The REAL Challenge for Investment Banks, Part II…

Posted by Peter Orr on Feb 16, 2009

"Finally, the business model of the investment banks is almost certainly going to change. Over the last 20 years, investment banking went from primarily an advisory business to being mostly a business where firms traded their own accounts – so-called proprietary trading."

- It's Not the Bonus Money. It's the Principle. New York Times, January 30, 2009

In Part 1 I described how investment banks in the current day are no longer organized to adequately address the needs of their clients. This will take a great deal of soul searching to correct. If this weren't challenge enough, the longer term secular trend is a more fundamental problem resulting from the information age and how it affects the traditional IB business model. In fact, I spoke to a comptroller of a state agency just last week on this very topic. His situation embodied the challenge (details below).

The Rise of Navigators

We live in an age of practically boundless information; we can consciously process far less than the 20 Mb/s rate I have at this computer. This information deluge, unorganized, paralyzes and renders us fearful of making suboptimal or just plain bad decisions. What has naturally emerged to help us cope with all this data is the information aggregator, or "navigator", which at this point we all find pretty valuable. There are many types of navigators, from Consumer Reports to Orbitz to the parent most qualified to give advice about raising the kid(s). In this day, the canonical ones are those with the big market caps: search engines like Google, Yahoo, YouTube, etc. Now we even have social navigators to organize our professional and personal relationships i.e. LinkedIn, Spoke, and Facebook. The feature that navigators share is that they aim to be (largely) unaffiliated with any particular buyer or seller. In fact, information businesses everywhere must understand that affiliation is now a very real and powerful axis of competition.

So what does any of this have to do with investment banks? Don't they sit at the top of the economic food chain above all of this stuff? Not remotely. This leads me back to my story about the comptroller. This particular state finance official was wrapping up an advisor request-for-proposal process and was curious about our capabilities. In response to why he was going through this process now, he told me that for the decade plus that he'd worked there, their investment bank (whom they only changed once) had run all of the numbers. But now, they're planning on a financial advisor running the numbers because, "We want to make sure the advice we're getting is solely in our interest."

The REAL Challenge for Investment BanksWhat Information?

Obviously, one instance does not make a rule. But the increasing awareness and commensurate skepticism associated with the sources of our information is surely not an isolated trend. Investment banking clients want either unaffiliated information or better yet, information that they feel is purely and unfailingly affiliated with them. Investment bankers always walk through the door with their bank's name on their business card. In the back of the client's mind is that name. Rightly or wrongly, along with it is an ongoing question of whether the information coming from that banker isn't perhaps a bit influenced by the interest of her/his employer.

Bankers are hardly defenseless; they can do a great deal to fight the good fight. I personally haven't seen it yet, but that's a topic for another post…

ps Many thanks to Professor Orr for the penny image above.