Diversification may actually hamper a biz to survive, rather than help it...

As said, I am intending to crank up the frequency a bit by which I will post these days. Having a bit more time on my hands also provides to some extent a luxury to do this…. Hope you will like this and provide me with some feedback and challenges. As with such challenge the thoughts can, worst case, only get better…. ??

One comment for format I have to make is that the posts are getting somewhat too long for the generic post functionality of LinkedIn and I thus had to switch to the Newsletter format. Hope that is no problem for you and the text now thus also comes with a Headline as a bonus.

Anyway, one of the key themes I have noticed is the ability for larger institutions to be “master of their own destiny”. This is a quote from a former CEO, I served (some of you may remember him saying this), but who in the end also did not “survive”. The paradoxical part of this, for us as risk managers, is that being diversified should give you ample opportunity to survive. However, in today’s world it matters if you are the top number 1 (or 2) supplier for a certain service or product. Providing a multitude of diversified services ranking stably lower than the top 1-3 will thus not secure a bright future. As products and services can easily be (digitally) distributed across the world, consumers/buyers can just purchase the number 1 (or 2) product/service and not bother about anything lower on the list. We have seen many examples of this already over the past 20 years. Textbook examples by now are clearly the search engines and social media platforms, but many more pop up when you come to think about it.

The same thing about either being the best (regarding a certain service or product) or going belly up applies more and applies to the FS industry. Specialized companies are founded (already for the past 20 years) and focus on one-and-only-one-thing. (Do I still hear somebody talking about business model risk management and diversification?) With this determined focus they become extremely good providing this one service/product (or not) and rank at the top of the market (or not) picking up all the business in that one market (as scaling to provide these is also less so an issue than in the past). “The winner takes it all”. A very good example is the payment industry and then I am glad to see that we have a Dutch unicorn in that space. This unicorn has however taken over some serious business from the incumbent banks, but because of its ability to scale it out further, they can run it profitably whereas the incumbent banks could/can hardly. This is a trend we see generically more and more.

To be able to focus on one business proposition and not having to diversify is a function of being able to provide that service/product to a large set of customers in no time and this is what is a key concept to remember. With boarders disappearing (although we clearly also see some pushback for countries to become self-supporting again), regulatory jurisdictions aligning or even merging, distribution capabilities enhancing (even non-digital goods can be across the world in under 24 hours), the world becomes the place to target for any new player/Fintech. This is what we see everywhere happening. The one obstacle for digital FS services is where it matters deepened client insight and where clients can differ from one geographical area to another, but I will try to address this a bit more in a next post as that has to do with data, data, data….

Backing up a little bit from the content and zooming out on the organization this requires, I am of the opinion also the boards of the institution should not be too diversified (yes, I am still a risk manager…), to make or expedite the bold decision to start focusing. Any investor can diversify himself these days by holding a diversified portfolio of companies, so why should the companies diversify themselves? To remain in existence? Well, I just argued that if you are not the best for a certain product or service, you will lose…., so not focusing makes a company lose anyway.

To be continued in the next post as LinkedIn does not allow for more than 4000 characters…

A focus on the company level (rather than an overarching portfolio of an investor level) is thus needed and should not be compromised in any shape or form for the product or service delivered. It is this compromise that quite often is arrived at with more stakeholders/board members involved, let alone the many regulatory bodies in the FS industry. This latter statement should by no means be taken as if I would (even remotely) suggest for regulation to be sidelined. Quite the opposite, as I think, and this may be a surprise to many of you, regulation has been the driving force over the past 30 years for innovation in the incumbent FS space! Quite a revelation, right? So better to thank the regulator than to hammer them down.

This is however different for the Fintechs, where they are setting the pace of innovation and sometimes feel held back by the regulator. Regulatory countervailing power is however good to ensure a good balance is struck between risk management insights of regulation and the young and vibrant competition usually is at play within those focused business areas (THE example is compiled by what’s at this very moment happening in the crypto space). As again, if you don’t come out on top (“winner takes it all”), you don’t tend to have future there.

Stakeholder and more specifically board composition (Managing Board, Supervisory Board, shareholders) is thus very important for defining the right focus. Next to this, it is also very crucial to see objectives between these parties and/or people aligned. Another thought-provoking statement (I think) is that non-concentrated shares ownership is making a company (very) slow to move, possibly too slow and not able to focus. The entrepreneurial drive should therefore exist with all parties, both benefiting from potential upside as well as feeling the pain when the business goes sour. Having people in the board managing the downside risk of not being in that position anymore in the next period is just not good enough for the company to beat the competition. Being committed and having real skin in the game for the longer term (not just a term to serve), inspires good risk management (clearly as a function of own/personal absorption capacity of losses). This may not only be relevant for the boards though, but also for wider parts (the entire?) company and its employees.

Given the above, one may be inspired then to ask whether in the long run any board of a company, determined to be viable (given competition) in the long run, should be run by non-shareholders, and even non-large shareholders. We all know the extremes of this capitalistic view, as we see play out in the larger social media companies at this very moment, but it does make even these very large companies, nimble, swift, and quick on their feet to accommodate the latest market insights. Although not appreciated by all (especially those negatively impacted by these decisions) I personally believe that this is necessary to remain viable and, in the end, provide also optimal employment opportunities (yes, this may be taken as a very capitalistic view). Although choices may turn out wrong, a choice is at least made. One could argue, not acting, because of a too slow process or too many stakeholders driving decision making into a compromise, is also a choice, but that choice will most likely be even worse than actively considering and making one.

If you read through the above, you may come across some companies, or even people, I refer to. I intend to not name them specifically, unless indicated by those parties themselves if they’d like to (although you may guess who they are anyway). If you are representing them (and I will be referring to smaller firms going forward as well) and would like to be mentioned by name, please let me know.

All in all, and for now, I am wondering how you reflect on the above as the statements may not completely correlate with your own views.

I will be back with more thoughts shortly. Tx for reading and responding.