How Disruptive Innovation Works: The Robo-Advisors Case

Let’s compare the Job-To-Be-Done, value proposition, and business model to understand how disruptive innovations work.

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Robo-advisors are automated digital platforms to provide financial management services. They began to be available for general investors in 2010 with the launch of Betterment. This technology was launched to provide an affordable, convenient, and easy way for investors to manage their cash. Little by little, these algorithm-driven advisors are entering the low-end wealth management market while creating a new market, managing $980B assets in 2019, and expecting to manage $2,552B assets by 2023.

While the expected growth and disruption are not occurring as quickly as predicted, I believe that we will see an acceleration in the adoption of these platforms once the new digital generations of people start to have more net worth available for investing. In the next images, we can see how the non-digital born ages are the owners of the net worth in the US.

US Net Worth distribution by Age 2016 https://www.listenmoneymatters.com/average-net-worth-age/

US Estim Total New Worth by Age 2016. Self elaboration + https://factfinder.census.gov/

After thinking about how the robo-advisors compare with the traditional wealth management industry, I came up with some conclusions that could help to understand why they are disrupting the market.

Targeting the low-end and non-consumption market

These new financial advisor products focus on low-end and not-existing markets that are unattractive for the traditional wealth management firms:

  • Potential new customers for the wealth management market that do not want to pay the high management fees of the big companies, or cannot use their services because they do not have the minimum amounts required for investment, or do not understand the products they offer. This market is more known as the non-consumption market.More specifically, we could associate this market with the younger technology-friendly crowds like millennials and Gen-Z that do not own too much worth.

  • The overserved customers of the big firms. Individuals in their mid-career (Gen-X), or small companies that do not need the sophisticated services of the investment management companies and are eager to pay less for less complicated and more convenient products. Thus, the low-end of the market.

A good enough product to solve the wealth management job to be done

These automated financial advisors are good enough to fulfill the Job To Be Done “I need help managing my cash easily, conveniently and cheaply”. To satisfy that Job To Be Done with a disruptive product which attracts low-end customers and create a new market, they have changed several traditional and socially assumed characteristics of the wealth management products to solve pain points and build gains:

  • Fees: Much cheaper than conventional investment firms (0.25%-0.5% vs. 1–2% annual fees) to attract low-end and non-consumption consumers. The transparency in the price is another crucial factor featured to have success when targeting the millennials and Gen-Z.

  • Convenience: Accessible very quickly in a centralized and digital manner. The experience is critical to allow the accessibility from anywhere, open an account with no minimum money requirements, and start saving money for retirement and other life goals in much less time and effort than with the incumbent investment firms.

  • Low-complexity: The financial products of the robo-advisors are easy to understand for customers. On the one hand, this attracts more overserved customers and non-consumption consumers, as we explained before. On the other hand, it helps the automated advisor products to not compete directly with the big firms for the mid and high-end customers, who are the ones giving high margins for the traditional firms. It benefits the robo-advisors to not being seen as competitors by the incumbent firms because they are stealing just some low margin customers.

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A different and challenging to copy business model for the big incumbent firms

There are several business model constraints in the traditional wealth management companies than would probably drive to fail any attempt to develop a robo-advisor based service under the same company structure. Among all those differences between both models, the most crucial factor to consider is how they make money (the profit formula).

Firstly, there is a difference in the margins of the target customer of each of both business models. The robo-advisors customers (the non-consumption and low-end markets) invest much less money than the high-end. It means that the margins of these low-end are too low for investment firms with this kind of customer. For them, this market is not attractive in margins, and having fewer of these customers would enable them to focus on the high-end market to earn better margins more efficiently. It is the asymmetric motivation of disruption: while being disrupted, the incumbent companies flee out the low-end market segment that the new entrants are taking because of this segment is unattractive for their businesses.

Secondly, the cost structure that the traditional business model should support to sustain their P&L limits their innovation movements. Robo-advisors have a cost structure much less complicated and cheap than the big wealth management firms. These firms could not copy this cost structure to attack the low-end and non-consumption markets even if they wanted to. This cost structure is more complicated for the incumbents in terms of:

  • Direct costs: Robo-advisor products use complex algorithms to automate investment management. They invest CAPEX in developing these technologies and amortize at the same time that they keep innovating in new algorithms and user experience improvements. On the opposite, traditional investment firms hire people for active investment management, which is labor extensive. Traditional firms have to compensate for much higher operative costs than robo-advisor products. Besides, low financial product complexity helps algorithms to be more affordable to develop. Investment firms need more time for people to manage all the products they have, which increases service costs and impede to have cheap services, even if they wanted to.

  • Overhead costs: There is a big difference between these costs of a digital-born business model versus the traditional business model of the incumbent firms that need, for example, offices and have massive management structural costs to support.

High-level business model differences

Incumbent firms still have options to be on the competition for these markets

The incumbent companies still have options and time to avoid disruption (let say to be disrupted but by companies they own):

  • Develop their robo-advisor product under a new business unit with independent resources, processes, profit formula, and P&L. Thus a new business model completely separated from the traditional one.

  • Acquire a robo-advisor firm and not merge it in the traditional company structure and business model, keeping it independent.

We have seen in the latest years some acquisitions of robo-advisors by traditional banks and wealth management firms. A smart movent to not being disrupted. Definitely this is an industry that innovation and strategy passionates should follow to see how it keeps moving in the future.

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Is this phenomenon happening in your industry?

Technological progress has been driving cases like this in almost all industries, along with history. If you believe this is happening now in your industry and your company’s traditional business is at risk of being disrupted similarly, it is time to transform your business and try to be on the disruption side of the industry.

CEOs and top management should work to envision the future of their industries and develop the strategy to ensure the reinvention of the company in the long term, balancing the resources invested for growth in each time horizon.


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