CAHPTER-I

INDUSTRY
ANALYSIS

INDUSTRY ANALYSIS
Introduction
India has a diversified financial sector, which is undergoing rapid expansion. The sector
comprises commercial banks, insurance companies, non-banking financial companies, cooperatives, pension funds, mutual funds and other smaller financial entities. The financial sector
in India is predominantly a banking sector with commercial banks accounting for more than 60
per cent of the total assets held by the financial system.
India's services sector has always served the countrys economy well, accounting for about 57
per cent of the gross domestic product (GDP). In this regard, the financial services sector has
been an important contributor.
The Government of India has introduced reforms to liberalise, regulate and enhance this industry.
At present, India is undoubtedly one of the world's most vibrant capital markets. Challenges
remain, but the future of the sector looks good. The advent of technology has also aided the
growth of the industry. About 75 per cent of the insurance policies sold by 2020 would, in one
way or another, be influenced by digital channels during the pre-purchase, purchase or renewal
stages, as per a report by Boston Consulting Group (BCG) and Google India.

Brief history of the industry

The term "financial services" became more prevalent in the United States partly as a result of the
Gramm-Leach-Bliley Act of the late 1990s, which enabled different types of companies
operating in the U.S. financial services industry at that time to merge.
Companies usually have two distinct approaches to this new type of business. One approach
would be a bank which simply buys an insurance company or an investment bank, keeps the
original brands of the acquired firm, and adds the acquisition to its holding company simply to
diversify its earnings. Outside the U.S. (e.g., in Japan), non-financial services companies are
permitted within the holding company. In this scenario, each company still looks independent,
and has its own customers, etc. In the other style, a bank would simply create its own brokerage
division or insurance division and attempt to sell those products to its own existing customers,
with incentives for combining all things with one company.

Until the 1970s, the financial services industry consisted of a few well-defined and separate
industries that dealt in money. These included banks and savings and loan associations for
personal savings, checking accounts, and mortgages; brokerage houses, such as Merrill Lynch,
for investment in stocks, bonds, and mutual funds; gold securities; and credit card companies,
such as Visa USA or MasterCard International, for consumer credit. The early stage of financial
sector reform in developing countries roughly the period up to the late 1980s concentrated on
liberalizing
Interest rates, moving to indirect instruments of monetary control, interest rates on reserves and
open market operations, dismantling directed credit and opening the capital account. For these
reforms to take hold and provide a broader liberalization of the financial sector it was necessary
to remove impediments to competition. This amounted to the privatization of banks and the
establishment of entry/exit laws for banks, introducing a level playing field for taxation of banks
and other financial intermediaries and establishing foreign ownership laws and allowing foreign
entry.

Government Initiatives
Several measures have been outlined in the Union Budget 2014-15 that aim at reviving and
accelerating investment which, inter alia, include fiscal consolidation with emphasis on
expenditure reforms and continuation of fiscal reforms with rationalization of tax structure; fillip
to industry and infrastructure, fiscal incentives and concrete measures for transport, power, and
other urban and rural infrastructure; measures for promotion of foreign direct investment (FDI)
in selected sectors, including defense manufacturing and insurance; and, steps to augment low
cost long-term foreign borrowings by Indian companies. Fiscal reforms have been bolstered
further by the recent deregulation of diesel prices. The launch of Make in India global initiative
is intended to invite both domestic and foreign investors to invest in India. The aim of the
programme is to project India as an investment destination and develop, promote and market
India as a leading manufacturing destination and as a hub for design and information. The
programme further aims to radically improve the Ease of Doing Business, open FDI regime,
improve the quality of infrastructure and make India a globally competitive manufacturing
destination.

Road Ahead
India is today one of the most vibrant global economies, on the back of robust banking and
insurance sectors. The country is projected to become the fifth largest banking sector globally by
2020, as per a joint report by KPMG-CII. The report also expects bank credit to grow at a
compound annual growth rate (CAGR) of 17 per cent in the medium term leading to better credit
penetration. Life Insurance Council, the industry body of life insurers in the country also projects
a CAGR of 1215 per cent over the next few years for the financial services segment.

Also, the relaxation of foreign investment rules has received a positive response from the
insurance sector, with many companies announcing plans to increase their stakes in joint
ventures with Indian companies. Over the coming quarters there could be a series of joint venture
deals between global insurance giants and local players.

Michael porters five force model

According to Michael Porter the Five Forces at work within an industry can be evaluated to
explain that industrys potential profitability. As an industry creates industry profits the
participants of each of the five forces will conspire to siphon profitability from that industry.
Blue Ocean Strategy is a related body of this work and is used to relocate a company from a red
ocean (intense rivalries) to a business strategy where the five forces have not matured or may not
mature. I want to introduce a new concept, brown-ocean. One where the business level
differentiation is not based on price, but marginally on the value side (i.e. small and marginal
differences in company policy, costs, fees, relationships at the point of consumption, locations,
recruiting of talented employees to gain their clients etc.). The perfect industry to illustrate a
brown ocean is the financial services industry.

A quick review of those five forces:

1. Threat of new entrants. If there are not enough barriers to restrain entrants, enough new
entrants may emerge to lower the profitability from the incumbents.

