How can you make a profit when the price of your product has fallen to zero?
Fund managers have been cutting the fees on many of their main products for years. Fidelity has now gone a step further and set a price that customers love more than anything else: the fund manager has introduced two core tracker funds with no fees at all. Regardless of how much you pay in, it won’t cost you a penny, nor will you have to pay any transfer fees.
The robots come for the fund managers
That is worrying enough for fund managers who have made a good living for decades creaming off one or two per cent on the money they manage. But it is unlikely to stop there. The fintech start-up, Trading 212, last year started offering a free share-dealing account, undercutting the £10 or so a trade that even the low-cost web-based brokers charge. What will come next? Free investment advice? Wealth management? Tax planning, custody, insurance and basic legal services? There are a whole range of services that could be offered for nothing very soon.
The reason is simple: technology means the cost of providing many financial products is falling so close to zero that it is not really worth charging for them, especially when you consider how easy it is to win new customers for stuff you give away. How hard is it to put together a tracker fund? It is a task a computer can complete in a few seconds. The same is true of many other services. Artificial intelligence can come up with basic portfolios and tax plans, and within a few years may well be able to choose stocks as well – indeed, some investment banks are already dabbling with robotic analysts to predict which shares to buy. As tasks get computerised, the costs fall so steeply, it is possible to give these products away.
Three ways to make free work
It has already happened in plenty of other industries. There’s no reason why many finance products should not be free as well. Set the price at nothing and market share can be built up very quickly. If established companies are not happy with it, then very quickly a few ambitious start-ups will have raised enough venture-capital money to give it a go. The City needs to prepare. Here are three ways it can respond.
First, traditional financial-services firms need to start offering free products themselves – before rivals do. If your lunch is going to be eaten anyway then you may as well get a share of it yourself. Sure, the share you end up with will probably be less profitable, and it may well cannibalise a unit that was churning out decent profits – but resistance is futile.
Next, they need to invest to cut costs. There’s no point charging zero unless your costs are close to zero as well. Sure, there will be spin-off revenues, but as the newspapers discovered, they won’t be as substantial as you hoped. Banks and brokers will have to invest heavily in IT and re-engineer their processes so that they can offer free products without it costing them very much. Otherwise they will quickly end up losing tons of money – and could easily go out of business.
Finally, they need to work out where they offer real value that they can charge for, and figure out pricing strategies. It shouldn’t be that hard. On your smartphone, there are dozens of app companies with successful “freemium” models: they hook you in on the basic product for nothing, then start charging small sums for extras on top of that. The banks could do the same. Or they could look at the all-you-can-eat models that work so well for Netflix or Amazon Prime, offering a lot of stuff for a monthly subscription. There are plenty of models out there – the banks just need to work out which will work for finance.
There is no reason why free can’t work. High-street banks offered free accounts for years, and made money elsewhere. Google offers lots of free stuff and makes a fortune. When it goes well, it can be a very powerful business model. And if the traditional firms don’t get on board soon, they will find themselves overrun by competitors who have.