The following is a presidential
address to the nation — to be
delivered in March 2026.
MY fellow Americans, I come to you today with a heavy heart. We have a crisis on our hands. It is one of our own making. And it is one that leaves us with no good choices.
For many years, our nation’s government has lived beyond its means. We have promised ourselves both low taxes and a generous social safety net. But we have not faced the hard reality of budget arithmetic.
The seeds of this crisis were planted long ago, by previous generations. Our parents and grandparents had noble aims. They saw poverty among the elderly and created Social Security. They saw sickness and created Medicare and Medicaid. They saw Americans struggle to afford health insurance and embraced health care reform with subsidies for middle-class families.
But this expansion in government did not come cheap. Government spending has taken up an increasing share of our national income.
Today, most of the large baby-boom generation is retired. They are no longer working and paying taxes, but they are eligible for the many government benefits we offer the elderly.
Our efforts to control health care costs have failed. We must now acknowledge that rising costs are driven largely by technological advances in saving lives. These advances are welcome, but they are expensive nonetheless.
If we had chosen to tax ourselves to pay for this spending, our current problems could have been avoided. But no one likes paying taxes. Taxes not only take money out of our pockets, but they also distort incentives and reduce economic growth. So, instead, we borrowed increasing amounts to pay for these programs.
Yet debt does not avoid hard choices. It only delays them. After last week’s events in the bond market, it is clear that further delay is no longer possible. The day of reckoning is here.
This morning, the Treasury Department released a detailed report about the nature of the problem. To put it most simply, the bond market no longer trusts us.
For years, the United States government borrowed on good terms. Investors both at home and abroad were confident that we would honor our debts. They were sure that when the time came, we would do the right thing and bring spending and taxes into line.
But over the last several years, as the ratio of our debt to gross domestic product reached ever-higher levels, investors started getting nervous. They demanded higher interest rates to compensate for the perceived risk. Higher interest rates increased the cost of servicing our debt, adding to the upward pressure on spending. We found ourselves in a vicious circle of rising budget deficits and falling investor confidence.
As economists often remind us, crises take longer to arrive than you think, but then they happen much faster than you could have imagined. Last week, when the Treasury tried to auction its most recent issue of government bonds, almost no one was buying. The private market will lend us no more. Our national credit card has been rejected.
So where do we go from here?
Yesterday, I returned from a meeting at the International Monetary Fund in its new headquarters in Beijing. I am pleased to report some good news. I have managed to secure from the I.M.F. a temporary line of credit to help us through this crisis.
This loan comes with some conditions. As your president, I have to be frank: I don’t like them, and neither will you. But, under the circumstances, accepting these conditions is our only choice.
We have to cut Social Security immediately, especially for higher-income beneficiaries. Social Security will still keep the elderly out of poverty, but just barely.
We have to limit Medicare and Medicaid. These programs will still provide basic health care, but they will no longer cover many expensive treatments. Individuals will have to pay for these treatments on their own or, sadly, do without.
We have to cut health insurance subsidies to middle-income families. Health insurance will be less a right of citizenship and more a personal responsibility.
We have to eliminate inessential government functions, like subsidies for farming, ethanol production, public broadcasting, energy conservation and trade promotion.
We will raise taxes on all but the poorest Americans. We will do this primarily by broadening the tax base, eliminating deductions for mortgage interest and state and local taxes. Employer-provided health insurance will hereafter be taxable compensation.
We will increase the gasoline tax by $2 a gallon. This will not only increase revenue, but will also address various social ills, from global climate change to local traffic congestion.
AS I have said, these changes are repellant to me. When you elected me, I promised to preserve the social safety net. I assured you that the budget deficit could be fixed by eliminating waste, fraud and abuse, and by increasing taxes on only the richest Americans. But now we have little choice in the matter.
If only we had faced up to this problem a generation ago. The choices then would not have been easy, but they would have been less draconian than the sudden, nonnegotiable demands we now face. Americans would have come to rely less on government and more on themselves, and so would be better prepared today.
What I wouldn’t give for a chance to go back and change the past. But what is done is done. Americans have faced hardship and adversity before, and we have triumphed. Working together, we can make the sacrifices it takes so our children and grandchildren will enjoy a more prosperous future.
Sunday, March 27, 2011
Tuesday, March 22, 2011
Continuing the Conversation on Free Trade
My previous posts on free trade opened a lively conversation among readers on its pros and cons. Today I’d like to wrap up these exchanges with a coda.
Public discussions on foreign trade sometimes convey the impression that China and the rest of the world make everything, as the United States sits idly by, importing their stuff and going to hell in a handbasket, to use the vernacular.
This is simply not so. Goods and services produced here still represent the great bulk of gross domestic product in the United States.
Our gross domestic product consists of:
Imports are subtracted because they are contained in the other spending categories and do not represent goods and services produced in the United States. Without subtracting spending on imports, one would overstate gross domestic product by close to 14 percent.
What is often overlooked in our debate on foreign trade is that American exports – about $1.6 trillion in 2009 — create millions of jobs for Americans. That is part of the foreign-trade picture, too.
To be sure, American imports in the last several decades have tended to exceed American exports. The difference between these is called net exports. They are positive when exports exceed imports, and negative when the opposite is the case.
As the next chart shows, net exports were positive in the 1960s to the mid-1970s, when much of the world was still recovering from World War II or was highly underdeveloped. As the rest of the world sought to catch up with the United States, net exports turned negative — in some years (2005-6), close to 6 percent of gross domestic product.
Economic Report of the President, 2011, Table B-1In plain English, Americans have become used to spending more on themselves than their own gross domestic product year after year and enjoying themselves as they’ve done that.
When net exports are negative, how do Americans pay for the excess imports?
Ultimately, they pay with financial paper, namely, I.O.U.’s in the form of Treasury bonds, corporate bonds sold to foreigners, ownership claims on American corporations (stock certificates) or legal titles to real estate sold to foreigners.
Americans have taken full advantage of this external financing facility in the last several decades. Until about 2008, American households saved less and less of their disposable income, falling to 1 percent of gross domestic product by 2006, although recovering somewhat thereafter (see next chart).
Economic Report of the President 2011, Table B-32Through the politicians they have elected, Americans have granted themselves a series of generous tax cuts, all the while driving up government spending. Unable to finance the resulting federal deficits fully from domestic savings, borrowing from foreigners, as described above, was used to fill the gap.
Thus, the much lamented trade deficit — more accurately, the current account deficit — enabled Americans to spend more than their own gross domestic product.
The tax-cut theme still sells well among the electorate and undoubtedly will be dangled before voters again in 2012, abetted no doubt by some economists, while even cuts of $100 billion (or about 2.5 percent) of a federal budget of close to $4 trillion face serious political hurdles.
Home-grown fiscal mismanagement at many levels, however, does not make the case against the benefits of free trade. It merely cries out for more responsible fiscal management at home –- which, at some point, might come. In principle, a nation can both be fiscally responsible and enjoy the overall benefits of free trade.
As I noted several weeks ago, the basic proposition of economists on free trade is:
In this regard the United States is not, of course, exactly a saint, especially in agriculture. A glaring example is the American quota on sugar imports with a truly dubious –- one might even say ugly –- redistribution of income. And as the libertarian Cato Institute has remarked, even President Reagan, widely thought of as a devoted free trader, often enacted or supported protectionist policies.
Criticism of unfair trade restrictions do have validity, especially in periods of global recession, during which trade restrictions imposed by one nation can help it export its unemployment to other nations. The proper policy response to trade barriers, however, is not the abandonment of free trade but efforts to eliminate these barriers.
After all, imagine what life would be like in the United States in the absence of foreign trade, with all products we use daily made domestically –- many would be far more expensive than they currently are, and many would be likely to be of inferior quality to those now available.
One can only imagine what American cars would be like if domestic auto makers had not been exposed to stiff price- and quality competition from Europe and Asia.
Most of those who commented on my posts did recognize that a liberalization of foreign trade, while it is beneficial over all to a nation, can lead to significant redistributions of economic privilege within that overall national benefit. That is a valid concern, which naturally pushes the issue into the political forum.
My argument is that economists, in making the case for free trade, should be more understanding of this political dimension than they often are. That might make their message more effective.
In making their case, economists can, of course, point out that international trade is not the only and probably not the major source of economic disruptions in a dynamic economy. The renowned economist Joseph Alois Schumpeter viewed such disruptions as an outcome of the process of “creative destruction” in a dynamic economy.
The question is whether those who gain from what we celebrate as “disruptive innovations” owe the losers compensation for their loss.
Suppose the Jones family is hurt financially by low-cost imports from abroad, while the Smith family is hurt equally by home-grown disruptive innovation – such as the displacement of travel agents by online booking of airlines and hotels or of airline ticket-counter personnel by online check-in. Should only the Jones family be compensated for its loss because it involves foreign trade?
A far better approach would be to have in place a solid, general economic safety net that helps all families whose economic base is disrupted through forces beyond their control, whether such disruptions originate in foreign trade or domestic developments.
Unfortunately, too many economists decry that approach as a welfare state –- and that makes selling the case for free trade that much harder.
http://economix.blogs.nytimes.com/2011/03/21/continuing-the-conversation-on-free-trade
Public discussions on foreign trade sometimes convey the impression that China and the rest of the world make everything, as the United States sits idly by, importing their stuff and going to hell in a handbasket, to use the vernacular.
This is simply not so. Goods and services produced here still represent the great bulk of gross domestic product in the United States.
Our gross domestic product consists of:
1. spending by American consumers on goods and services produced in the United States and abroad (70.8 percent of G.D.P.)From which we then subtract imports – that is, spending by Americans on foreign-produced goods and services (13.9 percent).
2. government spending in the United States, at all levels, on goods and services produced in the United States and abroad, excluding government transfer payments (20.6 percent)
3. spending by American companies on equipment, structures and inventories and by American households on residential construction, some of which may be on foreign-produced goods and services, lumped together as gross private investment (11.3 percent)
4. American exports – that is, spending by foreigners on goods and services produced in the United States (11.2 percent)
Imports are subtracted because they are contained in the other spending categories and do not represent goods and services produced in the United States. Without subtracting spending on imports, one would overstate gross domestic product by close to 14 percent.
What is often overlooked in our debate on foreign trade is that American exports – about $1.6 trillion in 2009 — create millions of jobs for Americans. That is part of the foreign-trade picture, too.
To be sure, American imports in the last several decades have tended to exceed American exports. The difference between these is called net exports. They are positive when exports exceed imports, and negative when the opposite is the case.
As the next chart shows, net exports were positive in the 1960s to the mid-1970s, when much of the world was still recovering from World War II or was highly underdeveloped. As the rest of the world sought to catch up with the United States, net exports turned negative — in some years (2005-6), close to 6 percent of gross domestic product.
Economic Report of the President, 2011, Table B-1When net exports are negative, how do Americans pay for the excess imports?
Ultimately, they pay with financial paper, namely, I.O.U.’s in the form of Treasury bonds, corporate bonds sold to foreigners, ownership claims on American corporations (stock certificates) or legal titles to real estate sold to foreigners.
Americans have taken full advantage of this external financing facility in the last several decades. Until about 2008, American households saved less and less of their disposable income, falling to 1 percent of gross domestic product by 2006, although recovering somewhat thereafter (see next chart).
Economic Report of the President 2011, Table B-32Thus, the much lamented trade deficit — more accurately, the current account deficit — enabled Americans to spend more than their own gross domestic product.
The tax-cut theme still sells well among the electorate and undoubtedly will be dangled before voters again in 2012, abetted no doubt by some economists, while even cuts of $100 billion (or about 2.5 percent) of a federal budget of close to $4 trillion face serious political hurdles.
Home-grown fiscal mismanagement at many levels, however, does not make the case against the benefits of free trade. It merely cries out for more responsible fiscal management at home –- which, at some point, might come. In principle, a nation can both be fiscally responsible and enjoy the overall benefits of free trade.
As I noted several weeks ago, the basic proposition of economists on free trade is:
Relative to a status quo of no or limited international trade, permitting full free trade across borders will leave in its wake some immediate losers, but citizens who gain from such trade gain much more than the losers lose. On a net basis, therefore, each nation gains over all from such trade.Many of those who commented on my previous posts did not dispute this proposition, which is, in fact, hard to dispute either at the theoretical or empirical level. Rather, these readers note, the main problem with free trade is that many countries merely pay lip service to its principles but breach them through a variety of trade restrictions.
In this regard the United States is not, of course, exactly a saint, especially in agriculture. A glaring example is the American quota on sugar imports with a truly dubious –- one might even say ugly –- redistribution of income. And as the libertarian Cato Institute has remarked, even President Reagan, widely thought of as a devoted free trader, often enacted or supported protectionist policies.
Criticism of unfair trade restrictions do have validity, especially in periods of global recession, during which trade restrictions imposed by one nation can help it export its unemployment to other nations. The proper policy response to trade barriers, however, is not the abandonment of free trade but efforts to eliminate these barriers.
After all, imagine what life would be like in the United States in the absence of foreign trade, with all products we use daily made domestically –- many would be far more expensive than they currently are, and many would be likely to be of inferior quality to those now available.
One can only imagine what American cars would be like if domestic auto makers had not been exposed to stiff price- and quality competition from Europe and Asia.
Most of those who commented on my posts did recognize that a liberalization of foreign trade, while it is beneficial over all to a nation, can lead to significant redistributions of economic privilege within that overall national benefit. That is a valid concern, which naturally pushes the issue into the political forum.
My argument is that economists, in making the case for free trade, should be more understanding of this political dimension than they often are. That might make their message more effective.
In making their case, economists can, of course, point out that international trade is not the only and probably not the major source of economic disruptions in a dynamic economy. The renowned economist Joseph Alois Schumpeter viewed such disruptions as an outcome of the process of “creative destruction” in a dynamic economy.
