bonus reductions and the investment freeze do not reach farenough

• Potential restructuring costs put an additional strain on wealth managers’ cost base

1

2

3

4

5

6

Factors impeding timely profit margin restoration

Dec

2008

Dec

2007

Dec

2006

Dec

2005

Dec

2004

35.1

bps

37.4

bps

5742

pts

6929

pts

6925

pts

45.2

bps

33.1

bps

4567

pts

5626

pts

Average profit margin of wealth management industry (basis points)*

Swiss Performance Index (index points)

*2009 figures are estimates based on the publicly available first half figures of a restricted sample of Swiss wealth managers

Indicative

Dec

2009

+ 23%

37.0

bps

34.0

bps

Figure 3. Hindering factors

Profitability trap

4234

pts

41.5

bps

Profit

Revenues



Hampered revenue generation[1] Recent political and regulatory pressure on Swiss wealth managers with a material share ofoffshore business and on the Swiss offshore privatebanking hub has forced the industry to reduce itsrevenue projections. There are three factors driving thisdevelopment. First, client acceptance criteria havebecome more rigid, preventing wealth managers from“on-boarding” offshore client segments that representan unacceptable reputational risk due to their countryof residence. Second, existing service models foroffshore clients need to be modified to cater for thenew realities. Third, the offshore client segment’sproduct and service needs are slowly convergingtowards those of the slightly profitable domesticonshore clientele.

As a consequence, and particularly in terms of thenewly-accepted OECD transparency and informationexchange standards and tax matters, the impact ofincreasing regulatory pressure is considered to be oneof the biggest threats to offshore revenues. Othersignificant threats emanate from tax amnesties in majorEuropean countries and from the increasing pressure onthe part of European governments for the implementationof an automated administrative assistance system withregard to tax issues. In the near future thesedevelopments could well drive assets back onshore.

[2] Investors remain wary of investing in complexproducts with attractive revenue margins for wealthmanagers. Since the outbreak of the market turmoil in2007, private clients have gravitated towards secure/simpler asset classes. Money market instruments servedto park liquid assets temporarily during turbulent times[see Figure 4].

604bn

390bn

464bn0.7%

1.5%

5.9%

0.4%8.3%

35.0%

15.8%

40.3%

34.9%

26.2%

31.5%

5.6%

33.5%

23.5%

36.9%

Private onshore clients Private offshore clients

Secu

riti

es h

old

ings

in S

wis

s cu

stod

y ac

coun

ts (C

HF

bn)

1,200

1,000

800

600

400

200

0

Boom peak(Jun 2007)

Trough(Feb 2009)

Recovery phase(Oct 2009)

SharesStructured products Money market instruments

Bonds Units in collective investment schemes

1078bn

656bn

708bn

2.5%

4.4%

5.9%

2.0%

8.2%

48.4%

22.3%

46.2%

27.3%

14.5%

7.9%

43.7%

18.5%

Secu

riti

es h

old

ings

in S

wis

s cu

stod

y ac

coun

ts (C

HF

bn)

1,200

1,000

800

600

400

200

0

Boom peak(Jun 2007)

Trough(Feb 2009)

Recovery phase(Oct 2009)

Note: Derivates and other securities are not shown in the chart above. Percentage changes are based on rounded total assets.

18.6%

7.6%

27.9%

Source: Deloitte Research (2009)

Figure 4. Shift in client’s wealth allocation

10

Private clients often see their relationship managers astoo sales-oriented, are unsure whether they arereceiving objective advice or best-in-class products andtherefore take investment advice with a pinch of salt. Investors typically react by retaining thefinancial decision making, engaging independentfinancial advisors to better “manage” their wealthmanagers or even by avoiding the market entirely.

“Sticky” costs[4] Wealth managers’ cost side will generally not beable to fully absorb the revenue shock in the nearfuture. Risk management and compliance costs haveincreased substantially over the past few years and areexpected to grow even further as a result of increasingregulatory requirements. The financial crisis and recentmassive investment frauds are driving a new wave ofregulations. The financial services industry is likely toface increased capital requirements and it will need toadapt its compensation models to the changing riskenvironment.

Moreover, wealth managers’ costs will also increase dueto the unrelenting international pressure, forcing marketplayers in major offshore locations to take a critical lookat their compliance. Many wealth managers will needto make significant investments to ensure that theirproducts and services are in line with tighteningregulation. In reaction to changes in public opinion,some players have already started to establish improvedonshore offerings. These often result in higher costsboth in terms of infrastructure and resources required to fulfil the need of onshore clients for frequent contactwith their advisors.

More recently, private clients have started to re-direct theirassets from money market instruments towards equitiesand bonds.

Simultaneously, asset volumes of equities and productswith more favourable revenue margins (e.g., structuredproducts and collective investments) plummeted, dueboth to asset devaluation and net new money outflows. This has had a significant effecton the wealth management industry’s bottom line.However, non-resident account holders were moreprone to invest in products with higher margins fortheir wealth managers than onshore clients,highlighting the importance of the non-residentbusiness on overall revenue generation.

More recently, private clients have started to re-directtheir assets from money market investments towardsequities and bonds.

The rebound in the capital markets has reduced theattractiveness of near cash instruments. Instead, itfuelled private clients’ desire to benefit from revaluationof more risky asset classes. However, Figure 4 highlightsthat the investment funds, and in part, the structuredproducts industry too, have suffered from shrinkingasset volumes even in the course of recovering capitalmarkets.

On and offshore clients’ volumes held in these assetclasses have decreased between the climax of the crisisand November 2009 (with the exception of structuredproducts for offshore clients). Investors’ newly foundappetite for risk does not automatically imply anincreased willingness to invest in complex vehicles.

[3] Wealth managers are still confronted with aconsiderable trust deficit. Our discussions with HighNet Worth private clients have revealed that manyremain sceptical about their wealth managers,irrespective of the current rebound of most capitalmarkets.


[5] Whilst cost reduction initiatives aiming at a quickreduction in personnel expenses and bonuses – as wellas minor headcount cuts – are effective near-term, theymay not suffice to fully overcome wealth managerscurrent cost disadvantage. To unlock longer-term costsavings that contribute to closing the profitability gap,wealth managers need to review all aspects of theirbusinesses.

[6] Restructuring decisions need to be assessedcarefully, as corresponding programmes are generallyaccompanied by major challenges. These are likely toput an additional strain on wealth managers’ cost base.If not managed effectively, restructuring efforts mayfurther deplete wealth managers’ short- to mid-termprofitability.

Restoring profitability is likely to prove difficult for manywealth managers as the ripple effects of the financialcrisis have further added to the complexity of theirmarkets and propositions. External and internal factorsdriving wealth managers’ profitability have changedrapidly. This “game change” looks set to continue sincemultiple market parameters, including the changingregulatory environment, volatile capital markets, wealthgrowth, customer behaviour and technology adoptionwill lead to even shorter market cycles and will impactwealth managers’ ability to generate sustainable profits.

In light of the expected “game change” Swiss wealthmanagers have considered retreating from the Swissmarket [see Focus box 2]. We therefore expect anoticeable consolidation wave in the near future.

For most of the market participants, however, astructured approach towards managing the rapidlyincreasing complexity of their business has become acrucial prerequisite for extricating themselves from theimminent profitability trap. The following sectionelaborates on how complexity can be managed as oneof the most effective strategic instruments to achievesustainable profit generation.

