Buttonwood has posted an excellent analysis of why financial markets are unlike other markets for goods and services:
This apparent contradiction can be resolved. Financial markets do not operate in the same way as those for other goods and services. When the price of a television set or software package goes up, demand for it generally falls. When the price of a financial asset rises, demand generally increases.
Which explains why bubbles develop and burst and why ‘market fundamentalism’ does not generally serve us well when thinking about financial markets (as opposed to other markets.) Buttonwood also alludes to the fact that bubbles often develop at times of great change (has he read Perez???):
Why not just let the markets rip? Some would say that bubbles tend to coincide with periods of great economic change, such as the development of the railways or the internet. Individual speculators may lose from the resulting busts but society gains from their overoptimistic investments. However, this argument is harder to sustain after the recent bubble in which society “gained” some empty condos in Miami and holiday homes in Spain.
His conclusion is that because of these structural characteristics of financial markets, central banks (and possibly regulators and/or governments) have a natural, pro-active role to play in trying to mitigate or counter these problems.
Of course a few investors – the most high profile being Warren Buffet – have successfully arbitraged this weakness in capital markets buy being countercyclical, being “greedy when others are fearful, and fearful when others are greedy”; but as most people know this is bloody hard to pull off and exposes the investor to significant liquidity/solvency risks if they get the timing wrong. As Keynes said, “the markets can stay irrational, longer than you can stay solvent…” If you have an edge, even a small one, doubling down will usually work as long as you have an infinite bankroll. Ooops, small fly in the ointment. (Besides, if you have an infinite bankroll, what the hell do you need to bother about worrying about returns!)
Well I have neither an infinite bankroll nor the skills (and/or luck) to adopt a Buffet-esque investment strategy. But I do have some skills. And some experience. And I can recognise patterns reasonably well. And I have conviction. And a reasonable track record for building new markets and adopting and executing novel business models. So a few years ago I figured out that by focusing these modest talents and skills on investing in and helping to build new businesses, with a lot of hard work and days and months of research and reading I could generate pretty decent financial returns that were (almost) completely uncorrelated with the massive tides that buffet the world’s financial markets. And most importantly, this lack of correlation is structural – ie it doesn’t disappear in violent bear markets when almost all mainstream asset classes discontinuously jump to near perfect correlation (much to the chagrin of the VaR boys.)
It’s not hard to understand why. In fact it’s pretty obvious. For a new business, the ups and downs of the market, GDP, etc. have at best a second or third order effect on the company’s value. These factors are overwhelmed by the single most important factor driving value creation which is of course, can the company successfully sell it’s products or services to paying customers (or be more and more clearly on that path.) As someone wise once said: a “start-up is not GM” ie They are not correlated to GDP.
Now don’t get me wrong, I’m not suggesting that investing in new companies is without risk. In fact as most people would glibly observe, investing in start-ups is ‘very risky’. Well yes, but the risk is almost entirely idiosyncratic and manageable – much much less dependent on vast, uncontrollable, macro-economic trends and forces. And just because the risks are easier to identify and name, doesn’t mean it is easy to manage them, just that they are potentially (more) manageable.
So if this is true, why have venture capital returns generally been so poor (at least in the last decade or so) and why don’t more smart people try their hand at this (rather than trading/managing other types of assets)? Answering the second question first, I suspect this is because failing together is much nicer than failing alone, and so if the global financial crisis wipes out your hedge fund or investment bank or savings, well that sucks but, you know, shit happens. If however you pour your own (or worse your investors’) capital into a couple of dozen new companies that crash and burn, well that’s just a very lonely place to be. The answer to the first is not simple and you could probably write a book on this (perhaps Paul Kedrosky will?) but with the disclaimer that I don’t pretend to really know, my short and dirty take would be that there are two related factors at the heart of this failure. First, investing in new companies is hard to scale – at least compared to many/most other asset classes and secondly, the traditional structure of the industry is poorly adapted to this reality. Private equity legal and economic structures (which is how most venture partnerships are structured) doesn’t really fit the risk/reward/resource profile needed to invest successfully in new companies. Of course their are exceptions – both temporal and human – but just because their are some investors clever and/or lucky enough to make it work doesn’t make it right.
