Thinking Strategy: Retooling for the Post-Crisis World

At Thomson Reuters we are constantly talking to financial institutions to feel the pulse of market trends and their impact on application technology for the capital markets. One theme in particular has been repeatedly coming across over the past few months, spanning a variety of market participants, geographies and segments. Namely, that in the post-financial-crisis world, survivors are re-focusing their business models in ways that require a servitized IT infrastructure beneath. While servitization is not a new concept and in fact IT has unpersuasively championed it for years, what is new is that the business itself is the driver this time, since it views technology as key to its existential metamorphosis.

A study of the German market that we commissioned in December is typical of trends we see in many developed countries. Banks are aggressively reducing their balance sheets and re-balancing their portfolios away from structured products towards flow products. Revenues are flat, which perversely masks the key dynamic: trade volumes have more than doubled over the past few years, which is another way of saying that margins-per-trade are down by more than half.

In other words, many shops are having to run twice as fast just to hang on. This is clearly not sustainable as a trend unless efficiencies are found all along the chain, from front office through middle office, operations, finance and control, and back office. And “efficiencies” are unlikely to come through additional reduction of staffing levels, which have already been significant. What is needed instead is to significantly shift the production cost curve, i.e., business increasingly requires the kind of automation that existing application silos have hindered and which hadn’t mattered when margins-per-trade used to be high, but which, at our present Darwinian moment, can make all the difference.

Closely related to this, many institutions are trying to not merely avoid extinction by improving their cost structures, but also seek to thrive by providing add-on services in the hope of retaining their customers and attracting them towards higher-margin products. A good example is the focus on single dealer platforms (SDP), which are envisioned to provide much more than simply online execution of trades at efficient prices. They are in fact supposed to “open up” the bank and exhibit to customers a number of functionalities that only traders have traditionally have direct access to, such as position keeping, risk management, trade lifecycle management, financing workflows, etc.  This “self-service” model is of course a contributor to cost reduction, since it means less customer-facing staff, and could be thought of as analogous to what happened to bank tellers 30 years ago when ATMs became ubiquitous. But it is more than a pure cost-efficiency play: more fundamentally, it is a strategic move to differentiate from competitors and save customers’ time by providing in a single easy-to-use portal all the financial information and workflows that customers need.

Such differentiating drive is palpable also in the buy side. We have talked to a number of asset management/custodian firms in the past few months and they all express an ambition to do more than just passively hold customers’ portfolios and provide daily or monthly static valuation reports. They are motivated by a simple Darwinian consideration: domiciled as they are in high-cost countries, such custodian firms couldn’t compete in price with newly established custodians in emerging countries. In other words, the internet and related technologies have reduced the barrier of entry to firms that provide bare-bones custody, which can be easily commoditized in Thailand or India. So what are custodian firms to do in rich countries? Many are opting to seize the moment and develop a number of new products, such as investment finance platforms and risk management solutions which could be thought of as the buy-side equivalent of the sell-side SDPs: application platforms that enrich the customer experience in a way that retains and triggers sales of higher-margin products.

When we look at these three examples (front-to-back efficiencies, SDPs, value-added services from custodians) what they have in common is the need to migrate from a situation where application business logic is siloed to one where it is servitized, so that it can be exposed, for instance, in a portal or in an investment financing workflow. Automation savings can only come through a simplification of the full application chain that must accomplish two things: reduce the number of connection points which today have to be nursed at high cost, and ensure that application business logic is exposed for flexible re-use, i.e., turn it into services to handle pricing, risk, position keeping, collateral management, trade lifecycle, etc. To the extent some of this application logic lives today in closed silos, some of it might have to be replaced.

This is what financial institutions have been telling us. And we put serious credence to their views, as it is clear that the post-financial-crisis world does call for some serious existential re-thinking.