“We reckon it’s no longer asolution to sit out the bad timesin the belief that our revenueissue will vanish into thin airwhen markets pick up again.”

Head of Private Banking, Swiss wealth manager

Focus box 2: Opting out has become an option

As a result of the turmoil in the capital markets and of their sluggish recovery, retreatingfrom the Swiss market has become an option for a considerable number of foreign bankswith Swiss wealth management operations.

Figure 5. Drivers of market consolidation

First, several institutions savaged by the capitalmarkets meltdown need to divest in order tosurvive. Second, maintaining wealthmanagement operations in offshore destinationsis no longer politically feasible for some newlystate-owned global players (given the fact thattheir government is leading the internationalefforts against tax evasion). Third, the decisionto opt out is driven by the fear of reputationaldamage, implementation of a refocusingstrategy or simply a wealth manager’s inabilityor unwillingness to bear the additional costburden caused by soaring regulatoryrequirements.

Mar

ket

cons

olid

atio

n

1Need to divest to tacklefinancial difficulties

2Heavy government influence

3

Fear of reputational risk

4

Refocus on core activities

5Unwillingness to bearspiralling costs forregulation and compliance


12

Wealth managers need to manage complexity byfocusing their efforts on selected key profitability leversto restore their pre-crisis profitability levels. In 2008,wealth managers with their own traditional and markettracking products and a dedicated proprietary tradingfunction exhibited a profitability disadvantage vis-à-vistheir peers. In contrast, market players with a clearfocus on Affluent/HNW clients, a strong Institutionalclient base, an extended service offering, outsourcedbusiness processes, and an international footprintexperienced superior profit margins.

Identifying key profitability levers Senior executives cannot influence and control everyaspect of the complex wealth management business.The key to managing complexity in challenging marketsthus lies in identifying the internal levers which directlydrive profitability.

The limited ability of wealth managers to grow withoutcompromising profitability imposes a need to widentheir previously narrow perspective in their quest torestore profitability. Instead of zeroing in on plain assetgrowth, revenue and cost targets, wealth managersshould improve their understanding of relevant non-financial and internal factors that drive profitability.

It is critical that wealth managers address thecomplexity of their business operating models (BOMs)holistically. A wealth manager’s BOM [see Figure 6]determines how the chosen business strategy will beexecuted.

Managing complexity to focuson profit

The business operating model breaks down thestructure of the wealth manager’s organisation into its elements and components, allowing the impact ofthe chosen strategy to be seen in a structured manner.It therefore addresses all the relevant strategic questionscovering the entire business value chain from clients tophysical sites.

As will be substantiated in this report, a significantshare of the profitability differences between individualmarket players can be explained by the specific designof their business operating model along the differentBOM components.

Given a wealth manager’s strategic intent, which of theprofitability levers should senior executives address as a priority in order to improve profitability?

To answer this question, we followed a three-stepprocess. Step one, we identified all profitability driversand levers [see Focus box 3.0 and 3.1] that can bedetermined with company information available in thepublic domain.


Figure 6. Profitability drivers, profitability levers and strategic key questions

Business strategy Profitability levers Profitability drivers

Strategic key questions BOM elements BOM components

• Client segmentation• Client insight• Client targeting

• Relationship manager• Traditional, new and emerging channels• Multi-channel management

• Product/service offering• Product sourcing management• Pricing

• Process model• Resources capacity• Finance/performance measurement

• Single client view data• Core banking and trading data• Performance management data

• CRM system• Core banking and trading system• Performance management system

• Organisational structure• Business unit interfaces• International dimension

• Service delivery model• Skills capacity • Incentive systems

• Branches• Representative offices • Processing hubs

Clients

Revenues

Costs

Asset composition

Balancesheet items

“Which clients?”

“Via which clients?”

“Offered which products and services?”

“Supported by whichprocesses?”

“Requiring what information?”

“Using which enablingtechnologies?”

“Organised in which wayto deliver?”

“Requiring what resources and skills?”

“In which locations?”

Channels

Physical sites

Products/services

Processes

Information

Bus

ines

s va

lue

chai

n

Profitability(profit margin)

Technology

Organisation

People


It is critical that wealth managers address thecomplexity of their business operating models(BOMs) holistically.

14

Focus box 3.0. Definition of profitability drivers and levers

Figure 7. Publicly available financial information on profitability drivers

Profitability

• Profit margin• Revenue margin• Cost margin• Cost/income ratio

Revenues

• Net interest income• Net commission and fee income

• Net trading income• Other ordinary income

Asset composition

• Client assets• Net new money (NNM)• Assets in discretionary mandates

• Assets in own funds

Costs

• Personnel costs• Other operating costs

Balance sheet items

• Loans and advances to clients (Lombard credits)

• Securities lending volume



Focus box 3.1. Definition of profitability drivers and levers

Figure 8. Publicly available non-financial information on profitabily levers

BOM elements Profitability levers Key questions analysed

Clients Focus on Affluent/HNW clients Focus on Affluent/High net worth clients?

Focus on V/UHW clients Focus on very/ultra high net worth clients?

Serving Intermediary clients Specific value proposition for Intermediary clients exist?

Serving Institutional clients Specific value proposition for Institutional clients?

Products/services

Producing and offering traditional products Mutual funds, absolute return mandates and/or managed fundportfolios produced and distributed?

Producing and offering market tracking products Index funds and/or exchange traded funds produced and distributed?

Producing and offering alternative investments Structured products, quantitative products, private equity and hedgefunds produced and distributed?

Producing and offering extended services Complex financial planning requirements of clients addressed and/orlifestyle products offered?

Degree of openness of product architecture Relative penetration of own products in client portfolios?

Process Standardised advisory process Standard advisory process with corresponding system supportintroduced?

Organisation Outsourcing single/multiple back office services Specific parts or all back office functions outsourced?

Degree on organisational independence Subsidiary of a Swiss/foreign bank or truly independent?

Listing on Stock Exchange Wealth manager or parent listed?

Running a proprietary trading function Trading on own account covering a variety of strategies, such asindex, statistical, merger and volatility arbitrage as well asfundamental analysis and macro strategies?*

Maintaining an investment banking function Own investment banking division (covering M&A, ECM, DCM and/orFinancing business)?

Technology Core banking solution Core banking solution sourced externally or built in-house (packagesolution)?

Application service outsourcing One or multiple applications sourced to an external ASP?

IT outsourcing Specific parts or entire IT infrastructure (hosting) outsourced?

Physical sites Maintaining an international footprint • Domestic onshore and offshore business only?• Domestic on/offshore and European onshore business?• Domestic on/offshore as well as selected global onshore business?• Truly global onshore business?

* Proprietary trading related to market making and product management is not considered here (out of scope)


Step two, we determined the degree of interconnectivitybetween identified profitability levers by means of across-impact analysis. The aim of this step was toeliminate those profitability levers which exertuncontrollable influence on other levers in the system,and those levers which did not influence profitability at all. These types of levers are called “critical”,“buffering”, and “reactive”.

Step three, we investigated the net effect of each leveron an average wealth manager’s profit margin for theyears 2007 and 2008. For this purpose, we appliedstatistical methods to the publicly available financial and qualitative data of 103 Swiss-based wealthmanagers in our research.

