Sean Park Portrait
Quote of The Day Title
I say profound things
Einstein

On creative destruction, transitions and such.

So first Stan, now Chuck. Who’s next?

I don’t know these gentlemen, and obviously I am not privy to the internal workings of the financial behemoths that they were charged with piloting, but I wonder if the problem isn’t so much who is at the helm but the ship they were trying to steer. As Mr. Prince said, taking personal responsibility was the “honorable thing to do” as a leader (I’m reminded of the immortal words of Hopper – “The first rule of leadership: everything is your fault”) and I would tend to agree. And there is no reason to cry for these men – they were amply rewarded for their efforts and will – I’m sure – land on their feet so to speak, so don’t misunderstand what is to follow as sentimental apologia for their failings (real or perceived.) However I wonder if these giant firms are manageable at all – at least under the current constructs of managerial science – and ask honestly if any one individual however smart, charismatic or experienced (Mr. Rubin would seem to have all these qualities in excess) can realistically succeed in steering the turn-of-the-21st-century financial megafirm through the oceans of Extremistan (Mr. Taleb‘s metaphorical “province where the total can be conceivably impacted by a single observation.”)

For some years now, I have been interested in trying to understand how the corporate ecosystem would change under the effects of the onslaught of accelerating social and economic change driven by the revolution in information and communication technologies. Applying Coase’s Theory of the Firm to a world where communication and transaction costs move unrelentingly towards zero (at least in many contexts) must in my mind lead to a fundamental – quantum – shift in the optimal organizational dynamics of companies and the economy more broadly speaking. The vision I seem to be ineluctably drawn towards is one that looks like the classic map of a network, containing millions (or billions) of nodes and interconnections, with a fractal geometry. So yes I do think that ‘super-nodes’ (read mega-corporations) will continue to exist and even grow, but I think that complexity will migrate away from any particular node to the network. So in my mind, bigger is only sustainable if ‘simpler’. Today’s financial behemoths are anything but ‘simpler’.

If we look back from a vantage point twenty years hence, I suspect that the period between 2002 and 2012 (or so, I’m not hung up on exact dates…) will be seen as a transitionary period – when the one wave (of linear giganticism) crested, and another of specialization and the migration of organizational complexity to the network (the “edge”) emerges. Will the takeover of ABN Amro be the last of the mega-mergers (although and perhaps fittingly the 3-way break-up involved added an element of deconstruction to the transaction…)? If I had to guess, probably not but it will more likely be ‘one of’ the last of its kind. Of course, I am far from alone in wondering if these giants have passed the point of diminishing returns on scale (from the BBC article on Mr. Prince’s resignation:)

“The actual structure of Citigroup is broken – it’s too big, it’s too bloated and we think it should be broken up into three of four pieces,” added Bill Smith from Smith Asset Management in New York.


(and Frank Partnoy‘s early take on this from an FT editorial in April 2005:)

Ronald Coase, the economist, famously observed that private companies are different, because they are not the only place to do business. An alternative to costly and complex banks is an atomised market, where individuals and institutions do business without a large financial intermediary. Banks may merge to survive this inevitable transition; but in the long run many of their functions will disappear…the core functions of any Wall Street Bank cannot remain inside the same complex and costly shell forever.

Given this is probably a topic worthy of a doctoral dissertation (and if done well perhaps a Nobel prize in 25 years), there is no way I can even start to do it justice in a short blog post, but I hope I have been able to give at least a taste of how I think this might play out and why it is likely to be a core consideration in any investment thesis for financial services over the coming two or three decades.

Update: Link to WSJ article on Citi’s troubles.

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Comments
  1. At 10:10 pm on 05 Nov 07 David Thomson said:

    Your “Black Swan” reference was definitely highly relevant to the ongoing crisis in the sub-prime meltdown. It qualifies as one of those events people refer to as a “perfect storm”, but I personally think was highly probable even if the specifics of how it was going to happen were hard to predict. I would say it more reflected how people ignored the very obvious warning signs in favor of “everyone else is doing it”.

    As far as the future of the financial services industry, I think it’s interesting to look at Google as a leading indicator of where things might be going longer-term. What’s so interesting about Google to me is that they created a market for words. It’s like a new economy NASDAQ of sorts, but with a very different type of index when considering what’s most valuable:

    http://www.cwire.org/2006/03/23/updated-highest-paying-adsense-keywords/

    We recently opened our software platform after working in exclusive relationships with hedge funds and financial services firms for years, trying to expose our business to some “good Black Swans” by allowing opportunities to come in from as far beyond left field as possible. As far as the overall topic warranting an entire doctoral dissertation, I totally agree. Here’s some of my perspective with an equivalent level of effort to your fantastic blog posting:

    http://www.suprasphere.com/Project_Vision.pdf

    I still think Dee Hock’s description of the period we’re living in is the most satisfying:

    “We are at that very point in time when a 400-year-old age is dying and another is struggling to be born — a shifting of culture, science, society, and institutions enormously greater than the world has ever experienced. Ahead, the possibility of the regeneration of individuality, liberty, community, and ethics such as the world has never known, and a harmony with nature, with one another, and with the divine intelligence such as the world has never dreamed.”

    http://www.fastcompany.com/magazine/05/deehock.html

    David

  2. At 11:39 am on 09 Nov 07 Sean said:

    David, thanks for the comments and the interesting links.

  3. At 10:10 am on 14 Aug 08 The Park Paradigm » Peak Hierarchy said:

    […] Regular readers will know that I have a healthy skepticism with respect to the supposed benefits of ever-increasing size in corporations and in particular with respect to financial services firms. Given the preponderant importance of human capital to creating and maintaining a competitive advantage in financial services, the exponential increase in complexity arising from imposing traditional hierarchical organizational paradigms on tens or hundreds of thousands of employees quickly outweighs the benefits of economies of scale in infrastructure and financial capital in today’s hybrid / universal banking and insurance giants. […]

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