What Banks and Brokers can learn from Amazon

Afternoon all,

I was reading the Economist this week which was running an interesting leader on Amazon, and it struck me there are many lessons the investment community, in particular the stockbroking industry, can learn from Amazon.

I’m ashamed to say I’d never read the now-famous 1997 Letter to Shareholders penned by Jeff Bezos, so I read it over the weekend. This was written when the internet was only just getting started, and Amazon was a fraction of the size of today, achieving $150m of revenues compared to the $136bn it generated in 2016.

What struck me was how Amazon saw the future potential of being the leading marketplace so early, and how Mr Bezos zeroed in on exactly what was required to achieve it, namely a long-term perspective and an obsessive focus on the customer.

My favourite quotes from Amazon’s 1997 Shareholder letter

“We believe that a fundamental measure of our success will be the shareholder value

we create over the long term. This value will be a direct result of our ability to extend and

solidify our current market leadership position. The stronger our market leadership, the

more powerful our economic model. Market leadership can translate directly to higher

revenue, higher profitability, greater capital velocity, and correspondingly stronger

returns on invested capital.”

“We will continue to make investment decisions in light of long-term market

leadership considerations rather than short-term profitability considerations or

short-term Wall Street reactions.”

“When forced to choose between optimizing the appearance of our GAAP

accounting and maximizing the present value of future cash flows, we'll take

the cash flows.”

“Though we are optimistic, we must remain vigilant and maintain a sense of urgency.”

The final two quotes are especially interesting. The first is an acknowledgement of the shortcomings most businesses face as they work to satisfy shareholders, who are often focussed on quarterly performance. The second gives an insight into a corporate culture that has held onto the urgency felt in its entrepreneurial beginnings to continue raising the bar in terms of delivery and service.

The importance of network effects

One of the main factors that make Amazon successful is its network effects. Having the scale of offering and customer experience attracts the customers. Having the customers attracts the retailers, which further attracts the customers, and so on in a virtuous circle.

Once there is a significant number of retailers and customers, Amazon can refine its intelligent algorithms to connect customers with more of what they want, allowing greater sales for retailers and higher consumer surplus from customers who need to spend less time searching for what they want. These network effects are powerful and reinforcing.

What can the Bank and Broking industry learn from Amazon

Applying these lessons from Amazon to the broking industry shows how short-term and divided thinking has led to the malaise many Sell-side business models now face, and the antiquated service most Buy-side clients receive. Focussing on the long-term and customer experience improves Banks' and Brokers' service and relative market strength, reducing the probability Sell-side firms will be price-takers.

The Broking landscape is fragmented at the small and mid-cap end of the scale, as firms cover different areas and sectors of the market, and it is oversupplied at the larger cap end. This fragmentation makes the delivery mechanism of research to clients inefficient. In other words, the fantastic, high-quality research that is generated is often hidden amongst content that is more “maintenance” in nature. This impacts customer experience and obscures the critical value that the Sell-side brings.

Brokers sit between two sets of clients, the asset management industry and listed corporates. The oversupply drives corporates to switch and chase lower fees from competitors, putting downward pressure on Broker fees. On the other side, the asset management industry is far more consolidated and less oversupplied than the Broking industry meaning it carries more weight and pricing power. 

How can Broking industry improve clout and service?

The only way for Banks and Brokers to maximise value, in my view, is to aggregate their offerings on a single mutually owned platform, thereby improving their service to customers and negotiating with one voice. This will allow network effects to kick in, generating attractive returns, and only then will there be sufficient market power for the investment research community to hold their own.

With MiFID II on the horizon, we are starting to see warning shots from both sides about the pricing of research. My sense is that the current landscape means Banks and Brokers will come off second best once the dust settles.

As things stand, there is a considerable risk that the drop in addressable revenues for Banks and Brokers will accelerate a brain drain that has been ongoing for a number of years now, resulting in a drop in quality of research. If their content were controlled through one mutually owned platform, the network effects and pricing power would be significantly improved. 

There is a wealth of quality content that is published by these smart, hardworking analysts, much of which drives the narrative of media and news outlets, as well as influence corporate strategy, and fund manager asset allocation. There is also a lot of what we call “maintenance research” which fills up my inbox but doesn’t add too much value. Maintenance research still has its place, and I understand analysts need to publish it to comment on events and tweak forecasts. The issue I have is the delivery mechanism.

Amazon was able to use its algorithms and data to create an excellent customer experience by putting the right products in front of the right customers. A central platform that represents the Sell-side would have the data to be able to revolutionise the customer experience for people like me, not just by filtering out undesired content, but also by learning what interests me and suggesting relevant content. Amazon has mastered this, as has Youtube, obviously Google, and many other companies in different industries, but we in finance are still poorly served.

Overall

A centralised platform would bring benefits to all:

• It would allow the buyside voting process to be managed in one place or fully automated if that was desired, saving fund managers and analysts precious time.
• There would be an opportunity to offer a central digital publishing platform with bespoke branding, which would reduce headcount costs for Banks and Brokers.
• It would also standardise the way research was displayed, allowing it to be fully viewable on mobile, tablet and desktop, rather than the mix of pdfs and web pages that are currently distributed.
• There would be better control placed on where the research goes should Banks be worried about people who haven't paid getting hold of it.
• There is a long list of obvious benefits...

Besides an improved customer experience for consumers of research, there would also exist a Sell-side with more pricing power. This may well drive prices a little higher for the Buy-side, but it would be a price worth paying if it meant better service and the avoidance of a brain drain. Thinking long-term like Amazon is the best way to improve our industry for all stakeholders. 

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To read a brief outline of how I think about stocks, and what I aim to achieve in this blog, please check out my first blog where I set out my stall.

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Please Note: To be clear, I do not and will not ever give any advice. I will rarely mention individual stocks but when I do these will not be recommendations, instead just my thoughts at that point in time.