I could of course be wrong. And I could fairly be accused of hubris, especially as at this point I don’t have a long enough track record and/or enough exits to prove without doubt that my approach is correct. And while I am confident in my own abilities and have backed that up with a lot of “skin in the game”, I am even more confident in my larger analysis that while the venture capital industry might be broken / poorly organized, the risk-adjusted returns available to those who chose to invest – methodically and with a well-calibrated capital and incentive structure - in new companies, are excellent and, for the VaR-boys out there, truly uncorrelated to mainstream asset classes. The challenge is of course to find these investors and not to swamp them with too much capital. This problem isn’t solved but it looks a hell of a lot like the problem facing hedge fund investors (in most strategies that also do not scale beyond certain amounts of capital) and the asset allocation community would do well to try some of their more successful solution there on finding and seeding managers in this asset class.
And if you ask me, the rise of the ‘super-angel’ much talked about in venture circles these past months, is a step in the right direction and perhaps an indication that asset allocators are (finally) waking up to this opportunity.
Where is Goldilocks when you need her? On the one hand you have high frequency and algorithmic trading dominating the world of listed companies with market shares often exceeding 50% of all volumes traded and with increasing instances of unstable trading and extreme volatility in liquidity as these machines enter and exit the market creating a complex, unstable chaotic system where long term investors who aren’t careful can literally be run over in both directions like Wile E. Coyote on an Arizona desert highway… On the other hand, in the world of private investments – in particular in the broad category known as venture capital – liquidity remains elusive with (too) many practitioners having a disfunctional and often irrational set of beliefs as to how and when liquidity is acceptable and when it is not, with the end result making naturally illiquid investments even more so. And yet, wouldn’t it be nice (for investors and companies) to have a long term capital market where liquidity was “just right?”
So what would just right liquidity look like? Can you have your cake (all the typically enormous strategic advantages that accrue to a private company) and eat it too (the advantages of being listed, afforded by having a periodic mark-to-market and the ability to use your equity as a real currency)? I think you (mostly) can and am very encouraged to see this sweet spot slowly emerging and gaining traction outside of a handful of what previously would have been considered exceptions to the rule. In my opinion, the answer (as I have mentioned before) lies in further developing secondary markets in private company equity.
The two most successful companies I have had the privilege of investing in – Markit and Betfair – despite being multi-billion dollar companies and market leaders, are still today private companies and have provided liquidity to investors, management and employee shareholders (in different ways) which has gone a long way to allowing them to remain private and reap the associated benefits. The flexibility of Facebook’s management to run their company for the long term optimal outcome has I suspect been a direct function of the liquidity that secondary investments (from DST) and a relatively active secondary market in Facebook shares on platforms like Second Market and SharesPost have provided to early investors and employees. And it’s not just about cashing out – at least half the value of these secondary markets comes from providing a credible mark-to-market and the reasonable expectation that – if needed – an investor could access liquidity. Perhaps paradoxically, with these two factors in hand, more often than not, investors will actually have a higher propensity to hold on too their investment, not lower.
Another benefit of secondary markets would be to improve the health of the overall venture investment ecosystem which while evolving in fits and starts, most recently with the rise and rise of “super-angels” and “seed funds” still mostly remains in the eyes of this industry outsider, static and prone to herding around the notion that one-size-fits-all in terms of capital structure and financing paradigms is somehow optimal and should not be questioned. In particular, I fail to understand why the received wisdom of the venture capital community seems firmly stuck on the concept of “nobody exits until everybody exits”. It’s a dumb concept and worse, quite frankly is at odds with the interests of the various investors and stakeholders in a private company, including later stage investors (aka mainstream venture capital funds.) I believe much of the angst surrounding seed stage investing and (traditional) venture capital investing, arises as a result of a dysfunctional transition mechanism. (ie There isn’t really one.)
