The majority of revenues for Merrill Lynch came from underwriting activities. However, alternate revenues came from offering short-tern notes payable for companies in need of extra working capital and in ordinary brokerage functions for retail customers.
Level of Fit
High quality service, the focus on long term relationships, and the focus on the costumer’s needs are the three core elements that describe the company’s beliefs. These three elements come together homogenously to accomplish the company’s long term goals of creating a brand reputation of trust and proficient expertise.
Externally, Merrill Lynch’s strategy and core activities were well fitted to both the current economic and competitive climate on the 1920s. Their expansion into mid-sized cities was designed to simultaneously take advantage of economies of scale and attain greater market share. This aggressive move was concurrent with the booming economic situation. Furthermore the company’s position of targeting secondary markets was consistent with their situation within the industry as a new entrant with relatively limited brand recognition.
Conclusion/Take Away
The success of Merrill Lynch as a new entrant illustrates the effectiveness of a niche market strategy in an industry plagued with a very high degree of rivalry. Their ability of targeting untapped markets enabled them to profitability operates in a highly competitive environment, and in essence avoided head on confrontation with larger, more established competitors. As exhibited by Merrill Lynch, the success of this strategic strategy depends on the ability to reach the niche market and the retention of these new customers. Merrill Lynch implemented their aggressive marketing campaigns and expansion on their brokerage retail offices to reach the middle class segment. Furthermore, the company achieved a strong sense of customer loyalty by providing their customers with personalized and trust worthy service.
A Period of Readjustment to Promote Growth- 1930-1970Historical Overview
The stock market crash on October 24, 1929 signaled the fragility of the US economy. Over the next couple of years, over 5,000 banks failed, leading to a great distrust in the American financial services industry. During this time, much debate over the performance of financial institutions and securities fields was happening in Washington. As a result, there was a congressional investigation into the questionable practices of the top investment banking firms and new federal Acts were enforced.
With the change of climate in investment banking, and the impact of the recession, Merrill Lynch decided to focus its attention to the commercial market of investment banking industry and cut down on expenditure by eliminating retail brokerage services. In 1930, Merrill Lynch sold its retail brokerage business to E.A. Pierce & Co, a midsize brokerage house with offices in 30 cities. Merrill and Lynch still kept some interest in the company but took no involvement in the management. Charles Merrill chose to focus on one of the company’s acquisition, Safeway chain stores. He had gained controlling interest in Safeway grocery stores in mid 1920s and through his guidance the stores had grown rapidly nationwide.
In late1930s, E. A. Pierce was going through huge losses and the company was close to dissolution. Merrill’s $1.8m investment in the company was turning into a loss. The problem was primarily rooted in the low rate of trading volume. The problem was not just for Merrill Lynch, but also extended to all brokerage houses nationwide. The effect of the 1929 market crash had materialized not so immediately but years later. After the sharp recession in 1937 and the smell of the war from Europe, Hitler invasion of Poland in 1939, there was little hope left for most of investors and the industry. In 1938, when everyone saw nothing in the market but “gloom and doom”, Winthrop Smith, one the junior partners at Merrill Lynch, saw opportunity in investment banking. He convinced Charles Merrill to go back to Wall Street.
By 1940, Merrill Lynch became incorporated with E.A. Pierce again and the firm was reorganized. Merrill insisted on keeping his partner’s name “Lynch” in the company title for sentimental reasons. Pierce stayed in the new reorganization but agreed to fade into the background. The policies Charles Merrill and his team developed rejuvenated the firm and the industry for the next quarter of the century. His goal was to create higher public trust to the firm and its employees so that it would bring more customers and trading volume. Recognizing insurance companies’ success in absorbing the savings of the large sector of middle class citizens, Charles Merrill pursued to attract more American households to invest in common stock as a mean of income for old age. Through his contributions to the development of modern brokerage field, Charles brought “Wall Street to Main Street.”
Charles Merrill wanted to create a new culture in the industry. He believed that his rivals’ growth would guarantee his firm prosperity in the long run. What he looked for was competitive advantage and not termination of his competitors. In this path, he designed a two-fold plan. The first was to draw tens of thousands of upper middle class households into Wall Street, and second, to encourage more corporations with an outstanding growth prospect into the marketplace.
In the first few months of operation, Merrill Lynch accounts rose by one-third to approximately 50,000. The growth was steady for the next four years. In 1941-1944, 27,000 to 46,000 new accounts were added to the firm. By the end of WWII, a total of 250,000 personal accounts were served by Merrill Lynch. All through these years, Merrill Lynch had quite a steady volume of trading in the NYSE, not fluctuating more than 8-12% of the total. The $300,000 loss in 1940 had turn to $459,000 pre-tax revenue in 1941. Two years later this amount listed $4.1 million in pre-tax income. Partners earned a respectable 16% net profit on their investment. (Annual reports, 1940-1950, Merrill Lynch Corporate Archives)
Industry Analysis and Competition
The two most important changes in the industry during this period are Government Regulation and economic situation. The New Deal administration used government regulation to provide stability to industries, such as the investment-banking sector, that had experienced great volatility. In 1933, congress passed the Securities Act that regulated the issuing of new securities. Furthermore, the Securities and Exchange Commission (SEC) was founded to regulate proper registration of securities and to verify the validity of the information provided by investment banking houses.
The economic situation became extremely unfavorable to the financial services industry. The 1930’s were characterized by one of the worst economic depression in United States history. In 1940, the Investment Act by the SEC defined the terms and conditions in brokerage and investment. After the great depression, the financial services industry began to recover. After the World War II, the rise of conglomerate corporations and accessibility to the international telephone and telegraph system introduced new opportunities to brokerage houses and underwriters.
During the 1940’s many large brokerage houses started training their employees for the first time. The industry tried to renovate itself through mergers and acquisitions, better customer service, and outreaching the more scattered clientele throughout the nation rather than their focus in New York.
Merrill Lynch continued its growth all through the 60s. After World War II, the firm “consolidated its leadership position in brokerage field and it began to impact in the investment banking field as well.”
In 1950, after a decade of struggle, the firm reached a “sustainable plateau”. Charles Merrill offered global financial service of high quality to a broad range of people. When he died in 1956, his company was among the top ten underwriters of corporate and governmental securities, and the leader in brokerage commodities.
In conclusion, the once stagnant industry that had been exhibiting huge market losses and great inefficiencies as a result of the extreme shift in the economic climate and the government interference had now begun to pick itself back together.
Five Forces
Barriers to Entry
Previously, investing in the United States was predicated upon a “buyer beware” attitude, but the stock market crash underlined the need for more government regulation. In 1933, with the passing of the Securities Act and the formation of the Securities and Exchange Commission, the barriers to enter the industry became much higher. Commercial and investment banking was segregated in the Glass-Steagall Act of 1933. The issuance, distribution, and sales of new stocks were closely watched by SEC and governmental agencies. To make things worse, brokers accused of misleading customers were subject to criminal prosecution. The prospect jail for white collar crime in secondary markets was quite deterrent. What this effectively meant for those wishing to enter the market was that significant restrictions were placed into the financial services activities. These restrictions severely limited the number of entrants into the industry.
Substitutes
In pursuit of attracting the middle-class savers to invest in Wall Street, Merrill Lynch faced a vigorous challenge from outside the industry: life insurance companies, and to a lesser extent, banks, that paid minimal interest on savings. Insurance companies continued to expand rapidly through 1950. During the early part of the 19th century, the majority of people were concerned about morality of buying insurance policies on human lives. They believed making money from someone’s death is “tainted money”. Therefore, marine and fire were the main insurance polices sold. However, there was a large shift in the early part of the 20th century. People began to buy a broad range of insurance because of losses in income. Policies that benefited customers as a result of death, retirement, or old age became commonly accepted and increased the investment made to insurance companies. Charles Merrill recognized the enormous success of insurance companies in soliciting the savings of middle class people. Merrill Lynch had always viewed the insurance companies as a substitute for their product, and wanted to direct some of these savings to common stocks.