The question is whether those who gain from what we celebrate as “disruptive innovations” owe the losers compensation for their loss.
Suppose the Jones family is hurt financially by low-cost imports from abroad, while the Smith family is hurt equally by home-grown disruptive innovation – such as the displacement of travel agents by online booking of airlines and hotels or of airline ticket-counter personnel by online check-in. Should only the Jones family be compensated for its loss because it involves foreign trade?
A far better approach would be to have in place a solid, general economic safety net that helps all families whose economic base is disrupted through forces beyond their control, whether such disruptions originate in foreign trade or domestic developments.
Unfortunately, too many economists decry that approach as a welfare state –- and that makes selling the case for free trade that much harder.
http://economix.blogs.nytimes.com/2011/03/21/continuing-the-conversation-on-free-trade
Sunday, March 20, 2011
Goldman Code Thief Gets 8 Years
NEW YORK—A former Goldman Sachs Group Inc. computer programmer was sentenced to eight years and one month in prison Friday for stealing the confidential source code of the investment bank's high-speed trading system.
Federal prosecutors in Manhattan had alleged that Sergey Aleynikov, 41 years old, secretly copied Goldman Sachs's confidential source code in his last days at the investment bank and intended to use it to build a similar trading platform at his new employer.
"I very much regret the foolish decision to download information, part of this information was proprietary to Goldman," Mr. Aleynikov said before sentencing. "I never meant to cause Goldman any harm. I did not intend to harm anyone."
However, U.S. District Judge Denise Cote in Manhattan didn't agree. "He knew that what he was doing would harm Goldman Sachs. There is no other impact," she said.
High-speed-trading firms and other financial firms aggressively protect their code, considering it a trade secret and a competitive advantage. Goldman required employees to sign a confidentiality agreement as part of their employment and that any software created by them in their jobs were the property of the investment bank.
Mr. Aleynikov was convicted of theft of trade secrets and transportation of stolen property in December.
Kevin Marino, Mr. Aleynikov's lawyer, had previously argued that Mr. Aleynikov only intended to use portions of the downloaded code that were "open source," or freely available.
"He made a tragic mistake," Mr. Marino said Friday.
Mr. Marino said Mr. Aleynikov plans to appeal his conviction
Mr. Aleynikov is the second person to be convicted in recent months of stealing proprietary computer code related to an investment bank's high-frequency trading business.
Samarth Agrawal, a former Société Générale SA trader, was sentenced to three years in prison in February for the theft of the French investment bank's computer code. He was convicted in November of theft of trade secrets and transportation of stolen property.
Late last month, a federal judge ordered that Mr. Aleynikov be jailed pending sentencing after prosecutors claimed he was an increased risk of flight in part because of the lengthy sentence he faces and his connections to his family in the U.S. are strained. Mr. Aleynikov holds dual Russian and U.S. citizenship and is separated from his wife.
Federal prosecutors in Manhattan had alleged that Sergey Aleynikov, 41 years old, secretly copied Goldman Sachs's confidential source code in his last days at the investment bank and intended to use it to build a similar trading platform at his new employer.
"I very much regret the foolish decision to download information, part of this information was proprietary to Goldman," Mr. Aleynikov said before sentencing. "I never meant to cause Goldman any harm. I did not intend to harm anyone."
However, U.S. District Judge Denise Cote in Manhattan didn't agree. "He knew that what he was doing would harm Goldman Sachs. There is no other impact," she said.
High-speed-trading firms and other financial firms aggressively protect their code, considering it a trade secret and a competitive advantage. Goldman required employees to sign a confidentiality agreement as part of their employment and that any software created by them in their jobs were the property of the investment bank.
Mr. Aleynikov was convicted of theft of trade secrets and transportation of stolen property in December.
Kevin Marino, Mr. Aleynikov's lawyer, had previously argued that Mr. Aleynikov only intended to use portions of the downloaded code that were "open source," or freely available.
"He made a tragic mistake," Mr. Marino said Friday.
Mr. Marino said Mr. Aleynikov plans to appeal his conviction
Mr. Aleynikov is the second person to be convicted in recent months of stealing proprietary computer code related to an investment bank's high-frequency trading business.
Samarth Agrawal, a former Société Générale SA trader, was sentenced to three years in prison in February for the theft of the French investment bank's computer code. He was convicted in November of theft of trade secrets and transportation of stolen property.
Late last month, a federal judge ordered that Mr. Aleynikov be jailed pending sentencing after prosecutors claimed he was an increased risk of flight in part because of the lengthy sentence he faces and his connections to his family in the U.S. are strained. Mr. Aleynikov holds dual Russian and U.S. citizenship and is separated from his wife.
Wednesday, March 16, 2011
Asia’s $1 trillion infrastructure opportunity
Despite bright economic prospects, most emerging Asian countries—China, India, and the Association of Southeast Asian Nations (ASEAN)—continue to suffer from underdeveloped infrastructure. In India, for example, electricity generation is 16 percent to 20 percent short of what is needed to meet peak demand, thanks to persistent underinvestment and poor maintenance. In Indonesia, infrastructure investments dropped from 5 percent to 6 percent of GDP in the early 1990s to 2 percent to 3 percent of GDP for much of the last ten years. We estimate that the consequent deterioration in energy, transport, housing, communications, and water facilities has restrained economic growth by 3 to 4 percentage points of GDP.
We believe that situation is about to change. Across the Asian region as a whole, we calculate that around $8 trillion will be committed to infrastructure projects over the next decade to remedy historical underinvestment and accommodate the explosion in demand.
Traditionally, most Asian infrastructure projects have been funded by governments or domestic banks. Foreign investors were mostly excluded. Those that were allowed to participate faced severe restrictions, including complex regulatory and legal regimes, uneven workforce quality, and occasional political interference.
In the wake of the financial crisis, however, we have started to see signs that global private capital is increasingly welcome. The combined effects of increased stimulus spending and reduced tax receipts have increased deficits, with the result that restrictions on foreign investment are easing and a growing number of projects are being carried out under public–private partnerships (PPP). We estimate that over the next ten years fully $1 trillion of the $8 trillion of projected infrastructure projects will be open to private investors under PPPs.
The questions for owners of global capital are how to identify the opportunities, how to mitigate the main risks, and how to develop appropriate entry strategies.
Our analysis suggests that much of this new investment will be in advanced technologies. For example, Asia may leapfrog developed economies in its adoption of clean-energy technologies, thanks to falling costs and improving effectiveness.
Several countries, such as China and Malaysia, have sufficient financial depth in their domestic private-capital markets to meet their infrastructure funding requirements (Exhibit 2). Foreign investors should therefore focus on countries such as India, Indonesia, Thailand, Vietnam, and the Philippines, where the financial markets have less capacity.
Although the environment is changing, even in these countries the bulk of infrastructure investments will likely remain effectively closed to private investment. The obstacles are varied. Many governments, for instance, have ill-defined PPP policies that, because of their vagueness, inhibit private participation, while capital controls frequently deter investors who worry that they may not be able to repatriate their cash flow. Weak regulatory or legal systems intensify the risk, and while shallow or illiquid capital markets make private investment necessary, they also complicate exit strategies. Exhibit 3 calculates the effect of restrictions on foreign direct investment in India, Indonesia, the Philippines, Thailand, and Vietnam.
Despite all this, Asia remains an exciting place for infrastructure investment over the next ten years. India alone is set to spend $500 billion on projects from 2007 to 2011, thereby raising its infrastructure investment from 4 percent to 8 percent of GDP per annum. Domestic capital markets will finance some but not all of this demand: as in other parts of the region, global investors will have an opportunity to fill the gap.
As in other parts of the world, infrastructure investors in Asia should have long investment horizons and should be prepared to have capital locked up for many years.
They need to be wary of—and ensure they make changes to—partnership agreements that are often poorly structured and drafted due to a lack of skills or experience in government departments.
They should plan for the possibility of continuing political, legal, and regulatory uncertainty with respect to foreign ownership restrictions, capital controls, and partnership terms. During the 1997 Asian financial crisis, for example, several countries suddenly imposed capital controls, which in some cases were only lifted many years later.
And global investors must find ways around capital markets that lack the full range of financial instruments for risk mitigation. For example, the foreign-exchange (FX) markets for some emerging Asian currencies might not be liquid enough to allow full hedging of a currency exposure, while local derivative instruments may be insufficient to offset particular risks.
Offshore products or structures domiciled in financial centers like Singapore and Hong Kong could be a solution when local currencies are illiquid. One example is the use of a Singaporean dollar fund (or fund of funds) that then invests in, say, Vietnamese infrastructure assets. The currency risk between Vietnamese đόng (VND) and the Singapore dollar (SGD) is mitigated by a simultaneous synthetic contract that is renewed annually. While this does not completely do away with the currency risks, it reduces the volatility significantly.
Another option is to set up a holding company in a tax-friendly jurisdiction rather than have the investment in the underlying infrastructure special-purpose vehicle (SPV), which is a domestic asset. The fund-raising entity enters into a contract outside the country, which at least partially helps to reduce the sovereign risk.
Third, partnerships between foreign players and a dominant local institution—SBI-Macquarie Fund in India and the CIMB-Principal fund in ASEAN are two examples—can help.
Foreign investors and institutions typically follow an equity-led entry strategy in the initial years, since their local balance sheets tend to be insufficiently capitalized to support debt-led models. Domestic and regional banks, by contrast, typically use their strong local balance sheets to engage in debt financing.
In recent years, savvy financial institutions with a well-rounded suite of financial services have begun adopting integrated models for infrastructure investment. For example, besides funding the construction of an airport, an integrated player might also offer transaction banking services and insurance to the airport operator. Such cross-selling can deliver significant value, as our research suggests an estimated 40 percent of potential revenues from infrastructure projects come from nonlending sources (Exhibit 5). Even better, this extra value opportunity comes with relatively little additional risk—after all, the operation of an airport, or indeed a power plant, once up and running, is relatively straightforward compared with getting it built in the first place.
It is critical, however, to note that infrastructure investment requires significant dedication of time, organizational resources, and management focus. The example of Macquarie Group provides a good illustration of how a global infrastructure-investment business can be built. Macquarie first developed its expertise in infrastructure by capitalizing on the wave of Australian privatization of national infrastructure in the 1990s. Armed with the knowledge built up, Macquarie then launched its international expansion. Despite its expertise, however, it still took Macquarie more than six years for infrastructure to become a significant international platform. Along the way, it has developed sophisticated risk-management techniques to oversee activities in disparate markets.
Despite the challenges and risks, Asia’s infrastructure growth over the next ten years is an attractive opportunity for global investors and financial institutions. There will be more than $1 trillion of infrastructure projects open to foreign investment, and further value can be captured by offering a full range of associated financial services besides lending. To tap into this growth, global capital players must select the appropriate participation model and dedicate sufficient resources to build up their expertise and familiarity with Asian infrastructure markets.
McKinsey on Finance on iPad
https://www.mckinseyquarterly.com/Financial_Services/Banking/Asias_1_trillion_infrastructure_opportunity_2765?gp=1
We believe that situation is about to change. Across the Asian region as a whole, we calculate that around $8 trillion will be committed to infrastructure projects over the next decade to remedy historical underinvestment and accommodate the explosion in demand.
Traditionally, most Asian infrastructure projects have been funded by governments or domestic banks. Foreign investors were mostly excluded. Those that were allowed to participate faced severe restrictions, including complex regulatory and legal regimes, uneven workforce quality, and occasional political interference.
In the wake of the financial crisis, however, we have started to see signs that global private capital is increasingly welcome. The combined effects of increased stimulus spending and reduced tax receipts have increased deficits, with the result that restrictions on foreign investment are easing and a growing number of projects are being carried out under public–private partnerships (PPP). We estimate that over the next ten years fully $1 trillion of the $8 trillion of projected infrastructure projects will be open to private investors under PPPs.
The questions for owners of global capital are how to identify the opportunities, how to mitigate the main risks, and how to develop appropriate entry strategies.
Growing demand for outside capital
More than 80 percent of the demand for infrastructure investment in emerging Asia over the next ten years will come from energy and transport, the sectors most critical to supporting heightened economic activity. Exhibit 1 shows the full breakdown.
Our analysis suggests that much of this new investment will be in advanced technologies. For example, Asia may leapfrog developed economies in its adoption of clean-energy technologies, thanks to falling costs and improving effectiveness.
Several countries, such as China and Malaysia, have sufficient financial depth in their domestic private-capital markets to meet their infrastructure funding requirements (Exhibit 2). Foreign investors should therefore focus on countries such as India, Indonesia, Thailand, Vietnam, and the Philippines, where the financial markets have less capacity.
Despite all this, Asia remains an exciting place for infrastructure investment over the next ten years. India alone is set to spend $500 billion on projects from 2007 to 2011, thereby raising its infrastructure investment from 4 percent to 8 percent of GDP per annum. Domestic capital markets will finance some but not all of this demand: as in other parts of the region, global investors will have an opportunity to fill the gap.
Key risks to be managed
Once they have decided to invest, foreign firms must overcome several risks. Thanks to political pressures, environmental considerations, and local issues, there are often long delays between planning and project approval; this can severely affect capital deployment and productivity. The Hangzhou Bay Bridge project in China, for example, was held up for 10 years, and the Bandra-Worli Sea Link in Mumbai, India, required more than 20 years before approval was finally given.As in other parts of the world, infrastructure investors in Asia should have long investment horizons and should be prepared to have capital locked up for many years.
They need to be wary of—and ensure they make changes to—partnership agreements that are often poorly structured and drafted due to a lack of skills or experience in government departments.
They should plan for the possibility of continuing political, legal, and regulatory uncertainty with respect to foreign ownership restrictions, capital controls, and partnership terms. During the 1997 Asian financial crisis, for example, several countries suddenly imposed capital controls, which in some cases were only lifted many years later.