16

The subsequent analysis focuses on the selected eight“active” levers in order to identify their impact onprofitability.

Finding the golden nuggets – the eight “active”profitability leversLevers exhibiting a strong influence on profitability whilenot having uncontrollable effects on other leversrepresent the most favourable starting point formanagement to find a way out of the profitability trap.

We identified these so called “active” levers by applyinga sensitivity network [see Figure 9].

Our analysis highlights that all “active” levers relate tothree distinct BOM elements of a wealth manager: theydetermine which client segments a wealth managerintends to focus on (levers 1-2), specify what kinds ofproducts and services are offered (levers 3-5) and definethe internal organisation (levers 6-8). These three BOMelements therefore represent the most critical areas forconsideration by a wealth manager when reconfiguringa BOM setup.

Figure 9. BOM profitability levers in the sensitivity network

Sensitivity network Key profitability levers

Deg

ree

of in

fluen

ce

Degree of influenceability

Active Critical

Reactive

9

10

12

17

181615

14

13

11

5

2

8

6

1

3

7

4

Focusing on Affluent/HNWI clients

Serving Institutional clients

Producing and offering traditional products

Producing and offering market tracking products

Producing and offering extended services

Outsourcing single or multiple back office services

Maintaining an international footprint

Running proprietary trading function

Buffering

1

Other profitability levers

Producing and offering of alternative investments

Degree of openess of product architecture

Full-fledged investment banking function

Serving intermediary clients

Organisational independence

Listing on Stock Exchange

Standardised advisory process

IT outsourcing

ASP outsourcing

Core banking solution

9

10

11

12

13

14

15

16

17

18

2

3

4

5

6

7

8

Influenceableand controllableprofitabilitylevers

Active

Levers thatcan eithernot beinfluencedor that effect othersin an uncontrollablefashion

Critical Reactive Buffering


“The active leversexplain 48% ofvariation inprofitability acrossdifferent marketplayers.”

Regression equation, R2 adjusted = 0.48

Maximising profitability through effectivecombination of profitability leversHow can wealth managers combine and configure“active” profitability levers to maximize profitability?Based on the results of our analysis, we argue that themost profitable wealth managers succeeded in addingthose profitability levers with a positive influence onprofitability (called profitability cultivators) to the basicwealth management setup [see Focus box 4], whileavoiding or resolutely reengineering levers with anegative impact on profitability (called profitabilityslayers).

Focus box 4: Basic wealth management setup

The basic wealth manager setup describes a syntheticstructure that excludes the eight levers under analysiswhich are common to most players in the Swiss wealthmanagement market. It depicts a simplified model bankfocusing on domestic on-/offshore business with Affluent,HNW or UHNW private clients. The model bank offerscustody, advisory and brokerage services, as well asstandardized and individual discretionary mandates.However, it does not produce its own investmentproducts.

Statistical analysis5 of financial and qualitative data ofmore than 100 Swiss wealth managers has shown thatinstitutions with a basic wealth management setup butno further implemented profitability levers yielded anaverage profit margin of 26.7 bps in 2008 (46.6 bps in 2007).


Figure 8 highlights the effect of individual levers onSwiss-based wealth managers’ profitability. In 2008,players with a strong focus on the Affluent/HNW clientsegment, an Institutional client base, an extendedservice offering, outsourced business processes and aninternational footprint achieved a 49.6 bps profitabilitybonus in excess of the standard 26.7 bps profit marginthat resulted for wealth managers with a basic setup.

In contrast, players who implemented every singleprofitability slayer but no profitability cultivatorsexperienced a total 44.4 bps profitability “malus”. Those wealth managers were confronted with anegative overall profitability of -17.7 bps (26.7 bpsminus 44.4 bps).

However, individual levers not only differ regarding theiroverall impact on profitability, but also regarding theirimpact on revenue and cost margins [see Figure 9].

Therefore, wealth managers formulating and executingtheir strategy should think carefully about why certainlevers have either a positive or negative effect onrevenues and costs.

To facilitate this process, the rationale behind theeffects of each “active” profitability lever on revenues,costs and profitability is discussed in detail in thefollowing section.

Basic wealth manager setup

Domestic on- andoffshore business

Custody andadvisory services

Discretionarymandates

Brokerage services

5 Deloitte Research [2009],based on regressionanalysis; mathematically,the “average“ profitabilityfor the basic wealthmanager setup representsthe constant in theregression equation

18

BOM elements

Clients Products/services Organisation/physical sites

1 2 3 4 5 6 7 8

Profit margin(bps)

Focusingon

Affluent/HNWIclients

Focusingon

Institutionalclients

Producingand

offeringtraditionalproducts

Producingand

offeringmarkettrackingproducts

Producingand

offeringextendedservices

Outsourcingsingle

ormultiple

back office

services

Maintainingan

international footprint

Running a proprietary

tradingfunction

2007

46.6 bps

2008

26.7 bps

+8.1 +3.9 +7.1

-23.2 -14.3 -6.7 -11.0-0.9

+19.1

-56.1

+49.6

-44.4

+13.8 +14.0

-16.9 -17.8

+5.1 +13.6 +3.1-9.7

Profitability cultivators: Levers which have positively influenced profitabilityProfitability slayers: Levers which have negatively affected profitabilityBasic wealth management setup

Figure 10. How wealth managers cultivate or slay their own profitability


∑

∑

∑

∑

Figure 11. Profit, revenue and cost margin impact of the “active” levers


Positive impact (profitability bonus)Negative impact (profitability malus)

(+): relative advantage if compared to control group(-): relative disadvantage if compared to control group

Observed financial impact*1

Clie

nts

Pro

duct

s/se

rvic

esO

rgan

isat

ion

BOM profitability levers 2007 2008

+8.1 +13.8 =

=

=

=

=

=

=

=

+3.9 +14.0

1 Focusing on Affluent/HNWI clients

2 Focusing on Institutional clients

3 Producing and offering traditional products

4 Producing and offering market tracking products

5 Producing and offering extended services

6 Outsourcing single or multiple back office services

7 Maintaining an international footprint

8 Running a proprietary trading function

Profit margin (bps)

-16.9+7.1

-17.8-23.2

+5.1-14.3

+13.6-0.9

+3.1-6.7

-9.7-11.0

2007 2008

+3.8 +2.5 -

-

-

-

-

-

2007 2008

-4.3 -11.2

+1.5 -2.1

Cost margin(bps)

+9.5+5.1

+8.8+4.7

+10.3+8.9

-16.1-1.3

+14.9+3.8

+9.5+4.4

-

-

+5.4 +11.9

Revenue margin(bps)

-7.4+12.2

-9.1-18.5

+15.4-5.4

-2.5-2.2

+18.0-2.9

-0.2-6.6

* Note that the decimal places of certain revenue and cost margin figures in this table do not add up to total profit margin due to rounding differences


Clients[1] Superior revenue margins with Affluent/HNWclients: In 2007, wealth managers focusing on low-and mid-end private banking clients achieved onaverage both a higher profit and a higher revenuemargin than those who served mainly Very and UltraHigh Net Worth Individuals (V/UHNWI). Revenuemargins tended to be lower for wealthier clients asthese, often, have greater bargaining power andfinancial sophistication, follow a more product/deal-driven approach and are characterised by higher pricesensitivity. Many of the wealthiest clients can also beexpensive to serve. In 2008, focusing on low- and mid-end clients led to an even greater positive effect onprofit margin (+13.8 bps).

