Go big or go bust?

The last 10 days has seen a great deal of industry speculation and media coverage about the possible acquisition of Trimark Financial Corp. The rumoured candidates include large domestic competitors, the Canadian operation of a major U.S. player and global firms looking to establish their presence in Canada.

Trimark would not be the first instance of a fund company being swallowed by another -- in fact, there have been three such acquisitions in Canada in the past year alone. All of these, however, have been relatively modest in scale. By contrast, Trimark is Canada's sixth-largest mutual fund company, a firm that despite weak short-term performance by some key funds is still one of the highest-profile and best-regarded players in the industry.

What would be the significance of the sale of Trimark to a competitor?

Does this mark the onset of major consolidation in the mutual fund industry?

Finally, what does this mean to the Canadians who look to mutual funds as their primary savings vehicles, to investors in shares of fund companies and to the industry as a whole?

To put the current events in the Canadian mutual fund industry in perspective, it is important to understand the stages of growth for most new industries.

The first stage is hypergrowth. This phase is marked by very rapid increases in sales and customer growth. Competition in this phase is sometimes characterized as the "Wild West," with an "anything goes" mindset. New entrants jump in, attracted by the industry's rapid growth prospects because there are few entrenched competitors, barriers to entry are relatively low and new players find easy access to capital.

Success is driven by new ideas, and innovation comes fast and furious. There is an intense fight for market share, with sales being more important than profit, as players position themselves for the future.

Virtually every significant new industry goes through this phase -- think the automobile industry in the early 1900s (there were over 200 car manufacturers in 1920), consumer electronics in the 1960s and 1970s, the computer hardware and software industry in the 1980s and, of course, the dot.coms over the past three years.

This hypergrowth phase marked the Canadian mutual fund industry through the 1990s. While funds have existed in Canada since the 1930s, assets exploded over the past 10 years, growing from $30-billion at the start of the decade to $400-billion today.

The hypergrowth phase is inevitably followed by maturation. In this stage, sales slow down, often because of new alternatives from outside the industry and because customers have made their initial purchases.

Overcapacity from all the new competitors who have flocked to the industry means that competition continues to be intense, but changes in focus, frequently resulting in downward pressure on prices. Customers who were often naive and unsophisticated in the hypergrowth phase become more discerning. If you're a manufacturer, the retailers who distribute your product become more demanding as well and often launch internal "house brands" to compete against your products. As a result, there is a shift in emphasis from sales alone to increasing attention to the bottom line, as future sales prospects no longer justify a single-minded focus on market share.

In this phase, the determinants of success change. Driving down the cost of manufacturing and distribution through economies of scale and investment in technology becomes critical. It is necessary to build a deep management team. Creating a well-recognized consumer brand name is essential to build customer loyalty, command a premium price and maintain bargaining power against retailers who have their own versions of your product to sell.

In this stage, good ideas are not enough -- scale becomes absolutely critical if you want to be an industry leader. It is this maturation stage that the Canadian mutual fund industry has entered in the past eighteen months.

One other factor drives corporate strategy. Not only does size become more important in a maturing industry, but in an environment of slower sales, scale becomes more difficult to achieve through new sales alone. As a result, the way to achieve bulk shifts from new sales to acquisition of existing players.

This environment is sometimes described as "go big or go home." There is room for large, dominant players and there is scope for well-focused, smaller niche competitors, but mid-sized players get squeezed. If you're a mid-sized firm, at a certain point in time your options become to buy, sell or to hope that you come up with an incredibly hot new product leading to a flood of sales. While we're not at that point in the Canadian mutual fund industry quite yet, we might not be a huge distance away either.

What does all this mean to consumers?

Consumers are often alarmed by consolidation, because they see it undermining what they look for in any industry -- choice, innovation, low prices and good value. This is at the crux of concerns about the recent acquisition of Canadian Airlines by Air Canada.

The mutual fund industry is a very different story. Even after a round of dramatic consolidation, we will still have a substantial number of firms with vigorous competition. We currently have five large Canadian fund companies with assets of $20-billion or more. Each bank also has a fund company. We also have three major U.S. firms with a presence in Canada, with more potentially on their way. In fact, nationalists should applaud the merger of Canadian firms -- it may be the only way to compete effectively with foreign entrants. In the meantime, Canadians will ultimately benefit from the better products at lower prices that only scale and competition can bring.

From the perspective of investors in fund company stocks and the industry itself, this should be seen as a normal evolution in the development of any industry. Now that the easy sales are behind us, the real hard work to win the hearts and savings of Canadian investors begins. Dan Richards is president of Toronto consulting firm Marketing Solutions.