21 Jan 2014
The Waterbed effect is a phenomenon that should increasingly cause concern to those who regulate the industry and those it regulates in regard to pricing and the detriment the post RDR world has wrought upon the intended beneficiary- the consumer.
The Waterbed effect is the natural but not necessarily intended potential to squeeze one part of a complicated and complex regulated business model (and the attendant regulatory processes) to cause a serious bulge elsewhere in the process.
As an owner in the 70’s of a waterbed (with the attendant fond memories) the metaphor of the water-filled mattress seems to be a common sense albeit simplistic description supported by a little known mathematical formula called Bode’s Sensitivity Integral.
The Waterbed effect is already well illustrated in the mobile phone and utilities industries where regulation and political interference fixes or manipulates the prices of basic products and services only for consumers to see complicated pricing structures ensue by way of significant increases in the price of peripherals and additional services as a direct consequence.
So, the Waterbed effect theory in RDR dictates that in achieving:
We will no doubt see the bulge appear somewhere else.
And this will be seen in costs in every conceivable way and particularly for consumers. Cost is something that the FCA incurs for firms, often with little thought of logic or affordability and with little benefit analysis being done on the consumer impact and detriment it created. And none is being considered politically at least until 2015.
So how else will the Water Bed effect manifest itself?
In ensuring the adviser is the true agent of the consumer, the result is that the mass-market consumer will not, does not want to pay for advice that has previously been seen as free. Why do you think the banks bailed out of the crashing plane, much to the annoyance of Martin Wheatley, who felt they had 5 years to prepare?
For clarity over the costs of advice, sadly that clarity will be that for the mass market, cost equals no advice sought if they have to be seen to pay for it, even indirectly by way of fund deduction.
Consider an investment in an ISA. The fee costs of advising could be a couple of hours work. The average hourly rate is around £150 based on our recent research. This could equate to say £300. I suspect that in the current market this cost, together with other management costs would mean no client return of any significance in year one. Similar to the days of commission in both amount and effect, you really could not make this up if you tried?
So clarity is achieved, but as for savings to the client or the cost impact to the client by way of fee rather than commission, what is the outcome? Also consider this example of the Waterbed effect.
When a consumer is able to obtain lower prices from an adviser, is it possible that other consumers will have to pay more for the same input from another adviser firm as a result? Is this bad for consumers?
The asymmetric exercise of consumer power can lead to consumer detriment through raising other consumers’ advice charges- the Waterbed effect.
While a large and powerful firm or distribution channel improves its own terms of advice supply by exercising its market power in getting cost reductions, the terms of its lesser resourced competitors can deteriorate sufficiently so as ultimately to increase the average price of advice - the Waterbed effect.
Even the recent FCA paper on inducements will have little effect now for smaller firms, but it will later on networks- in extreme cases the reduction of cash flow resulting in network failure- the Waterbed effect.
Such consumer detriment is more likely very soon if adversely affected firms are already sufficiently squeezed, due to relatively higher regulatory and other operating costs and a lower market share. They will close leaving orphan clients - the Waterbed effect..
So while we lay in our Waterbed, what should we wear to prevent a bulge getting the better of us?
Chanel No. 5, of course was Marilyn Monroe's choice, what is yours?