While these substitutes did indeed exist, they were vastly limited in both scope and size. What this meant for investors was that if a competitor was utilized, there was the possibility that the client would not be able to have all of his financial needs met by one company. Thus, in the post war era, securities, as a complement to life insurance policies, absorbed a good amount of savings of increasing number of American households.
Supplier Power
The supplier power remained at a low point as it has throughout most of the industry’s history. The federal regulations and rules in 1930s did not allow a large stream of brokerage houses to come into play. And as a result of low competition in underwriting, corporations as the main supplier remained low in power.
Buyer Power
Buyer power declined after the crash in 1929. Ironically the decrease did not materialize until later in 1937. The second economic crisis changed the remaining optimism of stock markets. There was not much activity conducted by investment bankers throughout 1930s.
After the WWII, new hope was developed. Industries had grown and there was new prospect in the economy. With the supporting regulations enacted by Securities and Exchange Commission, there was more reliable information available to investors. The average middle-class households were attracted to invest their saving in securities. Nevertheless, low competition in the industry and lack of many new entrants had resulted on limited choice for the buyers.
Degree of Rivalry
As the result of fraudulent practice of investment bankers during 1920s, stock market bubble, and the crash of 1929, the congress had in-depth investigation into questionable practices of leading commercial and investment banking firms. SEC was created to design new regulation to provide the public with pertinent information about companies and stock market. Thousand of brokerage houses and financial institutions were bankrupt due to the stock market crash, and distrust from the public. As a result, many brokerage houses had ended up in mergers and acquisitions in the early 40s, leading to larger sized firms that were able to compete on a nationwide scale.
Strategic Positioning
As a result of the well designed plan and strategies by Merrill Lynch, the firm was able to attract tens of thousands of upper middle-class households to invest in stock market. ML provided outstanding services at a reasonable fee. The company had positioned itself as a trustworthy and reliable brokerage house. The increasing number of loyal and profitable customers, who appreciated the honesty and clearness of the firm’s business, ranked Merrill Lynch as one of the top names in securities’ field. In post War era, the company took a sustainable leadership position through innovative strategies and aggressive advertising. Over the next few decades Merrill Lynch expanded national and globally. 1950s were the years of confidence and growth. ML opened offices in Great Britain, France, West Germany, Netherlands, Switzerland, Belgium and Canada.
In1960s, change was in the air; the bull market of the post war was fading. However, the decade gave rise to institutional investors. Merrill Lynch solidified its leadership by offering “Comsat”, the first communication satellite to be launched in the space. By mid 60s the firm’s underwriting exceeded $1 Billion domestically, while expanding successfully around the globe.
Merrill Lynch Activity System in the Second Period
Survey
Before agreeing to return to Wall Street, Merrill hired Ted Braun, a California public relations consultant, to conduct a thorough analysis of the operations of the Pierce branch in Los Angeles and, simultaneously, to organize a survey of the opinions of random sample of its 3,000 customers. This type of investigation was quite unconventional in the history of the industry. The policies derived as the result of this survey transformed the company and the industry for next couple of decades.
The survey showed that only 15% of customers with open accounts actually conducted sufficient trades to bring the firm to net profit. A large number of these customers were those who either consistently bought stock on margin or kept accounts with some credit balances, waiting for future trades.
Compensation to brokers
Based on the result of this survey, Braun proposed to Merrill the most unusual idea in the entire history of the financial services. He recommended that the brokers be compensated on salary base and not commission. Traditionally, at E. A. Pierce, the brokers received 28% of the gross commission. This survey and almost all the other polls from public confirmed that most customers of brokerage field with active accounts were at some point suspicious to the advice they received from their brokers. This unorthodox policy in compensation gave more reassurance to customers in relying on the brokers and their recommendation on buying or selling stocks.
The addition of salaries to the fixed costs of the company was a great risk. It shifted 30% of total expenses of the firm’s variable costs to the fixed costs at partners’ risk. To be prepared for the worst scenario, Smith found different ways to save money at this crucial stage and saved the company over $1 million, reducing operating costs by 15%. These savings were crucial for the survival of the firm as trading was low and it dropped significantly below the record from the start of the century. Fortunately, trading volume doubled in 1943, leaving the partners and the employees off at a better position. (Wall Street to Main Street)
The bold compensation policy, though very risky in the beginning, gained competitive advantage for the firm and paid off by obtaining trust from the public and the industry. By the end of the decade the firm had the highest volume of transactions and was among the top ranked companies in Wall Street.
Upgrading Employees’ Status
In pursuit of upgrading the status of the brokers, Merrill chose the title of “account executives” for the brokers. It communicated a more professional desire to provide sincere and careful service to the customers. In line with upgrading the brokers’ status, Merrill Lynch became the first firm to introduce training schools for brokers. Smith mandated “security analysis” courses for the brokerage sales people. The age range of these students was 24-25, thinking of keeping these employees with the firm for a long period. Except a few U.S. colleges, there were no specific courses in preparing young students in finance. Merrill Lynch filled this gap.
Annual report
In a mission to gain trust from consumers and the industry, Merrill Lynch wanted the firm to open to scrutiny and subject to accountability. While no other large investment-banking house was willing to release any information to public, Merrill Lynch encouraged journalists to contact public relations office and ask any question they might have. Merrill Lynch had supported the act of 1933 as well as subsequent acts regarding financial reporting and later became the first firm on Wall Street to voluntarily publish annual reports. No rules and regulation had required the brokerage system to publish income statement and balance sheet; however, Merrill Lynch had nothing to hide. Thus, the favorite quote from Charles Merrill, dating back to his early time in Wall Street, “investigate-then invest,” became one of the most popular mottoes of the company.
Superior Customer Service
Even during this time period, Merrill Lynch offered such a wide range of products and services that most of its competitors were unable to keep pace with the company. Charles Merrill brought his experience and knowledge from supermarkets and retail chain stores from early in the century to financial services. He wanted to the customers to be able to shop all their financial needs in one place. The firm provided different financial services such as underwriting, mutual funds, retail of bonds/stocks, and loan on margin to customers and merchants. ML provided outstanding customer service to the customers both in brokerage and underwriting. It provided the clients with clear reports and personalized account management. Merrill Lynch triggered its services to small and midsized corporate clients which the top large underwriters had long neglected.
Mergers
When the majority of brokerage houses were doing poorly as the result of the crash in 1929 and the restricting Acts in 1930s, Winthrop Smith, a senior manager at Pierce, lobbied Charles Merrill to return to Wall Street. The company was merged with Merrill Lynch in 1940. A year later, ML merged with another large brokerage chain, Fenner & Beane. Through these mergers the firm was able to move more aggressively and develop a nationwide strategy to draw tens of thousands of middle-class households to stock market and to make them grateful and loyal customers to the firm.
Two-fold Plan
Charles Merrill wanted to create a new culture in the industry. He believed that his rivals’ growth would guarantee his firm prosperity in the long run. Merrill sought competitive advantage but he had no plans to destroy rivals. Rather, he aimed to reform and rejuvenates them. In this path, he designed a two-fold plan. The first was to draw large number of upper middle-class households into securities investment. And second, in pursuit of more investment choices available to customers, to encourage more well-managed corporations with an outstanding growth prospect into Wall Street.
Aggressive Advertising
For the first time in the history of Wall Street, Merrill Lynch started an aggressive advertising and public relation campaign. Louise Engle, a former manager of Business Week, constructed this advertising campaign. During the mid-1940’s, an instructive and informative ad of about 6,000 words was printed in a full-size newspaper page. The content of the ad was educational and informational with dry textbook tone. There was no explicit reference to Merrill Lynch except a small calling card at the bottom of the page that offered free reprint to any reader interested. This advertising campaign became one of the groundbreaking ads in the entire industry. “In the history of print media, no single advertisement with so much seemingly boring copy had ever been published for any product or service-not anywhere at anytime.” The company received over 5,000 responses in the first week. Merrill ran the same advertisement or similar versions of the same ad in newspapers across the country over many years. In total, over three million customers responded to this ad.