[2] Intergroup synergies in serving Institutionalclients: Serving this client segment had a positive effecton revenue margins (+5.4 bps in 2007 and +11.9 bps in2008) as similar or identical products and services canbe sold to a wider range of clients. In 2007, this wenthand in hand with an increased cost margin (+1.5 bps)because in general the average time spent with Institutionalclients is on average slightly higher compared to privateclients.

This reduces the number of clients per relationshipmanager which in turn limits the wealth manager’seffectiveness in leveraging expertise. Therefore, agreater number of relationship managers are requiredto serve Institutional clients. The slightly higher costmargin also suggests that infrastructure and fixed costsmay not have been distributed effectively enoughbetween asset management and private banking. In 2008, a slightly improved cost margin (-2.1 bps)could be observed. We argue that this is mainly due to an improved cost distribution between the assetmanagement and private banking entities describedabove.

Products/Services[3] Margin disadvantage for traditional in-houseproducts: In 2007, wealth managers producingtraditional products achieved a positive financialoutcome as they realised a more attractive revenuemargin on in-house investment funds than on thirdparty funds. In addition, absolute return mandates andmanaged fund portfolios yielded a higher revenuemargin than non-managed mandates.

In 2008 however, the positive effect turned into a clearprofitability disadvantage of -16.9 bps, triggered by aconsiderable outflow of in-house funds and a shift ofclient assets into less profitable mandates (e.g., clientsinvested less in absolute return mandates and managedfunds portfolios). However, despite the market turmoil,no significant correlation between profitability and awealth manager’s degree of open productarchitecture (i.e., the degree to which the providerpushes proprietary products into clients’ portfoliosirrespective of the availability of better performingalternatives in the market) could be established by ouranalysis. Moreover, a private bank’s interest in sellingindex products is limited. The rationale is that they cangenerate higher revenue margins with in-house funds(200+ bps) compared to a per annum Total ExpenseRatio (TER) between 30 and 40 bps for ETFs.6

[4] Lack of scale of low margin market trackingproducts: Wealth managers producing and offeringmarket tracking products displayed a significantly lowerprofit margin than their peers without such offerings.Our research suggests that Index Funds and ETFsrepresent a relatively low revenue margin business. Despite its attractiveness for clients, this business couldnot (yet) generate a critical business volume and did notyield sufficient additional revenue for sales force tocover the costs that result from producing and sellingthese products.

[5] Cost-effective charging of extended services:In 2007, delivering extended services, such as financialplanning, family office services and lifestyle offerings,had a negative impact of -14.3 bps on the overallprofitability. One year later the situation changedsignificantly (+5.1 bps), driven by a combination ofhigher demand and new revenue generation.

To overcome the recent trust deficit exhibited by theirclients, many wealth managers decided to increase thedepth and breadth of their advice-based services. This led to an increased demand for those types ofproducts. Furthermore, following the financial crisis, less risky lower-margin products became more popular. To limit the damage to their profitability, a number of wealth managers who used to provide extendedservices as a courtesy to their clients, began to charge for that service. 6 Source: Deloitte Research

[2009] based on EDHECEuropean ETF Survey[2008]

20

Organisation[6] Maturing business process outsourcing (BPO)solutions: In 2007, wealth management providersengaging in BPO benefited from a cost marginadvantage (-1.3 bps) as compared to institutions thatdid not outsourced their business processes. This relatively low advantage highlights the fact that theBPO concept has not yet exploited its true benefitpotential. In the underlying business cases, certainplayers did not consider hurdles such as high shut downcosts, redundancy operating costs and migration costoverruns – all on the outsourcing party side. These havehindered maximum benefit-realisation on the cost side.If planned and executed correctly, the expected benefitfrom BPO is considerably higher, as can be seen in acost margin advantage of -16.1 bps and a profit marginadvantage of +13.6 bps in 2008. The revenue decreaseof -2.2 bps (-2.5) for wealth managers relates to thefact that high-margin, complex and hard to standardizeproducts are usually no longer processed by theoutsourcing provider.

[7] Increasing importance of international presence:Wealth managers with a focus on domestic Swiss on-and offshore business achieved a considerably higherprofit margin (+6.7 bps) in 2007 than players with aninternational footprint. The cost advantage for wealthmanagers without an international footprint arose fromtheir avoidance of costly branch expansions outsideSwitzerland, e.g., banking license expenses and costsrelated to regulatory as well as compliancerequirements. This becomes obvious when looking at2008’s cost margin disadvantage of +14.9 bps forplayers with an international footprint. Prior to thefinancial crisis, revenue margins tended to be higheroffshore as such clients were generally less pricesensitive and less focused on performance. As a result,our data suggests that players with an internationalfootprint had a slight revenue margin disadvantage of – 2.9 bps in 2007. In 2008, this revenue disadvantageturned into a clear advantage and grew to a total +18 bps. Wealth managers with the ability to capturerepatriated onshore assets have proven to be thebeneficiaries of recent asset outflows from Swiss wealthmanagement market. The pure offshore players’disadvantage regarding revenue margin, on the otherhand, arose due to clients’ reluctance to invest assetsoffshore in 2008.

[8] Loss-making proprietary trading: The last keyprofitability lever included in the analysis relates toproprietary trading activities. The observed revenuemargin difference of -6.6 bps in 2007 between playerswith and without proprietary trading resulted directlyfrom drying-out and falling markets for complexderivatives and structured products.

Several market players were forced to write-downpositions on their own books. Interestingly, the moretrading-oriented market players managed to recouptheir revenue disadvantage already in 2008. For theperiod in scope of this research, these players achievedonly a slightly lower revenue margin (-0.2 bps) thantheir peers without proprietary trading desks. This striking change is suggestive of wealth managers’swift measures to resolve their valuation and riskidentification issues brought to light in the course of the market turmoil.

However, wealth managers with a proprietary tradingdesk exhibited (in both 2007 and 2008) a significantlyhigher cost margin than their peers.

We argue that the resulting cost disadvantage is mainlydriven by higher investment costs into a complex andexpensive infrastructure ranging from IT to employmentof specialised traders. Particularly interesting is the factthat the cost disadvantage of wealth managers withproprietary trading has increased from 2007 to 2008.This demonstrates that most wealth managers startedbuilding up relevant proprietary trading capabilitiesbefore the outbreak of the market turmoil. The associated investment costs do not seem to havebeen fully amortised by 2008.


Concluding appraisal of key profitability leversBased on our previous analysis and interpretation ofkey profitability levers, we can draw the followingconclusions:

• A clear focus on Affluent/High Net Worth clientsand a strong Institutional client base is a verystrong profitability contributor in any kind of market.

• Producing & offering traditional products is verymarket sensitive and has to be managed verycarefully.

• Producing & offering market tracking products is a significant profitability slayer, indicating that theindustry is facing a lack of scale challenge.

• Producing & offering extended services will, in thenear future, also be a key differentiating factor as thisrepresents one of the most powerful means toovercoming the trust deficit.

• Outsourcing single or multiple back officeservices, when planned and executed correctly,demonstrates considerable added profitability and isan indicator for operational excellence in this part ofthe value chain.

