CHAPTER 7 BUSINESS STRATEGY AND MODELS
ILLUSTRATION 7.1 Vanguard’s low-cost strategy comes to Europe
The US company Vanguard pioneered a distinct low-cost strategy in the mutual fund industry
and is now exporting it worldwide.
Mutual funds are managed by investment companies
that raise money from multiple customers and invest
the money in a group of assets (stocks, bonds, money
market instruments, etc.). Each customer, often as part
of a retirement plan, then owns shares that represent
a portion of the holdings of the fund. They are charged
an annual fee or ‘expense ratio’ that covers investment
advisory fees, administrative costs, distribution fees
and other operating expenses. The traditional way of
competing in the industry was by actively managed
and differentiated investments that tried to generate as
high returns as possible and thus being able to charge
higher fees. The emphasis was on the business perfor-
mance end of the business by offering differentiated
funds with higher returns. Vanguard instead focused
on the cost end of the business and offered custom-
ers considerably lower annual fees and costs. Most
comparisons showed that Vanguard’s fees or expense
ratios were 65–80 per cent less than the industry
average depending on investment asset. The company
also launched the industry’s first index mutual fund
that passively followed a stock market index without
ambitions to generate a better performance than the
market, but which outperformed many actively man-
aged funds.
Vanguard has started to export its low-cost focus to
Europe, and their non-US assets have more than dou-
bled in the last six years, reaching over $90bn (€68bn,
£54bn) in Europe. ‘Lowering the cost of investing is in
our DNA,’ blogged Tom Rampulla, former head of Van-
guard Europe. Their low-cost strategy involved several
components. First, unlike competitors it did not need
to make a profit. Tim Buckley, chief investment officer
explained:
‘We are not a listed company. We’re a mutual com-
pany. We’re owned by our clients. So when we make
a profit, we have two choices. We can roll that profit
back into the business or we can pay it out to our
owners, our clients, in the form of lower expenses.
Over the years we have lowered expenses and that
has attracted more clients.’1
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Second, Vanguard distributed their funds directly to
customers and did not need to pay commissions of
around eight per cent to brokers. Third, the company
had internalised investment advisory functions of the
funds at cost instead of using external investment advi-
sors that would charge a premium. Fourth, Vanguard
relied on a no-nonsense thrifty organisational culture
where managers were incentivised to control cost and
no one, not even senior executives, flew first class.
Fifth, the company had only a few retail centres and
spent less on advertising than anyone else in the indus-
try. Last, but not least, as one of the largest asset man-
agers globally they gained large economies of scale.
By 2015, the next step for Vanguard was to do to
the financial advisory services industry what they had
done to the mutual fund industry. Based on webcam
chats and other cost reductions, the aim was to offer
advisory services at a fraction of the cost of compet-
itors. They would charge annually 0.3 per cent on
assets compared to the industry average of one per
cent, according to Vanguard CEO Bill McNabb:2
‘Can we provide really super-high quality advice at
a very low cost and do that in a very large way, and
change the market? I think we can. We continue to
think of our primary mission to reduce the complex-
ity and cost of investing across the board.’
Sources: (1) D. Oakley, Financial Times, 4 March 2015. (2) S. Foley,
Financial Times, 8 December 2014.
Questions
1 What type of competitive strategy, low-cost,
differentiation, focus or hybrid, would you
suggest as a way of competing with Vanguard?
2 Using webcam chats is one approach to
lower costs in financial advisory services
as indicated above. What other ways could
there be to lower costs to support a low-cost
strategy?