Communication
Merrill Lynch aimed to support the brokerage houses in far reaches of the branch network. It improved communications and research capabilities at the firm’s headquarter, New York. Their news department was focused on important business and financial developments and made the news available through prompt newsletters and wire transfers to all offices across the country.
In 1964, Merrill Lynch led the public offering of the Communications Satellite Corporation (COMSAT). The company, which was instituted in 1962, was “created by the Communications Satellite Act of 1962 to launch and operate a global satellite system.” By enabling the company to go public, Merrill Lynch became an integral player in the launching the first communication satellite into space. This move poised the company to reach the $1 million expansion mark before the end of the 1960’s.
Level of Fit
Merrill Lynch wanted to differentiate itself from other brokerage houses. They wanted to be known as an honest and reliable firm. The policies selected by the firm fitted with its strategy both internally and externally. ML internal policies such as in-depth training, compensation policy, and giving brokers the title of “account executive” not only served the company well, but also worked externally by reassuring the customers with their personal accounts. Although, to many competitors this method of compensation to brokers seemed out of ordinary and a misfit, it worked well for the company for at least a period of time. These policies brought competitive advantage to the firm through obtaining trust from the clients and the industry.
ML aggressive expansion at this period also fitted well. It was coherent with the firm’s strategy to bring middle class savers in far reach cities to Wall Street. On the internal side, Merrill Lynch kept close relationship with its offices across the US and other countries and updated them with the latest financial news.
Conclusion
The innovative strategies of the top managements of Merrill Lynch in early 1940s ranked the firm among the top ten underwriters of corporate securities; a position that no other investment service provider with brokerage origin had ever accomplished. Merrill Lynch changed the public’s perception of Wall Street by promoting trust in brokerage services. Being aware of their main threat, insurance companies, in soliciting the savings of middle-class households, Merrill Lynch sought to persuade more people to invest in securities. After a long struggle, Merrill Lynch achieved a sustainable plateau in 1950. All their hard work in reorganizing the firm and developing new principles paid off. ML earned a pretax profit of $17 million in 1946, and $4 Million of this amount went to employees. The innovative strategies mostly introduced by the founder, Charles Merrill, withstood for the whole period. When Charles dies at 1956 his firm handles the larges volume of trades on Wall Street.
Take Away
- Value can be created through the education of the clients of the target market.
- In-depth quality research plus bullish decisiveness can pay off
Merrill Lynch created value by educating the public about the advantages of investing in securities.
Merrill Lynch made thorough marketing research in how the firm could gain public trust. Once the firm concluded how to do it, it went bullish with its concepts. It changed the compensation policy, reported annual financial reports, kept low margin and offered superior customer service, and expanded globally.
Merrill Lynch Goes Public and Continues to Expand – 1971-1989
Historical Overview
Looking at the environmental forces that were prominent in the 1960’s, it becomes clear that as the decade dawned, the rise of the institutional investor became the central focus of the investment market. While this did not have a notable impact on the industry until the 1970’s, by this time the rise of the institutional investor coupled with shifts in the overall structure of the investment industry had profound impacts on the overall function of the industry. So notable in fact, that the 1970’s changed the face of investment banking.
Elucidating the changes that occurred at this time period, one author notes that at the beginning of the 1970’s investment banking shifted to being more “transactional” from which promulgated the expansion of the services offered by investment firms. “Until the 1970s, almost all investment banking firms were private partnerships with a limited capital base. When underwriting for large securities offering, these partnerships almost always formed underwriting syndicates in order to meet regulatory capital requirements, distribute securities and share risk.” However, in the 1970’s firms began utilizing investment-banking services on an “as needed” basis. What this meant for investment brokers is that the size and scope of services provided began to grow.
But over the course of the 1980’s, Merrill Lynch was affected by many drastic economical changes. The 1980’s were a very disorderly time for the stock market. The impact of “Black Monday” also proved to disrupt the state of the economy. When the crash of 1987 hit on October 19, it sent many companies scrambling to cut costs. Merrill Lynch eliminated their odd-lot stock department, which processed trades of less than one hundred shares. Its cost cutting efforts were part of a restructuring by Merrill Lynch, which was a sign of the deepening recession in the securities industry since the crash. Merrill’s then chairman William A. Schreyer and President Daniel P. Tully had attributed the restructuring to:
“… The over-capacity in the securities business, competition from commercial banks and well-capitalized foreign firms and to increasing risks in Merrill’s investment banking and securities activities.”
Since the end of 1987 to the end of 1989, Merrill had reduced payroll by 5,500 employees. Towards the end of 1989, Merrill Lynch had shown a 38% decline in income from the $65.6 million that it had earned a year earlier. Merrill had stated that the numbers were a result of an industry “softness in some of our core business activities including stock and municipal-bond underwriting activity and bond trading.”
Merrill Lynch also slashed year-end bonuses for its highly paid investment bankers. These cuts in bonuses would be given to the bankers as “incentive certificates” that would be cashed in for at least two years. And if Merrill did not achieve a specified return on equity during that period, then the certificates would become worthless.
Throughout this period, Merrill Lynch spent much of their resources to calm and inform all of their clients. Merrill Lynch also spent much of this time to meet new challenges in new worldwide markets. By the end of the time period Merrill Lynch had become a prominent player in the global market through innovation and paying attention to and meeting their clients evolving needs. And by 1988, Merrill reigned for the first time as the top debt and equity underwriter in both the US and abroad.
Industry Analysis and Competition
During this time period, the financial services industry encountered many changes. One of the major factors in the transformation of the industry at this time was the United States government. New government legislation allowed financial services companies to increase the services that they provided to customers. Government legislation also helped to regulate the industry, preventing the industry to be flooded with new entrants.
Five Forces
Barriers to Entry
The barriers to entry into the financial services industry became increasingly high during this time period. Government regulation remained as the backbone for limiting competition in this market. The increasing amount of mergers also increased the size of many investment banking companies, causing an increase in required investment capital for anyone interested in starting another financial banking institution.
Substitutes
The 1980’s represented a time where the role of many financial services companies expanded. With the introduction of the Cash Management Account, the financial services industry was now removing the previous boundaries between banks and brokerages. Due to the expansion of services in the financial services industry many previous substitutes became direct competitors. This resulted in a weaker threat of substitutes but lead to an increase in the number of players in the market.
Supplier Power
Throughout this time period, there were a large number of mergers and acquisitions in the financial services industry, especially after the crash of 1987. These mergers and acquisitions kept the amount of supplier power held in the industry at a low point.
Buyer Power
At the beginning of the 1980’s buyer power was relatively low due to the lack of strong competition in the financial services industry. Throughout this time period, there were no significant changes in the industry that increased the amount of power held by the buyers.
Degree of Rivalry
With the diversification of the investment market more firms were indeed offering a wider range of services. This meant that the number of competitors in the industry increased. During the 1970’s and 80’s investment houses found that in order to remain competitive, mergers were often necessary to ensure survival. Hence, while the number of competitors in the investment market grew over the course of this time period, the overall strength of the rivals in the market also grew due to the sheer size and volume of capital that could be amassed by these organizations. Even though Merrill Lynch spent the majority of the 1970’s consuming its competition, during this time period, the most formidable competitors to the company were Morgan Stanley and Goldman Sachs. Now with the global expansion of many companies in the industry they were now facing increased rivalry from new competitors in the global market such as Nomura Securities of Japan.
Strategic Positioning
Throughout the course of the 1970’s and 80s, Merrill Lynch began to position itself not only within the context of the domestic financial market, but also within the context of the international financial market as well. Merrill Lynch had come to realize that if the company were to remain viable for the future, investment would be a venture that would take place in an international, rather than national context. In addition to expanding it markets, Merrill Lynch also began expanding the services it offered to its customers. This coupled with the community service programs developed by the company made it one of the most dynamic companies during this time period.
