In 1914, when Merrill, Lynch ? Co. entered the market, three kinds of securities firms could be identified. The first of these three group where the elite private banks. These firms were primarily involved in issuing gilt-edge bonds, preferred stock, and, to a lesser extent, common stocks. Generally the headquarters of these banks where located on Wall Street. The most important established private banks of this period were J. P. Morgan, Kuhn Loeb, Kidder Peabody, and Goldman Sachs. These firms prided themselves on their long-established reputations and conservative policies.
These established firms frowned upon aggressive sales tactics or mass marketing. Furthermore, even though common stocks became extremely popular in the 1920s, common stock was sold almost exclusively to the more experienced investors who better understood the underlying risks. These companies focused mainly on higher end investors with a good knowledge of the financial industry. Their major competitive advantage relied on their brand recognition and well-established ties to international bankers and financiers. Syndicates amongst these firms were also used to distribute securities in the US market and overseas.
The better part of the profits for these banks was derived from the underwriting fees paid by their corporate clients to float new issues. Brokerage houses operated in the retail market. Unlike the investments banks, brokerage houses were geographically dispersed and had offices in many big and middle-sized cities. Their coverage areas can be best described as regional and lacking nationwide scope. They primarily focused on specific regions such as South, Midwest or Northwest, and they were locally owned and managed. These houses acted as intermediaries and they were mainly active in the secondary markets.
The profits for these firms were derived from the commissions paid by their clients. Their target market was typically not as knowledgeable or experienced in the industry as sophisticated investors targeted by elite private banks. Some of these brokers were not official members of any major exchanges and so they established alliances with other member firms. During 1914-1925 Merrill Lynch conducted all its trades on the New York Stock Exchange (NYSE) through these types of agreements. A third "hybrid" firm also operated in the financial market during this time. These firms offered both brokerage services and underwriting services.
In particular, their strategy was to gain steady returns on the former services and focus in particular to small and medium sized firms that could not be listed on the NYSE. The underwriting commissions from the issuance of these new stocks in fact generated the majority of their profits. Merrill Lynch introduced the innovative concept of consist of all three types of firms to offer a wider range of services to a broader customer base. This gave Merrill Lynch the opportunity to compete in all aspects of the security industry. Five Forces Barriers to entry Entering the investment-banking sector was not very hard.
In fact, during this period there were no particular government restrictions or regulations. In particular, only after 1929, year of the big crisis, more government rules started to arise. At the same time, huge initial investments were not necessary (Merrill Lynch ? Co. started the business renting an office in Wall Street and with an initial working capital of $50000 (that is about $1 million in 2003 terms). Moreover, no companies were exploiting eventual economies of scale and since the industry was quite young, brand identity of existing company was not a big barrier to entry.
Furthermore, marketing efforts by existing firms to create brand awareness were almost non-existent in the industry. Besides, access to necessary inputs and access to investors were not impeded by particular obstacles. What constituted a relevant barrier to entry was the low diffusion of information. The necessary knowledge and competencies to compete in the industry were restricted to a select group of individuals with previous investment banking experience. The lack of formal training institutions in the field further increased to the scarcity of a well-trained workforce.
Furthermore, it was difficult for a new company to create brand recognition amongst the investors since it took long time to gain investors trust. Among leading companies there were a lot of tacit noncompetitive agreements to keep competition down and to stonewall new entrants from effectively integrating themselves in the industry. Even tough during this period some difficulties to enter the financial industry existed, the absence of relevant impeding government policies, absolute cost advantages by competitors and huge capital requirements characterized the barriers to entry as low. Substitutes
The investment banking services industry had to be worried with the possibility of their clients putting their money elsewhere. Not only did they have to worry about their direct competitors, but they were also fighting with the possibility of substitutes. These substitutes were insurance companies and traditional banks all across the nation. These institutions provided potential customers another outlet to invest and save their money with products such as life insurances and low rate but safe saving accounts. In particular, due to previous fraudulent behavior by several brokers, buyer propensity to substitute was high.