What I would like to see – and quite frankly have never heard a good counter-argument against – is a more dynamic and flexible financing chain, one that pragmatically combines both primary and secondary elements. Practically speaking, what would this mean? At its simplest, it would mean that at any given funding round, the possibility of existing investors exiting part or all of their holding is considered objectively and without undue emotion. Having participated in many such transitions in companies going from “seed” funding to “series A”, or “series A” to “series B”, etc. the relationship between existing shareholders and the new shareholders is far to often one of conflict – to the extent that this is often seen as just the normal way of things – when there is no reason that this ever need be the case. Venture capital firms often talk of “needing” to invest a minimum amount of capital and/or “needing” to own a certain minimum stake in the companies they invest in. While I think the case is sometimes overstated, if you understand the dynamics of their business model, their attitude is easily understandable and basically rational. And yet, I have never yet seen a venture capital fund offer to buy-out the early stage investors in whole or in part when more often than not this would be an ideal outcome for everyone:
the company: not needing to raise more new capital than strictly necessary
the early stage investors: (whether professional angels or seed funds or friends and family) allowing them to reduce risk, recycle capital and retain focus on the market segment (early stage) they know best and which corresponds to their capital base
the venture capital funds: allowing them to simplify the capital structure, deploy more capital and ease negotiations
If this became the norm, I think it would drive a massive downstream benefit which would be to create a more dynamic, focused and intelligent early stage investment paradigm as investors in this ecosystem niche could really focus on funding two types of companies:
companies that have a plausible case to become successful but modestly sized businesses worth $10-40 million; and
companies that have a plausible case to become “VC fundable” where the goal is to exit in a series A or series B at $10-40 million
This would considerably improve both the availability but also the quality of early-stage capital as the risk / return dynamics would become much less random and the impact and velocity of the best investors in this space would increase considerably, providing more, cheaper and easier access to capital to entrepreneurs while at the same time providing a fantastic “farm-system” of talent and corporate development to later stage VC’s, perhaps even allowing (the best amongst) them to deploy their hundreds of millions or billions of capital efficiently as their ecological niche becomes better defined. I am absolutely convinced that this paradigm would create a much healthier, more vibrant capital market for innovation and disruption, improving returns for everyone in the ecosystem.
What I am not saying is that buying out seed investors would be appropriate in every situation. Nor that all seed investors would always be happy to sell all or even part of any individual investment. Nor that later stage investors should always look to buy out early stage investors. What I am saying is that this discussion should always be a part of the financing tool-kit, this option should always be on the table, and dismissed only when and where it is objectively inappropriate. Let’s get rid of the dogma and let markets work. Liquidity: not too much, not too little, let’s get it right!
You start. You struggle against initial inertia to gain velocity. You succeed. You grow. Your success breeds more success. Momentum is now your friend. But the world changes: technology, markets, society… And your hard won momentum keeps hurtling your (now large and profitable) company down the same trajectory. And momentum is now your enemy. Ah, the joys of…inertia.
The recent sensation caused by an ex-Microsoft insider’s NYT op-ed is just one more example of this seemingly inevitible ‘circle of (corporate) life.’:
Microsoft’s huge profits — $6.7 billion for the past quarter — come almost entirely from Windows and Office programs first developed decades ago. Like G.M. with its trucks and S.U.V.’s, Microsoft can’t count on these venerable products to sustain it forever. Perhaps worst of all, Microsoft is no longer considered the cool or cutting-edge place to work. There has been a steady exit of its best and brightest.
What happened? Unlike other companies, Microsoft never developed a true system for innovation. Some of my former colleagues argue that it actually developed a system to thwart innovation. Despite having one of the largest and best corporate laboratories in the world, and the luxury of not one but three chief technology officers, the company routinely manages to frustrate the efforts of its visionary thinkers.