And global investors must find ways around capital markets that lack the full range of financial instruments for risk mitigation. For example, the foreign-exchange (FX) markets for some emerging Asian currencies might not be liquid enough to allow full hedging of a currency exposure, while local derivative instruments may be insufficient to offset particular risks.
Offshore products or structures domiciled in financial centers like Singapore and Hong Kong could be a solution when local currencies are illiquid. One example is the use of a Singaporean dollar fund (or fund of funds) that then invests in, say, Vietnamese infrastructure assets. The currency risk between Vietnamese đόng (VND) and the Singapore dollar (SGD) is mitigated by a simultaneous synthetic contract that is renewed annually. While this does not completely do away with the currency risks, it reduces the volatility significantly.
Another option is to set up a holding company in a tax-friendly jurisdiction rather than have the investment in the underlying infrastructure special-purpose vehicle (SPV), which is a domestic asset. The fund-raising entity enters into a contract outside the country, which at least partially helps to reduce the sovereign risk.
Third, partnerships between foreign players and a dominant local institution—SBI-Macquarie Fund in India and the CIMB-Principal fund in ASEAN are two examples—can help.
Selecting the right form of participation
In addition to mitigating the inherent risks, investors must choose the right participation model if they are to maximize. Exhibit 4 explains the choices, several of them suitable for use in a PPP.
Foreign investors and institutions typically follow an equity-led entry strategy in the initial years, since their local balance sheets tend to be insufficiently capitalized to support debt-led models. Domestic and regional banks, by contrast, typically use their strong local balance sheets to engage in debt financing.
In recent years, savvy financial institutions with a well-rounded suite of financial services have begun adopting integrated models for infrastructure investment. For example, besides funding the construction of an airport, an integrated player might also offer transaction banking services and insurance to the airport operator. Such cross-selling can deliver significant value, as our research suggests an estimated 40 percent of potential revenues from infrastructure projects come from nonlending sources (Exhibit 5). Even better, this extra value opportunity comes with relatively little additional risk—after all, the operation of an airport, or indeed a power plant, once up and running, is relatively straightforward compared with getting it built in the first place.
It is critical, however, to note that infrastructure investment requires significant dedication of time, organizational resources, and management focus. The example of Macquarie Group provides a good illustration of how a global infrastructure-investment business can be built. Macquarie first developed its expertise in infrastructure by capitalizing on the wave of Australian privatization of national infrastructure in the 1990s. Armed with the knowledge built up, Macquarie then launched its international expansion. Despite its expertise, however, it still took Macquarie more than six years for infrastructure to become a significant international platform. Along the way, it has developed sophisticated risk-management techniques to oversee activities in disparate markets.
Despite the challenges and risks, Asia’s infrastructure growth over the next ten years is an attractive opportunity for global investors and financial institutions. There will be more than $1 trillion of infrastructure projects open to foreign investment, and further value can be captured by offering a full range of associated financial services besides lending. To tap into this growth, global capital players must select the appropriate participation model and dedicate sufficient resources to build up their expertise and familiarity with Asian infrastructure markets.
McKinsey on Finance on iPad
https://www.mckinseyquarterly.com/Financial_Services/Banking/Asias_1_trillion_infrastructure_opportunity_2765?gp=1
Is Groupon Ruining Retailing?
Recently, a 30-year-old woman came into my custom framing business with a designer purse and a question, “What kind of coupons do you have out there?”
It is indeed a new world. Thanks mostly to Groupon, which is based about two miles from my framing business, this social coupon craze has become a big thing. For retailers, the question is whether it’s a good thing or bad thing. The coupons can drive an awful lot of people into your store, but not every store is prepared for the onslaught. And there’s another issue, one that has gotten less attention: the daily-deal sites are also training people to expect that they can get a coupon for almost anything.
Groupon didn’t invent this problem. There have been coupons all over the Internet for years, but it’s getting worse. As Jessica Bruder wrote in The Times last week, there are hundreds of companies chasing Groupon, many hoping to create a regional niche or a product niche. I suspect there will soon be a shakeout among these Groupon clones, but for now, the upshot is that most small businesses that sell a product or service are getting deluged with offers to partner with one or more of the coupon sites. Those offers are producing a lot of confusion and anxiety for businesses. To deal or not to deal, that is the question.
In a previous post, I emphasized that Groupon is advertising and while you don’t pay anything up front, it can be very expensive advertising. I went through the math that I suggest small businesses use to try to figure out whether social coupons make sense for them. There are many variables, including whether a customer spends more than the face value of the coupon, how many existing customers purchase a coupon, what percentage of the discount customers become regular customers, how many coupons are sold to each customer and the true cost of delivering the additional sales driven by the coupons.
The difficulty is in determining — or in some cases guessing — what these numbers will be. It’s been two years since I used Groupon at my frame shop. Few of the sales have turned into repeat customers, which is not typical of my business — we have a percentage of repeat customers. And that’s one reason I am concerned about the potential damage a daily deal can do to a company’s brand. The deals are a threat to what I call price integrity.
When you charge some customers full price and others half price, you make some happy and others unhappy. Worst of all, you make the wrong customers happy! The regulars are unhappy because they feel they overpaid; the discount customers are happy — but they’re probably not coming back because they’re used to shopping at half price. When you decide to do a daily deal, you are training your existing customers to wait for the next coupon. Does that sound like a recipe for success?
It has been noted that this kind of promotion works best for a business that has big fixed costs but low, if any, variable costs — a yoga class, for example. Whether there are 5 people in a class, or 20, the cost of delivering the service is basically the same. There is, however, a potential for conversion. You risk converting an existing customer into a coupon customer. Or, you may even replace a full-price customer with a coupon customer because you have exceeded capacity.
Let’s do the math on a simple example. A yoga class charges $20 per person and can take 20 students. The class has been averaging 14 people at $20 each, or $280 per class. The owner decides to run a daily deal to fill the class and attract new customers. It works splendidly.
The class is now filled. There are now 10 people paying $20 each (two regulars bought coupons and two regulars signed up too late and got bounced). Ten people pay $10 each, revenue that is split 50/50 with the deal site. That means the total for the class is $200 from the full-price customers plus $50 from the coupon customers, which equals $250. The studio is busier, the parking is lot is full, but the cash drawer holds fewer dollars — 30 fewer in fact. That might not sound like a lot but that’s 10 percent of sales, which might represent the company’s entire profit. What’s good for the customer could prove fatal to the business.
The scary thing about this scenario is that it’s something of a best-case scenario. The coupon sales didn’t generate additional expense for the yoga business (the way they would for, say, a restaurant); the numbers could be far worse for a business that is selling a product or service. Busier does not necessarily mean more profitable.
Of course, the deal could still pay off if the new customers turn into repeat customers. Will they? Maybe. But a typical new customer is gained because a business is near the customer’s home or office, or because the customer heard something good about the business, or because the customer needed the product or service. These sales were generated because of a deal. Maybe the customers will move on to the next yoga studio that offers a coupon deal — or maybe they will decide not to try yoga again, especially not at full price. And how many existing customers did the yoga studio lose by doing the deal?
I recently spoke to about 150 retailers at a trade convention. One of the board members of the trade association asked the retailers if they had used Groupon. One person in the audience said he had used a competitor and was satisfied with the results. No one in the room asked the important follow-up question, so I asked it: “What was your average sale to the coupon customers?” He said it was a good bit higher than the face value of the coupon, which is probably why he came out O.K. on the deal. But how many times can he do it without damaging his brand?
The board member then asked the crowd, “Who thinks that Groupon will be out of business in three years?” Almost every hand went up. They are wrong. Groupon is here to stay. Daily deal coupons are here to stay. I’m sure they work for some businesses. Lots of businesses will try them at least once — and there are lots of businesses out there. But all of us, even those of us who never try a daily deal, will have to accept that we are training customers to believe that the next discount coupon is always an e-mail away.
Over time, I think the competition from all of the Groupon clones may force the deal sites to let the retailers keep a higher percentage of the coupon split. Perhaps the discount to the customers will go down, as well. And then maybe daily deal sites will work for more businesses as well as for the customers and the coupon sites.
http://boss.blogs.nytimes.com/2011/03/16/is-groupon-ruining-retailing/?partner=rss&emc=rss
It is indeed a new world. Thanks mostly to Groupon, which is based about two miles from my framing business, this social coupon craze has become a big thing. For retailers, the question is whether it’s a good thing or bad thing. The coupons can drive an awful lot of people into your store, but not every store is prepared for the onslaught. And there’s another issue, one that has gotten less attention: the daily-deal sites are also training people to expect that they can get a coupon for almost anything.
Groupon didn’t invent this problem. There have been coupons all over the Internet for years, but it’s getting worse. As Jessica Bruder wrote in The Times last week, there are hundreds of companies chasing Groupon, many hoping to create a regional niche or a product niche. I suspect there will soon be a shakeout among these Groupon clones, but for now, the upshot is that most small businesses that sell a product or service are getting deluged with offers to partner with one or more of the coupon sites. Those offers are producing a lot of confusion and anxiety for businesses. To deal or not to deal, that is the question.
In a previous post, I emphasized that Groupon is advertising and while you don’t pay anything up front, it can be very expensive advertising. I went through the math that I suggest small businesses use to try to figure out whether social coupons make sense for them. There are many variables, including whether a customer spends more than the face value of the coupon, how many existing customers purchase a coupon, what percentage of the discount customers become regular customers, how many coupons are sold to each customer and the true cost of delivering the additional sales driven by the coupons.
The difficulty is in determining — or in some cases guessing — what these numbers will be. It’s been two years since I used Groupon at my frame shop. Few of the sales have turned into repeat customers, which is not typical of my business — we have a percentage of repeat customers. And that’s one reason I am concerned about the potential damage a daily deal can do to a company’s brand. The deals are a threat to what I call price integrity.
When you charge some customers full price and others half price, you make some happy and others unhappy. Worst of all, you make the wrong customers happy! The regulars are unhappy because they feel they overpaid; the discount customers are happy — but they’re probably not coming back because they’re used to shopping at half price. When you decide to do a daily deal, you are training your existing customers to wait for the next coupon. Does that sound like a recipe for success?
It has been noted that this kind of promotion works best for a business that has big fixed costs but low, if any, variable costs — a yoga class, for example. Whether there are 5 people in a class, or 20, the cost of delivering the service is basically the same. There is, however, a potential for conversion. You risk converting an existing customer into a coupon customer. Or, you may even replace a full-price customer with a coupon customer because you have exceeded capacity.
Let’s do the math on a simple example. A yoga class charges $20 per person and can take 20 students. The class has been averaging 14 people at $20 each, or $280 per class. The owner decides to run a daily deal to fill the class and attract new customers. It works splendidly.
The class is now filled. There are now 10 people paying $20 each (two regulars bought coupons and two regulars signed up too late and got bounced). Ten people pay $10 each, revenue that is split 50/50 with the deal site. That means the total for the class is $200 from the full-price customers plus $50 from the coupon customers, which equals $250. The studio is busier, the parking is lot is full, but the cash drawer holds fewer dollars — 30 fewer in fact. That might not sound like a lot but that’s 10 percent of sales, which might represent the company’s entire profit. What’s good for the customer could prove fatal to the business.
The scary thing about this scenario is that it’s something of a best-case scenario. The coupon sales didn’t generate additional expense for the yoga business (the way they would for, say, a restaurant); the numbers could be far worse for a business that is selling a product or service. Busier does not necessarily mean more profitable.
Of course, the deal could still pay off if the new customers turn into repeat customers. Will they? Maybe. But a typical new customer is gained because a business is near the customer’s home or office, or because the customer heard something good about the business, or because the customer needed the product or service. These sales were generated because of a deal. Maybe the customers will move on to the next yoga studio that offers a coupon deal — or maybe they will decide not to try yoga again, especially not at full price. And how many existing customers did the yoga studio lose by doing the deal?
I recently spoke to about 150 retailers at a trade convention. One of the board members of the trade association asked the retailers if they had used Groupon. One person in the audience said he had used a competitor and was satisfied with the results. No one in the room asked the important follow-up question, so I asked it: “What was your average sale to the coupon customers?” He said it was a good bit higher than the face value of the coupon, which is probably why he came out O.K. on the deal. But how many times can he do it without damaging his brand?
The board member then asked the crowd, “Who thinks that Groupon will be out of business in three years?” Almost every hand went up. They are wrong. Groupon is here to stay. Daily deal coupons are here to stay. I’m sure they work for some businesses. Lots of businesses will try them at least once — and there are lots of businesses out there. But all of us, even those of us who never try a daily deal, will have to accept that we are training customers to believe that the next discount coupon is always an e-mail away.
Over time, I think the competition from all of the Groupon clones may force the deal sites to let the retailers keep a higher percentage of the coupon split. Perhaps the discount to the customers will go down, as well. And then maybe daily deal sites will work for more businesses as well as for the customers and the coupon sites.
http://boss.blogs.nytimes.com/2011/03/16/is-groupon-ruining-retailing/?partner=rss&emc=rss
The appeal of Asia has seldom been stronger for corporate and investment banks. Supported by financial systems that proved resilient during the recent financial crisis, the region continues to enjoy rates of economic growth superior to those of more developed Western markets. And the prospects for new revenues for most banking businesses look enticing over the next two to three years.
As of 2009, Asia accounted for 36 percent of global corporate banking revenues and 21 percent of global capital market and investment-banking revenues. McKinsey’s global research, which identified opportunities worth $200 billion to $220 billion over the next five years, suggests these proportions may be set to rise (exhibit). We estimate, for example, that 45 percent of all new growth in global wholesale banking revenues up to 2014 will take place in the region, and that emerging Asia1 will grow about three times faster than developed Asia.2
All the major global firms have established beachheads or are evaluating multiple options for doing so. Some are opting to grow organically; for example, Morgan Stanley set up a joint venture with Mitsubishi UFJ Financial Group. Others are taking the acquisition route—Merrill Lynch, for instance, took over its local partner in India.