During the 1970’s Merrill Lynch acquired a number of it competitors in an attempt to build its competitive foundation. Acquiring both White, Weld & Company and Goodbody & Company, Merrill Lynch was able to initiate a number of changes in the scope of the services offered to both businesses and individuals. By acquiring these firms in the 1970’s, Merrill Lynch poised itself for expansion into foreign markets. The end result was the creation of a worldwide investment house that grew to encompass over 40 countries before the close of the 1980’s.
In evaluating the innovation that was displayed by the company during this time period, it is evident that Merrill Lynch set the precedent by which all other investment companies were measured. In 1971, Merrill Lynch went public—“only the second Big Board member to do so at the time.” In 1977, the company unveiled its new “Cash management account” which combined a securities margin account with a money market account plus a checking account and a VISA debit card.” In 1982 Merrill Lynch opened its first office in Hong Kong and by 1985 “Merrill Lynch became the first foreign securities firm to be granted a regular membership on the Tokyo Stock Exchange.” By the close of the 1980’s Merrill Lynch had topped the “U.S. and global debt and equity underwriting chart for the first time.” Additionally, the company had created a scholarship fund in conjunction with the National Urban League to provide four-year grants to 250 inner city youths completing high school.
Considering what has been written about the development of Merrill Lynch throughout the 1960’s through the 1980’s it is evident that during this time period the central focus of the company’s advancement was the expansion of its interests into Asian markets and the development of the cash management account. Both of these tactics encompass what Merrill Lynch set out to accomplish during this time frame and both are still enduring parts of the company’s backbone. Furthermore these advancements were predicated upon the core principles and values outlined by the founder of the company, Charles E. Merrill. According to Merrill, “the interest of our clients must come first.” To this end, the following principles for core activity were developed:
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Client Focus—the client is the driving force behind what we do.
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Respect for the Individual—we respect the dignity of each individual, whether an employee, shareholder, client or member of the general public.
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Teamwork—we strive for seamless integration of services. In the client’s eyes, there is only one Merrill Lynch.
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Responsible Citizenship—we seek to improve the quality of life in the communities where our employees and customer live and work.
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Integrity—No one’s personal bottom line is more important than the reputation of our firm.
Activity System
New Thickening and Supporting Activities
Cash Management Account
The cash management account was and still is the cornerstone of the financial services offered by Merrill Lynch. Reviewing how the CMA account revolutionized by Merrill Lynch and the investment banking industry, one author makes the following observation:
The CMA account…began the process of breaking down the walls of the silos that historically separated the various elements of the financial services business. Along the way, the CMA and other money market funds helped usher in deposit rate deregulation, a sea change for banks that had worked under the restrictions of Regulation Q for decades. The Monetary Control Act of 1980 put the phase out of rate controls into motion and created a temporary—though often controversial—coalition of federal regulators to oversee the transition.
While the cash management account was indeed quite simple by today’s standards, the ability of Merrill Lynch to coordinate several baking services into one account during the 1970’s was a revolutionary move that was not reproducible by any other firm in the industry during this time period.
When Merrill Lynch’s cash management account was first introduced in 1977, it met with high amounts of resistance from Merrill Lynch employees. Many refused to work with the new system, which later brought in more than twenty billion dollars in assets to the company. The cash management account, which could be referred to as the “one-stop, womb-to-tomb account” allowed brokerage firms to enter the banking industry. It allowed a person who opens an account with $20,000 to enjoy a combined checkbook and securities margin account. For a small monthly fee, account holders were allowed to use a supplied VISA card, buy and sell stocks, and write checks all under the same account. All of the transactions would be recorded electronically and put on a statement that the account holder would receive each month. All of the features in the CMA were designed to create a higher willingness to pay from the customer and to differentiate Merrill Lynch’s product from competitors.
When the cash management account was first announced, there was no competition in the entire market. None of Merrill Lynch’s competitors in the brokerage industry had anything like it in the works, and banks were not offering money-market accounts. The only problem was that there seemed to be no initial demand from clients as well as Merrill’s own account executives. Most of the employees at Merrill Lynch were afraid to offer it to their clients because they were unfamiliar with the product themselves. Enrollment in the cash management accounts was so low that Merrill Lynch spurred an incentive program. The company offered bonuses to account executives based on the number of CMA accounts they opened. When that failed, the company offered a variety of travel packages to such places as Honolulu and Puerto Rico. But what really turned the fortune of the CMA’s can be attributed to the budding economy. In 1980, when the money market economy took off, so did CMA’s. By 1983, Merrill Lynch had captured 90 percent of the potential market. Brokerage fees climbed to more than $60 million as almost a million customers took advantage of the CMA’s services.
In 1987, Merrill Lynch’s leadership wanted to retain the dominant leadership position that it held with their CMA’s. As John Steffens, its president and CEO of Merrill Lynch’s Capital Markets stated:
“When we developed the cash management account 10 years ago, the rest of the industry was so specialized that none of our competitors tried to copy it for several years. This gave us the lead… But there won’t be any more head starts like that; the competition is too keen now. And by the year 2000, it will be even tougher, with brokerages, banks, and insurance companies combining and competing for the financial services customer.”
Merrill Lynch wanted to sustain its advantage with its cash management accounts. So it was now adding new features to its CMA accounts. These new features were designed to respond to changing consumer needs. Some of the new features included an automated mutual fund investment program, funds transfer service and the CMA directed reserve program.
Merrill Lynch’s competitors did not respond to the introduction of the cash management accounts until 1981, four years after it was introduced. The reason for such a delay was that many competitors formed committees to explore the possibilities of cash management accounts. And in many of these committees, information systems people were not present and were not involved in the specifications for a cash management account type product. As a result of Merrill’s successful CMA introduction, several banks began acquired underwriting companies, and the operational boundaries between brokerages and banking began to blur.
Expansion into the Tokyo Stock Exchange
While the cash management account was indeed the preeminent product offered by Merrill Lynch during the 1970’s, the key focus of the company was expansion into foreign markets, most notably Asia. Starting in the 1980’s, there was much talk of membership to the Tokyo stock exchange. Many foreign brokers welcomed the move to lift the ban on foreign members, but few were eager to sign up. Becoming a member of the Tokyo Stock Exchange meant that a company would have to spend between $4 million and $5.2 million to expand their operations to maintain the seat. On the other hand, if a firm did not bid on a seat, they ran the risk of being left behind, because the exchange was very reluctant to expand again in fear that they would water down the market value of exchange seats.
Merrill Lynch has been a “pioneer in the foreigners’ effort” in attempting to garner seats on the exchange. When the exchange finally decided to add ten new seats in 1985, Merrill Lynch was one of the first firms to place a bid for a seat. Later that year, they were the first foreign securities firm to be granted regular membership on the Tokyo Stock Exchange. In garnering membership, Merrill was now able to make their own trades, no longer having to pay 27% of their commissions to Japanese members for formally executing transactions.
Merrill Lynch not only wanted membership to the exchange, but also wanted to serve on the board of governors. According to Walter Burkett, the head of the Tokyo branch of Merrill Lynch, Merrill had at least three specific changes it wanted to see in the exchange. Merrill wanted to see more products, such as a market in currency options, integration of foreign shares that are listed on the exchange, and a movement towards keeping the exchange open 24 hours keeping it closely linked to foreign markets.
Merrill Lynch took a very aggressive approach in expanding into the Asian market. They were leaders in advocating the lowering of barriers to an international interchange of finances. The move has been wildly successful as Asia has become the predominant source of revenue for the company since its introduction to the Asian market: “Asia gives Merrill a huge source of potential clients in a region where growth rates have been triple those of the U.S. for a decade. Already, Merrill boasts one of Asia’s biggest brokerage networks, a burgeoning asset-management arm, and is the leading debt underwriter and a powerful force in equities.” Merrill Lynch helped to signify the 1980’s as a time where many financial markets of the world became tied together like never before in history.