Innovation is a new way of doing something or “new stuff that is made useful”
I’ve of course added my two cents to this discussion, with my thoughts on the subject drawing on my personal experiences (and those of friends and colleagues) of having tried (very hard) to sponsor a pro-active approach to disruptive innovation in a very large company. For those of you not familiar with my hypothesis on the question, I’ll save you the trouble of digging through my blog, it boils down to the complex weave of organizational and personal dynamics that unavoidably emerge when you assemble large groups of people in one organization:
Loss aversion dominates: most people (and sub-groups) fear loss much more than they enjoy gain. This is why the status quo is so closely guarded (at any level of resolution, from the individual through to the overall company.)
Dancing with the one that brought you: at any level of seniority, it is likely that the person in charge got to be that person in charge by being particularly skillful or adept at navigating the existing business and/or organizational model. It’s like the America’s Cup: the winner sets the rules (and has no incentive to adopt “new rules” for which they are probably less well adapted.
In fact, Machievelli eloquently summed it up 500 years ago:
It must be remembered that there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than the creation of a new system. For the initator has the enmity of all who would profit by the preservation of the old institutions and merely lukewarm defenders of those who would gain by the new ones.
These principles form the core of the corporate immune system which considers any disruptive innovation as a threatening virus. So what is a big company to do? Should they accept the inevitability of decline (hopefully slow, profitable and graceful) or can they postpone or avoid this fate?
In some (most?) cases, I would suggest that they accept decline but this does not mean giving up. On the contrary it means aggresively (and even creatively managing the exisiting assets to create as much value as possible as the business model and or product ‘runs off’. This indeed was my prescription for Microsoft when I wrote two years ago that they should break-up the company and re-jig the capital structure, running the Windows/Office businesses for cash (with a debt financed balance sheet) and let a thousand new baby Microsofts bloom. A conventional view would see this as a failure of management and/or ambition. Obviously I think this attitude is ass backward: running the core products for cash while releasing enormous amounts of human and financial capital, which in turn could be used to create hundreds of new companies could – using any metric you like – only be considered a triumphant success. But convention, inertia and ego means that this path to success is rarely if ever taken by the leaders of market giants. Just in the last couple weeks the idea that Google might becoming the ‘next Microsoft’ has gained currency (at least in the valley.) I asked this same question (in May 2008:)
I know it has been asked a million times before but is Google the next Microsoft? (At least from a financial point of view…) At the start of 1996, MSFT traded at c. $6/share. Four years later they peaked at almost $60/share. GOOG IPO’ed at c. $85/share in 2004, and just over three years later peaked at over $700/share. Both moves of approximately 10x. Since 2000, MSFT has been more or less range bound at around $30/share, despite continuing to grow it’s top and bottom lines and produce prodigious amounts of cash. I’m not suggesting history will repeat itself exactly – perhaps we have not yet seen the peak in GOOG’s share price (sell at $850?), and I’m certain they will continue to grow their top and bottom lines and produce prodigious amounts of cast in the next 5-10 years. But…will the stock eventually settle at around $500 – 600/share…? Is it conceivable that Google, like Microsoft before it, will become the place where good companies are bought only to disappear?
However, like with human life, I think there are probably a number of recipes to extend the natural corporate life (and the quality of those extra years) and to leave a more valuable legacy when and if the company ultimately disappears. Starting with investing some of their excess capital in the innovation ecosystem that surrounds them. As I have found however, this idea is anathema to most large companies. And with some reason. The history of ‘corporate venturing’ is indeed (as Azeem Ahzar eloquently writes) riddled with failure. My view is that this is because it is exceeding hard to do this in house: the corporate antibodies as described above will almost always do their job and sabotage any in-house venture program. And yet just investing as an LP in an outside venture fund – even if one that happens to focus on markets relevant to the company – is an understandably unsatisfactory and probably equally ineffective alternative.