• Maintaining an international footprint – in thecontext of a stricter regulatory environment –characterises a profitability cultivator in the near term.

• Running a proprietary trading function turned outto be a loss maker over the last two years.

Our research has demonstrated that the key to leading-edge profitability generation primarily lies in theeffective combination and design of key profitabilitylevers. Therefore, the next section investigates tendistinct profitability lever combinations that have beenadopted by a large number of Swiss-based wealthmanagers. Each of these lever combinations representsa unique business operating model and contributessignificantly to explaining variations in profitabilityacross different market players. Our goal is thus toidentify those business operating models yielding thehighest absolute profit margin and profit margin growth(“winning BOMs”).

“Had we known earlier how littlewe actually make with theseproducts after considering allrelated costs, we would haveintervened much moredecidedly.”

CFO, medium-sized Swiss Private Bank

22

Our research suggests the existence of ten predominantbusiness operating models in the market. A “winning”BOM is characterised by above-average absoluteprofitability and by profitability growth in both abullish and bearish market environment. However, we found no evidence that either client asset size or asimple BOM setup contributes decisively to winning in the market. Of all models under analysis, only BOMtype 3 outperformed its peers in 2008 thanks to itscrisis-resilient setup. This model represents roughly22% of the analysed market players.

Winning business operatingmodels

Identifying the winnersWealth managers seeking to maximise profits shouldbuild their models around profitability cultivators whileminimising the negative effects associated withprofitability slayers. Yet, which BOMs did actuallymaximize profitability during the bull market in 2007and the following bear market in 2008? Just asimportantly, which BOMs will emerge as winners in the future?

Figure 12 highlights that BOM 3 is the most commonlyobserved model in the Swiss wealth managementmarket. It has been adopted by over 22% of the banksunder analysis, ranging from small (CHF 2 bn AuM) tomid-sized private banks (CHF 25 bn AuM).

BOM 9, on the other hand, is the largest in terms ofclient asset size, representing 15% of the total AuM.

The eight “active” levers represent the foundation ofthe following analysis. We identified ten major clustersof banks in the Swiss wealth management market. Eachof these clusters exhibits a unique combination of these“active” levers as depicted in Figure 12. Their individuallever combination builds on the basic wealth managersetup which is common to all players [see Focus box 4].This BOM has been adopted by a relatively smallnumber of banks with AuM ranging from CHF 10bn toCHF 150bn.

Finally, it should be noted that all BOM types divergewith respect to how many profitability levers they haveimplemented. This is an indicator of the BOM’scomplexity.


We classified each business operating model into one of four distinct clusters (winning, catching-up, stagnantand struggling) [see Figure 13] according to absoluteprofitability in 2007 and 2008, respectively, andprofitability CAGR between 2004 and 2007 or 2004and 2008, respectively. This approach is based on therationale that winning BOMs are characterised both byabove average absolute profitability and by superiorannual compounded profit margin growth during theperiod under analysis. We argue that using absoluteprofitability as a basis for comparison accommodatesthe fact that profit maximisation should be theoverarching goal of most wealth managers. On theother hand, annual compounded profitability growth,serves as a proxy for sustainable profit generation overa given time period and acknowledges the dynamicsbehind wealth managers’ profit generation.

Winning models – BOMs 2, 3, 7, 9The most successful model (BOM 3) is characterised bya superior robustness in terms of sensitivity to marketturmoil. With a profit margin of 58 bps, it was already a top performer in 2007. Its setup turned out to be veryfavourable once again (54 bps) in 2008. Its focus onmore profitable, geographically diversified clientsegments was rewarded, and it managed to avoid otherelements that have a detrimental effect on profitability.Moreover, BOM 3 benefited from an efficient backoffice operating model.

Figure 12. Business operating models identified in the Swiss market

Profitability levers

Business operating model description Perc

enta

ge o

f ba

nks

incl

uded

in B

OM

clus

ter

(200

8)

Perc

enta

ge s

hare

of

tota

l mar

ket

AuM

repr

esen

ted

by B

OM

clus

ter

(200

8)

Num

ber

ofim

plem

ente

dpr

ofita

bilit

y le

vers

Affl

uent

/HN

WI

clie

nts

Inst

itut

iona

l clie

nts

Exte

nded

ser

vice

s

Bac

k of

fice

outs

ourc

ing

Inte

rnat

iona

l fo

otpr

int

Prop

riet

ary

trad

ing

Trad

itio

nal p

rodu

cts

Mar

ket

trac

king

prod

ucts

Clients Products/services Organisation

1Pure play private bank with truly open product architecture (advisory focus) 16.7% 2.3% 1

9 Internationally present wealth manager with very broad own product/service offering and BPO

7.4% 15.1% 7

10 Internationally present wealth manager with very broad own product/service offering

5.6% 31.4% 5

8Wealth manager with very broad own product/service offering and BPO 7.4% 4.3% 5

6 Internationally present private bank for Very/Ultra wealthy clients withbroad own product/service offering and BPO 5.6% 13.5% 4

7 Internationally present wealth manager with broad own product/service offering and BPO 7.4% 14.6% 5

5Wealth manager with broad own product/service offering and BPO 7.4% 8.1% 4

4 Private bank for Very/Ultra wealthy clients with truly open product architecture and focus on extended services

9.3% 0.5% 1

3Internationally present wealth manager with own traditional products and BPO 22.2% 7.2% 5

2Pure play private bank with traditional product offering and BPO 11.1% 3.0% 3

Ana

lyse

d on

ind

ivid

ual W

M p

laye

r le

vel o

nly

Implemented profitability lever Most common BOM Largest BOM in terms of AMA

“Private bank” = Domestic onshore/offshore player with Affluent/High Net Worth clients“Internationally present” = Player with domestic, global onshore as well as offshore business“Wealth manager” = Focus on private (Affluent/HNW/UHNW) and institutional clients

Most used lever Least used lever

24

BOMs 7 and 9, which were somewhat struggling in 2007, became winning models in 2008 as they managed toincrease their average profit margin by 10 bps. These models achieved a clear advantage over their peers byfocusing on the more stable Institutional client segment, charging for extended services instead of providing theseas a mere courtesy to clients, increasing back office efficiency, and leveraging their international footprint.

Figure 13. Business operating models in the Swiss market

Bullish market – BOM clusters 2007 Bearish market – BOM clusters 2008

Profi

t m

argi

n 20

07 (b

ps)

Stagnant70

60

50

40

30

20

10Struggling

Average profitmargin growth

= 9% Winning

BOM 2BOM 3

BOM 1

BOM 5 Average profitmargin = 45.2 bps

BOM 7

BOM 6

BOM 8

BOM 4

BOM 9BOM 10

Catching up

-12%-10% -7% -5% -2% 1% 3% 6% 8% 11% 13% 16% 18%

Profit margin CAGR 2004 – 2007 (bps)

Bubble size indicates number of wealth managers included in BOM

Profi

t m

argi

n 20

08 (b

ps)

Stagnant70

60

50

40

30

20

10Struggling

Average profitmargin growth

= -1% Winning

Average profitmargin = 33.1 bps

Catching up

-12%-10% -7% -5% -2% 1% 3% 6% 8% 11% 13% 16% 18%

Profit margin CAGR 2004 – 2008 (bps)

BOMs in 2007

Bubble size indicates number of wealth managers included in BOM

BOM 3

BOM 7

BOM 9

BOM 2BOM 1


BOM 5

BOM 4

BOM 6 BOM 8

BOM 10

Contrary to these relatively robust models, BOM 2 wasa top performer only in the booming market. In 2008,this model faced a profit margin decline of 24 bps,equalling approximately twice the extent of the averageprofit decline in the Swiss wealth management market.Its very favourable lever combination in 2007 (worth 61 bps) turned out to be less advantageous in 2008.This model’s focus on Affluent/High Net Worth clientsmade it vulnerable to overreactions of this clientsegment in the course of the market turmoil. Affluentclients exited more quickly than UHNW individuals fromhigh margin products such as mutual funds andstructured products. On the other hand, the model’straditional product offering could not easily cope withthe changing market environment.

