Where Robo-Advisors Went Wrong

What’s next for the robo-advisor? First championed by venture-backed startups, the robo-advisor was quickly replicated by incumbent firms. Today, the startups in the space are seeing declining growth rates, while competing with the incumbents they once threatened. To achieve staying power as stand-alone companies, the next generation of wealth management startups will need to invest heavily in cutting-edge technology, not clever marketing.

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In the past 5 years, VC-backed robo-advisor startups appeared left and right, offering low-cost diversified ETF portfolios that are “advised” algorithmically with a risk questionnaire. Many industry analysts were quick to call their bluff. The robo-advisors, they said, were just a traditional target-date retirement fund with a sleek mobile app, marketed as a replacement for a human financial advisor.

The Copycats

Revolutionary technology? Maybe not. But the startup robo-advisors were onto something, and incumbents started copying them. In 2015, Vanguard and Schwab launched their own robo-advisors, which gobbled up more assets in six months than the startups did in four years, combined.

Vanguard and Schwab eclipsed the startup competition, not because their product was better, but because they had economies of scale, a recognizable brand name, and large customer bases to cross-sell to. All of this translates to a relatively low customer acquisition cost (CAC) for their new products.

E*TRADE and TD Ameritrade have since released their own robo advisors. Fidelity, Merrill, and Morgan Stanley are likely follow suit, further eclipsing the market.

An Uphill Battle

Analysts estimate startup robo-advisors spend up to $1000 to acquire a new customer, and will need $40B in assets to break even. The largest startup robo-advisor, after five years operating, is at $10B, and growth rates have slowed drastically. 

With incumbent robo-advisors going “mainstream,” most people have access to a robo-advisor from their existing financial institution. Given the high costs of switching, this doesn’t bode well for the startups’ growth.

What’s next?

For the well-funded startup robo-advisors, a diversified product suite is a good next step. That way, they can cross-sell to the (mostly young) clients they acquired, as their financial needs become more complex. Wealthfront, the second-largest startup robo-advisor, seems to be pursuing this strategy, offering a portfolio line of credit, 529 plans, and direct-index investing to help wealthier clients avoid underlying ETF fees. Complementary products might boost per-customer revenue, but until a startup robo-advisor can drastically lower their acquisition costs, they will continue to experience the same setbacks.

For the next generation of fintech startups, the rise and fall of startup robo-advisors provides some valuable lessons:

  1. Invest in technology, not customer experience and design, which are too easy to replicate.
  2. Watch your CACs. Robo-advisors reduce some operational costs, but that edge is wiped out by sky-high acquisition costs.
  3. Sell high – don’t raise money at valuations that make exiting impossible.
  4. License your technology to the industry you thought you’d disrupt. B2B robos need just a handful of deals to prosper, and can do so with less manpower.

Beneath the glitz of the heavily-funded fintechs, smaller players are already focusing heavily on technology. In the investment world, tomorrow’s winners will build tech to enhance the incumbents, rather than competing for their customers.

One thought on “Where Robo-Advisors Went Wrong

  1. Damion Hänkejh (@hankejh) says:

    There is so much value in this prescription. My company, InstantService.com (now Oracle), fought bitter battles with dozens of competitors who rose like weeds around us. Our focus on technology rather than customer experience set us apart — in fact, Oracle has neither moved our network operations center nor even bothered to change our domain. LivePerson spent and focused too little on tech and they lost their largest customers to us. Great post!

    Like

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