Evolution is Hard Work
UBS Exits Businesses While Blackstone Adapts to the New World Order
UBS AG, Switzerland’s largest bank, has been conducting multiple rounds of job cuts at its securities division in order to to shrink the fixed-income unit after record losses from the global financial crisis, according to Bloomberg and other media sources. The Zurich-based bank will exit its real estate and securitization and exotic structured products businesses. The company had already announced about 6,100 job reductions at the investment bank since October is also quitting municipal bonds, proprietary trading and commodities businesses, excluding precious metals. “These changes will enable us to leverage our core strengths while relying on lower risk and balance sheet utilization,” said Jerker Johansson, head of UBS’s investment bank, in a separate statement. As a result, it is highly likely that UBS’s investment bank is a business entirely focused on equities, equity underwriting, merger advice and foreign exchange.
The announcement sure seems to describe something awfully similar to a static business model, where a typical response to recent losses or an unfavorable market outlook is to scale a business down or exit it altogether. Is there a better response, the one that does not mechanically exit businesses at the bottom only to lose market shares, reopen these same businesses at the top of a cycle, suffer losses, and exit them again? Is there no value in being in real estate and securitization and structured products businesses going forward? Or in municipal bonds, proprietary trading and commodities businesses? The answer to these questions is a resounding “no.” Is retrenching to highly commoditized “red oceans” of equity trading and underwriting, merger advice and foreign exchange trading a better strategic decision? Highly debatable.
Static business models have been at the core of many ills that got financial institutions in trouble in the first place. Following losses, they exited businesses, exposing themselves to loss of market share and opportunity costs. When the perception of the environment turned favorable, abandoned businesses were re-entered and existing businesses were scaled up. Throughout, the risks underlying these businesses always remained the same. Importantly, this latter feature is responsible for yet another highly undesirable and dangerous properly of static business models: the fact that they tend to respond to earnings pressures and low return environments with blind leverage and excessive risk taking. The ongoing financial crisis is, in many ways, a manifestation of static business models in action.
UBS’s response poses a sharp contrast to other financial institutions that seem to be transforming their business models in the spirit of Financial Darwinism. The Blackstone Group, for example, has been using its natural expertise in analyzing and advising companies to shift focus from leveraged buyout to advisory businesses. Note that it is not exiting private equity business altogether; it’s just supplementing it with other sources of revenue in an area where its natural expertise and competitive advantages can be leveraged. As a part if its adaptive evolution, Blackstone has already advised Procter & Gamble Co. on the $4.5 billion sale of its Folgers coffee unit to J.M. Smucker Co. and worked with Microsoft Corp. on its proposed takeover of Yahoo! Inc.
In all, according to Bloomberg, Blackstone earned fees from clients on 18 deals worth $12.3 billion in recent
months. The group’s profit almost tripled to $61.1 million in the third quarter of 2008 compared with a year earlier. “The problems at all the major banks and securities firms are causing widespread cutbacks, distraction and personnel defections,” one of the firm’s executives said. “This turmoil at our major competitors is clearly benefiting our advisory business.”
No one claims that organizational change is easy, but firms like Blackstone have shown that the effort can mean not only survival but long-term prosperity. Such actions are clearly a superior alternative to typical knee-jerk behavior of institutions with “static” business models.