This fact had a noticeable impact on profit generation:between 2004 and 2008, the model’s profit margingrew by only 1% [see Figure 13].

Catching-up models – BOMs 6, 8, 10BOM types 6, 8 and 10, are positioned in the “catchingup” cluster. The profit margin of BOM 6 remainedstable (32 bps) as the implemented levers – extendedservices, back office outsourcing and internationalfootprint – turned out to be a backbone for profitabilitygeneration in a changing market environment. The profitability slayer ‘traditional products’ did nothave as great an impact, as this, the most frequentlyused lever, punished the vast majority of Swiss-basedwealth mangers in the same way.

BOM 8, otherwise similar to BOM 6, realised additionalbenefits due to its Institutional client base. The latterregistered fewer asset outflows and more stableinvestment behaviour than the private client segment.However, BOM 8 was punished as a result of itsunprofitable production and provision of markettracking products.


BOM 10 remains one of the least profitable models and suffered from a profitability decrease from 25 bps to 14 bps. The simultaneous production andoffering of both traditional and market trackingproducts in combination with a lack of focus onprofitable private client segments and back officeefficiency weighs too heavily against it.

Struggling models – BOM 4BOM 4 faces a profitability growth challenge and thegreatest negative profit margin growth in the periodunder consideration (profit margin CAGR 2004-2008equalled -9%). This setup indicates that such a simplelever combination is not as well suited as its peers tothe rigours of an increasingly competitive environment.Most notably, the model’s reliance on domestic on-/offshore business represents a major challenge in thelight of the increasing regulatory and political pressure.Also, this model failed to achieve any economies ofscope with respect to focusing on the more profitableAffluent/HNWI client segment and back office efficiency.

Stagnant models – BOMs 1, 5Although BOM 5’s profit margin was above average(43 bps) in 2008, it did not manage to grow itsprofitability between 2004 and 2008 (-6% profit margindecrease). The model’s underlying profitability levercombination was therefore not robust enough towithstand the negative effects of the 26% decline inasset prices [see Figure 1]. In consequence this setup isgenerally more likely to be successful in boomingmarkets than in turbulent markets.

The case for BOM 1, with its very simple lever setup, isvery different. Focusing exclusively on Affluent/High NetWorth clients and disregarding any other profitabilitycultivators turned out to be an insufficiently diversifiedstrategy in an environment of decreasing markets.

Varying degrees of resilience across differentmodelsAcross the 103 Swiss headquartered and globallyoperating wealth management businesses analysed, the market meltdown in 2008 had an uneven impact.This led to a polarization in prospects between potentialwinners and losers.

Figure 13 illustrates that, whilst the entire industry wasaffected by the financial crisis, individual BOM typesdemonstrated varying degrees of resilience. This findingis best explained by comparing absolute profit marginsfor 2007 and 2008, and profit margin growth for theperiod 2004-2007/2008. BOM 3 ranks highest withinthese two categories and can be seen as a very robustbusiness operating model generating constantly highprofit.

In contrast, BOMs 1, 4, 5, 6, 8 and 10 demonstratedsome weaknesses around their setup, having been“struggling”, “stagnant” or “catching-up” in both 2007 and 2008. Those models represent 52% of theproviders under analysis, which is a clear indicator ofthe challenge the wealth management industry faces in terms of sustainable profitability generation.

In summary, our analysis has demonstrated thatdifferences in profitability across individual wealthmanagers can largely be explained by the characteristicsof their business operating model. Each businessoperating model can be characterised by its uniqueprofitability lever combination and design, which in turn represents the outcome of a wealth manager’schosen strategy.

To address potential profitability issues, market playerstherefore need to transform their existing businessoperating models by means of changing or adaptingparticular key profitability levers. The following sectionpresents eight distinct strategic initiatives that supportwealth managers in this transformation process.

26

Transformation agenda

A fundamental business operating modeltransformation is required for players with stagnant,struggling or catching-up models. Depending on amarket player’s strategic intent and current BOMsetup, specific strategic initiatives allow them toimplement, improve, avoid or reengineer relevant keyprofitability levers and to manoeuvre to a moreattractive profit margin.

Business operating model transformation – the key to successWealth managers will have to transform their currentbusiness operating model setup in order to extricatethemselves from the profitability trap. Depending ontheir strategic intent and on the profitability levers thatneed to be addressed, the transformation focus willvary between the different players. Such transformationusually includes a high degree of complexity, which isbest managed by applying a structured approach.To identify, select and plan appropriate strategicinitiatives, wealth managers should better understandtheir current BOM setup, assess how well the latter isaligned with their strategic intent and compare theiractual profitability against that of their peers(competitors in the same BOM cluster).

These considerations support wealth managers indetermining if the implemented BOM, the chosenstrategic intent, or both, need to be revised.

Wealth managers can select, plan and execute differentstrategic initiatives for each lever that has to beaddressed [see Figure 14]. These initiatives aimed atmanoeuvring to a more attractive industry profit margin level are formed around individual BOMelements and their corresponding “active” profitabilitylevers. The underlying logic behind this approach is thatthe BOM concept, with its capability-based view (CBV)of strategy, acts as the most powerful catalyst forprofitability generation.

Figure 14. Strategic initiatives


Stra

tegi

c in

itia

tive

s

1Sales and service effectiveness

2Improved organisational model execution

3Product sourcing and management

4Product profitability management

5Service delivery model effectiveness

6Proprietary trading reorientation

7Operational excellence in back office

8On-/Offshore business model redefinition

Addressed profitability leversFocusing on

Affluent/HNW clients

Serving Institutional

clients

Producing and offeringtraditional products

Producingand offering

markettracking products

Producingand offering

extendedservices

Runningproprietary

tradingfunction

Outsourcingsingle ormultiple

back officeservices

Maintainingan

internationalfootprint

Indicating that the strategic initiative has an impact on the profitability lever in question


1. Sales and service effectiveness The market turmoil has proved the need for wealthmanagers to focus on changing the skills and attitudeof private bankers in their interaction with clients. This client focus consists of three main capabilitycomponents: customer orientation, customerinteraction and customer enablers. Of these, customerinteraction is likely to become the most crucial factor.As revenues decrease, sales and service effectivenessbecome even more important.

In this context, a complementary approach toimproving the sales effectiveness of relationshipmanagers is to focus on the time they spend withclients, using the following three-step plan:

1. Increase the overall amount of time spent withclients (‘sales capacity’).

2. Allocate time more effectively across the clientbase.

3. Maximise the effectiveness of time spent with a given client.

Optimizing the client-facing time is a very strongrevenue enhancement lever as research shows thatthere is a reasonably strong, positive relationshipbetween the time spent with clients and assets undermanagement growth.

