Know your place

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Successful businesses have unique competitive advantages, but times change and they can be faced with strategic dilemmas. Sometimes, these dilemmas have no solution.

Standard Life and National Westminster are two businesses in the news. Each are organisations with a great past behind them. Each of them has a name which commands envy and respect. Each of them has well-publicised current problems. And, although the businesses and problems are very different, there is an important sense in which the issues they face are the same.

The banks which were central to the British economy in the twentieth century are products of the nineteenth. They came into existence in order to mobilise the small savings of individuals and lend them on to growing companies. Their effectiveness rested on the local knowledge of their managers. These managers were traditionally key figures in the local community. Their local knowledge gave confidence to depositors and allowed shrewd and informed assessments of the viability of the businesses the banks supported.

There were some advantages to scale in banking. National coverage gave depositors confidence in the stability of the institutions which they trusted with their savings. An institution with branches from Carlisle to Camborne seemed likely still to be there when savers wanted their money back. The marble banking halls and grandiose head offices reinforced the sense of permanence. And bigger banks were needed to handle bigger borrowers.

By the 1920s the number of major clearing banks in Britain was reduced to five. Midland, its roots in Britain’s manufacturing heartland, was not just the largest bank in Britain; it was the largest bank in the world. Its rivals – Barclays, Lloyds, National Provincial, and Westminster – were not too far behind.

But around this time, the rationale for the banks’ traditional collection of functions disappeared. Securities markets developed. That meant that you did not need to be a big financial services retailer to lend money to large corporations. And the skills involved in the two activities of retail deposit taking and business lending, once rather similar, had become quite distinct.

Nobody really noticed. As competitive pressures increased, the British banks followed the usual strategies of firms which do not really know what to do. They sought greater size by merger and internal expansion, and engaged in unfocused diversification into new businesses and new areas of the world. All of that was irrelevant, or worse. One final mega-merger created the National Westminster Bank, but the government blocked further concentration. Banks discovered that it is easy to meet targets for growing your balance sheet so long as you are not too bothered about getting your money back. And they lost a packet buying stockbrokers and American banks.

Standard Life, too, had a golden era of success. It pioneered the retailing of equities to a mass market. That was not what the firm said it was doing; in fact, if it had, it would probably have been stopped. But by packaging equities as a life insurance product, it avoided restrictive regulation and secured effective distribution.

There was not a long-term business there. It became easier, both legally and operationally, to sell shares more directly to individuals. And once that happened, there ceased to be a rationale for linking the three main things which Standard Life did: financial services retailing, investment management, and the underwriting of risks. Standard Life’s response has been another standard recourse for those with no easy strategic options: if you are not doing well enough at what you are doing already, try something else. Become a bank, or an investment management house. But there do seem to be quite a lot of well capitalised banks and successful investment management houses around already.

What National Westminster and Standard Life have in common is that each embraces a range of functions which were sensibly undertaken together at a particular point in history, but for which the rationale of combination has now disappeared. And each business has found that when you unpick the individual things they do, most of them are performed better by someone else. The banks found that their retail deposit services were upstaged by building societies, that their merchant banking arms found it difficult to match the resources and professionalism of specialist investment banks, and that lending to very large corporate and sovereign borrowers was so competitive that no one has made any money out of it, or is ever likely to. British insurers learnt that their retailing capabilities were very limited in competition with people who had branch networks – or a red telephone; their investment skills were inferior to those of specialist fund managers; and that their underwriting was outstripped in professionalism by continental reinsurers.

So what should firms faced with these kinds of strategic dilemmas do? The key requirement is to identify which of the many activities such a firm will be engaged in are ones in which it has an ongoing competitive advantage. What can you do that others cannot readily do as well? Lloyds did this in the 1980s when it understood that its strengths were in retail financial services and small business lending, and quit the more glamorous but less profitable activities which required it to compete with every other bank in the world.

But sometimes strategic dilemmas have no solution. This is difficult for executives to accept, but not all questions have answers. Sometimes the proper job of managers is to preside over an orderly transfer of the activities they control to other firms. This does not often happen quickly or without the costs and uncertainties associated with the takeover process. Perhaps it should.

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