In this letter, we reflect on the critical issues facing the financial services industry, and how capital markets companies can position themselves as more coherent companies.

As the economic recovery takes a fragile hold, we see several powerful market trends significantly altering the economics of the financial services industry. In response to these trends and to remain competitive, many companies will need to reassess their business models, operations, and technology infrastructure. This will entail a rigorous but vital process, given the magnitude of the forces at play—margin pressure, regulatory changes, globalization and complexity, and fast-moving technology innovation.

Tackling any one of these trends would be a challenge. Combined, they demand a vigorous response. Margins continue to be under pressure as asset values decline, net inflows for assets under management remain low, and investors continue to press for lower expense ratios. On the regulatory front, the push in the U.S. and Europe to increase transparency and risk management is driving up the costs of compliance.

Meanwhile, increased globalization and complexity mean that financial institutions need to offer a wider array of investment strategies and increasingly complex products (for example, OTC derivatives) to a global client base. Finally, technology innovation such as cloud computing and the need for on-demand data is speeding upgrade cycles and pushing companies to continually invest.

To navigate these trends and position themselves for growth, we at Booz & Company believe, companies should pay close attention to their capabilities and how they fit together to form a mutually reinforcing system. Three elements make up a capabilities-driven strategy.

• Way to play: How you choose to face the market and create value for your customers.
• Capabilities system: Including foundational capabilities (basic competencies necessary to operate in a particular industry or market) and differentiated capabilities (the key strengths that set your company apart from its rivals).
• Product and service fit: Based on your chosen way to play and capabilities system, which elements in your portfolio will grow—and which should go?

Together, these interlocking elements create a coherent company. Only a coherent company—one that pursues a clear strategic direction, builds a system of differentiating capabilities consistent with that direction, and sells products and services that thrive within that system—can reliably outpace competitors. The advantage of a coherent capabilities system is that it adds value beyond the sum of its components, and it is almost impossible to copy.

Ours is a complex industry with many kinds of companies playing many different roles. Each has a distinct set of ways to play. We recently took a close look at how two of these groups could use a capabilities-driven strategy to their advantage. The first is the investment management community, which includes institutional investment managers, subadvisors, mutual fund complexes, and hedge fund managers, all of which face pressures to perform and manage risk in a challenging margin environment. The second is the service provider community, which includes large global custodians, local market bank custodians, technology platform vendors, and outsourcing service providers, all of which are deeply dependent on cutting-edge technology to provide their services.

Investment Management Landscape

In the investment management community, companies can choose among five emerging ways to play, based on their market orientation—retail, institutional, or some combination of the two—and the breadth of their product offering. These five ways to play are the following:

• Retail product experts: Companies such as Aviva and Dreman that manage a range of products and offer an array of investment styles
• Supermarkets: Companies such as Fidelity, Vanguard, and Charles Schwab that provide access to many in-house and third-party brands and products
• Off-the-shelf shops: Companies such as Federated and Aberdeen that provide a wide range of ready-made investment products for institutional and retail clients
• Institutional pure plays: Companies such as Wellington Management, Conning, and Research Affiliates that manufacture products in-house and offer advice to institutions and family off
• Smart customizers: Companies such as BlackRock, Dimensional Fund Advisors, and Russell Investments that offer separately managed accounts and other customized products in addition to a range of standard investments

All investment managers, regardless of which way to play they choose, require a core set of capabilities in performance management, risk management, talent management, market access, and data analytics. However, to build a sustainable “right to win” in today’s environment, investment managers must move beyond these “table stakes” capabilities and pursue at least one (and usually two or three) of four distinct capabilities.

Smart execution
The ability to leverage standard, electronic, and private trading platforms to execute investment strategies and manage liquidity efficiently. This capability is most important for institutional specialists, institutional pure plays, and smart customizers. For example, institutional specialists require speed and agility across multiple markets and product types.

Continuous product innovation
The ability to continually drive fact-based product innovation and speed-to-market through management of the full end-to-end product development process. This capability is vital for retail product experts, off-the-shelf shops, and smart customizers. For example, smart customizers require seamless management of the innovation process to speed time-to-market.

End-to-end operating model management
The ability to align technology, organization, and processes across the internal and supplier value chain so the company is efficiently leveraging its operating model. This capability is critical for supermarkets, off-the-shelf shops, institutional pure plays, and smart customizers. For example, supermarkets need to manage a complex value chain through lean-led design and execution.

Customer-centric sales and service
The ability to deliver best-in-class, end-to-end client experiences through efficient and preferred channels. This capability is most relevant for retail product experts, supermarkets, off-the-shelf shops, and institutional pure plays. For example, institutional pure plays need to focus on key consultant metrics and service.

As previously noted, ways to play and capability requirements will vary depending on the type of financial institution.

Service Provider Landscape

In contrast to investment managers, we believe that service providers can choose from among six emerging ways to play based on market orientation (local or global focus) and the breadth of banking services offered. These six ways to play are as follows:

• The universal bank: Companies such as J.P. Morgan and Rabobank that leverage their balance sheets and provide value through product bundling and low cost
• Securities service expert: Companies such as BNY Mellon that drive down costs through massive global scale and leverage high-margin businesses on top of core securities servicing
• Market specialist: Companies such as HSBC, Standard Chartered, and Société Générale that understand local or regional markets exceptionally well and leverage bank services beyond securities services to gain scale
• High-touch servicer: Companies such as Brown Brothers Harriman and Northern Trust that offer seamless, consistent customized service to clients of any size and focus on securities services to the exclusion of other corporate banking functions
• Niche player: Companies such as U.S. Bancorp, China Construction Bank, and ICICI Bank that operate in local markets and are protected by special regulations, long-standing ties to markets and clients, or limited global asset flows
• Platform providers: Companies such as Bloomberg and SunGard that offer automated and integrated platform solutions and provide outsourcing services

As with investment managers, all financial securities service providers, regardless of which way to play they choose, require a core set of capabilities. These table-stakes capabilities include relationship management, internal connectivity, risk management, and regulatory and compliance management. Like investment managers, financial securities service providers must build beyond these foundational capabilities for a sustainable right to win by pursuing at least one or two of five unique capabilities:

Organizational integration
The ability to organize leadership teams and provide transparency and coordination across regions, business units, and product lines. This capability is particularly important for universal banks and market specialists. For example, universal banks must integrate business units to streamline service and bundle products.

Product development
The ability to develop and manage complex products as financial instruments rapidly evolve. This capability is critical for high-touch servicers and platform providers. For example, platform providers must continuously analyze market trends to develop new instrument servicing requirements.

Market expertise
The ability to provide deep market expertise and anticipate changes in customer needs and regulations. This capability is vital for market specialists and niche players. For example, niche players must implement retention policies for talent, knowledge, and data as well as gauge market trends.

Data-centricity and analytics
The ability to apply technology to leverage data and provide advanced analytics. This capability is necessary for securities service experts and platform providers. For example, platform providers must deliver data aggregation across all components and provide leading analytics capabilities.

Low-cost operating model
The ability to drive down costs through economies of scale and automation. This capability is key for universal banks and securities service experts. Both must become cost leaders by leveraging scale and efficiencies through lean practices, business process reengineering, and automation..

The process of identifying, building, and deploying strategic capabilities is challenging and will take a concerted, enterprise-wide effort led by the top of the organization. But we believe strongly that this approach will be necessary if a company is to outperform in the years ahead.

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