2. Improved organisational model executionWealth managers serving not only private but alsoInstitutional clients face important organisationalchoices. Success – on both the cost and revenuesides – is driven more by better execution of a specificmodel than by selection and structure of the model itself.

The range of models includes:

• Sovereign model: Private client and Institutionalasset management are kept entirely separate. This typically enables greater private client productcustomisation and a closer relationship betweenclient, relationship manager and portfolio manager.

• Private client integrated model: The private clientasset management unit reports to the private clientdivision, with strong functional coordination betweenprivate client business and Institutional assetmanagement.

• Asset management integrated model: Assetmanagement is centralised, with dedicated privateclient asset managers who liaise closely with theprivate bankers.

• Manufacturing-distribution model: A centralisedasset management function serves the Institutionaland private client distribution channels.

3. Product sourcing and managementOn the product origination side, the productdevelopment area is of specific interest. A disciplined,well-executed product development process is key to a successful product launch. Manufacturing costs canbe significantly reduced. However, this requires achange in the product development process via focuson the following key areas:

• Process governance has clear ownership and end-to-end accountability.

• Only business case driven product ideas are pursuedaddressing a critical mass of clients.

• Product developing ideas receive input from allrelevant sources – the clients, the front line andmarketing.

• Strong focus on commercial aspects instead of risk,infrastructure and legal issues dominating go/no-godecision.

• Performance tracking of post product launch.

28

4. Client and product profitability management (CPP)Many wealth managers pursued an undisciplined“product rush” in the belief that product diversificationand customisation would drive volume and thus marginexpansion would be a key competitive differentiator.Overall, however, the impact has too often beendisappointing [see Figure 11].

Against this background, it is crucial to track performanceas mentioned above, whilst also using a profitabilitycalculation framework which makes it transparent whycertain product/service offerings are not profitable(enough) and why they should therefore no longer beproduced (or maintained). Such transparency addsconsiderable value as wealth managers often lack therequired knowledge, process and system support toaccount for true product, client and relationshipmanager costs.

Actual resource consumption by any of these is in manycases unknown. This poses a considerable challenge forthe management, as strategic as well as operationaldecisions related to clients and the product/serviceoffering can only be undertaken on a partially informedbasis. The optimal outcome of a more structured formof client and product profitability management istherefore a clear view on client, product, relationshipmanagers and business line profitability and a betteridea of the root causes of identified revenue and costissues. This also provides a sound basis for theimplementation of continuous profitability monitoring/steering further down the line.

5. Service delivery model effectivenessThe financial crisis caused a trust deficit that triggered a fundamental shift in client behaviour, putting a strainon every wealth manager’s future revenue generationpotential. The key point here is to reshape the servicedelivery model from the product/service offeringperspective.

Therefore, wealth managers need to act decisively andpro-actively to implement a host of measures whichrestore clients’ trust in their business:

• Successful wealth managers increasingly seethemselves as partners to their clients. They seek a professional and emotional lock-in by adaptingpricing schemes to hourly billing based mandates or the introduction of participation schemes.

• Products and services offered to the client need to be less complex and more easily understandable.Leading wealth managers enhance their clientsupport by more frequent communication, by aconcisely-defined investment timeframe and byrefocusing on the client’s risk/return profile.

• By simplifying product description, increasing pricetransparency, emphasizing managed accounts andfollowing a “client first” approach they move towardsgreater product transparency.

• Wealth managers need to aim at realistic performance.The key to positive, realistic investment performancelies in counteracting both excessive performanceexpectations and speculative investment behaviour of clients with substandard risk ability.

• To achieve optimum client service levels, players need to improve their understanding of their clients’ buying behaviour and correctly align the servicemodel. Relationship managers need to demonstrate a willingness to go the extra mile.

6. Proprietary trading reorientationThe reorientation of the proprietary function starts withthe alignment/reduction of trading limits. In wealthmanagement, this is a direct consequence of a clearfocus on the core business. The strategic intent of along-lasting, sustainable investment philosophy ofprivate banking does not operate well in conjunctionwith large volatile trading positions within investmentbanking. Thus, the necessary strategic fit of privatebanking business with proprietary trading has a directinput on investments into the complex and expensivetrading infrastructure. This alignment and rightsizingcovers not only information technology, but alsoorganisation and people.


7. Operational excellence in back officeOne of the most effective disciplines that characterisewealth management operational excellence leaders isback office outsourcing. As our analysis concluded,there is a benefit to be achieved by outsourcing backoffice services. In 2008, this benefit was worthapproximately 13 bps. However, wealth managementproviders should not automatically infer thatoutsourcing their operational and support infrastructureis the answer. The most appropriate way to assessoutsourcing as a strategic initiative is to formulate arobust operational and support strategy, shaped by the business strategy and founded on rigorous andcomprehensive analysis.

The operational strategy should examine the completespectrum of potential operational models, of whichoutsourcing is only one. For some functions, processes,or geographies, value creation may be best achieved by rebuilding and re-engineering internally; for others, it might be to look at opportunities for cross-product or cross-geography shared service facilities, utilising thebest internal infrastructure to enhance service andeliminate duplication.

8. Onshore/offshore business model redefinitionInternational efforts on a macroeconomic level towardsstricter regulation of cross-border banking and plannedtax amnesties as well as similar measures such as“voluntary disclosure” in various countries will lead tostrategic challenges for wealth management providers.Regardless of past and expected future internationalinitiatives, private banks are used to dealing with new regulations, as the banking industry has always beenone of the most regulated economic sectors. In consequence, regulatory management should alreadybe a core element of a wealth manager’s corporatestrategy, as there is constant uncertainty about futurechanges.

Against this background the entire business operatingmodel needs to be redefined with respect to on- andoffshore wealth management. Figure 15 summarisesthe most important strategic questions in this specificcontext.

Despite differing initial situations across the sample ofwealth managers investigated, we argue that thestarting point for most models is a decisive steptowards changing their organisation with the aim ofovercoming the deep-seated lack of private clienttrust towards their wealth management providers.Frustrated and disappointed clients now expectsolutions better tailored to their needs, honestcommunication and a readiness to change.

The key to success: Informed choice and correctexecution To move away from the profitability dilemma, acombination of different strategic initiatives is necessary.As different BOMs stem from varying initial situationswealth managers will prioritize differently in order to address their profitability ambitions. Once again, asuccessful outcome is highly dependent on making aneducated decision on strategic initiatives, and executingthem correctly.

Onshore business Offshore business

1

• How attractive is the onshore market (potential, structure,and environment)?

2

• To what extent can a privatebank capture offshore moneyoutflow of own clientportfolios?

3

• Which capabilities do alreadyexist in the domestic onshoremarket which can be leveragedmost effectively into otheronshore markets?

4

• If partnering with a third partyin the country of clientresidence, are there anyimprovement areas to beconsidered?

5

• Is the product and service offering in the target market enough competitive in order to gain sufficient profit margins?

• What is the degree of separation of on- and off shore private banking from anorganizational perspective, including people, processes, information and systems?