The big battalions see Asia as an important battleground in the struggle for global supremacy in wholesale banking. But ambitious local players, no longer content to settle for the relatively low-margin commodity-lending business, are also looking for an increased share of the more glamorous capital market and investment-banking action, with competition intensifying on all sides.
Based on our work with leading institutions, as well as our proprietary research, we believe future opportunities will most likely be captured by institutions that can:
This is a missed opportunity. Revenues from midcorporate clients across Asia could amount to as much as $185 billion by 2014, according to our estimates. But the pie is not divided evenly. There is a significant difference between the return on equity (ROE) and share of wallet of the primary bank and that of other banks serving the midcorporate segment.
Take Hong Kong, for example, where the share of wallet of the primary bank is 40 percent and ROE is 33 percent; for secondary banks, share of wallet is 20 percent and ROE is 24 percent, while for the tertiary banks that only rarely serve the client, share of wallet is 6 percent and ROE is 16 percent. The winners would appear to take most, if not all.
To move into pole position will require challengers to analyze how the client interacts with different levels of the bank’s organization and possibly rebuild the relationship model; challengers must also find ways to efficiently offer nonlending products, work out how best to customize credit, and ensure that they overcome organizational friction to capture accompanying private banking opportunities.
There are several ways to resolve the issue: some institutions might even consider building a mid-cap-focused investment bank to meet the capital market financing needs of clients—but others can find organizational mechanisms to encourage product units to focus on this opportunity. The key is to emphasize the potential of these revenue sources rather than the immediate—and not necessarily very appealing—prize.
As a consequence, the ROE of the locals’ mid-corporate portfolio is just 10 percent to 15 percent, compared with the 20 percent to 30 percent that foreign players earn from their Asian wholesale banking activities. Local players should start to leverage their strong balance sheets and extensive relationships to boost their share of fee-income revenues. They can do this by instituting more systematic account planning, taking account of the skills needed for specific product markets, and improving their negotiating capabilities.
The Asian globalizers will no doubt be courted by local institutions eager to play on their domestic banking relationships and by foreign players positioned to leverage their global network. Local institutions can capture their share of the pie by carefully identifying their strategic approach and choosing the appropriate implementation and organization model.
Each of these choices involves legitimate and critical trade-offs that will reflect the bank’s specific context and its stage of evolution. It might seem expedient to choose more conservative home-country risk norms, for example, but not if international market conditions drive pricing.
One local ASEAN player has struck a good balance—in foreign locations, the CEO is always a home-country person, and the COO is a local hire. The rest of the staff varies, depending on the specific needs and requirements. In this way, the bank has preserved its home culture and mode of working, simultaneously ensuring that it is able to adapt to and embrace the foreign banking environment.
Several Indian power companies, for instance, buy coal from Indonesian mines using “take or pay” structures. The coal is transported to India, and the power produced is sold through fixed contracts or the trading markets. This chain generates several opportunities for financial institutions: on the Indonesian side, coal financing structures, forward rate agreements for shipping, and treasury products; on the Indian side, project financing, working-capital management, liability insurance, transaction banking, power contracts, and possibly even private-equity investment in the power plants.
Traditionally, different business units would have focused on each of these opportunities in isolation, capturing some and missing out on others. An integrated understanding of the value chain and consequent adjustments to the organization can increase share of wallet, improve pricing, and mitigate risk.
Institutions will want to evaluate several organizational options, including “virtual opportunity organizations” (a group of individuals pooled together from different parts of the bank, for example, treasury, debt servicing, and custody services, to tap a specific opportunity, such as bullion flows into Asia), a redefinition of profit and loss centers around specific opportunities (say, end-to-end commodity chains), and “thematic verticals” extending across clients, products, and geographies. One example might be an infrastructure vertical, organized around offerings in debt finance, equity funds management, and fund-raising.
The compensation philosophy in wholesale banking has shifted from an “eat what you kill” approach to a system based on the team and the institution. Bonuses linked to annual performance are giving way to a long-term wealth-creation philosophy.
Institutions building new franchises must also balance recruiting and developing local talent with the former approach of hiring laterally, including experienced international bankers.
Finally, senior management must devote time to mentoring next-generation leaders and creating personal career-development plans that include international exposure, cross-product rotation, and an improved understanding of compliance.
Competition will intensify in Asian wholesale banking as global and local players alike seek to raise their game in the coming era of high stakes and lucrative opportunities. Several revenue pools of more than $100 billion are up for grabs; the winners will be those that position themselves as a primary bank for midcorporates, develop new capital market skills, successfully target Asian companies expanding beyond their domestic base, and adapt more flexible organizational structures.
McKinsey on Finance on iPad
https://www.mckinseyquarterly.com/Financial_Services/Banking/Asian_wholesale_banking_Winning_in_the_new_battleground_2761?gp=1
As of 2009, Asia accounted for 36 percent of global corporate banking revenues and 21 percent of global capital market and investment-banking revenues. McKinsey’s global research, which identified opportunities worth $200 billion to $220 billion over the next five years, suggests these proportions may be set to rise (exhibit). We estimate, for example, that 45 percent of all new growth in global wholesale banking revenues up to 2014 will take place in the region, and that emerging Asia1 will grow about three times faster than developed Asia.2
All the major global firms have established beachheads or are evaluating multiple options for doing so. Some are opting to grow organically; for example, Morgan Stanley set up a joint venture with Mitsubishi UFJ Financial Group. Others are taking the acquisition route—Merrill Lynch, for instance, took over its local partner in India.
The big battalions see Asia as an important battleground in the struggle for global supremacy in wholesale banking. But ambitious local players, no longer content to settle for the relatively low-margin commodity-lending business, are also looking for an increased share of the more glamorous capital market and investment-banking action, with competition intensifying on all sides.
Based on our work with leading institutions, as well as our proprietary research, we believe future opportunities will most likely be captured by institutions that can:
- Position themselves as the primary bank for midcorporates that are currently underserved, notably in lending, transaction banking, and simple fixed-income, currency, and commodities products
- Develop the skills to earn fees from activities like treasury and capital markets
- Target Asian companies expanding beyond their domestic bases, initially through financing and trade-related services
- Adapt their organization to opportunities and segments rather than product and client “silos,” and develop an employee “proposition” that provides more than just financial compensation
Winning the primaries
Banks in Asia invariably have dedicated units for large and very large businesses, but not always for midcorporates. Midsize customers are often served peripherally by the corporate bank, or worse still by the consumer arm. Relationship managers of corporate banks with a mixed portfolio of large and midsize clients tend in our experience to earn just 10 percent to 15 percent of their revenues from the latter.This is a missed opportunity. Revenues from midcorporate clients across Asia could amount to as much as $185 billion by 2014, according to our estimates. But the pie is not divided evenly. There is a significant difference between the return on equity (ROE) and share of wallet of the primary bank and that of other banks serving the midcorporate segment.
Take Hong Kong, for example, where the share of wallet of the primary bank is 40 percent and ROE is 33 percent; for secondary banks, share of wallet is 20 percent and ROE is 24 percent, while for the tertiary banks that only rarely serve the client, share of wallet is 6 percent and ROE is 16 percent. The winners would appear to take most, if not all.
To move into pole position will require challengers to analyze how the client interacts with different levels of the bank’s organization and possibly rebuild the relationship model; challengers must also find ways to efficiently offer nonlending products, work out how best to customize credit, and ensure that they overcome organizational friction to capture accompanying private banking opportunities.
Relationship management
Midcorporates typically rely on bank credit to finance their growth, since most are not large enough to obtain capital market financing. The relationship-cum-credit manager of the bank therefore plays a pivotal role in interactions with its midcorporate clients. However, the approach needed is quite different from, and in some ways more demanding than, that used to serve large corporates: for example, relationship managers in the midcorporate segment will most likely differentiate themselves from rivals by the amount of “touch time” they devote to customers, as well as by the ideas and solutions they can proactively bring forward to help solve client problems. That’s different from the approach to serving large companies that many banks use, in which the relationship manager is often a mere gatekeeper for the product specialists.A more appropriate credit model
Plain-vanilla credit is no longer enough to satisfy most midsize customers; banks must develop new custom products and services and get away from the all-too-common one-size-fits-all product basket. This requires balancing centralized decision making, which is essential to manage the complexity of products, with the sort of local inputs appropriate for firms that may not yet be national champions but aspire to be so. Successful banking players have developed a variety of tools and approaches, including a qualitative credit assessment to help the front line screen applications for final authorization by central committees, clear sector-based guidelines to save time and provide minimum lending standards, and innovative policies such as inviting frontline managers to join select meetings of the central credit committee.Nonlending products
While midcorporate clients rely on bank credit for their core needs, they increasingly need other services such as capital market and treasury products. Given the low volumes, however, the bank’s product specialists are often disinclined to work on nonlending propositions; if their incentive is to maximize revenue, they are naturally likely to devote their energies and time to larger clients.There are several ways to resolve the issue: some institutions might even consider building a mid-cap-focused investment bank to meet the capital market financing needs of clients—but others can find organizational mechanisms to encourage product units to focus on this opportunity. The key is to emphasize the potential of these revenue sources rather than the immediate—and not necessarily very appealing—prize.
Don’t forget the private bank
Targeting senior executives with sizable private portfolios might seem obvious, but in practice, banks often struggle to capture these synergies. Internal organizational issues include incentive conflicts among relationship managers and disputes over “named credit” allocations (for example, should the individual who arranged the corporate credit also be recognized and rewarded for any business from a senior executive in his or her individual capacity?). There are two main ways to tackle the problem: institutions should weigh the merits of a more integrated organization structure against simple referral and incentive schemes. Our experience of working with two banks that got this integrated approach right in the Association of Southeast Asian Nations (ASEAN) region was that the prize is significant—an increase of at least 4 percent to 5 percent in ROE.Playing in the premier fees league
Across Asian markets, foreign players tend to dominate the high-ROE fee-income pools in treasury and capital markets, while local players focus more on providing low-margin credit and payments products. Throughout most of the ASEAN region, excluding Singapore, and in India, local banks claim just 10 percent to 15 percent of the available investment-banking revenues (against 85 percent to 90 percent of lending revenues).As a consequence, the ROE of the locals’ mid-corporate portfolio is just 10 percent to 15 percent, compared with the 20 percent to 30 percent that foreign players earn from their Asian wholesale banking activities. Local players should start to leverage their strong balance sheets and extensive relationships to boost their share of fee-income revenues. They can do this by instituting more systematic account planning, taking account of the skills needed for specific product markets, and improving their negotiating capabilities.
Systematic account planning
Banks that are serious about this opportunity must set targets and budgets across the banking product range—not just on lending and deposit advances. They should analyze clients’ needs so as to assess their likely demand for these financial products. The process starts with a current client-product map that shows product usage by client, identifies those banks that provide each product at the moment, and indicates their respective share of the customer’s wallet—the total that the customer spends on banking products and services. The second step pinpoints the key client executives responsible for product decisions and the people at the bank charged with maintaining the relationship. Next, banks take a view of the client’s future needs, based on any knowledge of, say, the company’s expansion plans, M&A ambitions, and operational changes—perhaps a new factory that has put pressure on working capital. The final step is to draw up an action plan and product-specific budgets for the client account, complete with clear accountabilities and timelines. In our experience, the entire process takes one to two weeks and involves analysis, client discussions, and one joint session of relationship managers and product specialists.New capabilities for product markets
Successful local players have used a combination of internal resources and external support to build competitive positions in niches (for instance, transaction banking, derivatives, and project advisory). One leading state-owned bank in India, for example, partnered with a European bank to provide foreign-exchange derivatives solutions to clients: the local player focused on client acquisition and servicing, and the foreign bank provided a “white labeled,” back-to-back product arrangement that enabled the local bank to capture a share of the derivatives wallet it could not get on its own. The foreign player was happy because it was able to sell derivatives in the Indian market, something that had not been possible earlier because it did not have the requisite client relationships.New capabilities for selling and negotiating
Developing negotiating and selling skills is critical if a bank is to price fee products accurately and bundle them with its lending offering. The relationship managers of local players frequently bundle products for a given customer so as to capture a larger share of his or her business—but in so doing, they give up too much upside to the client. This happens for a number of reasons: an inadequate understanding of each product’s ROE, an inability to understand the local market and the bank’s pricing power, and a failure to use the influence of hierarchy in negotiations. Relationship managers need to understand the full economics of the overall customer relationship and leverage this knowledge to extract the best deals from the bank’s perspective.Targeting the globally ambitious
Domestic Asian companies readying themselves for international expansion represent another lucrative customer for investment banks. Our research suggests that by 2015, Asia will have up to 30 percent of the world’s 100 largest companies and up to 40 percent of the world’s 500 largest. The financial opportunities they offer include trade finance, foreign exchange, international capital raising, M&A, remittance flows, and foreign-country banking.The Asian globalizers will no doubt be courted by local institutions eager to play on their domestic banking relationships and by foreign players positioned to leverage their global network. Local institutions can capture their share of the pie by carefully identifying their strategic approach and choosing the appropriate implementation and organization model.
