The long battle for control of ABN Amro is over, with the group headed by the Royal Bank of Scotland prevailing recently in its record €71 billion (approx. Rs3.97 trillion) bid. The deal, the biggest takeover in banking history, has brought into sharp relief some of the most important strategic issues confronting financial services companies, including those operating in India.
Shareholders have turned up the heat on companies that fail to maximize the value of every business in their portfolio. Some regulators in the EU and US are allowing wider scope for industry consolidation and cross-border deals, putting more big institutions into play. Meanwhile, companies are forming consortia to carve up the industry’s underperformers as potential takeover prey.
What will it take to thrive in this new environment? Some telling patterns emerged when we analysed 30 of the largest publicly-held European and USfinancial services firms such as Citibank and HSBC to identify which companies generated the highest profit growth and best total shareholder returns from 1996 to 2006. While their assets and strategies differ, we found that investors tend to reward companies that focus on three priorities.
First, the top performers attain best-in-class earnings for each business in which they compete. Financial services executives have traditionally measured and communicated how their company’s overall performance stacked up against that of their peers, irrespective of their business mix. For many, that meant setting a broad earnings growth objective of 10% or so annually, across all business units.
The industry elite, by contrast, target ambitious goals for each business in their portfolio. By capturing the full value of their core business units and making smart acquisitions that reinforce their core, the leaders grew at an18% annual rate over the past decade.
Investors have taken notice, judging companies against their top competitor in each business. As a result, the companies that concentrated on a few key customers and markets usually outperformed their more diversified rivals. In retail and commercial banking, an attractive sector during the past decade, top performers such as Santander and Wells Fargo posted earnings growth that outpaced the sector’s 17.9% average.
Even in slower-growing businesses, investors prized leadership. Profit growth among insurers averaged just 9.6% annually, but gains at France-headquartered AXA, the sector leader, were far higher at 13%.
The upshot: Investors are likely to reward companies that excel both in terms of overall earnings growth and business by business.
Second, leaders benefit from strong concentration, measured by market share in a few key markets. Companies such as Morgan Stanley and Royal Bank of Canada, whose market share in their main business was at least 60% that of the market leader, had shareholder returns nearly one-third greater than their rivals, on average. Likewise, firms that derived more than half their revenues from a single large geography, such as the EU or the US, generated annual shareholder returns 50% higher than more dispersed competitors.
That mandate to focus will intensify pressure on companies to divest holdings that distract from their core markets. It also encourages the formation of consortia to acquire and break up the assets of underperformers.
Third, sector leaders are skilled at both growing their current businesses organically and shifting to mergers and acquisitions when industry cycles favour deal-making. Through the late 1990s, as regulatory changes fuelled market integration in the EU and consolidation in the US, the top performers included big acquirers. But, as the M&A wave receded after 2001, the leaders focused mainly on organic growth.
A close look indicates that the leaders wall off the day-to-day operations of their core businesses from the distractions of deal-making. Milan-based Unicredit, for example, has a dedicated team that continuously scans the market for attractive targets, builds relationships across the industry, and anticipates potential post-merger integration issues. When circumstances align, it is ready to pounce.
Those capabilities should be more prized than ever in the years ahead. Financial services remain far less consolidated globally than other major industries, such as auto manufacturing or energy production.
According to our projections, the average market capitalization of the biggest firms could increase to some £275 billion over the next five years, from £77 billion today. But sheer size is no guarantee for success. Only three of the companies we examined, that were among the ten biggest in 1996, remain in the Top 10 or survived the decade as independent organizations. Heeding lessons from today’s winners, it will be companies that focus on growing their core profits and market share that will control their own?destinies.
Ashish Singh is the managing director of Bain & Co. in India. John Ott is a partner in Bain’s London office and a leader of the firm’s European Financial Services practice. Andrew Schwedel is a partner in Bain’s San Francisco office and leads Bain’s Financial Services practice for the Americas.
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