Published in The Hindu - Sunday Magazine on Jan 18, 2009
With retail distribution channels, financial advisors, agents and brokerages playing a vital role in your day-to-day transactions, their commissions are increasingly determining your choice – be it groceries or mutual funds.
Henry Ford, who is still considered the father of the modern automobile industry despite his firm (Ford Motors) hitting rock bottom in the recent economic turmoil, made a famous statement at the launch of his first factory made car – the Model T. When asked how many colours the car would be produced in, his reply was – “you can have any colour, as long as it is black”! Until the liberalization in the 90’s the Indian scenario was pretty much the same with consumer choice being limited to standardized products offered by few companies (meaning two or three) at best – be it cars, toothpaste or even mutual funds.
With the seeming explosion in product variety that is visible in recent years (as seen in the media) - it is easy for you to come to a forgone conclusion that the consumer is really the king and can finally buy whatever best suits his/her tastes or requirement. Well, sadly you are wrong.
A revelation
This article is the result of a revelation (I would rather call it disillusionment) from my recent shopping escapade at the neighbourhood outlet of a large national super market chain. The missus having left the country on a ‘business trip’, I was free to wander the store aimlessly with no list in hand, just checking out what’s new (especially the ready to eat stuff). As I was staring at the freezer, I had an epiphany. Firstly, the essentials like curd, cheese etc… where only available in large SKU’s (stock keeping units or package size). Secondly, many products were restricted to single brand (or company). I quickly did a survey of other sections in the store, and I could sense that under every category there were one or two preferred brands that were being promoted by the store. Curd – Britannia, Milk –Heritage, Cheese – Britannia, Ghee –Hatsun, Water- Cherio, Masala – Eastern, Powdered beverage - Horlicks and the list goes on. The other leading brands that offered these products were either non-existent or strategically sidelined (in a corner, with very few variants displayed). Interestingly for some products, such as rice, sugar, salt etc. the ‘inhouse’ store brand (i.e the retail chain’s own brand) was the most prominent.
The situation demanded a quick call to my friend who works for a FMCG (fast moving consumer goods) firm. The chat revealed just what I feared. With the growing footprint of national retail chains, they are able to offer a unique selling proposition to the consumer goods companies- near monopoly for the one who offers highest percentage commission. The retailing chains believe that customers (you and me) are reasonably loyal to their neighbourhood super market due to the proximity (it is close to the home), ability to shop in peace and leisure (air conditioned aisles etc..) and availability of all products (not necessarily all brands) under one roof. Once inside a store, as long as the particular product is available, customers are willing to trade off one brand to another, based on availability. This means that although you may actually want Amul curd, if the store has only Britannia curd, you are more likely to buy the Britannia curd instead of going to another store to pick up Amul (the one you like). This apparently holds true even if Britannia curd would be a couple of rupees more expensive than Amul, because you justify that a trip to another store merely to pick up one item is just not worth it.
Retailers exploit the above-described psychology of customers by carrying only those brands that pay them maximum commission, under every product category (and price band). In effect the end customer is successfully deceived into buying the product that the store wants him to buy, while the whole point of him visiting the supermarket was so that he could buy whatever he wants! Next time you find your favourite brand repeatedly unavailable in the supermarket, try asking the store-helper. You will either be told that the particular item is out of stock or that the item is not being supplied off late – as if the blame is on the supplier!
This phenomenon of the retailer selling you only those products for which he gets a higher commission is particularly pronounced in the financial services industry. You will be surprised to know that most financial advisors (and/or agents, brokers) also work on the same model. Commissions (paid out of your investment amount) are the answer to the following riddles when it comes to investment instruments:
Why are ULIPs (unit linked insurance plans) more popular than term cover or pure mutual funds (including ELSS – tax saving schemes)?
Mutual funds deduct not more than 2.5 per cent as the agent's commission. And this deduction is 0 per cent (by law) if investors don’t use an agent and go directly to a fund company. In ULIPs, the agents' commission varies, but in the first year, it could be anywhere between 25 per cent and in some cases, 75 per cent.
A ULIP is technically a combination of term cover insurance and a mutual fund i.e one portion of your annual payment goes towards the insurance policy and the other portion is invested in stocks or debt. But the commission that an agent gets by selling a ULIP is many times what he would get by selling the equivalent term cover and mutual fund separately.