Management Science Group
Merrill Lynch established its management science group in 1986. The group’s mission was to aid the strategic decision making process in complex business situations through quantitative modeling and analysis. The group tried to help quantify the impact of different business strategies. The group also helped financial advisors to deliver value-added solutions and enhance relationships with clients. The group focused on business problems and tries to solve those using analytical tools, research and management techniques such as optimization, simulation, expert-system models and neural networks. To ensure the responsiveness and to keep a focus on implementation, the management group took on all of the aspects of the modeling process. The group had earned a reputation of “an objective, analytical entity that has a can do attitude.”
Mergers and Acquisitions
In the first nine months of 1987, Merrill Lynch’s mergers and acquisitions group had earned them $500 million in fees and had an equity position at $100 million. The crash of 1987 brought all of its activity practically to a halt. Talks still went about, but the flow of closing transactions was practically terminated. The primary factor in the halt was due to the sharp change in stock market values. As a result of the drop in value, many buyers started to withdraw their offers in an attempt to renegotiate. Jerome Kenny, Merrill’s mergers and acquisitions chief believed that:
“Gradually there will be a resurfacing of bids and renewed negotiations. Activity will return, but not to the prior level, because of the major disruption in company values.”
Merrill Lynch had planned to continue to remain involved in the mergers and acquisitions business, but they needed to remain careful. In the times after the crash, Merrill Lynch rejected many deals in which they would have accepted had they been proposed before the crash. This reserved behavior led to a fifty- percent decline in Merrill Lynch’s mergers and acquisitions activity.
The one good thing that may have come out of the crash of 1987 for Merrill Lynch was that it had hoped to see less competitive pressure as other firms began to pull back from many of the offers. Since there were a smaller number of firms who were willing to give sellers a better price, it increased the buyer power in the acquisitions market, allowing only the major players with the capital to be able to make the acquisitions.
Consumer Markets
In 1989, Merrill Lynch began to shift a focus towards the aging population in America. Many top executives began to appear before audiences to argue for a bold new approach to retirement security planning. Merrill Lynch organized a group to analyze the financial and economic consequences of the aging population from the baby boom era. It also underwrote a number of research studies and well as hosting a seminar on long-term health care. The entire goal of the group was to make sure that people, who are living longer, live well.
Merrill Lynch believed that there was a high correlation between a person’s financial health and their physiological, psychological, and social health. Merrill Lynch believed that many people took the aging process for granted, and wanted to take a leadership role in educating people on how to prepare for their future, particularly to their financial health. Merrill Lynch saw four distinct market segments; the current old group of people 65 and older, the “preboomers”, between 45 and 64 years of age, the boomers, and everyone younger than the baby boomers that they called the future workers. Their major market at that moment was people in their mid 30s or late 20s who were making critical choices between savings and consumption.
Merrill Lynch’s ultimate goal in organizing a group and performing the research studies was to educate people about long-term healthcare. They emphasized that people need to be prepared to allot a bigger portion for their retirement in the future. Even Merrill Lynch’s 1988 annual report talked about the importance to save money to ensure a quality life for people as they began to live longer lives.
Advertising Campaign
Once Merrill Lynch went public in 1971, it needed a savvy campaign logo to draw public attention. “During a baseball World Series that saw the Pittsburgh Pirates edge out the Baltimore Orioles, Merrill Lynch introduces its ‘Merrill Lynch is bullish on America’ ad campaign in a television commercial.” This move established the bull as the company’s chief logo and also brought the company to the forefront of public awareness.
Holding Company Format
The extensive growth of Merrill Lynch in the 1970’s prompted the company to seek a new method for expanding its flexibility. As such, the company developed a holding company format in which, Merrill Lynch & Co., Inc. was the parent and Merrill Lynch, Pierce, Fenner & Smith functioned as the operating subsidiary. Utilizing this format, the company was able to further diversify the services that it offered to both individual and corporate investors.
Seeking to delineate why Merrill Lynch chose to employ a holding company format, it is evident that this move was prompted by the company’s choice to move into foreign markets. To better understand how this process works a brief overview of a holding company format is first warranted. A holding company is defined as, a company that “owns most or all of the voting stock of another company. Companies so owned are referred to as subsidiaries.” What this effectively means is that subsidiaries of a company can operate completely independently of one another. However, because they are held by the same parent company, they are under the control of the parent company and are ultimately responsible to this entity.
The holding company format creates a situation in which an organization is given the free range to exert significant market control without becoming an outright monopoly. As the size of Merrill Lynch began to grow extensively in the 1970’s and the need for more products and services grew, the company chose this format so that it could dominate all segments of the market and ensure that it did not violate anti-trust laws or become an outright monopoly. With the company’s decision to expand its services to the international community in 1960, the adoption of a holding company format ensured the viability of the company through the long term.
Scholarship Program
In 1988 Merrill Lynch developed a scholarship program aimed not only at improving the inner city youth’s chances at an education but also aimed toward fulfilling one of the elements of the company’s core principles “responsible citizenship.” In 1988, Merrill Lynch, “in partnership with the National Urban League, offered college scholarships to 250 first-graders in 10 cities…” These scholarships were available to students that completed high school and sought to continue their education. Of the 250 students chosen, 90 percent completed high school and went on to receive the scholarship.
Risk Management
Substantial financial blunders in 1987 promulgated the company to institute a plan of risk management that has taken precedence in the company since this time. “A failure of management controls in its mortgage-backed securities business led to a $377m loss, prompting a sobering reassessment of internal procedures. Risk management was placed at the top of the firm’s agenda and has remained there. To this day, a small but powerful risk-management unit reports directly to the chairman’s office.”
Customer Service
Deregulation of the investment industry in 1975 forced all investment firms to focus on customer service. Gone were the days when fixed commissions could be garnered from client interactions. Deregulation meant that investment managers now had to rely on negotiated rates to achieve financial success. To this end, customer service became a central focus of the financial service industry; an issue that until this time had not been pertinent.
Misfit Activities
Merrill’s Bonus Credits
In 1988 Merrill Lynch caused an uproar in the mutual fund business by offering its huge sales force bonuses if it pushed its clients towards Merrill’s own in-house mutual funds. Many critics were worried that Merrill’s new incentive program could persuade their brokers to put their own interests ahead of their clients. They were especially concerned since Merrill was the US’s second largest fund manager, with over $65 billion in assets. What happened with the incentive program was that Merrill Lynch gave “bonus credits” to Merrill brokers who sold at least $500,000 of the firm’s in-house funds by the end of 1989. It was expected that the top performing brokers were to obtain 0.3% of all the assets they attracted. Many viewed Merrill’s plan as a growing concern, which more and more brokers will begin to push their own products. In 1986, 39% of funds sold through brokers were independent funds, where as in 1988, only 29% were independent funds.
Employee Incentive Program
To promote an integral investment in the company, Merrill Lynch began offering its employees stock in the company during the 1980s. “Employees are encouraged to see themselves as part of a larger team, rather than as individuals out to beat the rest. The firm reinforces a long-term outlook by giving bonuses in shares as well as cash. Around a quarter of Merrill’s shares are owned by employees.”
A Level of Fit
In creating many of these new activities, Merrill Lynch was successful in thickening their core competencies in their focus to their customer and in providing a high quality service. Internally Merrill Lynch created the Risk Management and Management Science Group in order to provide advisors with the most accurate and useful information. Externally Merrill Lynch began such programs as the Scholarship program and their focus on customer service to increase their brand recognition.
In starting the employee incentive and bonus plans, Merrill Lynch created a misfit activity that took away from what Merrill Lynch was trying to accomplish. Through these programs, Merrill Lynch in fact lowered their quality of their services and shifted the focus from the customer to the company. While these were a few misfit activities Merrill Lynch was able to quickly identify them and ceased those activities.
Conclusion/Takeaways
Throughout the 1970’s and 1980’s Merrill Lynch used innovation to create a proper strategic positioning in order to handle the sequence of events that happened through the decade. Although many of the events such as the crash of 1987 resulted in a depressed state of Merrill Lynch, they were able to rebound through cost cutting activities.
