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.

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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 well9. ” 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. 10” 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. “11 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. 12 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 accounts13.

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 Street14. 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.