Pick the most realistic strategy
Banks will have to decide whether to pursue a “follow the customer” strategy, targeting select countries outside of the region with bilateral trade relationships and strong cultural links, or create regional “hub and spoke” models for adjacent countries. State Bank of India’s thrust into geographies where Indian entrepreneurs are expanding, Banco Santander’s focus on Spain and Latin America, and Malaysia-based CIMB Group’s regional model for ASEAN markets illustrate the different approaches. Banks will be influenced by their own distinctive capabilities and the risk-return profile of the chosen approach.Define the international business model
The business model for operating in foreign countries is likely to be different from the domestic model for a range of issues: products, credit, service proposition, account coverage, financing and funding of the balance sheet, and delivery capabilities. Should there, for example, be a single lead relationship manager for each major country, or should there be multiple relationship managers? Should credit assessment be localized or centralized? Should credit pricing be based on home-country risk norms or adjusted for local-country conditions? How much emphasis should be put on building a local-country balance sheet? Or should the emphasis be on alternative structures, such as lines of credit, in addition to swaps and offshore financing?Each of these choices involves legitimate and critical trade-offs that will reflect the bank’s specific context and its stage of evolution. It might seem expedient to choose more conservative home-country risk norms, for example, but not if international market conditions drive pricing.
Identify international implications for the organization
Local players typically either move home-country talent to foreign locations or hire local personnel to manage the new foreign operations. Without relationships and networks, however, home-country talent is usually ineffective, while newly hired locals lack oversight and struggle to adapt to the organization’s culture. A combination of local and foreign talent is often the best bet, enabling the bank to retain its core institutional culture.One local ASEAN player has struck a good balance—in foreign locations, the CEO is always a home-country person, and the COO is a local hire. The rest of the staff varies, depending on the specific needs and requirements. In this way, the bank has preserved its home culture and mode of working, simultaneously ensuring that it is able to adapt to and embrace the foreign banking environment.
Adapting the organization
The new opportunities in wholesale banking will require local banks to organize themselves in some respects around opportunities and segments rather than using traditional structures. New ways of attracting and retaining talent must also be considered.New structures
Several of the new markets are complex and cut across clients, geographies, and products. As a result, the traditional wholesale structures of product groups and client teams, used by both global banks and local players, will be inadequate to capture future revenue opportunities. More integrated structures, however, can mitigate the risks.Several Indian power companies, for instance, buy coal from Indonesian mines using “take or pay” structures. The coal is transported to India, and the power produced is sold through fixed contracts or the trading markets. This chain generates several opportunities for financial institutions: on the Indonesian side, coal financing structures, forward rate agreements for shipping, and treasury products; on the Indian side, project financing, working-capital management, liability insurance, transaction banking, power contracts, and possibly even private-equity investment in the power plants.
Traditionally, different business units would have focused on each of these opportunities in isolation, capturing some and missing out on others. An integrated understanding of the value chain and consequent adjustments to the organization can increase share of wallet, improve pricing, and mitigate risk.
Institutions will want to evaluate several organizational options, including “virtual opportunity organizations” (a group of individuals pooled together from different parts of the bank, for example, treasury, debt servicing, and custody services, to tap a specific opportunity, such as bullion flows into Asia), a redefinition of profit and loss centers around specific opportunities (say, end-to-end commodity chains), and “thematic verticals” extending across clients, products, and geographies. One example might be an infrastructure vertical, organized around offerings in debt finance, equity funds management, and fund-raising.
Talent
Changing opportunities also call for changes in the talent-management model. The existing model at most banks, focused primarily on compensation, is insufficient for the new competitive environment. Many of the new opportunities are long term in nature, and shrewd institutions are starting to realize that an exclusive P&L focus that ignores franchise building is shortsighted.The compensation philosophy in wholesale banking has shifted from an “eat what you kill” approach to a system based on the team and the institution. Bonuses linked to annual performance are giving way to a long-term wealth-creation philosophy.
Institutions building new franchises must also balance recruiting and developing local talent with the former approach of hiring laterally, including experienced international bankers.
Finally, senior management must devote time to mentoring next-generation leaders and creating personal career-development plans that include international exposure, cross-product rotation, and an improved understanding of compliance.
Competition will intensify in Asian wholesale banking as global and local players alike seek to raise their game in the coming era of high stakes and lucrative opportunities. Several revenue pools of more than $100 billion are up for grabs; the winners will be those that position themselves as a primary bank for midcorporates, develop new capital market skills, successfully target Asian companies expanding beyond their domestic base, and adapt more flexible organizational structures.
McKinsey on Finance on iPad
https://www.mckinseyquarterly.com/Financial_Services/Banking/Asian_wholesale_banking_Winning_in_the_new_battleground_2761?gp=1
Capturing the investment-banking opportunity in ASEAN
The economic rise of Asia has been much noted. But many have not realized that this is not just a story about the emerging giants, India and China. Countries that are a part of the Association of Southeast Asian Nations (ASEAN) are also an important contributor to Asia’s growth.1 By 2009, this region already accounted for 9 percent of Asian wholesale banking revenues and 13 percent of capital markets and investment-banking (CMIB) revenues. To be sure, these are not dominant positions. But several key ASEAN economies will grow faster than the rest of Asia over the next five years. GDP growth in Vietnam (7 percent), Indonesia (6 percent), and Malaysia (5 percent) will be notably faster than in the established markets of Japan (2 percent) and Australia (3 percent).2
Several forces are propelling ASEAN growth. Chief among these are the need for new roads, ports, and power plants, and governments’ determination to expand capital markets. Evidence of both was seen in the announcement at the July 2010 ASEAN summit in Hanoi of a plan for road and rail development across the region. ASEAN’s brightening star will likely attract yet more investment from global banking majors, many of which have already built formidable presences across the region. For local banks, an inflection point is at hand. As Asian companies expand into new regions and the largest go global, incumbent banks will need to redouble their efforts or risk losing a substantial share of their investment-banking franchise to the big international banks. We see five core capabilities that local banks must build, including the coverage model, account planning, research, cross-border capabilities, and the talent proposition.
A leading incumbent bank in India set out to build these five capabilities, with considerable success: among other achievements, average monthly fee income increased by 125 percent over baseline. Several ASEAN banks will probably achieve similar success, and that in turn will increase the pressure on foreign banks to respond. We see three likely responses for these global firms, including balancing their “footprint,” capturing the midcorporate opportunity, and developing capabilities to deliver cross-cutting customer solutions.
We focused our research on five of the biggest ASEAN banking sectors (Indonesia, Malaysia, Singapore, Thailand, and Vietnam). All except Vietnam have a higher proportion of CMIB revenues than would be indicated by their GDP per capita. This implies that for a given amount of capital, banks may enjoy greater revenues from CMIB products than from lending. Not surprisingly, the region has proved attractive to global banks that traditionally focus on fee-based businesses. Many of these foreign banks have already built leading franchises in several products and countries.
These banks also find the growth of CMIB in ASEAN attractive. The region is projected to grow faster than the rest of Asia in the key areas of equity and debt capital markets (ECM and DCM) and mergers and acquisitions (M&A) (Exhibit 2).
Skeptics would counter that, for all its attractions, “investment-banking in ASEAN” really means “investment-banking in Singapore.” It is true that Singapore currently accounts for over two-thirds of total ASEAN CMIB revenues. However, the city-state’s share is projected to decline to around 58 percent by 2014 as capital markets in other economies develop.
Similarly, at present, CMIB in ASEAN is heavily focused on sales and trading, which generates over 80 percent of revenues. Again, we expect to see a growing diversification. By 2014, sales and trading will account for 72 percent of revenues.
Over the next five years, the ASEAN region is expected to spend more than $350 billion on infrastructure. Indonesia, Thailand, and Vietnam will commit the biggest sums, while Singapore is expected to spend little. Indonesia will look to address a lack of quality roads, inadequate power supply, and a dearth of public transport. In 2009, the newly elected government announced that the total infrastructure spend needed between 2009 and 2014 will be around $140 billion. Much of this investment may be structured as sukuk, a bond-like instrument that conforms with Islamic law. (For more on sukuk, see sidebar “Sukuk in Malaysia and Indonesia.”)
In Thailand, infrastructure spending has lagged in recent years. While GDP grew at over 8 percent between 1999 and 2008, infrastructure spending grew at only 3.6 percent. From 1999 to 2008, infrastructure spending as a share of GDP fell from over 9 percent to about 6 percent.
Like Indonesia, much of Vietnam currently lacks reliable electricity, quality roads, or seaports. Its infrastructure requirements are estimated at $70 billion to $80 billion over the next five to ten years. Today most of its infrastructure investment is funded by government debt. That is expected to change, as the government begins to seek investors to form public-private partnerships.
On the other hand, governments in developing markets like Indonesia and Vietnam are taking initiatives to expand markets and improve trading and settlement infrastructure.
Vietnam currently has a growing primary bond market with mainly public-sector issuances, but a thin secondary market. The government is addressing this; first, it has established a specialized secondary state bond market where most government securities are now traded. It also intends to build a benchmark yield curve and to encourage the creation of credit-rating companies. Finally, it is also installing a securities depository and a new settlement system with support from the Asian Development Bank (ADB) and the World Bank.
In Indonesia, the government has also taken the assistance of the ADB, in the form of an ongoing technical-assistance program. The goal is to build deeper and more liquid capital markets, enhance market supervision, and improve regulatory resources and capacity.
In financial services, almost all the leading banks in Singapore and Malaysia have made regional forays to expand their presence in ASEAN. These banks have achieved varying degrees of success. Among the most successful is Malaysia’s CIMB Group, which has gone through five transformational deals in four years, taking the bank into new markets in Thailand, Indonesia, and Singapore.
Several ASEAN telecommunications firms have adopted a similar growth strategy. SingTel, for instance, is now active in over 20 markets and has acquired strategic stakes in AIS in Thailand, Telkomsel in Indonesia, and Globe Telecom in Philippines.
In energy and natural resources, Indonesia in particular has seen significant M&A activity—about 130 transactions in the past eight years—originated by both domestic and overseas firms.
CMIB revenues will mirror the growth in GDP. ECM in particular will prosper from a wave of local listings in both markets. In Vietnam, the government has already privatized several good-size state-owned enterprises (SOEs) and has announced plans to privatize some of the biggest, including AgriBank, Bao Viet Insurance, Vinatex, and Vietnam Airlines. Similarly, in Indonesia, following the successful listing of Bank Tabungan in 2009, the government has announced plans to divest stakes in some of the largest SOEs, including PT Krakatau Steel, Plantation Company PT Perkebunan Nusantara (PTPN) VII, and Garuda Indonesia.
M&A advisory will also benefit, as fragmented local industries are expected to consolidate. Indonesia has more than 120 banks, of which 4 are state owned. That’s many more than in mature markets such as Australia and India. Vietnam is similarly overbanked. The State Bank of Vietnam has mandated that all banks in Vietnam must have capital of at least 3 trillion Vietnamese ng (about $150 million) by the end of 2010. Many of the smaller banks will likely be unable to raise the requisite capital, and a forced consolidation of the sector may result.
Sales and trading businesses will also need more sophisticated products. As the ASEAN economies accumulate wealth, consumers will turn to life insurance and asset management. There is considerable room for these businesses to grow. The rise of insurance will create a kind of virtuous cycle, creating opportunity for institutional sales and trading firms that will be asked to deliver the kinds of sophisticated products (such as swaps, options, and other derivatives) that their counterparts in developed markets have sold for years.
Of course, all of Asia is expected to grow in affluence; assets under management of high-net-worth individuals are likely to rise to nearly $7.5 trillion by 2012. With interest rates low in Asia, as in the rest of the world, Asia’s private banking and affluent retail customers are likely to seek ever higher returns along with portfolio diversification, and will aggressively pursue investments such as initial public offerings, structured equity-linked products, and alternative investments such as hedge funds. This infusion of new money into equity-linked instruments will push up sales and trading revenues.
Despite the opportunity, some local institutions seem to be ceding the advantage in many of these markets to others. These firms are at risk of missing out on the next big wave of growth in ASEAN capital markets. To avoid that fate, they can draw on the examples of their emerging-market peers (for example, Kotak in India and Itaú BBA in Brazil), which have leveraged their balance sheets to build dominant local investment-banking businesses. In our view, local commercial and corporate banks must take five actions to succeed in investment banking:
Within investment-banking teams and products, banks align the coverage model with their understanding of the various segments of their client base. The most commonly observed model is a segmentation based on size; the coverage model is then tailored for each tier of clients. An alternative choice we see in smaller investment-banking houses is an alignment of coverage teams to sectors. Here the proposition is the coverage teams’ depth of product and sector understanding.
Wholesale banks choose the coverage model based on three criteria that reflect their stage of growth: the availability of sophisticated RMs and product specialists, the cost of coverage, and the feasibility of establishing coordination mechanisms among different product groups. There is no “right” model, and each player must tailor its coverage model based on its starting position, underlying market characteristics, growth aspirations, and manpower availability.
In investment-banking, we typically encounter six barriers that stand in the way of disciplined account planning. Three are behavioral problems: unwillingness on the part of RMs and other sales staff to commit time, a reluctance to share client-related information, and a bias against the current IT system and tools. Three problems have to do with poor processes: little understanding of the most and least profitable clients, a lack of clarity on roles and responsibilities in the client coverage team, and an absence of accountability and incentives.
A structured approach can be used to overcome these barriers and increase the effectiveness of account planning to maximize profitability per client, make salespeople more effective, and increase customer satisfaction.
Banks can start by identifying how best to meet increasingly sophisticated customer requirements. Many customers are building in-house capabilities and have consequently moved away from traditional research products (for example, PDF reports distributed via e-mail, containing the latest information on specific stocks). They are increasingly demanding “research services”—such as conversations, meetings, or analyst-introduced access to management. In response, many global players are rethinking their approach to research. HSBC has dropped two of its research product offerings—its “buy, sell, hold” recommendations and maintenance research—while increasing its analyst head count to support more in-depth analysis and customer contact. Similarly, some banks have experimentally outsourced maintenance research to specialists, while keeping sector experts, quantitative analysts, and strategists in-house.
