I sometimes wonder how much investment analysts and financial journalists really know. I test my wonderment when something happens that I think I know something about.
My recent test has been the purchase of BT by Westpac. (We’ve been told that Westpac had to do this to get scale. The industry is consolidating and the banks will dominate.) Guess what? My wonderment has been confirmed.
Many argue that financial services is a scale game — you have to be big to win. I disagree and will argue that product life cycle theory, diseconomies of scale, technology and history support my view. Further, I will look at it in terms of manufacture, platforms (interfaces) and distribution.
But, before I do, let me say that the big players (the banks especially) will be successful, but they will not dominate. They will be significant players, but there will be other significant non-bank players (including other institutions and non-institutions) and significant non-aligned players.
Product life cycle theory tells us that products, companies and industries go through a life cycle of innovation, rapid growth, maturity, and then stagnation and decline — unless they can reinvent the product or themselves. Often they can’t do this (reinvent) because they have such an investment (resources, culture) in the status quo that they have a mindset that won’t brook change. We only have to look back to the early 1980s to the life insurance industry for a recent example of this.
Also size brings with it inertia. Not only for the reasons listed above, but also because change is just so much harder. There are legacy systems and products and probably people in key positions who feel threatened by change. With size comes bureaucracy. This means that flexibility and personalised service are casualties.
Often we hear about the economies of scale, but there are diseconomies of scale. Big complex systems are needed — this means administration and layers of management. Any changes are difficult. Major system rebuilds or retraining of staff are fraught with danger. The effect of mistakes, or failure, are magnified — and haven’t we had some examples of that lately.
Until recently size was important. The economies of scale outweighed the diseconomies. But technology has reversed the equation. For example, once to be a stockbroker you needed a lot of resources in terms of systems, hardware and people. Today you can be a virtual broker, without any capital outlay on software or systems. Soon you will be able to be a virtual fund manager.
And history! I don’t want to be too unkind, but the past 20 years are littered with examples of big trying to dominate particular markets and resulting in big becoming small. In 1983 ANZ bought Australian Fixed Trusts (AFT), which was then the largest fund manager in Australia with the largest tied (non-life) advisory force. Westpac and NAB also attempted to move into distribution about that time (who remembers Vic Cotteren?). Some time later the banks tried their hand at stockbroking. Did size make them successful?
With funds management (product manufacturing) there are other issues as well. There is a view that large fund managers (especially equity) in Australia become constrained, given the size of the market here. They don’t have the same freedom to move that small managers have — it can take time to either accumulate a holding or dispose of it. Some argue their results tend towards the mean. This may be good, but for the smaller manager it is easier to take a position, and only be in the stocks they want to be in. This would suggest that they have a greater opportunity to outperform — possibly the converse is also true.
For platforms, size is obviously an advantage. But there is a big assumption in that statement. The assumption is that platforms will continue to play the pivotal role in distribution that they do today. Once to have size as a typewriter manufacturer was an advantage. But it turned out to be a disadvantage when word processing emerged. They could not accept (mindset) that there was any other way to type documents. We still type, but we don’t use typewriters. (I would imagine some readers have never even seen one!)
Technology (as it did with typewriters) will not make today’s platforms redundant, but it will make them commodities, possibly legacy products. There will still be the need for what they do now (as there is still a need for typing), but technology will provide a different and better solution.
The different and better solution (what I’m calling the interface) will be what sits on the advisers’ and clients’ desktops. The ones that succeed will be open systems that interface with all sources of information — they will not be tied to one platform. Technology or telco-type companies will run the systems behind these — not financial service companies. These technology/telco companies will need size, but the users won’t.
As the web has reduced the value of hoarders of information (such as encyclopaedias) and liberated the information, so technology will, through open architecture interfaces, enable advisers and clients to access information about their investments. This will be complemented by the straight-through processing of transactions.
Platforms will survive but they will not be playing the critical distribution role they do today. They, as I stated earlier, will become commodities with little or no value. We have a habit in this industry of adding products and services and not replacing. (Some will morph into being registries for fund managers.)
Nor do you need size for distribution. Technology will more and more enable the small to compete with the big — and may even allow the mid-size to survive and prosper. The problem for institutions to provide advice, is just that, advice. To do it profitably and to minimise risk they will have to commoditise it. There is nothing wrong with this, but it won’t appeal to all clients, nor all advisers.
When people try to convince me that the institutions will dominate distributions, which I think includes advice, I think about the legal and accounting professions. I wonder, why aren’t there 10 legal firms, or 10 accounting firms in Australia? Surely there would be economies of scale in this, better use of resources and better access to resources. My hypothesis is that neither the practitioners nor the clients want this.
So, is big beautiful? All is in the eye of the beholder. Will big guarantee success? No, and depending on how it is used it could almost guarantee failure.
Does big have any advantages? Mainly resources and a client base, but it doesn’t guarantee the resources will be used wisely and the acceptance of the client base. (It also provides the luxury of being able to ‘stuff up’ a few times.)
Now do you wonder why I wonder about investment analysts and financial journalists?
