What’s on the Menu? Engineering a better outcome for investors

Depositphotos_50578301_xsBy Robb Engen, Boomer & Echo

Special to the Financial Independence Hub

When I worked in the hospitality industry our hotel group placed a large emphasis on the profitability of its restaurants and catering departments. Considerable effort was made to drive overall food costs down while at the same time creating a sales culture that pushed the highest margin items in order to boost revenue.

One of the most effective ways to do this was through a process called menu engineering. Before hitting it big by turning around struggling nightclubs in the reality show Bar Rescue, Jon Taffer was a highly sought-after speaker and consultant in the hospitality industry. At the top of Taffer’s legendary revenue growth plan for restaurants and bars is the concept of menu engineering. Here’s how it works:

Restaurant owners divide their menu items into four main categories:

  • Stars – Stars are extremely popular and have a high contribution margin. Ideally Stars should be your flagship or signature menu items.
  • Plow horses – Plow horses are high in popularity but low in contribution margin. Plow horse menu items sell well, but don’t significantly increase profit.
  • Puzzles – Puzzles are generally low in popularity and high in contribution margin. Puzzle dishes are difficult to sell but have a high profit margin.
  • Dogs – Dogs are low in popularity and low in contribution margin. They are difficult to sell and produce little profit when they do sell.

The main goal of menu engineering is to steer restaurant customers towards your stars (highest margin items) and away from the dogs (low-profit items). The way to do that is by using a bit of psychology in the design of their menu.

For example, boxing an item on a menu will increase its sales by 20 per cent, and shadowing an item on a menu will increase its sales by 14 per cent. The serial positioning effect (our ability to remember the first and last items in a series best) means listing profitable appetizers and entrees first and last, since customers are more likely to ignore the middle.

Menu-engineered investments

Customers may not care if their dining experience is being subtlety manipulated by savvy restaurateurs. After all, we go to a restaurant to enjoy good food and drinks in the company of friends and family.

But what about when the stakes are higher, such as in the world of investing and financial advice? There,  the banks and mutual fund dealers are the restaurant owners, carefully crafting a menu of profitable funds; the advisor becomes the waiter or waitress, steering unsuspecting customers toward the catch of the day (with a side order of segregated funds).

What might a menu-engineered line-up of mutual funds look like?

  • Stars – The most popular and profitable mutual funds: most likely a Canadian equity fund or dividend fund with an average MER of 2.42 per cent
  • Plow Horse – High popularity but lower profitability: most likely a bond fund, where the advisor receives a 0.5 per cent trailing commission as opposed to 1 per cent with an equity mutual fund.
  • Puzzles – Highly profitable but low in popularity: most likely includes global funds or a niche fund with an exotic strategy that customers don’t understand. Fees likely in the 2.75 – 3.25 per cent range.
  • Dogs – Low margin or no-margin products such as index funds, e-Series funds, and f-series funds (less likely to be discussed or even included on the menu).

Revamping the mutual fund fee structure

The Canadian Securities Administration (CSA) is reviewing our mutual fund fee structure and whether commission-based compensation changes the nature of advice and impacts investment outcomes for the long term.

The first study, published last week by the Brondesbury Group, concluded among other things that commission-based compensation creates problems that need to be addressed. The second study was awarded to Dr. Douglas J. Cumming, professor of finance at York University, and focuses on whether sales and trailing commissions influence mutual fund sales. It’s expected to be released soon.

One potential outcome from these studies is that the CSA may look to ban trailer fees altogether. The Brondesbury report looked at the impact of banning commissions and determined that we’d see:

  • More sales of lower cost products including lower cost mutual funds and ETFs.
  • Less biased product selection from advisors.
  • Higher explicitly stated cost for full service advice.
  • More use of non-advised or simplified advice (robo-advisor) channels by lower income and lower wealth investors.

I reached out to Ed Weinstein, author of the Brondesbury report, about what happens next. He said:

“The CSA doesn’t tell me what they intend to do nor even what they think of the current report. What I understand is that they are trying to use evidence rather than opinion as the basis for setting policy and that is a laudable aim. With that logic, I expect they will see what Dr. Cumming finds in the Canadian market. I believe with that in hand they will likely have enough evidence to start thinking about what policies and regulations make sense based on the evidence. I would be surprised if they undertook more research unless there were some fine points they needed to settle before creating policy and rules.”

Investor advocate Ken Kivenko believes that both the Brondesbury and Cumming reports will support industry reform and that some decision could be made as early as Q1 2016. Kivenko says that reform could come in a number of ways, including a cap on trailers, requiring D class funds to be available, and banning commissions on leveraged sales.

“CSA is a political beast so the outcomes are hard to predict. Industry opposition also remains fierce.”

Final thoughts

In my view, there are three issues to tackle when it comes to reforming the investment industry in Canada.

  1. Commission-based advice is riddled with conflict of interest and trailer fees need to be eliminated1.
  2. Besides trailer fees, Canadian mutual funds cost far too much as a whole (2.42% for the average equity mutual fund) and need to be capped.
  3. A best-interest or fiduciary duty should be established to replace the current (and inferior) suitability standard for investment advice.

I believe the time is right for reform. The so-called advice gap (where banning commissions will lead to advisors leaving the field) is overblown as technology (robo-advice) can fill the void at a fraction of the cost. Pairing DIY investing or robo-advice with a fee-only or advice-only financial planner can still much cost less than what Canadians are currently paying with a commission-based mutual fund model.

That said, this is an incredibly complex topic and any reform the CSA takes is unlikely to solve all of the issues.

“I can only say if the answer looks simple to someone, they haven’t considered all the issues,” said Weinstein.

What most experts can agree on is that whatever the solution, investors must understand they are paying for advice as well as transactions.

Robb Engen

In addition to running the Boomer & Echo website, Robb Engen is a fee-only financial planner. This article originally ran on his site on June 14th and is republished here with his permission.


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