In building a research organization, banks need to consider the growing sophistication of most of their core customer segments: affluent/high net worth, domestic institutional investors, mass retail, and, of course, foreign institutional investors. Distinctive research capabilities for the right segment, as part of a full-service offering, can lead to an increased share in sales and trading as well as ECM. Similarly, ECM is linked to M&A advisory for large deals that need to be financed through capital market issuances.
Several local investment banks have built ties with global firms (for example, SCB Securities with Goldman Sachs and Phatra Securities with Merrill Lynch/Bank of America). The typical approach involves the local player using the partnership to build up capabilities over time, while the foreign partner accrues local market understanding and develops local relationships and brand equity. After time, when both parties have reaped the benefits of the alliance, it is often terminated and both partners go their separate ways, as Kotak and Goldman Sachs did in 2006.
An alternative approach is to establish alliances with local boutique firms with experience in cross-border deals. As an example, Avendus in India has partnered with Goetz Partners for India-Europe deals, while Kotak has an alliance with GCA Savvian for India-Japan deals. In the latter case, the alliance seeks to advise Indian and Japanese companies on cross-border mergers and acquisitions. Thus, clients of GCA Savvian in Japan can seek out acquisition targets in a high-growth market such as India with the help of local expert Kotak.
Commercial banks looking to build an investment-banking business also have to tackle the particularly acute challenge of integrating radically different performance and incentive systems. While banks have tried several approaches, our experience suggests that an approach that builds on the principles of the “one firm” model is likely to be successful. At its core, this approach ties most incentives to the overall performance of the firm as opposed to purely individual performance and contribution. Implementing this model involves instilling a culture that encourages people to work toward building the firm.
In addition to creating the right performance culture, banks will also need to develop other elements of the people strategy by designing a clear employee value proposition, a recruitment model that balances lateral and fresh hires, and an effective retention strategy.
In coming years, however, the centralized approach might no longer work. We see two major trends that will weaken the effectiveness of banks that try to cover the region from a strong center. One is greater local competition. As ASEAN capital markets deepen, local players will expand their investment-banking capabilities, given the positive impact on return on equity. Second, as noted above, a broader base of corporations will start to seek investment-banking advice. Often these will be smaller companies with no history with the global banks. Local institutions with upgraded capabilities will be in prime position to capture a greater share of this business, given their scale of operations. As an example, in Russia, local firm Renaissance has nearly 150 bankers, while the bulge-bracket firms have on average only 20 to 30. By virtue of its broader and deeper coverage, Renaissance has been able to provide superior client service and claim a greater market share.
First, this segment has traditionally been served by local incumbents, which have typically held lending relationships and which now seek to build their own investment-banking capabilities. Foreign firms cannot easily replicate this approach: they do not have a natural “entry product,” and so will need to invest in developing relationships over time. This will require a local presence.
Second, given the smaller deals and lower fees that these midsize companies will generate, many foreign banks will have to modify their cost structures if they are to generate attractive returns on equity.
Finally, foreign firms will have to find ways to inspire their bankers to work on midcorporate deals, likely by offering incentives to lure them away from the attractions of large deals. If this does not seem likely to work, firms should consider establishing a separate group, operating under a different set of economics, to cover this segment.
https://www.mckinseyquarterly.com/Financial_Services/Banking/Capturing_the_investment_banking_opportunity_in_ASEAN_2763?gp=1
Several forces are propelling ASEAN growth. Chief among these are the need for new roads, ports, and power plants, and governments’ determination to expand capital markets. Evidence of both was seen in the announcement at the July 2010 ASEAN summit in Hanoi of a plan for road and rail development across the region. ASEAN’s brightening star will likely attract yet more investment from global banking majors, many of which have already built formidable presences across the region. For local banks, an inflection point is at hand. As Asian companies expand into new regions and the largest go global, incumbent banks will need to redouble their efforts or risk losing a substantial share of their investment-banking franchise to the big international banks. We see five core capabilities that local banks must build, including the coverage model, account planning, research, cross-border capabilities, and the talent proposition.
A leading incumbent bank in India set out to build these five capabilities, with considerable success: among other achievements, average monthly fee income increased by 125 percent over baseline. Several ASEAN banks will probably achieve similar success, and that in turn will increase the pressure on foreign banks to respond. We see three likely responses for these global firms, including balancing their “footprint,” capturing the midcorporate opportunity, and developing capabilities to deliver cross-cutting customer solutions.
Opportunity beckons
McKinsey’s Global Banking Profit Pools estimates 2009 revenues from CMIB in the ASEAN region at $7.4 billion.3 Notably, CMIB accounted for 28 percent of all wholesale banking revenues in ASEAN, compared with 19 percent for Asia as a whole. This greater reliance on capital markets is a sign of greater sophistication in ASEAN
We focused our research on five of the biggest ASEAN banking sectors (Indonesia, Malaysia, Singapore, Thailand, and Vietnam). All except Vietnam have a higher proportion of CMIB revenues than would be indicated by their GDP per capita. This implies that for a given amount of capital, banks may enjoy greater revenues from CMIB products than from lending. Not surprisingly, the region has proved attractive to global banks that traditionally focus on fee-based businesses. Many of these foreign banks have already built leading franchises in several products and countries.
These banks also find the growth of CMIB in ASEAN attractive. The region is projected to grow faster than the rest of Asia in the key areas of equity and debt capital markets (ECM and DCM) and mergers and acquisitions (M&A) (Exhibit 2).
Skeptics would counter that, for all its attractions, “investment-banking in ASEAN” really means “investment-banking in Singapore.” It is true that Singapore currently accounts for over two-thirds of total ASEAN CMIB revenues. However, the city-state’s share is projected to decline to around 58 percent by 2014 as capital markets in other economies develop.
Similarly, at present, CMIB in ASEAN is heavily focused on sales and trading, which generates over 80 percent of revenues. Again, we expect to see a growing diversification. By 2014, sales and trading will account for 72 percent of revenues.
Sources of growth
We see five major trends propelling growth in ASEAN and shaping the evolution of CMIB markets.1. Infrastructure investment
Infrastructure has been a big source of growth for much of Asia, including ASEAN, and that looks set to continue. For CMIB, that will mean healthy developments in debt capital markets and syndicated loans, as well as in structured fixed-income products designed to attract funding from overseas investors.Over the next five years, the ASEAN region is expected to spend more than $350 billion on infrastructure. Indonesia, Thailand, and Vietnam will commit the biggest sums, while Singapore is expected to spend little. Indonesia will look to address a lack of quality roads, inadequate power supply, and a dearth of public transport. In 2009, the newly elected government announced that the total infrastructure spend needed between 2009 and 2014 will be around $140 billion. Much of this investment may be structured as sukuk, a bond-like instrument that conforms with Islamic law. (For more on sukuk, see sidebar “Sukuk in Malaysia and Indonesia.”)
In Thailand, infrastructure spending has lagged in recent years. While GDP grew at over 8 percent between 1999 and 2008, infrastructure spending grew at only 3.6 percent. From 1999 to 2008, infrastructure spending as a share of GDP fell from over 9 percent to about 6 percent.
Like Indonesia, much of Vietnam currently lacks reliable electricity, quality roads, or seaports. Its infrastructure requirements are estimated at $70 billion to $80 billion over the next five to ten years. Today most of its infrastructure investment is funded by government debt. That is expected to change, as the government begins to seek investors to form public-private partnerships.
2. Government support for capital markets
We see two thrusts by governments as they seek to strengthen capital markets in the ASEAN region. On one hand, developed-market governments are trying to create financial centers (as in Malaysia) or strengthen them (as in Singapore). While Singapore is succeeding in attracting hedge funds and private banking players, Malaysia seeks to become a global hub for innovation in Islamic finance through the Malaysia International Financial Centre (MIFC) in Kuala Lumpur.On the other hand, governments in developing markets like Indonesia and Vietnam are taking initiatives to expand markets and improve trading and settlement infrastructure.
Vietnam currently has a growing primary bond market with mainly public-sector issuances, but a thin secondary market. The government is addressing this; first, it has established a specialized secondary state bond market where most government securities are now traded. It also intends to build a benchmark yield curve and to encourage the creation of credit-rating companies. Finally, it is also installing a securities depository and a new settlement system with support from the Asian Development Bank (ADB) and the World Bank.
In Indonesia, the government has also taken the assistance of the ADB, in the form of an ongoing technical-assistance program. The goal is to build deeper and more liquid capital markets, enhance market supervision, and improve regulatory resources and capacity.
3. Expanding horizons for ASEAN companies
As ASEAN companies continue to grow, they will be tempted to look outside their home markets for growth. Already, about 40 percent to 60 percent of ASEAN M&A is cross-border deals, and more than a third of these are within the region. As companies outgrow their markets and become comfortable with international expansion, investment banks will see increased opportunities in M&A advisory and acquisition financing. Three sectors that illustrate this trend well are financial services, telecom, and energy and natural resources.In financial services, almost all the leading banks in Singapore and Malaysia have made regional forays to expand their presence in ASEAN. These banks have achieved varying degrees of success. Among the most successful is Malaysia’s CIMB Group, which has gone through five transformational deals in four years, taking the bank into new markets in Thailand, Indonesia, and Singapore.
Several ASEAN telecommunications firms have adopted a similar growth strategy. SingTel, for instance, is now active in over 20 markets and has acquired strategic stakes in AIS in Thailand, Telkomsel in Indonesia, and Globe Telecom in Philippines.
In energy and natural resources, Indonesia in particular has seen significant M&A activity—about 130 transactions in the past eight years—originated by both domestic and overseas firms.
4. Indonesia and Vietnam coming to the fore
Forecasts of real GDP growth in ASEAN to 2050 suggest that most of the growth will come from Indonesia and Vietnam. As mentioned, these countries will benefit from government actions to improve capital markets and from the push to build new roads, power plants, and seaports. But there are other forces at work. Both countries will see broad-based economic reforms and strong growth in manufacturing. And both will benefit from a young and rapidly growing labor force as well as improved political stability.CMIB revenues will mirror the growth in GDP. ECM in particular will prosper from a wave of local listings in both markets. In Vietnam, the government has already privatized several good-size state-owned enterprises (SOEs) and has announced plans to privatize some of the biggest, including AgriBank, Bao Viet Insurance, Vinatex, and Vietnam Airlines. Similarly, in Indonesia, following the successful listing of Bank Tabungan in 2009, the government has announced plans to divest stakes in some of the largest SOEs, including PT Krakatau Steel, Plantation Company PT Perkebunan Nusantara (PTPN) VII, and Garuda Indonesia.
M&A advisory will also benefit, as fragmented local industries are expected to consolidate. Indonesia has more than 120 banks, of which 4 are state owned. That’s many more than in mature markets such as Australia and India. Vietnam is similarly overbanked. The State Bank of Vietnam has mandated that all banks in Vietnam must have capital of at least 3 trillion Vietnamese ng (about $150 million) by the end of 2010. Many of the smaller banks will likely be unable to raise the requisite capital, and a forced consolidation of the sector may result.
5. Growing sophistication of customers
As ASEAN economies mature, capital markets are likely to see increased demand for more sophisticated products and services. As ASEAN companies grow, it is likely they will begin to tap into corporate bond markets and rely less on traditional bank borrowing, a path taken by maturing economies in the past. Banks will likely have incentives to help them do this, given the global regulatory push for bigger capital buffers and more liquidity. Southeast Asian companies are also likely to continue looking for customized currency and commodity hedges against price fluctuations.Sales and trading businesses will also need more sophisticated products. As the ASEAN economies accumulate wealth, consumers will turn to life insurance and asset management. There is considerable room for these businesses to grow. The rise of insurance will create a kind of virtuous cycle, creating opportunity for institutional sales and trading firms that will be asked to deliver the kinds of sophisticated products (such as swaps, options, and other derivatives) that their counterparts in developed markets have sold for years.
Of course, all of Asia is expected to grow in affluence; assets under management of high-net-worth individuals are likely to rise to nearly $7.5 trillion by 2012. With interest rates low in Asia, as in the rest of the world, Asia’s private banking and affluent retail customers are likely to seek ever higher returns along with portfolio diversification, and will aggressively pursue investments such as initial public offerings, structured equity-linked products, and alternative investments such as hedge funds. This infusion of new money into equity-linked instruments will push up sales and trading revenues.
Five core capabilities
In recent years, local and foreign banks have competed vigorously to position themselves for the coming opportunity. The current state of play of CMIB markets is shown in Exhibit 3.
Despite the opportunity, some local institutions seem to be ceding the advantage in many of these markets to others. These firms are at risk of missing out on the next big wave of growth in ASEAN capital markets. To avoid that fate, they can draw on the examples of their emerging-market peers (for example, Kotak in India and Itaú BBA in Brazil), which have leveraged their balance sheets to build dominant local investment-banking businesses. In our view, local commercial and corporate banks must take five actions to succeed in investment banking:
1. Strengthen client coverage to encompass the capital markets opportunity
In our experience, banks use one of three approaches to client coverage, defined by the role of the person at the client interface. The relationship manager (RM) acts as the single point of contact with the client in the RM-led model, occasionally calling on product specialists for expertise. The RM establishes and manages the relationship with the client’s CEO or CFO in the client-service-team-led model, an emerging trend. The RM then coordinates all account-related activities of the client service team, which consists mainly of product specialists. Team members establish links and coordinate activities with their client counterparts. Finally, in a product specialist model, senior bankers and product specialists establish coverage independently.Within investment-banking teams and products, banks align the coverage model with their understanding of the various segments of their client base. The most commonly observed model is a segmentation based on size; the coverage model is then tailored for each tier of clients. An alternative choice we see in smaller investment-banking houses is an alignment of coverage teams to sectors. Here the proposition is the coverage teams’ depth of product and sector understanding.