But we think there is a third way: a focused, strategic innovation program run independently from, but in close collaboration with the company. Maybe we can help your company. You know where to find us: where innovation grows.
A couple of months ago, I had the privilege to have been invited to speak at eComm 09 in Amsterdam. I have posted on this previously but recently the video of my talk was posted and perhaps will make it easier to understand my accompanying presentation. If you can spare 20 minutes (there is an additional 10 minutes of q&a at the end) and are interested in understanding how Nauiokas Park defines our opportunity space, please have a look as it is probably the most succinct expression of the worldview we bring to investing and analyzing potential investment opportunities.
And here is the presentation again, in case you would like to follow along as you listen to the video:
Well-built developer platforms are the future of every industry. (-ReadWriteWeb)
Note: Their is a small glitch around 7:40 where the video skips over a few seconds; funnily enough (for the conspiracy theorists out there) this is exactly where I say that had ZSIN’s existed, the extent of the disasters that occurred in the mortgage securitization markets would have been at least an order of magnitude smaller…)
Using the tried and tested TED 20min format, it was a great opportunity for me to collect my thoughts into (what I hope was) a coherent overview of how I think technological and economic forces will shape the optimally adapted ‘industrial stack’ for the sixth paradigm. It’s a great summary of the prism through which we look at potential investment opportunities and I hope will help us articulate this more powerfully to entrepreneurs and prospective investors.
I’d love to hear any feedback (good, bad and ugly) from any of the eComm delegates who saw my presentation and hope to continue the conversation with you and others here. You can also follow me on twitter @nauiokaspark.
Thanks to Paul and Lee for inviting me and especially to those of you who took the time to respond to my call for input – it was tremendously valuable in helping me to shape and refine my thinking and in building the presentation; just a few years ago, assembling this kind of distributed brainpower would have been impossible, and I hope I never lose my ‘childlike sense of wonder’ at the boundless possibilities that technology enables.)
You would think that the current problems facing mega-financial institutions (with Citigroup being the obvious poster child, but to be fair by no means the only example) that the CEO’s and Boards of large banks would think twice before thinking about pursuing large ‘industry-consolidating’ acquisitions. Don’t get me wrong, I can see how this current downturn could be seen as a seductive opportunity for anyone with a strong(er) balance sheet – not only are targets potentially cheap (at least by historical standards – setting aside concerns about visibility of future earnings) but they are possibly available which isn’t always the case (irrespective of price.) Furthermore, given the current labor market environment, the potential to actually realize efficiencies by consolidating and downsizing must indeed seem tantalizing to experienced industry leaders. And yet…
…and yet, at the risk of oversimplifying, it all just seems to underline a lack of creative strategic thinking at the top. Is the strong buying the weak, the big buying the less big, really the best or the only long term strategic choice faced by global financial services giants? Isn’t there a viable plan B? or C? At times like these, one can be forgiven for asking the question (from Here is the City news):
One upshot of the credit crunch is that some of the smaller or troubled banks look vulnerable to takeover. Only last week Bank of America CEO Ken Lewis said that he thought it will be more difficult for stand alone investment banks (like Goldman, Lehman, Merrill and Morgan Stanley) to survive, and that they may be swallowed up by commercial banking rivals with bigger balance sheets, better capital-structures and deeper pockets. Well, it didn’t take long for the rumour mill to kick into life.
The Daily Telegraph has come out Tuesday and reported that Barclays President Bob Diamond is trying to twist his board’s arm to make a bold bid for an investment bank. And, according to the newspaper, top of his wish-list is Lehman Brothers and under-fire UBS.
As the newspaper points out, Lehman would bolster investment banking arm Barclays Capital‘s presence in the US (something Diamond is keen to do), but there is significant overlaps in terms of jobs in fixed income and huge job losses are likely in the event that a deal is done. Over at UBS, of course, a large proportion of fixed income staff have been (or will be culled), so Diamond and the BarCap team won’t need to do as much axe wielding. And UBS’s equities, wealth management and private banking businesses would make a deal for the Swiss bank highly attractive.