• Are on- and offshore clients in the non-domestic country treated as integratedbusiness/market?

1

• What are the key risks servingoffshore clients with undeclaredmoney per country ofresidence?

2

• What is the policy of treatmentfor such existing clients goingforward?

3

• How must the offshorebusiness be set up in order tomatch with the requirements oflead1 and host2 regulators?

4

• Which markets and clients canbe served in the context of theoff-shore service offering?

[1] Regulating authority in the country of residence of the wealth management provider[2] Regulating authority in the country of residence of the client


Figure 15. Strategic questions for on- and offshore wealth managers

30

Wealth management markets have become morecomplex in recent years and the capital markets’meltdown in 2008 had a strong negative effect on theindustry’s asset base and, in consequence, revenues. It has thus become a challenge for wealth managers torun their businesses profitably. Our research shows thatprofit margins decreased on average by -27% in 2008and we expect profitability to recover only partially inthe near future. First, the ripple effects of the politicaland regulatory pressure on Swiss offshore business,continued risk-aversion on the part of private clients, as well as an unprecedented lack of private client trust all hamper the industry’s revenue generation.Second, many wealth managers struggle with aninflexible cost base. Despite recovering financialmarkets, these two effects keep them in a short-to mid-term profitability trap if no immediatecountermeasures are undertaken.

To address the increasing market complexity, extricatethemselves from the imminent profitability trap andemerge as winners, wealth managers have to identifythe key profitability levers which have a direct impacton their value generation. This research shows that only a few of the vast universe of profitability levers are directly and measurably driving differences inprofitability.

Our analysis suggests that focusing on profitable clientsegments, avoiding or reengineering value destroyingproducts/services and optimizing the internalorganisation measurably increases wealth managers’profitability. In contrast, a very opportunistic andunfocused client take-on approach, the offering ofoverly complex products and trading facilities as well as a heavy reliance on Swiss domestic on- and offshorebusiness reduce a wealth manager’s averageprofitability.

In general, “winning” wealth managers reconfiguretheir business operating models around the few BOMlevers, which have a direct and positive impact onprofitability. Our research highlights that winningmodels are superior with respect to robustness andflexibility, promising both above average absoluteprofitability and profitability growth.

Depending on their current situation and strategicintent, wealth management providers can choosebetween several transformation strategies to addresspotential profitability issues. Each of these strategiesaims at changing one or more BOM elements andcomponents in order to build a clearly defined andmore resilient business operating model.

Conclusion


Daniel KoblerHead of Financial Services Strategy Consulting+41 44 421 [email protected]

Anna CelnerPartner, Head of Financial Services Consulting+41 44 421 [email protected]

Adrian StaufferSenior Consultant, Financial Services Consulting+41 44 421 [email protected]

Key contacts

Thank you to the following contributors: AfsounHatami, Daniel Diederichs, Stella Pagnamenta, Jan Wittand Patrick Spiller

32

Contacts

Zurich

Rolf SchönauerHead of Financial ServicesIndustry+41 44 421 [email protected]

Geneva

Alexandre BugaPartner Financial ServicesIndustry +41 22 747 [email protected]

Lugano

Sandro ProsperiPartner Financial ServicesIndustry+41 91 913 [email protected]

Chris HarveyGlobal Head Banking & Securities+44 20 7007 [email protected]

Americas

ArgentinaClaudio Fiorillo+54 11 [email protected]

BrazilMarcia Ogawa Matsubayashi+55 11 5186 [email protected]

CanadaBill Currie+1 416 874 [email protected]

ChilePablo Herrera+56 2 [email protected]

Carlos Muñoz+56 2 [email protected]

MexicoDavid Goslin+52 55 [email protected]

Guillermo Roa+52 55 [email protected]

U.S.Jim Reichbach+1 212 436 [email protected]

Asia Pacific

AustraliaPaul Wiebusch+61 03 9671 [email protected]

ChinaDora Liu+86 21 6141 [email protected]

Gerry Schipper+852 2852 [email protected]

IndiaSachin Sondhi+91 (0)22 6619 [email protected]

IndonesiaBing Harianto+62 21 2312879 x [email protected]

Merliyana Syamsul+62 21 2312879 x [email protected]

Riniek Winarsih+62 21 2312879 x [email protected]

JapanYoriko Goto+81 2 6213 [email protected]

KoreaSeok Yeon Cho+82 2 6676 1124 [email protected]

Hong Sub Lee+82 2 6676 [email protected]

Kil Ho Lee+82 2 6676 [email protected]

MalaysiaJeremy Ng+60 3 7723 [email protected]

New ZealandRichard Kirkland+64 4 [email protected]

Rodger Murphy+64 9 [email protected]

PhilippinesAvis Manlapaz+63 2 581 [email protected]

Deloitte Touche Tohmatsu member firm banking sector leaders


SingaporeKaren Bowman+65 6224 [email protected]

Ai Phing Cheng+65 6530 [email protected]

Prakash Desai+65 6530 [email protected]

Kok Yong Ho+65 6216 [email protected]

Boon Suan Tay+65 6216 [email protected]

TaiwanDian Chen+886 2 25459988 x [email protected]

Olivia Kuo+886 2 25459988 x [email protected]

Peter Tsai+886 2 25459988 x [email protected]

ThailandSuttharug Panya+66 2 676 5700 x [email protected]

Suphamit Techamontrikul+66 2 676 5700 x [email protected]

VietnamHung Truong+84 4 3852 [email protected]

Europe, Middle East andAfrica

Africa (Eastern)Julie Nyang’aya+254 2 (0) 4230234 [email protected]

AustriaDominik Damm+43 15 3700 [email protected]

BelgiumFrank Verhaegen+32 3 800 [email protected]

Central EuropeMike Jennings+420 246 042 [email protected]

CISMaxim Lubomudrov+74 95 7870 [email protected]

CyprusNicos Charalambous+35 72 5868 [email protected]

DenmarkJens Ringbæk+45 3610 [email protected]

FinlandIlkka Huikko+358 20 755 [email protected]

FranceJose-Luis Garcia+33 1 40 88 [email protected]

GermanyFriedhelm Kläs+49 69 75 695 [email protected]

GreeceNicos Sofianos+30 210 678 [email protected]

IcelandThorvardur Gunnarsson+354 580 [email protected]

IrelandMary Fulton+353 1 417 [email protected]

IsraelAvi Keisar+97 23 608 [email protected]

ItalyRiccardo Motta+39 02 8332 [email protected]

LuxembourgOlivier Marechal +352 45145 [email protected]

MaltaStephen Paris+35 62 134 [email protected]

Middle EastJoseph El-Fadl+96 11 364 [email protected]

NetherlandsJean-Pierre Boelen +31 88 2887 [email protected]

NorwayArve Rafteseth+47 2327 [email protected]

PortugalMaria Augusta Franciso+35 12 1042 [email protected]

South AfricaRoger Verster+27 011 806 [email protected]

SpainFrancisco Celma +34 915145000 x [email protected]

SwedenGoran Engquist+46 7524 [email protected]

SwitzerlandRolf Schoenauer+41 44 421 [email protected]

Alexandre Buga+41 22 747 [email protected]

Sandro Prosperi+41 91 913 [email protected]

TurkeySibel Türker+90 21 2366 [email protected]

UKNick Sandall +44 20 7007 [email protected]

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