Strategies in Financial Services, the Shareholders and the System Is Bigger and Broader Better?

Abstract

The classic structure-conduct-performance approach to industrial organization centers on three questions. First, why is does an industry look the way it does, in terms of numbers of competitors, market share distribution and various other metrics? Second, how do firms actually compete, in terms the formation of prices, product and service quality, rivalry and collaboration within and across strategic groups, and other attributes of economic behavior? And third, how does the industry perform for its shareholders, its employees, its clients and suppliers, and within the context the system as a whole in terms of its impact on income and growth, stability, and possibly less clearly defined ideas about such things as social equity? In the financial services industry, these same questions have attracted more than the normal degree of attention. The industry is "special" in a variety of ways, including the fiduciary nature of the business, its role at the center of the payments and capital allocation process with all its static and dynamic implications for economic performance, and the systemic nature of problems that can arise in the industry. So the structure, conduct and performance of the industry have unusually important public interest dimensions. One facet of the discussion has focused on size of financial firms, however measured, and the range of activities conducted by them. Exhibit 1 depicts a taxonomy of broad-gauge financial services businesses. What are the strategic opportunities and competitive consequences of deepening and broadening a firm’s business within and between the four sectors and eight sub-sectors? Is size positively related to total returns to shareholders? If so, does this involve gains in efficiency or transfers of wealth to shareholders from other constituencies, or maybe both? Does greater breadth generate sufficient information-cost and transaction-cost economies to be beneficial to shareholders and customers, or can it work against their interests in ways that may ultimately impede shareholder value as well? And what about the “specialness,” notably the industry's fiduciary character and systemic risk -- is bigger and broader also safer? This paper begins with a simple strategic framework for thinking about these issues from the perspective of the management of financial firms. What should they be trying to do, and how does this relate to the issues of size and breadth? It then reviews the available evidence and reaches a set of tentative conclusions from what we know so far, both from a shareholder perspective and that of the financial system as a whole.