Asymmetrical Information

From the desk of Mindles H. Dreck:

Changing Business Models and the Iraq Handover

If you have decided to change your business model, do it quickly. Moving slowly in the name of "keeping everyone happy and working" during the transition is a good way to keep everyone miserable and working at cross-purposes. Business people keep 'learning' this lesson and then repeating the mistake.

There can be little doubt that the brokerage industry has been changing its business model over the last 5 years, and that the new business model is as desireable from a returns point of view as it is mandatory given present regulatory trends. Brokerages are converting to asset managers, earning fees on the assets managed rather than brokerage commissions on transactions. The revenue stream from an asset management model is both less cyclical and more aligned with the customer's interests. Furthermore, the cost of execution has plunged as the benefits of 'straight-through' technology caused vicious price competition (note that the benefits of technology-based competition, as in telecom, inure most permanently to the customer). Finally, both regulators and consumers have come to agree with asset managers that 'sell-side' research (research in exchange for brokerage volume) rarely provided value in the form of better investment ideas, and new regulations have made sell-side research all but impossible to practice in the old model (here's a decent summary).

Furthermore, the old model of broker or portfolio manager as independent stock-picker is dying. Once again, business efficiency and regulatory have joined forces to kill off the old methods. If securities and asset-class research is centralized, account executives can handle many more accounts than if they are performing their own research. In litigation, a client who has suffered from one account executive's ideas will win much more than those who suffered from the supposedly well-researched views of a central research and policy-making group. Regulators inspecting a financial institution expect to see formal account management policy and a record of disciplining those who stray. All documented, all discoverable in litigation.

All of the above is to demonstrate that these changes have an inexorable momentum and have been known for some time. Yet many financial firms have a lot of wood to chop before they will be operating on the new model. Why is that?

To be sure, financial consultants/account executives LIKE being stock-pickers, and don't like delegating that function to a money manager or centralized research. It's not why they entered the business. They long for the good old days when they could B.S. about stocks that only went up and clients didn't measure performance, question added value or want to understand their conflicts of interest. Yet these are well-informed people, they know what is coming.

Managers have been scared to transition rapidly. I've heard professionals from all sort of firms talk about 'gradual transitions' in order to keep all these account executive primadonnas happy. The bosses are afraid the account execs will walk with their clients. In addition, they too have to adapt to a different kind of environment, policing account management and supervising marketing activity instead of pleasing the producers with expensive boondoggles. It's a much more pedestrian job. So month after month they put up with inaction. They are willfully blind to insubordination.

At the houses 'going slow', lawsuits have blossomed out of the bear market and embarassed the firms that don't follow policy. Account executives have slowly left, or behaved so egregiously they've been fired. They survive their scared managers but not their compliance departments, and certainly not regulatory examinations. Most of the people managers feared losing have left slowly as they realized they were engaged in an irrational struggle and needed to start over or find a true portfolio management job.

A few firms have moved quickly. They re-wrote their incentive programs to accelerate the change. One firm simply re-made the bonus scheme to a percentage of centralized money management fees. Account executives quickly figured out the score and stopped picking stocks. By and large, the certainty forced them to confront their unhappiness and decide whether to buy in or opt out.

The organizational truth here is that when something is inevitable, do it now. While account execs mostly didn't desire the change, the ones forced quickly into the new model are happier and more successful. Change creates opposition, but ambivalence incubates opposition, hatching destruction.

For better or worse, this administration's decisions have reflected the organizational truths of management rather than government. The decision to hold fast to the June 30 handover is typical. While all worry that the level of public safety and services can interfere with the acceptance of a new government, the handover is inevitable, and the administration will get on with it. Few Middle Easterners see their own government as having moral legitimacy, but the U.S. has zero chance of gaining that legitimacy as an alien occupying power. The longer the new government is not fully in charge, the lower its chances of gaining that legitimacy. Better to take the risk now, as the reasoning goes, rather than assure the new government's failure by starving it of real authority.

In this sense, the sudden ascendance of Allawi is likely a blessing. Chalabi was perceived as a U.S. stooge even before he spent months as a pretender to power. Allawi will take charge while still in the 'honeymoon' phase, enjoying approval ratings Kerry or Bush can only dream about.

I have been quite unsure throughout the last few months as the administration stuck to its timetable. I see the reasoning now and have become cautiously optimistic, especially after the frenzy of Baathist/Qaeda efforts to destabilize the new regime. Iraqis must understand that we place as high a priority on self-determination and legitimate constitutional democracy as we do on confronting the Jihadis or securing the region's oil supplies. Grinding along in the hopes that we can handover a more conventionally stable country undermines the legitimacy of the new government.

UPDATE: It's done! They moved it up two days.

Then again, if the administration is so management-savvy, why did it take so long to sack Tenet? Demonstrating loyalty to staff in a difficult situation can be good leadership. But is it that important? And what about the bureaucrats who decided Gitmo''s prisoner treatment standards were 'one size fits all' ?

P.S. I apologize, I guess, for not writing much. My top priorities are family and work, with exercise, blogging and sleep in the second tier. There is no end of work, as we have more activity than 2000 and 25% fewer people. Exercise and blogging have lost, and sleep has suffered.

Posted by Mindles H. Dreck at June 27, 2004 09:24 PM | TrackBack | Technorati inbound links