2. Bargaining power of suppliers. If the suppliers are powerful enough, they may raise their
prices, decreasing their customers (industry in question) profitability.
3. Bargaining power of buyers. If the buyers are powerful enough they will demand lower
prices from the industry and thereby lowering profitability.
4. Threat of substitution. If the industry is not just competing against products and services of
their direct competitors, but also industries where the customers can meet their needs.
5. Intensity of rivalry. If there are enough players who are equally resourced for a fight, it could
move to cutthroat competition.
Now lets overlay the five forces on the financial services industry. The players are well known
as Bank of America, Morgan Stanley, Wells Fargo, Citigroup and UBS on the mass-market side.
On the niche player side, there are regional companies like Ed Jones, Stifel Financial and
Morgan Keegan to name but a few and there are the independent broker dealers, discounters,
insurance companies, private banks and trust companies competing for many of the same
investors. The five forces look like this:
1. Threat of new entrants. There will not be any new large mass-market players or niche
players bursting on the scene, but there will be new independent broker dealer players as
well as discounters, banks, insurance companies and credit unions. Count as well the
independent shops where a broker can set up shop literally overnight. The costs of selfclearing, recruiting, staffing, technology etc. prevent any new mass-market or niche
players from coming on the scene. The number of sub-industries developing within the
financial services industry has seen dramatic growth over the last couple of decades. With
the fall of Glass-Steagall, the barriers to entry fell impressively. Within each sub-industry,
there are few barriers to entry to prevent rapid growth. For instance, almost anyone can
get a job with an insurance company selling insurance. They can then get licensed to sell
securities (mutual funds and variable annuities). Within the banking system, many client
facing employees have at least a Series 6. Then within the independent/regional and
warehouse industries, the only barrier is the ability to pass the securities exams. Not a
barrier really, more like a speed bump.

2. Bargaining power of suppliers. Who are the suppliers to a business based on

intangibles? Mutual fund companies, hedge funds, other broker dealers in structured
deals, separate account managers, life insurance companies and companies looking to go
public, and believe it or not, Advisors fit in this category. Their bargaining power has
grown over the last 20 years from not being paid to move, to deals of up to 300% of their
trailing 12 months production as well as commission and fee payouts and benefits. Today
these mass-market firms must pay their Advisors to stay at work on top of salary, bonuses
and benefits. They are called retention bonuses. Mutual funds, insurance companies,
money managers can gain access to the various firms, but to be in a preferred list, these
entities have to pay a little extra. This is to gain a good spot on the shelf, eye level. Here
the heft of the warehouses can gain the firms more credibility when demanding the shelf
space fee (update: WSJ article of firms raising fees to fund companies).
3. Bargaining power of buyers. Shifted dramatically toward the favor of the buyers. Gone
are the days when the industry had all the information. I remember in the 80s the phone
would ring at night and the weekends with investors looking for an explanation for the
drop in AT&Ts stock. The newspaper was the only place to get a quote then and if AT&T
went ex-dividend it used to be enough to create a call. Along comes the internet and now
the buyers have access to faster, better and more clear analysis and information than the
industry itself provides to Advisors. As if that were enough, now there are multiple
sources of information the investor can access. While their Advisor is stuck with being
able to only supply the firms individual-investor-digestible research.
4. Threat of substitution. What is it the firms in the wealth management industry provide?
Wealth transfer, wealth preservation and wealth creation. Wealth Transfer can be handled
by insurance companies, and they do a lot! Wealth Preservation by banks, trust
companies, life insurance companies. Wealth Creation in this country has always been
through the creation of businesses; long, slow disciplined investing; luck with corporate
stock options; real estate and other non-financial markets; all of these not the domain of
diversified financial services companies. Financial Services firms are not the place where
investors go to become wealthier. It is the place wealthy people go in hopes of
maintaining their wealth.
5. Intensity of rivalry. These companies raid each others local shops offering checks
ranging from 200% to 300% of the financial advisors trailing 12-month production. One
company I worked for had about 6500 Advisors in the 90s. Recruiting wars were heating
up then. Fast forward 13 years, they still have about 6500 Advisors despite 3 acquisitions
and 13 years of recruiting. The industry has been completely neutered in the equity
research departments since 2003; there was a time when the quality of research was a
differentiator and the competition to offer the best advice was furious. There is no
competition to be the lowest cost provider, competition on prices is left up the advisor
sitting in front of the client for the most part. At the firm level, there is almost no way to
distinguish the client experience from one to the other on the mass-market side, other
than brand.

Conclusion
Just as you would expect from behaviors predicted by the Sheth Model, the large mass-market
participants compete for market share at the expense of financial performance following and
sometimes leap-frogging the leader. The niche players, those whose plan is to play for a small
niche can do so far more profitably. Compare the stock performance, ROE, ROA, etc. of UBS
(UBS), Wells Fargo (WFC), Morgan Stanley (MS), Bank of America (BAC), and Citigroup (C)
to Stifel Financial Group (SF).
Between these two industry participant groups lies the ditch. This is the place where the
companies who are too big to be a niche player and too small to take on the mass-market find
themselves sliding. The Ditch is a place where many never return. A question to ask, will the
market reward innovation? A review of an article and the associated research from an MIT Sloan
Review, The Business Models Investors Prefer provides insight. Also, those firms who have not
built strategy and executed it to combat the 5 competitive forces, will be found in the ditch.
The only real differentiator for investors to choose firms is the individual advisor. Any investor
can go into a single branch office and find a different experience for every Advisor in that
particular branch. The choice for investors is not based on the capabilities of the firms, yet really
and almost always based on the relationship with their Advisor. The time has come for the
financial services firms to innovate. The last real game changing innovation was Merrill Lynchs
rollout of the CMA account. Since then the innovations have been self-serving to the firms. The
names on the tombstones of offerings and product failures stretches back past the recent real
estate bubble. With the differentiation coming down to each individual Advisor, all competing
against each other (also within the same branches and firms) without the ability to compete on a
unique product or service offering, the ocean is a brown hue through and through.