People felt more comfortable in putting their money in traditional banks and insurances companies instead of investing their capital in the financial market (bonds, stocks, derivatives). Supplier power The financial services industry exhibits low supplier power due to the investment banks unique ability to reach the end consumer. The lack of distribution channels to successfully underwrite securities limited the power of firms seeking to offer their shares to the public. Firms that wanted to raise money issuing bonds and stocks had no direct access to investors.
To reach many investors they had to refer to such intermediaries as investment banks. Investment bank's particular position between companies and investors gave to them great bargain power. Moreover, the companies that wanted issue bonds and stocks were mainly small private owned firms. For this reason, they could not rely on high concentration or high volume of securities to be issued to gain power in their negotiations with financial intermediaries. Buyer power Buyer power in the industry was low because no buyer could successfully leverage against investment banks due to the small volumes the average buyer purchases.
The main investors of this period were private investors, and so these people had not enough capitals to invest to retain power in their negotiations with investment banks. At same time, low buyer concentration and their scarce access to relevant information acted in favor of financial institutions. Degree of rivalry The industry was characterized to have high competition due to the large number of existing firms. In particular, no dominant company was present in the company at that period but several players were trying to surpass the others competitors to gain market share.
Many new companies entered the financial industry and so the number of competitors increased even more (during this period the number of competitors grew from 500-800 to about 3000). Even though the rivalry was high the industry looked so attractive that many new companies decided to compete in the financial industry. Strategic Positioning Charles Merrill and Edmund Lynch brought core competencies from their previous industry experience. They had the deep knowledge of financial tools and mechanisms. Merrill & Lynch differentiated itself by providing a high quality product customized to the individual needs of their customers.
Merrill & Lynch created value by providing customized service to their clients (raising their willingness to pay), rather than lowering its costs. Furthermore, creating strong brand awareness became a strategic goal in the company. At the same time, Merrill & Lynch adopted a niche target strategy. When Merrill & Lynch entered the industry, long established firms like JP Morgan were the leaders. Instead of competing with these firms for the best market (rich people), Merrill & Lynch implemented a niche strategy to target the untapped market of the middle class investors. Their idea was to successfully fulfill the gap.
These became the pillars in which the company's activities were focused on. Activity System Eventually, Merrill Lynch wanted to achieve recognition in the market place amongst their competitors. They went on a marketing offensive and broke away from the preexistent tacit noncompetitive agreements and common beliefs of the unethical nature of advertisement. Some forms of Merrill Lynch's advertising campaign included circulars, newspaper advertisement and prompt follow-up letters to interested respondents. Merrill Lynch's strategy was characterised by great attention to customers.
The "know your customer" idea was a clear example of this focus to clients. In fact, before suggesting any product to a client, Merrill tried to understand each individual customer's needs expectations and financial circumstances. Merrill Lynch based its success on sincere and honest relationships with their customers. Co-founder Charles Merrill embraces the company belief by stating: "the thing to bear in mind is that once you get a customer's confidence in the integrity and honesty of the house, you have already paved the way for a string of repeat orders".
7 The main focus was on the so-called "Mr Average Investor", that is the investor of the middle and upper-middle classes. These were investors with low financial competencies and a scarce knowledge base of main financial tools. These customers gave great importance to loyalty and clearness. Merrill Lynch addressed these concerns by providing them with accurate and comprehensible information. Merrill broadened the market for securities by appealing to the upper-middle class investors in the hundreds of town across the nation.
To address this market Merrill Lynch started to open new offices and contracted partnerships in several cities across the country. Merrill explained that the implication of this strategic expansion was to lower the volatility of cash flows that occur when depending on a smaller group of wealthy investors: "Having thousands of customers scattered throughout the nation is infinitely preferable to being dependent upon the fluctuating buying power of a smaller and perhaps on the whole wealthier group of investors in any one section"8.
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.