Only seven or eight defined contribution record keepers might still be in business three years from now, a tiny remnant of the 89 or so currently in business, industry insiders say.
J.P. Morgan Chase & Co.'s planned buyout of American Century Cos. Inc. might be only the tip of the iceberg. The two are dissolving a joint venture that offered bundled defined contribution business plan services including record keeping.
The consolidation began three years ago when the market turned south, then accelerated in 2002 when at least 12 defined contribution record keepers outsourced, closed or sold their defined contribution business.
A bleak business environment is the prime culprit. In 2002, defined contribution assets fell to $3.2 trillion from a peak of $3.6 trillion in 2000, according to the Society of Professional Administrators and Record Keepers, Simsbury, Conn. Defined contribution assets under record keeping fell 7% in 2002 to $2.27 trillion (Pensions & Investments, Oct. 14).
Among the expected winners named by industry experts are Fidelity Investments, The Vanguard Group, The Principal Financial Group Inc., MassMutual and Merrill Lynch. Also named are niche players Nationwide Financial, Manulife Financial and Teachers Insurance and Annuity Association-College Retirement Equities Fund.
"It'll be companies like those that have either a retail presence or a retail brand and organizations that can focus on the investment business," said Robert G. Wuelfing, SPARK founder. "Those split between health and pension and investments, if they have to choose, a lot of them will choose the health-care business."
Deal structures different
What's different about the current wave of consolidations is how the deals are being structured. Five years ago, the acquirer paid a lot of money to buy the business, noted Ben Brigeman, senior vice president with Schwab Corporate Services, Cleveland. Now, he said, the sellers "want to get their losses off their books with not a lot of cash changing hands."
But Joshua Dietch, associate director of Cerulli Associates, a Boston consulting firm, said it's hard to sell a record-keeping business. "Buyers are saying: 'Why should I buy the business? If I wait awhile it will die off, and I can pick off the business I want,' " Mr. Dietch said.
The defined contribution business is not a good fit for institutional managers that do not have a retail presence, Mr. Dietch said.
Mr. Brigeman agrees. Companies left standing will have multidimensional business models that include institutional and retail capabilities. It will be difficult to survive on a single revenue stream from institutional money management and services, he said.
Size alone will not determine who will remain, he said.
"In the past it was said that if you don't have 250,000 participants, you are not going to have scale," he said. "In 20 years I have yet to see anyone who is reaching 500,000 or 1 million participants who has not seen a steep decline in per participant profitability."
Companies that serve the defined contribution business are beginning to understand that they must "manufacture" investments and have a good record-keeping system as well as a distribution channel, said Joe Ready, senior vice president and director of Wachovia Retirement Services, Charlotte, N.C.
"You could have the greatest asset management and the greatest record keeping but don't have the distribution to cross-sell," Mr. Ready said. "Then you'd have to pay for distribution through a third party and that's very expensive."
Companies that survive will have to be smart and pick a spot in the market and concentrate all of their resources in that market segment, Mr. Ready said.
"We will see further consolidation and outsourcing in the record-keeping business because it is a business of scale and not everyone will have the scale to run a profitable operation, especially in a market of shrinking profit margins due to declining asset fees," said Mr. Wuelfing.
Size, quality matter
Ron Eisen, president of the Portland, Ore., consulting firm Investment Management Consultants Inc., said size and the quality of a record keeper's book of business both matter. Record keepers will need to provide services to a minimum of 3 million participants, he said. And for most, the only way to get there is to take over their competitors, he said.
Of course, "for consolidation to occur there has to be one who is willing to consolidate and another willing to take the business over," Mr. Ready said.
Companies cannot sell their way out of inefficient operations, Mr. Wuelfing said. "The companies that are in trouble today built their business on the assumption that assets would rise forever and hide the inefficiencies of their record keeping," he said.
What's more, outsourcing record keeping may be seen as a graceful way of exiting the marketplace, and joint ventures are complicated by the question of what firm will get the assets flowing from the investment management. In joint ventures, both companies could be fighting to get their investments in plans in a world where, thanks to open architecture, fund executives can choose investments from a number of managers.
"Both companies are trying to get a piece of a shrinking pie," he said.
Pushing some firms out the door is an expectation that part of President Bush's retirement plan proposals will be adopted, particularly the universal qualified retirement plan. Should defined contribution plans be consolidated, some firms might be reduced to nothing more than payroll companies, observers say.
Industry has to change
"The industry has to change," said William J. Arnone, partner with Ernst & Young LLP, New York. "The big question is, does the industry still want to position the employer as an intermediary. The major change is the retailing of retirement plans."
With these and other changes looming, some predict the survivors will boast a mix of fees derived from investment and record-keeping services.
More fees for record-keeping service clients will allow companies to weather the storm, said Don Bartolai, senior vice president of Mellon H.R. Solutions, Fort Lee, N.J. Between 70% and 75% of Mellon's client base pays fees for services, he said.