A major issue that had been realized by management was their misfit activities. Earlier in this time period, Merrill Lynch had instituted employee incentive and bonus plans. What the management did not realize at first was that these incentive plans were indeed taking away from their core competency of providing a high quality service and their focus on the customer. These plans compelled financial advisors to push certain products that would lead them to these incentives, thus not providing the client with his best possible options. Management’s ability to realize this internal problem allowed them to fix the problem before it got out of hand, and helped Merrill Lynch avoid a potential disaster.
Merrill Lynch took the initiative during this decade to implement new ways to attract clients and create a larger amount of value that they could appropriate. Through investments made into the technology behind the CMA, that was unmatched by other companies, Merrill Lynch gained a firm-specific activity that garnered them an advantage. With this commitment to these firm-specific activities, they continued to hold an advantage over their competition, which led them to become the industry leader by the end of the decade.
Merrill Lynch Since 1990An Overview
The growth of previous years accelerated in the 90’s. At the end of the 1980s, Merrill strategically positioned itself to remain the market leader for the coming decade. In 1991, The Economist magazine noted, “The misfortunes of the country’s banks, thrifts and insurance companies are helping it exploit the strength of its brand name” History has shown that when the markets and the economy are struggling, Merrill still manages to do well for itself. This was the case in the late 1980s, when the company was able to withstand a near crippling recession, and even emerged relatively unscathed from the disastrous “Black Monday” stock market plunge of October 1987. It is true that Merrill had to lay off more than 8,000 workers following that debacle, but it still fared comparatively better than most of its competitors. When the economy is healthy and robust, as it was in the mid to late 1990s through the year 2000, Merrill Lynch typically does even better, particularly when compared to their main competitors (Exhibit 1). Their unique ability to be flexible and adjust their strategy to external forces has largely contributed to this success.
The dawning of the new decade brought with it a period of reorganization and a shift of business emphasis for Merrill. During the Reagan years, Merrill had fought the recession by devoting a major portion of its resources to chasing after well-financed clients who could provide the company with lucrative financial rewards. With recovery on the way, though, Merrill went back to its basic formula, adopting a strategy “to rid itself of the excesses of the deal-dotty 1980s.”
This meant a shift in priorities for Merrill. Part of the company’s new strategy revolved around further popularizing its cash management account (CMA), which it had first unveiled for average customers in the late 1970s. The CMAs conveniently combined investments with checking and credit, making money management that much simpler for ordinary investors and business owners alike. (In fact, business owners were targeted and attracted through these selling points in the hopes of later getting their personal brokerage business.) Although the CMAs had few takers when they first appeared, by 1991 Merrill Lynch had sold 1.3 million of them, and they were generating an extra $200 billion in assets for the company.
The real secret to Merrill’s success in the 1990s continued to rest in the fact that it placed its customer’s financial interest above its own. While other brokerage firms continued to invest in such instruments as derivatives, currencies or risk-free arbitrage, Merrill Lynch decided to “concentrate on servicing its customer base, not on speculating for its own account.” As the country climbed out of recession, financial opportunities seemed limitless. Wall Street was about to enter into one of its most affluent decades, and the company had to resist the temptation to over-speculate on customer investments. As Forbes magazine put it, Merrill had to go “from a firm hell-bent for revenues to one that carefully balances the sometimes conflicting goals of growth and profitability.”
With the 1995 acquisition of Smith New Court, Merrill Lynch became the largest equity organization in the world. In 1997, Merrill Lynch was sitting on top of the world. That was the year that the company’s total retail assets reached $1 trillion. Under the leadership of David Komansky, who had taken the helm just one year before, the nation’s largest brokerage firm had enjoyed unprecedented growth. During the bull market days of the Clinton Administration the company first reached, and then surpassed, the $1 trillion revenue mark. The markets were at an all-time high (Exhibit 2), and Merrill Lynch had positioned itself to reap the benefits.
But a slow-down was on the way. The Asian economy proceeded to all but crumble and the impact reverberated through the American marketplace. Declining value on the dollar led Merrill Lynch to begin cutting its workforce, as well as its overall expenditures in general. The bubble had burst and Merrill, like many of her competitors, went into an extended period of struggle.
Industry Analysis and Competition
Since its inception, Merrill has understood the importance of the client and therefore attempted to create a complex network to reduce the threat of imitation. In order to remain focused on its customer base, Merrill underwent some unconventional reorganization. Perhaps most importantly, the company created a five-member office of the chief executive to serve in the CEO post that was usually held by one individual. The five appointees, who included future CEO David Komansky, were experts in various specialized fields, who jointly hammered out a vision for the company’s future. This was a way to adapt Merrill’s “deliberate” strategy to the persistently changing environment.
The gamble paid off. Merrill’s year-end figures for the fiscal year 1991 are a case in point. That year, for the fifth time in a row, the company took the top spot for bank financing volume. According to United States Banker, the $10.8 billion dollars worth of business it did that year represented more capital alone than the previous year’s entire market. Its share of the market for that year grew from 32.9 to 36.9 percent. It also took credit for three of the four largest underwriting deals, including the largest, helping Republic National Bank secure $1.5 billion in notes. Merrill also gained the lead in equities, achieving “twice the volume and three times the number of financing of any other firm.” In terms of bank securities, the company issued “more than twice the dollar volume of any other firm.”
Merrill Lynch’s market leadership largely stemmed from the 14,000 financial advisors, located in over 8,000 communities across the country. Their commitment to clients was emphasized through the rigorous training and ongoing education of this powerful sales force. As of two years ago, each financial advisor was required to obtain a CFP designation.
According to the corporate website, it has “the largest advisor network of its kind in the world.” Each financial advisor manages, on average, somewhere in the range of $90 million in client assets. What’s more, Merrill Lynch enjoys a highly affluent clientele. Indeed, the company has been able to win the entire business of 70% of those households with $5 million or more of investable assets.
However, millionaires were not the only ones who used Merrill’s services. As one magazine wrote, the company has profited “handsomely from the old-fashioned business of managing middle-class savings,” but there’s more to the story. In fact, Merrill Lynch has reinforced its commitment of growth in their 3 main divisions. The Global Private Client Group (GPC provides individual investors with brokerage services), Merrill Lynch Investment Management (MLIM has $462 billion under management), and the Global Markets and Investment Banking Group (GMI offers worldwide investment banking and capital market services to corporations, institutions, and governments) all represent existing profit centers. Its basic operational costs, including salaries and commissions, continue to be covered entirely by fees and earned interest income from savings, money management, and tax advice. Money earned from trading stocks and bonds, retirement savings plans and insurance sales represent pure profit.
Five Forces
Barriers to Entry
Until the mid 90’s, threat of entry continued to be relatively low. Due to high start up costs and heavy government regulation, most financial services companies did little worrying about new entrants. In addition, a solid reputation steeped in tradition was a requirement in order to attract and retain clients. This, of course was all changed with the popularity of the Internet. New entrants found the Internet a useful tool in helping them reduce costs. They were focused on volume and were able to attract customers by offering drastically reduced commissions on trades, free research and quick execution. This all began to cut in on Merrill’s retail business.
Advertising campaigns touted the do-it-yourself investor and using an advisor who charged high fees became passé (Exhibit 3). During this time, threat of entry had dropped to the lowest levels in the history of the industry. However, with the ailing economy, rising unemployment, the bust of the technology bubble and the end of the “day-trader”, this threat has been reestablished to prior highs.
Substitutes
Unlike other periods, substitutes were on the rise. The repeal of the Glass-Steagall Act in November of 1999 fueled the rise. The substitutes of prior periods included banks and insurance companies. In the past they provided simple alternatives to cash, like fixed annuities, CD’s, etc. The repeal of this act now enabled them to get in on the investment game.
Supplier Power
Supplier power in the financial services industry has historically been very low. Some of the suppliers to the industry like mutual funds, insurance companies and the like are always anxious to gain access to additional channels of distribution. Merrill Lynch, with its formidable sales force, has always been a company coveted by these wholesalers. It is important to recognize that Merrill, like many of its competitors, created in-house proprietary products. These were often more profitable and easier to manage as they pooled existing resources.