Why are single premium insurance plans not as popular as annual premium plans?
For a single premium plan the upfront agents’ commission is 2%. For annual premium plans, not only does the agent get an initial commission of 35% -40% in the first year, but he also gets a commission every ensuing year during the term covered, in the order of 5% - 7.5%.
Why are equity mutual funds more popular than ETFs (exchange traded funds)?
ETFs can be directly purchased on the stock exchange just like buying a stock. So, other than the minimal brokerage fee (0.1%) there is no commission involved in purchasing ETFs. This explains why index exchange traded funds (discussed in my previous article dated Jan 4, 2009) are not very popular compared to regular mutual funds despite their low risk and high returns.
Why are banks interested in selling gold coins rather than gold ETFs, although the latter is safer and offers better liquidity?
Banks earn 8% distribution commission on gold coins.
Among mutual funds, why are NFOs (new fund offers) more popular than existing schemes?
NFOs offer higher commissions to agents (both monetary and non monetary: foreign trips and attractive ‘gifts’) than existing schemes.
Why does your agent advise you to churn your investment from one fund scheme to another, every few months?
Mutual funds pay an upfront commission of up to 2.5% to agents for getting you to invest in the scheme. Once you have invested in a fund, then all that the agent gets is a paltry trail commission of 0.5% every year you stay invested in the scheme. Your agent need not be a math wizard to figure out that he can earn more (2.5% > 0.5%) by getting you to churn your investment into a new scheme.
The next time you call your financial advisor for a tax saving mutual fund scheme and find that he recommends a ULIP, you better watch out!
Henry Ford, who is still considered the father of the modern automobile industry despite his firm (Ford Motors) hitting rock bottom in the recent economic turmoil, made a famous statement at the launch of his first factory made car – the Model T. When asked how many colours the car would be produced in, his reply was – “you can have any colour, as long as it is black”! Until the liberalization in the 90’s the Indian scenario was pretty much the same with consumer choice being limited to standardized products offered by few companies (meaning two or three) at best – be it cars, toothpaste or even mutual funds.
With the seeming explosion in product variety that is visible in recent years (as seen in the media) - it is easy for you to come to a forgone conclusion that the consumer is really the king and can finally buy whatever best suits his/her tastes or requirement. Well, sadly you are wrong.
A revelation
This article is the result of a revelation (I would rather call it disillusionment) from my recent shopping escapade at the neighbourhood outlet of a large national super market chain. The missus having left the country on a ‘business trip’, I was free to wander the store aimlessly with no list in hand, just checking out what’s new (especially the ready to eat stuff). As I was staring at the freezer, I had an epiphany. Firstly, the essentials like curd, cheese etc… where only available in large SKU’s (stock keeping units or package size). Secondly, many products were restricted to single brand (or company). I quickly did a survey of other sections in the store, and I could sense that under every category there were one or two preferred brands that were being promoted by the store. Curd – Britannia, Milk –Heritage, Cheese – Britannia, Ghee –Hatsun, Water- Cherio, Masala – Eastern, Powdered beverage - Horlicks and the list goes on. The other leading brands that offered these products were either non-existent or strategically sidelined (in a corner, with very few variants displayed). Interestingly for some products, such as rice, sugar, salt etc. the ‘inhouse’ store brand (i.e the retail chain’s own brand) was the most prominent.
The situation demanded a quick call to my friend who works for a FMCG (fast moving consumer goods) firm. The chat revealed just what I feared. With the growing footprint of national retail chains, they are able to offer a unique selling proposition to the consumer goods companies- near monopoly for the one who offers highest percentage commission. The retailing chains believe that customers (you and me) are reasonably loyal to their neighbourhood super market due to the proximity (it is close to the home), ability to shop in peace and leisure (air conditioned aisles etc..) and availability of all products (not necessarily all brands) under one roof. Once inside a store, as long as the particular product is available, customers are willing to trade off one brand to another, based on availability. This means that although you may actually want Amul curd, if the store has only Britannia curd, you are more likely to buy the Britannia curd instead of going to another store to pick up Amul (the one you like). This apparently holds true even if Britannia curd would be a couple of rupees more expensive than Amul, because you justify that a trip to another store merely to pick up one item is just not worth it.
