High Line Advisors LLC

management ideas for banks and broker-dealers

What Is Your Value Proposition?

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[part of a series on hedge fund sales coverage]

When advising banks and broker-dealers in global markets, we are often surprised to discover that client-facing professionals in sales or product management are unable to clearly differentiate themselves from their competition, even to explain why an institutional investor should transact with them before any other firm.

The solutions to this problem lies in understanding the bank or broker-dealer’s value proposition from the perspective of its client, the institutional investor.

The value proposition of a bank or broker-dealer to institutional investors is a bundle of resources that the investor will pay for. Ideally these resources are unique to the bank or broker-dealer. In order to compete effectively, resources must be differentiated in some way, either by comparative excellence or in unique combinations. Any bank or broker-dealer with an incomplete or merely parity offering may find itself able only to compete on the basis of price. Favorable legal or credit terms may bring additional risk, just as favorable pricing may result in lower profitability. These should be balanced commercially rather than included in the base value proposition.

Examples of such resources include: access to corporate client management, knowledgeable analysts, conferences, access to capital or balance sheet, exclusive distribution channels or stock loan supply, expertise in related asset classes, access to global markets and exchanges, risk analytics, client facing technology, operational ease, and so on. For example, a bank with lending relationships to companies in the energy sector that also trades commodities and provides research and makes markets in energy stocks and options may differentiate itself through a comprehensive and deep understanding of the energy sector. The valuable resources in this example include access to the bank’s corporate clients, access to its research (including insights from the commodities markets), thoughts from the bank’s risk managers on sector risks and their mitigation, and more consistent markets from the bank’s traders resulting from deeper understanding of the sector.

Client profitability should be measured across all products of the bank or broker-dealer, with appropriate costing for resource consumption by the client. A common mistake made by bank or broker-dealer management is failure to look outside of a product silo to construct a broad value proposition. For example, investors may value resources that are “owned” by other geographic regions or product areas of the bank or broker-dealer. Better coordination across product and regional silos can yield additional revenues, as investors increasingly pay for resources indirectly, by consuming seemingly unrelated products or services. Only with the support of the bank or broker-dealer as a whole can new business lines hope to grow, as it is otherwise difficult to compete in mature markets.

Resources are distinct from products, which are the primary collection mechanism for client revenues. Simply offering a product is not necessarily valuable to a client; however, the client may begin trading in a product in order to pay for something the client does value. Increasingly, institutional investors are taking a consolidated view of their banks and broker-dealers as opposed to a segmented view across specific product desks. This is most apparent in equities businesses, where hedge funds measure payments to banks and broker-dealers across cash, derivatives, and financing. For example, prime brokerage (financing) may be a profitable product for banks and broker-dealers; however, prime brokerage on its own is difficult to differentiate, particularly for new or smaller entrants. Prime brokerage balances may be a means of payment for resources consumed elsewhere at the broker, such as research or capital facilitation.

In order to drive profitability, resources must be scarce. If a corporate meeting has limited capacity or an analyst has limited time to speak with clients, competition among clients for access to these resources may result. The practice of resource allocation can be used to manage client behavior and to drive profitability. Access to resources may be given  to profitable clients on a priority basis. At the same time, the bank or broker-dealer may invest resources in promising clients with the ability to pay, or deny resources to clients who are not as profitable as they might be. Denying resources is the hardest action to take, but it can be most effective if communicated with tact and supported with accurate data on profitability.

Finally, value propositions may shift over time, often resulting from change in the strategy or organization of the parent company. For example, prior to the sale of Smith Barney to Morgan Stanley, Citi Global Markets may have emphasized its retail distribution, captive order flow, and stock loan supply as differentiating strengths or resources. Subsequently, the group may need to adjust its value proposition to emphasize the custodial capabilities and global network of Citi on the banking side.

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