Buyer Power
Due to increased industry competition, buyer power was at a very high level, particularly in the retail brokerage sector. As mentioned above, the repeal of the Glass-Steagall Act in combination with the popularity of the Internet brought buyer power to new heights. Customers now had more choices than ever before. In turn, they were able to appropriate an enormous amount of value. (Exhibit 3) This meant not only lower commissions, but also a variety of companies offering services specifically tailored to their particular needs.
Degree of Rivalry
Rivalry was very high in the late 90’s. Again, with the Internet as the main culprit, rivalry reached unprecedented high levels. In prior years, all of the major players were of relatively similar large size. They understood their interdependence and hence had similar pricing strategies, products and services. The entry of new, much smaller players into the industry, all fighting for market share, helped fuel the rivalry.
Strategic Positioning
Expanding Overseas
For most of the decade the company was flying high, but forecasters at Merrill did not know when to stop. Unable to realize that some of the late 90s economic boom was short-term and artificial, Merrill ultimately overextended its assets, and it was not long before the hammer fell.
Merrill’s ongoing strategy has always been to be the first to recognize opportunities and allocate the necessary resources toward becoming a dominant player in that new arena. Perhaps Merrill’s biggest mistake was to invest so heavily in foreign markets. As Robert Clow writes, “Merrill concluded that the future lay in global universal banking, and it began to lay the groundwork for a series of very big, strategic moves.” The trend began in 1995, when Merrill acquired Britain’s leading brokerage firm, New Smith Court, largely to have access to its stellar European research team. Then, in 1997, Merrill shelled out $5.3 billion to obtain Mercury Asset Management, another leading U.K. management firm boasting almost $170 billion in total assets and clients around the globe.
Merrill did not stop there. A year later, the company went to Japan and snapped up the ailing Yamaichi Securities firm, bringing all of its 2,000 employees on board as Merrill Lynch representatives. Then in August of 1998, Merrill invested $780 million in stock to obtain Midland Walwyn, a leading Canadian brokerage house. In addition, there were smaller investments made all over the globe. Indeed, Merrill made forays into South Africa, Australia, Spain, Italy and Thailand.
What Merrill did not realize, perhaps what no one did, was that the world economy was about to falter. The problem for Merrill lay in the fact that it had so heavily invested itself in a market that was poised to collapse. None of its many investments seemed to gel. Mercury’s first year performance was so far below par that Merrill had to transfer $56 billion to the firm’s core assets from other Merrill Lynch divisions. Yamaichi was disappointing as well. The problem there was that most of the firm’s pre-existing clients decided to take their investments elsewhere, rather than roll them over into Merrill Lynch accounts.
All in all, Merrill’s decision to go global proved to be a bad one. Once the worldwide recession set in, Merrill found itself holding assets that were losing value on a daily basis. The company’s stock plunged from $107 to $35. By late 2001, Merrill was pulling back. Having taken a heavy hit in the Canadian market, for instance, it put Midland Walwyn and other Canadian assets up for sale, apparently having decided that eventual gains would never outpace the losses that Merrill had sustained.
The Activity System
Core activities continued to be reinforced during this time period. Though the direction shifted more towards the more affluent investor, the focus on building long- term relationships, providing a high quality of service, and the reinforcement of the brand name continued to be paramount to Merrill’s strategy.
Services within the CMA account were expanded to include frequent flyer mileage for dollars spent. This was done to compete with the popular program offered by the American Express card. It was Merrill’s hope that by offering this added service, clients would make more use of their CMA accounts and shift more of their non-investment dollars to their Merrill accounts.
Online shopping services were added to the mix. Double and sometimes triple frequent flyer miles were awarded to clients who used their cards to make online purchases with key vendors with whom Merrill developed close relationships. Some of these included Amazon.com, 1-800-flowers, J. Crew and many others.
These added services not only promoted the Merrill name, but they were in many ways developed as sticky factors that Merrill used to tie the client to Merrill. With the use of each additional service, internal research showed that the client became more dependent on the convenience and would be less likely to switch to other firms.
Advertising continued to expand with expensive campaigns in traditional mediums as well as online. They tended to focus on customer conveniences and the long-standing name of the company. Trust, dedicated service were strongly emphasized and reinforced.
To further enhance the idea of building long-term relationships. Merrill continued to invest heavily in their sales force. It was said that $100,000 a year was spent on the training of new hires. Ongoing education of existing Merrill brokers was also a strict requirement. By 2001, all brokers were expected to obtain a Certified Financial Planner designation within a 2-year period.
Though it came later for Merrill than for other firms, the launch of their online discount brokerage site showed their resilience, level of commitment and flexibility to stay on top. They recognized that as the world of investing was changing, they had to change with it.
The Age of the Internet
With the late 90’s came the introduction of the Internet into the investment playing field. Companies like E-trade, Ameritrade and many others entered to capitalize on the new paradigm shift. Day trading was rampant and information was at the fingertips of every investor.
Merrill’s largest mistake was to underestimate the strength of the Internet as a powerful force in the industry. Merrill was considerably late to that game for two reasons. First, the company honestly felt that upstart e-commerce companies would be unable to provide customers with the quality service they needed and that customers would soon realize that ill advice (or none at all) was hardly worth the cheap transaction fees. In other words, Merrill shied away from the new trading paradigm because it did not appear to fit their long-standing client-centric philosophy. Secondly, and perhaps more to the point, creating anInternet trading service would cut out the thousands of financial advisors who worked in Merrill Lynch offices around the globe. Frankly, Merrill feared that a loss of revenue would encourage many of them to leave the company and take their best clients with them. It is important to note that though they were latecomers to the Internet arena, they were not behind technologically. As a matter of fact, Merrill had always invested heavily in technology. They were the first firm on the street to come out with a platform called TGA. This was a state of the art system that was the first of its kind on Wall Street. It armed each financial advisor with the latest software in financial planning, research and trading.
So, while all of its competitors were busy making Internet arrangements, Merrill derided it as a quick fad that would soon fade away. Unfortunately that did not prove to be the case, and Merrill soon found itself rapidly losing revenue on this new front. By the end of 1998, competitors were starting to close the gap on Merrill.
Merrill knew it had made a bad call on internet trading when, on the last day of the year (1998); discount broker Charles Schwab & Co.’s market capital finally outweighed the bull’s. One Merrill retail chief claims to have been quoted out of context, when he said that the “do–it-yourself model of” internet investing “should be regarded as a serious threat to Americans’ financial lives,” but either way the company image was seriously injured. In the words of one writer, Merrill Lynch was beginning to look “flabby, paternalistic and hopelessly stuck with a low return on equity,” hardly kind words for a company whose logo is a posturing bull.
The loss of revenue to the Internet sent Merrill back to the drawing board, and in 1999 the firm finally unveiled a web-based trading platform of its own. In an attempt to rekindle its steadily shrinking customer base, Merrill devised a program that, while not as affordable as cut-rate online brokerage firms, was clearly competitive with its chief rival, Charles Schwab and Co. In December of ’99 Merrill unveiled its flat-fee trading scheme to the public. For a flat fee of $29.95 per transaction, online traders could now buy and sell stocks through a Merrill Lynch site. In less than a year, the company had gone from scorning new technology to embracing it or at lease accepting it as an inevitable force.
With this shift in strategy came the decision to offer free online research. What had once been the pride of the company and a major reason why clients paid the exorbitant commissions was now essentially worthless and accessible for free to the general public.
An Era of New Leadership
In an effort to improve Merrill’s dismal record and restore “clarity to leadership,” Komansky was pressured by the board to name his successor prior to the end of the year. 50 year old, E. Stanley O’Neal, head of private client services, was named the new president.
The situation at the firm was highly precarious, and Merrill was desperate for new blood to take the helm. By July, the company’s stock had already fallen 31.7% and showed no signs of slowing down (Exhibit 2). What’s more, year-end revenue was expected to be down by almost 40%. Merrill was clearly struggling.
