Good businesses build customer trust. Bad ones destroy it by playing pricing games. That was my thought when confronted by the price of potato chips at my local pharmacy, which held a two-pack for $4 sale.
Those who wanted a single pack could get it for $4.29. I resisted the urge to buy two packs, destroy one and walk out the door better off than the single-pack purchaser.
Instead, I left empty handed and wondered whether the pharmacy stooped to other skulduggery such as selling expired, or counterfeit, medications.
Businesses that toy with customers do so at their peril.
The chip-pricing incident was likely an experiment inspired by “big data” analytics that ran amok. It’s also a relatively mild offence in comparison with the subtle games played by online retailers who deploy an array of tricks in an attempt to separate customers from their cash.
Similar technology is making its way – with more than a little boastful fanfare on the part of some robo-advisers – into the world of financial advice, where behavioural psychology and A/B testing can be used for the benefit of investors or, dare I say, against them.
For instance, marketers regularly test the response rate from slightly different versions of the same advertisement. Adding a picture of a family to an advertisement might improves sales. The goal is to sell more with the assumption that the product will be good for whomever buys it. It’s a troublesome attitude to take when it comes to providing individualized investment advice.
To understand the potential for harm, it’s useful to think about the profitability drivers of investment-advisory businesses. To start, they suffer from high customer-acquisition costs, which come in the form of advertising, the work needed to set up accounts and the like.
Good advisers will spend a considerable amount of time and effort at the beginning of a client relationship to put their clients on the right path. The process should include financial planning along with the development and implementation of a suitable investment policy.
The large upfront costs will then be recouped by fees, typically based on a percentage of the assets under management, over the course of many years. High-fee structures recover the costs quickly, while low-fee structures take longer and are riskier for the adviser while being better for the client.
To boost profitability, advisers generally favour undemanding clients who don’t require much maintenance. They also like loyal clients who are happy to stick with the service for many years. Client retention can make or break an advisory business.
And it’s at this point we get to an issue that gets short shrift. When client retention and investment advice intersect, there is the potential for both alignments – and conflicts – of interests.
For example, hand-holding during market downturns is often singled out as a key benefit of working with an adviser. There is a whole area of research – often of dubious quality – that indicates investors react poorly in downturns and often panic. But so do many advisers. After all, a crash is a period when most people panic and, as people, advisers are hardly immune.
The modern version of hand-holding comes bathed in the glow of behavioural finance, data analytics and computer screens. The idea is to study investors like lab rats in an effort to find ways to stop them from acting rashly in downturns.
But I’ve yet to be convinced that the technology works any better than getting reassurance from a human adviser who has been through crashes in the past. When investors panic, I doubt that an automated e-mail or popup notice is likely to stop them from selling.
To the cynical eye, the effort looks suspiciously like the repurposing of the A/B testing systems used by retailers to sell more chips. Instead of boosting chip sales, the goal is to improve client retention and the adviser’s profits.
Investors should be mindful that the application of behavioural technology can be used for both good and ill. Conscientious advisers will use it to help their clients, while others will use it on their clients to their detriment. The line between the two might be a fine one, but the trick is to find an adviser in the former rather than the latter category. I’d start by looking for a seasoned adviser who has their clients’ best interests at heart, rather than a robot that tries to maximize its own bottom line.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.