Can firms realistically cut costs by 50%?

John Gubert lays out a blueprint of how a firm could cut costs by half, and whether it could practically be done.

I was recently asked to put forward a proposal to cut unit costs at a firm by 50%. My initial reaction was that was going to be difficult, in no small part due to their internal office politics! My considered reaction was that a major cut was feasible, perhaps even up to the 50% level, but it needed several scenarios and time to execute. First, the firm needed to increase volumes that fed straight through to the bottom line and used up spare capacity. Secondly, it needed an increased spread of activity that raised costs by less than the average historic cost income ratio of the firm. Third, it required a material reduction in overhead and that would primarily be by reduction of headcount and the wage bill, for these can account for 60% plus of all costs in the business. And finally, it needed greater automation and usage of third-party utilities.

How does one increase volume throughput? There are really only three ways. The first is by rationalising all duplicative activity within a firm across group utilities. The second is through M&A activity. The third is to be a net business winner whilst maintaining risk quality and margins.

Core for many firms is to concentrate more activity across as fixed a cost structure as possible. It is critical to make a dispassionate analysis of duplicative activity across securities processing, primary and secondary market trading, asset and wealth management; and consider moving it to in-house utilities. Such utilities could be given the right governance structure to also gain third-party volumes, with the dual benefit of reducing the third-party’s costs and also those of the recipient organisation.

M&A activity is inevitable as there is excess capacity in markets and the P&L impact of this has only been hidden from view by the performance of markets, consolidation at client level and currency movements. In a more bearish market, these endowments would not only cease but would be reversed.

I appreciate everyone claims to be a net business winner, but the reality is different for the smaller players will continue to be marginalised, unless they have a truly unique value-add over and above geographical coverage, as they do not have the investment dollars to meet current market mandatory requirements nor do they have the balance sheet to satisfy the needs of the major players. And many of these firms can only adopt a self-destructive defence strategy of cutting margins to retain business, let alone win new accounts. This further reduces their ability to employ the right skill sets and make the needed changes to their rapidly ageing technology platforms.   

How does one increase activity faster than costs? The first is identifying new products that will genuinely increase revenues, improve margins and not materially change the risk profile of the business. I remain sceptical about the huge pot of gold at the end of the data lake but there is value in performance analytics or benchmarking as well as in complex reporting into those multiple regulators without common standards. I also do not believe modular pricing would lead to increased margins, but transparency could protect them albeit only when excess capacity does not lead to price led sales strategies. The industry though has new product areas and some old favourites to harness but they play to the strengths of the largest players rather than the mass market.

The first is collateral where new forms of asset finance will be required as the market moves more of its securities and cash activity into the secured transaction field. The second is liquidity allocation where a scarce resource is under-priced and the market needs to move to intraday and true risk pricing.  The third is clearer charging on STP and non STP transactions for the gap is too narrow. The cost of the true STP/no intervention process needs to be radically reduced whilst non STP rates need to better reflect the reality of costing.  And finally, we need to consider the value of the latest custodian love child, front to back office solutions.

I suspect these would attract some buyers but believe contingency needs to have alternative providers will force buyers into modular acquisition of services rather than split end to end outsourcing. It is critical that firms operate on as modular basis as possible but also that they have an end to end product either totally within the firm or, more likely, partly by partnerships with third party expert providers of niche requirements.

The key cost reduction question, though, is how does one reduce headcount? First of all, we need to look at cost distribution. After all an executive earning $250,000 equates to 8 or so earning $25000. So where is the surplus in senior management? I see too many non-revenue earners in this bracket. And I see several of them with colleagues undertaking comparable work elsewhere in their wider groups and each with their duplicative support teams.

So, the first step is to identify at a group level duplicative activity and rationalise this. I also believe that, under the banner of greater business complexity, there has been a major increase in staff posts and, over the last decade, splitting of roles with the result that there are greater silo specialists. As most solutions are multi silo, this necessitates internal meetings of stakeholders that have simply got out of hand. So, the second step is to rationalise management including a cull of the ubiquitous special duties and other support teams. Management should not need bag carriers! And finally, overall headcount needs to be reduced by faster adoption of proven industry robotic solutions, the development of AI based processes and, most of all, standardisation and automation within firms. And, as an extra cost benefit, network management needs to be a Group imperative with the aim of a single supplier for cash and securities other than where contingency rules from regulators and internal risk best practice demands otherwise.

What is the optimal technology strategy? In this world we need more automation. But we also need standards and consistency.  It is no use developing API’s that deliver data in non-standard forms, both operationally and in terms of messaging. It is no use developing distributed ledger solutions that are dependent on linked API’s to make the result of a trade compatible with the needs of the platform. And it is no use having duplicate facilities when lower or equal cost and risk solutions exist in the cloud. And it is no use believing that all that legacy technology can be subsumed in a new world. The challenge is to find an architecture that coexists with much of the legacy world but has the richness and power to deliver clients their requirements. It should include cloud-based solutions and more. The day of all being in house is for the dinosaurs!

The industry really needs transforming as it remains still too much of an automated version of the old manual processes. And intermediary outsourcing, such as the CSD world, the secure networks or data repositories will continue; and I suspect their coverage will be extended. Any in-house utility, if created, should not take on tasks better managed through industry utilities. The raft of non-productive activity, such as standing settlement instructions, corporate action data, KYC, proxy services or well over 95% of all instrument pricing are best placed in industry utilities that will offer scale price related reductions.

To that extent an internal utility could well be a stepping stone in the process, just as, a few decades ago, JP Morgan’s internal operations were a stepping stone to an ICSD. For, where an acceptable service is not currently available in the market for some of these non-value-added processes, it could be that the adoption of a best of breed solution of one of the players is the nucleus for a broader market collective.

I am aware that this is more of a brainstorm rather than a plan. But the key question was right. How do you cut costs by 50%? For that highlights the challenge for those who aim to survive.