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'The Innovator’s Dilemma:' A Roadmap to Survive Disruption in the 401(k) Space

As DC plans move into the next phase, providers and advisors stuck in the old paradigm will struggle to keep up.

There are very few business books that provide keen insight with actionable suggestions. Rare exceptions include Blue Ocean Strategy, which offers ways for new entrants to compete, and Professor Benartzi’s Save More Tomorrow, which provides practical insights about how to apply behavioral finance principles.

Harvard professor Clayton Christensen’s The Innovator’s Dilemma is perhaps the most relevant roadmap today for advisors and providers interested in riding the coming tsunami.

The defined contribution plan industry is about to enter its most prolific period of innovation since its accidental inception in the 1980s due to three factors:

  1. The explosion of the small business, startup plan market due to state mandates, PEPs and tax incentives;
  2. The growing need of 97% of participants who cannot afford or do not want traditional personal advice; and
  3. The full maturation of DC plans to replace traditional pension plans as the primary source of retirement income.

Before coining the term “disruptive innovation,” Christensen was known for introducing the concept of “disruptive technology,” which we all understand and have experienced. “Disruptive innovation” challenges well-established paradigms, which large incumbents miss and then struggle to catch up with.

 The Innovator’s Dilemma describes:

“… how large incumbent companies lose market share by listening to their customers and providing what appears to be the highest-value products, but new companies that serve low-value customers with poorly developed technology can improve that technology incrementally until it is good enough to quickly take market share from established business.

… the next generation product is not being built for the incumbent's customer set and this large customer set is not interested in the new innovation and keeps demanding more innovation with the incumbent product. 

… how successful, outstanding companies can do everything "right" and still lose their market leadership—or even fail—as new, unexpected competitors rise and take over the market.” 

Though it might be tough for fintech record-keepers to displace established ones who have significant client bases and distribution networks as the industry consolidates, or for robo advisors to displace the hundreds of thousands of traditional wealth and financial advisors, or for wealthtech to infiltrate the DC industry hindered by the lack of data, heavy regulations and resistant providers, the societal factors are too great to resist and maintain the status quo.

Well-funded fintechs like Guideline with almost 35,000 plans and 11,000 new ones last year alone are ready, willing and able to service and sell small and startup plans, as is Paychex, which crossed the 100,000 plan mark recently. Vestwell seeks to partner with broker/dealers like Morgan Stanley and record-keepers that sell through advisors. Others, like Human Interest, with 100 recently hired salespeople and rumored to be partnering with Amazon’s distribution network, are for real.

Wealthtech has just started to infiltrate the DC market driven by incumbents, with firms like Next Capital, which offers managed accounts bought by Goldman Sachs. Empower is integrating Personal Capital and the two largest robo advisors, Vanguard and Schwab, are well entrenched DC providers. Look for new firms like financial wellness provider Athena funded by Creative Planning to make an impact and pave the way for others.

Data will be the key to engaging and guiding the 97% of participants who cannot afford or do not want traditional advice as well as fueling lifetime income as we struggle to retrofit DC plans to replace DB plans. The recently announced Portability Services Network has the potential to create standards and facilitate data exchange as does blockchain technology, which could be used to integrate all DC and IRA accounts as well as outside assets.

Yet DC plans have the potential for even greater impact than pension plans, which only 18% of workers were able to leverage even at its height, according to EBRI, to help workers manage all finances at work with COVID-19 as the catalyst. Newcomers like Guideline, Vestwell and Human Interest and established providers and advisors that have complementary businesses like Paychex, Vanguard, Schwab and Goldman willing and able to take risk and serve new types of clients that are presently low-margin, high-risk opportunities will shepherd in and lead the next phase of DC plans. 

The new business model will welcome startups and small plans, force the integration of well-established wealthtech leveraging data to service most if not all participants, and finally offer lifetime income services that replace paychecks in retirement without sacrificing control or flexibility.

However, it is likely that most current advisors, broker/dealers and providers will, as Christensen describes, lose their positions and struggle to compete in the new paradigm because:

By the time the new product becomes interesting to the incumbent's customers it is too late for the incumbent to react to the new product. At this point it is too late for the incumbent to keep up with the new entrant's rate of improvement.

And if you don’t believe me, just ask the banks and insurance companies who dominated the DC industry in the 1980s and, in the following decades, active mutual fund providers late to target date funds offering only proprietary investments on their platforms.

Fred Barstein is founder and CEO of TRAU, TPSU and 401kTV.

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