Wholesale banks choose the coverage model based on three criteria that reflect their stage of growth: the availability of sophisticated RMs and product specialists, the cost of coverage, and the feasibility of establishing coordination mechanisms among different product groups. There is no “right” model, and each player must tailor its coverage model based on its starting position, underlying market characteristics, growth aspirations, and manpower availability.
2. Tighten up the account-planning process
The three objectives of disciplined account planning are to ensure that the bank can increase client satisfaction through tailored offerings that address the client’s needs, to improve the bank’s profitability per client, and to increase the time spent by salespeople on selling to the right set of clients.In investment-banking, we typically encounter six barriers that stand in the way of disciplined account planning. Three are behavioral problems: unwillingness on the part of RMs and other sales staff to commit time, a reluctance to share client-related information, and a bias against the current IT system and tools. Three problems have to do with poor processes: little understanding of the most and least profitable clients, a lack of clarity on roles and responsibilities in the client coverage team, and an absence of accountability and incentives.
A structured approach can be used to overcome these barriers and increase the effectiveness of account planning to maximize profitability per client, make salespeople more effective, and increase customer satisfaction.
3. Build research capabilities
The credibility and independence of the research function in investment banks was significantly tested during the dot-com shakeout in the first half of the decade. In response, a number of banks have worked hard to strengthen the independence of the research function and enhance transparency. Strong research capabilities are emerging as a critical success factor. Across markets, a strong position in league tables usually goes hand in hand with robust research capabilities.Banks can start by identifying how best to meet increasingly sophisticated customer requirements. Many customers are building in-house capabilities and have consequently moved away from traditional research products (for example, PDF reports distributed via e-mail, containing the latest information on specific stocks). They are increasingly demanding “research services”—such as conversations, meetings, or analyst-introduced access to management. In response, many global players are rethinking their approach to research. HSBC has dropped two of its research product offerings—its “buy, sell, hold” recommendations and maintenance research—while increasing its analyst head count to support more in-depth analysis and customer contact. Similarly, some banks have experimentally outsourced maintenance research to specialists, while keeping sector experts, quantitative analysts, and strategists in-house.
In building a research organization, banks need to consider the growing sophistication of most of their core customer segments: affluent/high net worth, domestic institutional investors, mass retail, and, of course, foreign institutional investors. Distinctive research capabilities for the right segment, as part of a full-service offering, can lead to an increased share in sales and trading as well as ECM. Similarly, ECM is linked to M&A advisory for large deals that need to be financed through capital market issuances.
4. Gear up for the cross-border opportunity
As ASEAN companies expand internationally, local banks will need to think through how best to meet their needs. For a few banks, it may be best to focus exclusively on the domestic market. But many will decide to follow their clientele and build capabilities to serve them in their expansion.Several local investment banks have built ties with global firms (for example, SCB Securities with Goldman Sachs and Phatra Securities with Merrill Lynch/Bank of America). The typical approach involves the local player using the partnership to build up capabilities over time, while the foreign partner accrues local market understanding and develops local relationships and brand equity. After time, when both parties have reaped the benefits of the alliance, it is often terminated and both partners go their separate ways, as Kotak and Goldman Sachs did in 2006.
An alternative approach is to establish alliances with local boutique firms with experience in cross-border deals. As an example, Avendus in India has partnered with Goetz Partners for India-Europe deals, while Kotak has an alliance with GCA Savvian for India-Japan deals. In the latter case, the alliance seeks to advise Indian and Japanese companies on cross-border mergers and acquisitions. Thus, clients of GCA Savvian in Japan can seek out acquisition targets in a high-growth market such as India with the help of local expert Kotak.
5. Adopt the right “people strategy”
The people strategy—the bank’s approach to compensation, its talent proposition, its recruitment model, and its retention practices—lies at the heart of building a successful investment bank. The current overhaul of regulations will have considerable impact on banks’ compensation practices. Banks will need to decide on the right mix between current and deferred compensation, and, in performance measurement, between current financial metrics or longer-term health-related metrics.Commercial banks looking to build an investment-banking business also have to tackle the particularly acute challenge of integrating radically different performance and incentive systems. While banks have tried several approaches, our experience suggests that an approach that builds on the principles of the “one firm” model is likely to be successful. At its core, this approach ties most incentives to the overall performance of the firm as opposed to purely individual performance and contribution. Implementing this model involves instilling a culture that encourages people to work toward building the firm.
In addition to creating the right performance culture, banks will also need to develop other elements of the people strategy by designing a clear employee value proposition, a recruitment model that balances lateral and fresh hires, and an effective retention strategy.
Three moves for foreign banks
Foreign banks should not take their current dominance of many products and markets for granted. Western banks that want to secure and expand their share of the ASEAN opportunity should consider three core actions.Effectively balance local and regional operations
Several global players have opted for a centralized approach, addressing opportunities throughout ASEAN from their offices in money centers such as Singapore and Hong Kong. Others have started this way but have expanded their presence in select geographies such as Thailand and Malaysia through their wealth-management and brokering arms; still, they remain more or less centralized. These approaches have been adequate up to now, during a period when the vast majority of deals were originated by multinationals and large corporates, which naturally turn to the global majors, either from long-standing relationships or to tap their deep product expertise.In coming years, however, the centralized approach might no longer work. We see two major trends that will weaken the effectiveness of banks that try to cover the region from a strong center. One is greater local competition. As ASEAN capital markets deepen, local players will expand their investment-banking capabilities, given the positive impact on return on equity. Second, as noted above, a broader base of corporations will start to seek investment-banking advice. Often these will be smaller companies with no history with the global banks. Local institutions with upgraded capabilities will be in prime position to capture a greater share of this business, given their scale of operations. As an example, in Russia, local firm Renaissance has nearly 150 bankers, while the bulge-bracket firms have on average only 20 to 30. By virtue of its broader and deeper coverage, Renaissance has been able to provide superior client service and claim a greater market share.
Capture the midcorporate opportunity
As ASEAN markets develop, a broader base of corporates will have investment-banking needs, and over time, they will form a larger portion of the fee pool. To capture an outsize share of these fees, foreign banks will have to do three things.First, this segment has traditionally been served by local incumbents, which have typically held lending relationships and which now seek to build their own investment-banking capabilities. Foreign firms cannot easily replicate this approach: they do not have a natural “entry product,” and so will need to invest in developing relationships over time. This will require a local presence.
Second, given the smaller deals and lower fees that these midsize companies will generate, many foreign banks will have to modify their cost structures if they are to generate attractive returns on equity.
Finally, foreign firms will have to find ways to inspire their bankers to work on midcorporate deals, likely by offering incentives to lure them away from the attractions of large deals. If this does not seem likely to work, firms should consider establishing a separate group, operating under a different set of economics, to cover this segment.
Serve cross-cutting needs
Local companies are likely to start asking for solutions that cut across wholesale funding and capital market products—for example, some companies are likely to need structured finance for infrastructure projects as well as sukuk. To deliver on these multifaceted needs, global firms should establish local-currency balance sheets to more effectively structure deals. Firms organized in product groups will need to develop mechanisms and incentives to link organizational “silos” (especially DCM, corporate banking, and Islamic banking) to create effective client solutions.https://www.mckinseyquarterly.com/Financial_Services/Banking/Capturing_the_investment_banking_opportunity_in_ASEAN_2763?gp=1
Seven steps to better brainstorming
Companies run on good ideas. From R&D groups seeking pipelines of innovative new products to ops teams probing for time-saving process improvements to CEOs searching for that next growth opportunity—all senior managers want to generate better and more creative ideas consistently in the teams they form, participate in, and manage.
Yet all senior managers, at some point, experience the pain of pursuing new ideas by way of traditional brainstorming sessions—still the most common method of using groups to generate ideas at companies around the world. The scene is familiar: a group of people, often chosen largely for political reasons, begins by listening passively as a moderator (often an outsider who knows little about your business) urges you to “Get creative!” and “Think outside the box!” and cheerfully reminds you that “There are no bad ideas!”
The result? Some attendees remain stone-faced throughout the day, others contribute sporadically, and a few loudly dominate the session with their pet ideas. Ideas pop up randomly—some intriguing, many preposterous—but because the session has no structure, little momentum builds around any of them. At session’s end, the group trundles off with a hazy idea of what, if anything, will happen next. “Now we can get back to real work,” some whisper.
It doesn’t have to be like this. We’ve led or observed 200 projects over the past decade at more than 150 companies in industries ranging from retailing and education to banking and communications. That experience has helped us develop a practical approach that captures the energy typically wasted in a traditional brainstorming session and steers it in a more productive direction. The trick is to leverage the way people actually think and work in creative problem-solving situations.
We call our approach “brainsteering,” and while it requires more preparation than traditional brainstorming, the results are worthwhile: better ideas in business situations as diverse as inventing new products and services, attracting new customers, designing more efficient business processes, or reducing costs, among others. The next time you assign one of your people to lead an idea generation effort—or decide to lead one yourself—you can significantly improve the odds of success by following the seven steps below.
Managers hoping to spark creative thinking in their teams should therefore start by understanding (and in some cases shaping) the real criteria the company will use to make decisions about the resulting ideas. Are there any absolute restrictions or limitations, for example? A bank we know wasted a full day’s worth of brainstorming because the session’s best ideas all required changing IT systems. Yet senior management—unbeknownst to the workshop planners—had recently “locked down” the IT agenda for the next 18 months.
Likewise, what constitutes an acceptable idea? At a different, smarter bank, workshop planners collaborated with senior managers on a highly specific (and therefore highly valuable) definition tailored to meet immediate needs. Good ideas would require no more than $5,000 per branch in investment and would generate incremental profits quickly. Further, while three categories of ideas—new products, new sales approaches, and pricing changes—were welcome, senior management would balk at ideas that required new regulatory approvals. The result was a far more productive session delivering exactly what the company wanted: a fistful of ideas, in all three target categories, that were practical, affordable, and profitable within one fiscal year.
In practice, this means building your workshop around a series of “right questions” that your team will explore in small groups during a series of idea generation sessions (more about these later). The trick is to identify questions with two characteristics. First, they should force your participants to take a new and unfamiliar perspective. Why? Because whenever you look for new ways to attack an old problem—whether it’s lowering your company’s operating costs or buying your spouse a birthday gift—you naturally gravitate toward thinking patterns and ideas that worked in the past. Research shows that, over time, you’ll come up with fewer good ideas, despite increased effort. Changing your participants’ perspective will shake up their thinking. (For more on how to do this, see our upcoming article “Sparking creativity in teams: An executive’s guide,” to be published in April on mckinseyquarterly.com.) The second characteristic of a right question is that it limits the conceptual space your team will explore, without being so restrictive that it forces particular answers or outcomes.
It’s easier to show such questions in practice than to describe them in theory. A consumer electronics company looking to develop new products might start with questions such as “What’s the biggest avoidable hassle our customers endure?” and “Who uses our product in ways we never expected?” By contrast, a health insurance provider looking to cut costs might ask, “What complexity do we plan for daily that, if eliminated, would change the way we operate?” and “In which areas is the efficiency of a given department ‘trapped’ by outdated restrictions placed on it by company policies?”2
In our experience, it’s best to come up with 15 to 20 such questions for a typical workshop attended by about 20 people. Choose the questions carefully, as they will form the heart of your workshop—your participants will be discussing them intensively in small subgroups during a series of sessions.
Instead, choose participants with firsthand, “in the trenches” knowledge, as a catalog retailer client of ours did for a brainsteering workshop on improving bad-debt collections. (The company had extended credit directly to some customers). During the workshop, when participants were discussing the question “What’s changed in our operating environment since we last redesigned our processes?” a frontline collections manager remarked, “Well, death has become the new bankruptcy.”
A few people laughed knowingly, but the senior managers in the room were perplexed. On further discussion, the story became clear. In years past, some customers who fell behind on their payments would falsely claim bankruptcy when speaking with a collections rep, figuring that the company wouldn’t pursue the matter because of the legal headaches involved. More recently, a better gambit had emerged: unscrupulous borrowers instructed household members to tell the agent they had died—a tactic that halted collections efforts quickly, since reps were uncomfortable pressing the issue.
While this certainly wasn’t the largest problem the collectors faced, the line manager’s presence in the workshop had uncovered an opportunity. A different line manager in the workshop proposed what became the solution: instructing the reps to sensitively, but firmly, question the recipient of the call for more specific information if the rep suspected a ruse. Dishonest borrowers would invariably hang up if asked to identify themselves or to provide other basic information, and the collections efforts could continue.
When you assign people to subgroups, it’s important to isolate “idea crushers” in their own subgroup. These people are otherwise suitable for the workshop but, intentionally or not, prevent others from suggesting good ideas. They come in three varieties: bosses, “big mouths,” and subject matter experts.
The boss’s presence, which often makes people hesitant to express unproven ideas, is particularly damaging if participants span multiple organizational levels. (“Speak up in front of my boss’s boss? No, thanks!”) Big mouths take up air time, intimidate the less confident, and give everyone else an excuse to be lazy. Subject matter experts can squelch new ideas because everyone defers to their presumed superior wisdom, even if they are biased or have incomplete knowledge of the issue at hand.
By quarantining the idea crushers—and violating the old brainstorming adage that a melting pot of personalities is ideal—you’ll free the other subgroups to think more creatively. Your idea crushers will still be productive; after all, they won’t stop each other from speaking up.
Finally, take the 15 to 20 questions you prepared earlier and divide them among the subgroups—about 5 questions each, since it’s unproductive and too time consuming to have all subgroups answer every question. Whenever possible, assign a specific question to the subgroup you consider best equipped to handle it.
Today, however, each subgroup will thoughtfully consider and discuss a single question for a half hour. No other idea from any source—no matter how good—should be mentioned during a subgroup’s individual session. Tell participants that if anyone thinks of a “silver bullet” solution that’s outside the scope of discussion, they should write it down and share it later.