Retailers exploit the above-described psychology of customers by carrying only those brands that pay them maximum commission, under every product category (and price band). In effect the end customer is successfully deceived into buying the product that the store wants him to buy, while the whole point of him visiting the supermarket was so that he could buy whatever he wants! Next time you find your favourite brand repeatedly unavailable in the supermarket, try asking the store-helper. You will either be told that the particular item is out of stock or that the item is not being supplied off late – as if the blame is on the supplier!
This phenomenon of the retailer selling you only those products for which he gets a higher commission is particularly pronounced in the financial services industry. You will be surprised to know that most financial advisors (and/or agents, brokers) also work on the same model. Commissions (paid out of your investment amount) are the answer to the following riddles when it comes to investment instruments:
Why are ULIPs (unit linked insurance plans) more popular than term cover or pure mutual funds (including ELSS – tax saving schemes)?
Mutual funds deduct not more than 2.5 per cent as the agent's commission. And this deduction is 0 per cent (by law) if investors don’t use an agent and go directly to a fund company. In ULIPs, the agents' commission varies, but in the first year, it could be anywhere between 25 per cent and in some cases, 75 per cent.
A ULIP is technically a combination of term cover insurance and a mutual fund i.e one portion of your annual payment goes towards the insurance policy and the other portion is invested in stocks or debt. But the commission that an agent gets by selling a ULIP is many times what he would get by selling the equivalent term cover and mutual fund separately.
Why are single premium insurance plans not as popular as annual premium plans?
For a single premium plan the upfront agents’ commission is 2%. For annual premium plans, not only does the agent get an initial commission of 35% -40% in the first year, but he also gets a commission every ensuing year during the term covered, in the order of 5% - 7.5%.
Why are equity mutual funds more popular than ETFs (exchange traded funds)?
ETFs can be directly purchased on the stock exchange just like buying a stock. So, other than the minimal brokerage fee (0.1%) there is no commission involved in purchasing ETFs. This explains why index exchange traded funds (discussed in my previous article dated Jan 4, 2009) are not very popular compared to regular mutual funds despite their low risk and high returns.
Why are banks interested in selling gold coins rather than gold ETFs, although the latter is safer and offers better liquidity?
Banks earn 8% distribution commission on gold coins.
Among mutual funds, why are NFOs (new fund offers) more popular than existing schemes?
NFOs offer higher commissions to agents (both monetary and non monetary: foreign trips and attractive ‘gifts’) than existing schemes.
Why does your agent advise you to churn your investment from one fund scheme to another, every few months?
Mutual funds pay an upfront commission of up to 2.5% to agents for getting you to invest in the scheme. Once you have invested in a fund, then all that the agent gets is a paltry trail commission of 0.5% every year you stay invested in the scheme. Your agent need not be a math wizard to figure out that he can earn more (2.5% > 0.5%) by getting you to churn your investment into a new scheme.
The next time you call your financial advisor for a tax saving mutual fund scheme and find that he recommends a ULIP, you better watch out!
6 comments:
Thanks Shyam,
Good details about both the retail sector and the Financial sector. So, once again, we are being pushed into some sort of Monopoly. :(
Hi,
Its a great revelation about various aspects of the retail stores and mutual funds.Its really interesting to know such informations.
where to get the details of Jan-04 column regarding ETFs. Kindly guide.
Siva, you can find this on my Dec 31st post in the blog.
I liked your article talking about how retaliers and financial intermediaries sell their products or services keeping in mind their own commission earnings and ignoring customer's interests.
I think we need more people like you to create awareness about financial products such as ETFs so that lay investors can avoid the perils of stock investing and huge commissions to advisors and losses in churning investments.
Nice article and very useful too. Are there any funds in India which offer Silver ETFs, Oil ETFs, REITs, etc ? Please let me know if you know of any news.
Hi Shayam,
Good work. keep it up.
After investing in ULIP (For tax saving purpose) and calculating the unit in my account after 2 years, I decided.. No more ULIP.
Purchase a term insurance, for what ever amount you want and remaining money into fixed deposits for 5 years and save tax.
What do you think ?
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