The Campaign for Sustained Leadership

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And consolidation is affecting all of financial services, not just investment banks. The merger of Citicorp and Travelers Group in 1998 created the quintessential business model for the super-big, one-stop-shopping, universal-bank for customers seeking eve rything from underwriting to insurance to credit cards. The Chase-J.P. Morgan deal will create a similar giant. Robert J. Hurst, WG'68, vice chairman of Goldman Sachs, cites several key factors in commercial and investment banks' drive to seek partners.

"Commercial-banking consolidation has really come about because banking was a fragmented industry nationwide and globally," says Hurst. "And it has been a relatively slower growth industry, and so consolidation has made a lot of sense. In general, in banking acquisitions, there has been a little loss of revenue and lots of synergies and overlap, which means cost cutting and expense savings. On the investment banking side, consolidation has been driven by a different set of factors. Acquisitions have happened to create scale, to strengthen product areas and to become global or increase capital. But it's not driven by the need to offset slower growth with expense takeouts."

Hurst and others say that, in general, it's OK to be big and OK to be a small, boutique firm with a well-defined niche. But middle-of-the-pack firms, they say, are finding themselves in the most difficult competitive position: They may be too big to be nimble but too small to offer the variety of services major clients demand.

Tanya Azarch, a Standard & Poor's analyst, says the current wave of consolidation began in the late 1980s. "It waxes and wanes," she explains. "When stock prices are high, firms will sell out. When the stock market falls, there's less compulsion to do that." A consolidation "crescendo" took place in 1997, when Chase Manhattan Bank merged with Chemical Bank. A brief hiatus followed.

"Now," she says, "we're starting to get different kinds of consolidations, across industries more. I would characterize Chase and J.P. Morgan like that. There's been a convergence between corporate banking and investment banking in terms of products. Chase has proven that you can do it all, from soup to nuts, and that puts pressure on investment banks to provide bank loans and banks to provide underwriting of securities. The pressures are felt both ways. There's a sense that commercial banks all these years have not developed an investment- bank franchise [of sufficient capability], as J.P. Morgan proved. It's terribly difficult and expensive to develop equity underwriting."

Is Bigger Really Better?

Rightly or wrongly, bankers believe that bigger is better, Azarch says. "There is a sense that [firms] want a commanding market share. And as the business globalizes, the business gets bigger, so [each firm feels it has to] get bigger." Hence, European and American financial institutions have been scrambling for acquisitions. "U.S. investment banks are more successful than any investment banks in the world, and everybody wants to buy them," says Azarch. "There's almost a frenzy because there's almost nothing left to buy."

Finance professor Anthony Santomero, who took a leave of absence from Wharton last summer to become president of the Federal Reserve Bank of Philadelphia, has analyzed consolidation in a research paper titled "The Determinants of Success in the New Financial Services Environment." Santomero and co-author David Eckles of the Wharton Financial Institutions Center found that size does indeed give financial institutions advantages that can boost profits.

Large institutions enjoy certain economies of scale, he says. Plus, diversification across businesses provides some earnings stability. If an institution only sells mutual funds, for instance, the whole company will suffer if the fund business turns sour. But if that same firm also has a brokerage business, revenues and earnings from that operation can soften any blow from the fund side. Big firms can also leverage distribution channels to cross-sell products and services.

But the article, which appeared in the October 2000 issue of Economic Policy Review, a publication of the Federal Reserve Bank of New York, says size is no guarantee of success. In fact, there are several reasons why a universal bank-style institution may actually become less stable. For one, a firm's brand name will become associated with all of its products; if something bad happens to one business segment, the whole franchise may get a black eye. Further, a firm may deceive itself into thinking it is diversifying into different businesses when in fact it is not. For example, the article says, third-world lenders became emerging-market trading houses only to court disaster. A firm offering many products also becomes more complex, and complexity can cause management to be sluggish in reacting to changes in the market.

"It is not automatically the case that size will overwhelm the more focused institutions," Santomero says. "It may be the case that the midsize firms are the ones having the most difficulty because they're big enough to have management problems but are not big enough to leverage their scale. As a result, small, agile firms tend to be more successful. Firms in the middle end up being vulnerable and merge into other organizations. That's what we're seeing in almost every aspect of the financial markets."