Prepare your participants for the likelihood that when a subgroup attacks a question, it might generate only two or three worthy ideas. Knowing that probability in advance will prevent participants from becoming discouraged as they build up the creative muscles necessary to think in this new way. The going can feel slow at first, so reassure participants that by the end of the day, after all the subgroups have met several times, there will be no shortage of good ideas.
Also, whenever possible, share “signpost examples” before the start of each session—real questions previous groups used, along with success stories, to motivate participants and show them how a question-based approach can help.
One last warning: no matter how clever your participants, no matter how insightful your questions, the first five minutes of any subgroup’s brainsteering session may feel like typical brainstorming as people test their pet ideas or rattle off superficial new ones. But participants should persevere. Better thinking soon emerges as the subgroups try to improve shallow ideas while sticking to the assigned questions.
One thing not to do is have the full group choose the best ideas from the pile, as is common in traditional brainstorming. In our experience, your attendees won’t always have an executive-level understanding of the criteria and considerations that must go into prioritizing ideas for actual investment. The experience of picking winners can also be demotivating, particularly if the real decision makers overrule the group’s favorite choices later.
Instead, have each subgroup privately narrow its own list of ideas to a top few and then share all the leading ideas with the full group to motivate and inspire participants. But the full group shouldn’t pick a winner. Rather, close the workshop on a high note that participants won’t expect if they’re veterans of traditional brainstorming: describe to them exactly what steps will be taken to choose the winning ideas and how they will learn about the final decisions.
The president, provost, and department heads of a US university, for example, announced before a brainsteering workshop that a full staff meeting would be held the morning after it to discuss the various cost-savings ideas it had generated. At the meeting, the senior leaders sorted ideas into four buckets: move immediately to implementation planning, decide today to implement at the closest appropriate time (say, the beginning of the next academic year), assign a group to research the idea further, or reject right away. This process went smoothly because the team that ran the idea generation workshop had done the work up front to understand the criteria senior leaders would use to judge its work. The university began moving ahead on more than a dozen ideas that would ultimately save millions of dollars.
To close the loop with participants, the university made sure to communicate the results of the decisions quickly to everyone involved, even when an idea was rejected. While it might seem demoralizing to share bad news with a team, we find that doing so actually has the opposite effect. Participants are often desperate for feedback and eager for indications that they have at least been heard. By respectfully explaining why certain ideas were rejected, you can help team members produce better ideas next time. In our experience, they will participate next time, often more eagerly than ever.
Traditional brainstorming is fast, furious, and ultimately shallow. By scrapping these traditional techniques for a more focused, question-based approach, senior managers can consistently coax better ideas from their teams.
McKinsey on Finance on iPad
https://www.mckinseyquarterly.com/Strategy/Strategy_in_Practice/Seven_steps_to_better_brainstorming_2767?gp=1
Yet all senior managers, at some point, experience the pain of pursuing new ideas by way of traditional brainstorming sessions—still the most common method of using groups to generate ideas at companies around the world. The scene is familiar: a group of people, often chosen largely for political reasons, begins by listening passively as a moderator (often an outsider who knows little about your business) urges you to “Get creative!” and “Think outside the box!” and cheerfully reminds you that “There are no bad ideas!”
The result? Some attendees remain stone-faced throughout the day, others contribute sporadically, and a few loudly dominate the session with their pet ideas. Ideas pop up randomly—some intriguing, many preposterous—but because the session has no structure, little momentum builds around any of them. At session’s end, the group trundles off with a hazy idea of what, if anything, will happen next. “Now we can get back to real work,” some whisper.
It doesn’t have to be like this. We’ve led or observed 200 projects over the past decade at more than 150 companies in industries ranging from retailing and education to banking and communications. That experience has helped us develop a practical approach that captures the energy typically wasted in a traditional brainstorming session and steers it in a more productive direction. The trick is to leverage the way people actually think and work in creative problem-solving situations.
We call our approach “brainsteering,” and while it requires more preparation than traditional brainstorming, the results are worthwhile: better ideas in business situations as diverse as inventing new products and services, attracting new customers, designing more efficient business processes, or reducing costs, among others. The next time you assign one of your people to lead an idea generation effort—or decide to lead one yourself—you can significantly improve the odds of success by following the seven steps below.
1. Know your organization’s decision-making criteria
One reason good ideas hatched in corporate brainstorming sessions often go nowhere is that they are beyond the scope of what the organization would ever be willing to consider. “Think outside the box!” is an unhelpful exhortation if external circumstances or company policies create boxes that the organization truly must live within.Managers hoping to spark creative thinking in their teams should therefore start by understanding (and in some cases shaping) the real criteria the company will use to make decisions about the resulting ideas. Are there any absolute restrictions or limitations, for example? A bank we know wasted a full day’s worth of brainstorming because the session’s best ideas all required changing IT systems. Yet senior management—unbeknownst to the workshop planners—had recently “locked down” the IT agenda for the next 18 months.
Likewise, what constitutes an acceptable idea? At a different, smarter bank, workshop planners collaborated with senior managers on a highly specific (and therefore highly valuable) definition tailored to meet immediate needs. Good ideas would require no more than $5,000 per branch in investment and would generate incremental profits quickly. Further, while three categories of ideas—new products, new sales approaches, and pricing changes—were welcome, senior management would balk at ideas that required new regulatory approvals. The result was a far more productive session delivering exactly what the company wanted: a fistful of ideas, in all three target categories, that were practical, affordable, and profitable within one fiscal year.
2. Ask the right questions
Decades of academic research shows that traditional, loosely structured brainstorming techniques (“Go for quantity—the greater the number of ideas, the greater the likelihood of winners!”) are inferior to approaches that provide more structure.1 The best way we’ve found to provide it is to use questions as the platform for idea generation.In practice, this means building your workshop around a series of “right questions” that your team will explore in small groups during a series of idea generation sessions (more about these later). The trick is to identify questions with two characteristics. First, they should force your participants to take a new and unfamiliar perspective. Why? Because whenever you look for new ways to attack an old problem—whether it’s lowering your company’s operating costs or buying your spouse a birthday gift—you naturally gravitate toward thinking patterns and ideas that worked in the past. Research shows that, over time, you’ll come up with fewer good ideas, despite increased effort. Changing your participants’ perspective will shake up their thinking. (For more on how to do this, see our upcoming article “Sparking creativity in teams: An executive’s guide,” to be published in April on mckinseyquarterly.com.) The second characteristic of a right question is that it limits the conceptual space your team will explore, without being so restrictive that it forces particular answers or outcomes.
It’s easier to show such questions in practice than to describe them in theory. A consumer electronics company looking to develop new products might start with questions such as “What’s the biggest avoidable hassle our customers endure?” and “Who uses our product in ways we never expected?” By contrast, a health insurance provider looking to cut costs might ask, “What complexity do we plan for daily that, if eliminated, would change the way we operate?” and “In which areas is the efficiency of a given department ‘trapped’ by outdated restrictions placed on it by company policies?”2
In our experience, it’s best to come up with 15 to 20 such questions for a typical workshop attended by about 20 people. Choose the questions carefully, as they will form the heart of your workshop—your participants will be discussing them intensively in small subgroups during a series of sessions.
3. Choose the right people
The rule here is simple: pick people who can answer the questions you’re asking. As obvious as this sounds, it’s not what happens in many traditional brainstorming sessions, where participants are often chosen with less regard for their specific knowledge than for their prominence on the org chart.Instead, choose participants with firsthand, “in the trenches” knowledge, as a catalog retailer client of ours did for a brainsteering workshop on improving bad-debt collections. (The company had extended credit directly to some customers). During the workshop, when participants were discussing the question “What’s changed in our operating environment since we last redesigned our processes?” a frontline collections manager remarked, “Well, death has become the new bankruptcy.”
A few people laughed knowingly, but the senior managers in the room were perplexed. On further discussion, the story became clear. In years past, some customers who fell behind on their payments would falsely claim bankruptcy when speaking with a collections rep, figuring that the company wouldn’t pursue the matter because of the legal headaches involved. More recently, a better gambit had emerged: unscrupulous borrowers instructed household members to tell the agent they had died—a tactic that halted collections efforts quickly, since reps were uncomfortable pressing the issue.
While this certainly wasn’t the largest problem the collectors faced, the line manager’s presence in the workshop had uncovered an opportunity. A different line manager in the workshop proposed what became the solution: instructing the reps to sensitively, but firmly, question the recipient of the call for more specific information if the rep suspected a ruse. Dishonest borrowers would invariably hang up if asked to identify themselves or to provide other basic information, and the collections efforts could continue.
4. Divide and conquer
To ensure fruitful discussions like the one the catalog retailer generated, don’t have your participants hold one continuous, rambling discussion among the entire group for several hours. Instead, have them conduct multiple, discrete, highly focused idea generation sessions among subgroups of three to five people—no fewer, no more. Each subgroup should focus on a single question for a full 30 minutes. Why three to five people? The social norm in groups of this size is to speak up, whereas the norm in a larger group is to stay quiet.When you assign people to subgroups, it’s important to isolate “idea crushers” in their own subgroup. These people are otherwise suitable for the workshop but, intentionally or not, prevent others from suggesting good ideas. They come in three varieties: bosses, “big mouths,” and subject matter experts.
The boss’s presence, which often makes people hesitant to express unproven ideas, is particularly damaging if participants span multiple organizational levels. (“Speak up in front of my boss’s boss? No, thanks!”) Big mouths take up air time, intimidate the less confident, and give everyone else an excuse to be lazy. Subject matter experts can squelch new ideas because everyone defers to their presumed superior wisdom, even if they are biased or have incomplete knowledge of the issue at hand.
By quarantining the idea crushers—and violating the old brainstorming adage that a melting pot of personalities is ideal—you’ll free the other subgroups to think more creatively. Your idea crushers will still be productive; after all, they won’t stop each other from speaking up.
Finally, take the 15 to 20 questions you prepared earlier and divide them among the subgroups—about 5 questions each, since it’s unproductive and too time consuming to have all subgroups answer every question. Whenever possible, assign a specific question to the subgroup you consider best equipped to handle it.
5. On your mark, get set, go!
After your participants arrive, but before the division into subgroups, orient them so that your expectations about what they will—and won’t—accomplish are clear. Remember, your team is accustomed to traditional brainstorming, where the flow of ideas is fast, furious, and ultimately shallow.Today, however, each subgroup will thoughtfully consider and discuss a single question for a half hour. No other idea from any source—no matter how good—should be mentioned during a subgroup’s individual session. Tell participants that if anyone thinks of a “silver bullet” solution that’s outside the scope of discussion, they should write it down and share it later.
Prepare your participants for the likelihood that when a subgroup attacks a question, it might generate only two or three worthy ideas. Knowing that probability in advance will prevent participants from becoming discouraged as they build up the creative muscles necessary to think in this new way. The going can feel slow at first, so reassure participants that by the end of the day, after all the subgroups have met several times, there will be no shortage of good ideas.
Also, whenever possible, share “signpost examples” before the start of each session—real questions previous groups used, along with success stories, to motivate participants and show them how a question-based approach can help.
One last warning: no matter how clever your participants, no matter how insightful your questions, the first five minutes of any subgroup’s brainsteering session may feel like typical brainstorming as people test their pet ideas or rattle off superficial new ones. But participants should persevere. Better thinking soon emerges as the subgroups try to improve shallow ideas while sticking to the assigned questions.
6. Wrap it up
By day’s end, a typical subgroup has produced perhaps 15 interesting ideas for further exploration. You’ve been running multiple subgroups simultaneously, so your 20-person team has collectively generated up to 60 ideas. What now?One thing not to do is have the full group choose the best ideas from the pile, as is common in traditional brainstorming. In our experience, your attendees won’t always have an executive-level understanding of the criteria and considerations that must go into prioritizing ideas for actual investment. The experience of picking winners can also be demotivating, particularly if the real decision makers overrule the group’s favorite choices later.
Instead, have each subgroup privately narrow its own list of ideas to a top few and then share all the leading ideas with the full group to motivate and inspire participants. But the full group shouldn’t pick a winner. Rather, close the workshop on a high note that participants won’t expect if they’re veterans of traditional brainstorming: describe to them exactly what steps will be taken to choose the winning ideas and how they will learn about the final decisions.
7. Follow up quickly
Decisions and other follow-up activities should be quick and thorough. Of course, we’re not suggesting that uninformed or insufficiently researched conclusions should be reached about ideas dreamed up only hours earlier. But the odds that concrete action will result from an idea generation exercise tend to decline quickly as time passes and momentum fades.The president, provost, and department heads of a US university, for example, announced before a brainsteering workshop that a full staff meeting would be held the morning after it to discuss the various cost-savings ideas it had generated. At the meeting, the senior leaders sorted ideas into four buckets: move immediately to implementation planning, decide today to implement at the closest appropriate time (say, the beginning of the next academic year), assign a group to research the idea further, or reject right away. This process went smoothly because the team that ran the idea generation workshop had done the work up front to understand the criteria senior leaders would use to judge its work. The university began moving ahead on more than a dozen ideas that would ultimately save millions of dollars.
To close the loop with participants, the university made sure to communicate the results of the decisions quickly to everyone involved, even when an idea was rejected. While it might seem demoralizing to share bad news with a team, we find that doing so actually has the opposite effect. Participants are often desperate for feedback and eager for indications that they have at least been heard. By respectfully explaining why certain ideas were rejected, you can help team members produce better ideas next time. In our experience, they will participate next time, often more eagerly than ever.
Traditional brainstorming is fast, furious, and ultimately shallow. By scrapping these traditional techniques for a more focused, question-based approach, senior managers can consistently coax better ideas from their teams.
McKinsey on Finance on iPad
https://www.mckinseyquarterly.com/Strategy/Strategy_in_Practice/Seven_steps_to_better_brainstorming_2767?gp=1
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