O’Neal went after Merrill’s problems with a three-pronged approach. First, he addressed the issue of declining assets by drastically cutting spending. In fact, by 2002, the company had shaved $500 million off of real estate initiatives and another $300 million off of technological programs. By the time O’Neal was finished with his cuts, insiders were expecting that the company would be saving as much as $1.4 billion a year. Even so, the move met some serious criticism. One S&P analyst told Business Week magazine that while the cuts brought down Merrill’s expense base, they did “nothing for spurring revenues, especially in investment banking”.
The second way that O’Neal addressed Merrill’s financial woes was through the authorization of 9,000 layoffs, which began in January of 2002. Many of these job cuts came out of Merrill’s decision to consolidate its overseas interests, such as the 1,200 jobs cut in Japan, but about half were spread out across the firm. Those job cuts represented a 13% slash in the payroll and most certainly had an impact on company morale. At least one editorial worried that Merrill had cut itself too deep and that remaining advisors, concerned with job stability, would be inclined to leave the firm as well, taking valued clients with them.
Finally, O’Neal had attempted to make Merrill more solvent by reverting back to the 1980s era strategy of courting high rollers while pulling resources and services away from Main Street customers, the ordinary middle class investors who once represented the meat and potatoes of Merrill’s financial strategy. In fact, O’Neal set the bar fairly high. Accounts with total assets less than $100,000 were deemed to be unprofitable, and O’Neal slashed the level of personal service for those customers. Instead, the company has set its sights on potential customers who had at least $1 million to invest, a very small crowd indeed. In its attempt to meet the demands of a feeble and fluctuating market, Merrill has set itself on a course that in many ways represents a straying away from its core values.
Conclusion
While Merrill underwent some tremendous changes in the past few years, a few things have remained the same. Merrill was still betting on its ability to cash in on international markets. While other firms were digging in at home, Merrill, once again, decided to focus more energy on the global component of its operation. Merrill wagered that the global slump would soon become a global boom, and it wanted to be poised to take advantage of it.
The company had taken some steps to better position itself in the global marketplace. For instance, Merrill consolidated its resources in places like Japan, which it saw as being potentially lucrative, and divested itself of foreign holdings in places it viewed as being less profitable, such as in Canada.
To a large degree, Merrill’s international investments have started to pay off. In 2002, its Global Markets and Investment Banking division “had a record year in terms of both profits and revenue, according to a Merrill Lynch spokesman.” Indeed, the company’s accomplishments overseas are remarkable given the current shaky economic climate. Merrill managed to raise $200 million for the German CLAAS Group, Europe’s largest manufacturer and distributor of agricultural equipment. Merrill also landed the biggest transaction ever done by an American company in Italy, a $450 million underwriting for Buzzi Unicem, a leading cement company. In Australia, Merrill was involved in three separate transactions totaling $650 million, and even pulled down $210 million worth of deals in Latin America.
Merrill Lynch is also forging ahead in its overseas services retail. As of May 2003, the firm had “nearly doubled its European client base.” As Acquisitions Monthly has observed, Merrill is using “its international distribution as well as its experienced professionals to secure important clients and engineer large deals.” In terms of international financing, this year looks as though it will match if not surpass last year’s numbers.
Until recently, Merrill struggled with net losses associated with poor market performances and negative publicity stemming some its involvement in the recent Enron and ImClone scandals. Despite those losses, it would be remiss to describe Merrill Lynch as anything less than a stupendously successful organization. Merrill Lynch still has a balance sheet that would make most rivals envious. Fortunately for Merrill Lynch, the hard times are often easier than the slumps endured by the competition. One look at all of their strengths helps explain much of this success (Exhibit 4). Merrill Lynch, the company who brought Wall Street to Main Street, is clearly the industry leader in the financial services industry.
Take Away
- The impact of a disruptive technology can shake the foundation of a firm’s strategy and focus.
- Flexibility in corporate strategy is essential in order to be successful.
For Merrill, the disruptive technology was the Internet. In many ways, the Internet forced Merrill to forge into a direction that was clearly a misfit with their intended strategy. Though the market essentially “forced” Merrill to proceed with developing and integrating this technology into their existing strategy, it sacrificed richness for reach. By doing so, Merrill Lynch stranded away from their strategy of client focus, high quality of service, and high price.
For Merrill Lynch, flexibility has been the sole ingredient in their recipe of success. By consistently keeping tabs on external changes in the marketplace, they were able to alter and adapt their strategy in order to capture the growing or apparent opportunities in the marketplace. This is obvious in their strategy to expand internationally. When certain markets did not work out as planned, they were flexible, adjusted their focus and pulled out; sometimes even at a loss.
Through Merrill’s flexibility, what has remained the same is their position within the financial services community as a whole and relative to their main competitors (Exhibit 5). In the beginning, Merrill sought to capture the “average” investor, but still maintained an image of relatively high prices and a wide array of products and services for that period. In more recent years, they have continued to expand their offerings and increased their prices alongside their main competitors. Much attention was paid not only to relative market share, but also to the perception of price and variety.
A Lesson in Strategy from Merrill Lynch
Merrill Lynch history demonstrates that the successful balance between flexibility and commitment yields a sustainable competitive advantage. In a period of nearly a century three core activities remain unchanged within the firm: high quality service, focus on customer, and focus on long term relationship. The strong commitment of Merrill Lynch to these three activities provided the company with a strong brand reputation. Due to the nature of the financial, where customers put their financial future in the hands of firms, brand recognition is a highly valued asset. It is this brand reputation that served Merrill Lynch with a long-term competitive advantage. However, this strong commitment did not inhibit Merrill Lynch's flexibility to changing industry and environment conditions. Firstly, at the beginning of the 20th century Merrill Lynch was new entrant in the industry and smaller in size and recognition than market leaders like J.P. Morgan and Goldman Sachs. As a result Merrill Lynch decided to focus their strategy on the niche market of the middle class. However, later in the century, when the company’s recognition and financial position became more established, Merrill Lynch correctly changed their marketing strategy to no longer focus on the middle class, but on the more profitable segment of upper end clients. This flexibility in targeting markets allowed Merrill Lynch to maximize their profits according to their competitive position within the industry. A second example of Merrill Lynch’s flexibility is exhibited in their asset management. In the early 20s in an attempt to reach the dispersed middle class, Merrill Lynch started an expansion of retail brokerages into middle-sized cities. However, after the crash of 1929, the company reacted with conviction by rapidly withdrawing completely of the retail brokerage sector. This allowed the company to cut costs in times of dire economic situations. Only later in the early 40s to aggressively embark on a nationwide expansion of retail brokerage offices to re-appropriate the niche market of the middle class in times of growing prosperity. Although Merrill Lynch response seems rather conventional, it is the swiftness and conviction in which they adapted to the changing environment that provided them with a competitive advantage.
Exhibit 1
A look at the Competition
Industry Leaders
Data: Compiled from various sources
* Formerly Salomon Smith Barney
Exhibit 2
Historical Stock Price
MER vs. S&P
Data: Bigcharts.com
Exhibit 3
A Race to the Bottom?
200 SHARES 3,000 SHARES
AT $20 AT $10
FULL SERVICE:
AVERAGE COMMISSION $116.90 $672.59
DISCOUNT BROKERAGE:
AVERAGE COMMISSION 66.09 145.05
ONLINE RETAIL BROKERAGE**:
DLJDIRECT 20.00 60.00
E*TRADE 14.95*** 74.95***
FIDELITY BROKERAGE 14.95 14.95
DATEK SECURITIES 9.99 9.99
AMERITRADE 8.00 8.00
SURETRADE 7.95 7.95
**INTERNET TRADES
***ACTIVE TRADERS
DATA: CREDIT SUISSE FIRST BOSTON CORP., COMPANIES 12/97
Exhibit 4
SWOT Analysis
Exhibit 5
Positioning Chart
1929
Wide Breath of Services
Low Breath of Services
2003
Wide Breath of Services
Low Breath of Services
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