Rumours are also swirling that Ken Lewis himself, despite his much-regretted comments last year about having about as much ‘fun’ as he could stand in investment banking, might be mulling over a run at Merrill Lynch. Although busy putting to bed the Countrywide deal at present, the smart money says that once that is sorted, Lewis might pounce (he is said to have long-coveted Merrill’s brokerage network).
I’m sure there are some good ‘consolidation’ deals out there to be had in the next 12-18 months, but I would further suggest that they will be the exceptions that prove the rule. The biggest risk in my opinion, will be when CEOs and Boards think like traders and not business leaders when considering these deals. In the majority of cases, they would be better off buying out-of-the money calls on firms they think are cheap and (if they are right) reaping the financial rewards of a good trade, rather than buying one firm lock-stock-and-barrel and having to valiantly try to manage through the (probably non-linear) increase in corporate complexity that this would engender.
I’ve been thinking about how to point you in the direction of a fantastic post by Going Private and despairing of just putting up a link saying ‘Read this’, or alternatively lamely regurgitating an executive summary, I am pleased to connect the dots in the context of the question posed above. Going Private blames the strategic ineptness of many businesses on Michael Porter and his Five Circles of Hell:
I blame Michael Eugene Porter. Not that Porter is a dipstick, (well not only that) but because the majority of his modern adherents certainly are.
The eager and almost rabid application of Porter’s “Five Forces” (Supplier Power, Customer Power, Threat of New Entrants, Threat of Substitute Products, Industry Rivalry) to technology products and services has bred an entire generation of MBAs in marketing positions dedicated to developing and maintaining closed systems and closed hardware platforms. This is particularly egregious in the case of business models that are effectively based on distribution channels. In conventional analysis there is nothing wrong with making your living on distribution channels. Remember, that in 1979, when Porter developed the Five Forces framework, distribution channels were highly expensive to create and maintain and, owing to these costs, constructing them effectively presented a significant barrier to entry. Your product didn’t even have to be particularly good, because the threat of substitutes was reduced via the difficulty and expense of the competition actually getting those substitutes (however good they might be) to your customers. Suppliers, if they wanted access to your customer base as a proxy to sell their raw materials, had to go through you. New entrants had to build an entirely new distribution channel. Customers were stuck. You owned the market. But you had to guard this distribution channel carefully. And you had to make sure you hadn’t forgotten something simple and critical. That’s not part of a conventional Porter analysis. But why would it be? Conventional distribution channels are quite physical, antique and boring.
In this post, Going Private makes the point by looking at a variety of businesses such as entertainment (videos, music), telecommunications and consumer electronics: “…particularly egregious in the case of business models that are effectively based on distribution channels.” (emphasis added) Now I would posit that this describes remarkably well much of the business of modern financial services as well. (Indeed some readers may recall my penchant for comparing the business models and the impact of technological changes thereon of the telecommunications industry and financial services…) (Mixing metaphors liberally…) bolting unreconstructed, 20th century, distribution platforms together ad infinitum, might get you a more efficient horse-and-buggy, but I sincerely doubt it will get you a car.
Admittedly this line of thinking is somewhat self-serving given that my business is predicated on helping large financial institutions develop a ‘Plan B’ and to helping them embrace new business ideas and approaches that are adapted to the new techno-economic paradigm. I am sympathetic however (see my previous post) to the institutional reality that it is often easier for a Chief Executive and his team to convince the Board to spend $10 billion on a ‘linear’ acquisition than it is to convince them to spend $10 million on an unproven ‘non-linear’ venture. We think we’ve found a way to help mitigate this behavioral paradox and plan to spend the next few years trying.
If we don’t succeed, I fear the future giants of banking will need a new mascot…
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.
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.
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