BMAN72201 Lecture 3

Business models (2) Industry context, trajectory and conjuncture

A threat to stakeholder credibility at Goldman Sachs?

In recent months, Goldman has faced an unprecedented spate of negative publicity as a variety of lawmakers, corporate governance experts and magazines have accused the bank of causing last years financial crisis, vilified its plans to pay bonuses on a par with those handed out in the frothy days of 2006 and 2007, and claimed Goldman was relying on its alumni network in Washington to insulate it from the consequences of the failure of AIG, the insurance group. The onslaught of criticism began slowly following the collapse of Lehman Brothers and the rescue of AIG last September, built gradually over the intervening months as the US plunged into the worst recession in decades, and reached a crescendo in recent weeks after Goldman paid back its taxpayer rescue funds and posted record profits, thus positioning the firm to ladle out bonuses as though last years financial crisis had never occurred. In Rolling Stone last month, Goldman was described as a great vampire squid wrapped around the face of humanity. The headline on the cover of New York magazine last week asked: Is Goldman Sachs evil? Or just too good? The subsequent article argued in favour of the former, with a tip of the cap to the latter. Financial Times 2nd August 2009

Structure of the lecture

Exploring the concept of business model (and its disruption) through examples

Ryanair: a low cost business model? The BBC: a public sector organisation under pressure Goldman Sachs: a new business model? Private equity: a conjunctural activity Industry business models -> pharmaceuticals (context for Workshop 4)

Conclusions

Ryanair: a low cost business model?

Ryanairs declared strategy is to be the lowest cost airline in Europe : what does this mean? Is this a business model? Sustained financial viability? Performing better than some peers (though flag carriers not directly comparable) Confusion about costs and prices (low price is not a business model); must be lower on key costs compared with competitors (eg labour, marketing, airport charges) Stakeholder credibility?: customer acceptance of the model; investor patience (expansion costs has limited dividends in Ryanair and Easyjet); regulatory & political context -> tension between allowing cheap air travel for the masses vs environmental costs of air travel

Ryanair: a sustainable business model?

What does success depend on? Continued ability to control costs All companies struggle with yield, uncertain future oil prices, regulatory changes; particular consequences for a low cost airline? Business model does not imply certainty/ stability Access to subsidies (claim that public subsidies contribute 22% of revenues and thus underpin low prices); undisclosed, but subject of investigations

http://www.scribd.com/doc/33124715/Ryanair-Business-Modelunder-a-new-light

The BBC: a public sector organisation under pressure (1)

BBC = broadcasting company funded by annual licence fee; purpose = inform, educate, entertain Critics argue that commercial ambitions compromise public service ethos; alternatively that BBC uses its positions to compete unfairly Pressures to be more commercial (revenues & costs ie job cuts, outsourcing, relocation) yet retain special nature (which justifies licence fee) Specific problem = digital channels -> demand for more programme hours

BBC (2) Business model

Financial viability? breakeven over the long term, with limits on borrowing more scope to raise revenue than many public sector organisation) Stakeholder credibility: can the BBC deliver (enough of) what its stakeholders want? Viewers & listeners (licence payers) -> consequence of lower ratings Politicians -> consequence of removal of licence or change in conditions Regulators -> consequence of limits on activities

BBC (3) Analysis

Why did the BBC impose significant job cuts at a time when it pledged to do more (quality & quantity?) Business model stressed in a digital age and channel proliferation No. of broadcast hours triples from 1998-2001 -> how to fill the hours cheaply & without criticism about undermining quality Business model problems because viability comes at some cost to credibility (job cuts, cheaper programmes, repeats etc); but this in turn threatens licence fee income (& viability) -> unresolved
Ref: Froud et al Stressed by choice: a business model analysis of the BBC, British Journal of Management

Goldman Sachs (1): in need of a new business model?

Was the investment banking business model a victim of the banking crisis? Lehman Brothers & Bear Stearns gone; Merrill Lynch rescued by Bank of America; Morgan Stanley & Goldman Sachs converted to bank holding companies. Goldman Sachs financial results just two years after the start of the crisis -> reports of investment bank death exaggerated?:

Goldman on Tuesday reported record earnings of $3.44bn (2.1bn) for the second quarter, up 65 per cent from the three months to May 30 last year, on revenues of $13.76bn figures that surprised even the most bullish analysts. If the bank maintains that growth, its staff could share total pay and bonuses of more than $22bn FT 14th July 2009

Goldman Sachs (2) The business model examined

Rapid growth in revenues Growing contribution from some business segments;

Competition and declining margins in traditional business areas balance sheet effects of growth in investments and proprietary trading (investment banks more like hedge funds?); more leverage, more risk

Always a cyclical industry (previous crises in early 1990s and early 2000s); but crisis after 2007 worse because it also brought more negative publicity. Does (temporary?) threat to credibility matter? Depends on regulatory and/or political response which might curtail future growth opportunities.

Goldman Sachs: revenue growth

50,000 40,000 30,000 20,000 10,000 0

19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08

40 35 30 25 20 15 10 5 0

net revenues $m

net profit margin %

net revenues (net of interest expense)

50,000 45,000 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

net profit margin %

40

35

30

25

20

15

10

0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Goldman Sachs, Contribution to net revenues by business segment, 19972009

100% 80% 60% 40% 20% 0%

Inv. Banking Asset management

Trading & proprietary invsts

Goldman Sachs (3): Key stakeholders & the comp ratio

Investment banks as joint ventures between shareholders and (senior) employees (Philip Augars The Greed Merchants); stakeholder within the organisation Compensation (ie pay in its various forms) as a proportion of revenues (the comp ratio); industry standard = 40-50% (occasionally more) Reform of banking practices compromised by reward structure; fear of losing teams

Goldman Sachs: Compensation ratio (total compensation as % of net revenues)

Compensation ratio %
50.0

45.0
40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2,009

Industry business models

The pharmaceutical industry Workshop 4

This page is deliberately blank

Key theme: disruption and change

Johnson et al (HBR 2008) propose a framework to explain how great models are built (p.61): customer value proposition; profit formula; key resources. New technologies or changed competitive dynamics do not always require a new business model; new business models can be difficult to define and implement and can fail Lazonick (2005): macro level analysis of how the new economy brought a different mode of organizing enterprises changing employment relations (p.1). New Economy BM brought economic growth but also unstable employment, increasing wage inequality and volatile stock markets ie complex socio-economic outcomes resulting from new modes eg ICT business models NB Lazonick defines business model in terms of strategy, finance and organisation (p.4)

Conclusions

Business model as analytical tool that stresses sustainable financial viability, external threats/ opportunities & need for adaptation (or, take your pick!) Change and disruption always important (see BCG paper on reading list for eg of consultancy opportunity on business model innovation) Not simply a strategy (eg Vodafone focusing on key emerging markets); but how to organise the business to capture value Numbers reveal shifts, pressure points, performance trends Stakeholder credibility contributes to the narrative about the conditions for financial viability -> come back to this later in the course

announcements

Workshop and presentation groups updated to add missing people Next week:

10.00 lecture for all 11.00 introduction to the assessed coursework for all See course schedule on Blackboard See Schedule for details of when presentations are due; everyone should do some preparation each week, even if not presenting

Week 5: presentations begin