Introduction

Healthcare providers like hospitals and medical clinics are under tremendous
pressure to enable patients to afford the ever-increasing cost of medical attention.
Many healthcare organizations are struggling because they are unable to offer
transparency in pricing and quality of services, target specific patient needs, or
maximize quality of care while simultaneously minimizing costs.

In the new world of increased competition and consumerism, healthcare providers

that are able to define and implement solutions to these challenges are those that
will succeed and thrive into the future. This paper examines the strategic role of the
contact center in the healthcare industry, and how it can deliver the increased
revenues and cost savings that will drive profitability and shareholder value.

The paper introduces ten essential strategies you can use to realize this potential by
improving the customer experience, leveraging revenue generation opportunities,
and promoting agent productivity and satisfaction:

• Facilitate Integrated and Consistent Cross-Channel Interactions

• Offer an intelligent Customer Front Door™

• Offer Live Agent Assistance onWeb Sites

• Handle Calls More Intelligently

• Give Medical Staff the InformationThey Need to DoTheir Jobs

• Initiate Proactive Contact

• Make More Effective Use of Customer Data and Segmentation

• Optimize Business Process Execution

• DeployWorkforce Management

• Create aVirtual Pool of Resources

This paper further explains how the Genesys Dynamic Contact Center provides
integrated communication technologies to optimize customer traffic, internal
resources, and business outcomes for today’s changing conditions. It concludes
with a real-world customer case study that illustrates how Liberty Medical has
used Genesys solutions to make its contact center vision a reality.

The Key Challenges Facing the Healthcare Industry

Consumers Demand Better Price and Quality Transparency

According to the Centers for Medicare and Medicaid Services, healthcare spending
in the United States will reach $4.3 trillion by 2017, nearly double the spending in
2007. This would represent nearly 20% of the gross domestic product. Factors
driving the increase include the aging baby boom generation and rising costs of
new drugs and medical technology.

Health Expenditures to Soar Over the Next Decade Clearly, the healthcare
spending trend is not sustainable, with many calling for a new consumerism model
where consumers have greater accountability for the costs of their healthcare
decisions. Transparency in quality and pricing was identified as a contributor to
sustainability by more than 80% of the more than 580 executives of hospitals,
hospitalsystems, physician groups, payers, governments, medical supply
companies, and employers participating in PriceWaterhouseCooper’s HealthCast
2020 survey. But, only 35% of respondents in the survey said hospital systems are
prepared to meet the demands of empowered consumers.

The contact center, defined as including all staff who are responsible for
interacting with patients or potential patients, medical companies, insurers, and
others, will play an increasingly critical role in the ability of healthcare providers
to keep up with the increasing demand for healthcare services as well as meeting
the transparency requirements for consumerism.

Consumers are also seeking multi-channel delivery to improve their access to

information. For example, the “Deloitte 2008 Survey of Health Care Consumers”
found that 3 out of 4consumers want physicians to provide online options to
schedule appointments, exchange e-mail, get test results, and access medical
records; further, 1 in 4 consumers say they would pay more for these
services.Consumers are also interested in using hospitalWeb sites to look up
information about the quality of hospital care (64%), the prices of hospital services
(62%), and health conditions and treatments (59%).
New Competition and Online Information Encourage Price Shopping Changes in
competition and information access will make the healthcare market
morecompetitive. For example, retail giantWal-Mart has entered the healthcare
market andmany of its stores are now offering affordable walk-in clinic services.
What’s more, lowcost healthcare clinics are opening apace in shopping centers,
and these changes may force other healthcare providers to change their pay
structures.

• Contact center resources are difficult to share

The increased use of outsourcing and home-based agents, geographically dispersed

offices/ contact centers, requirements for 24/7 contact center availability, as well as
the need forsmaller providers to share staff across offices, are all increasing the
need for IP technology,which helps draw upon a virtual pool of resources as
needed.

Healthcare Organizations are Among the Largest Emerging Investors in Contact

Center Outsourcing Healthcare organizations are continuing to migrate to IP-based
contact centers as theyrecognize the inherent benefits that can be gained by moving
from closed proprietary solutions to a more standards-based environment. Still, one
of the biggest concerns forproviders considering the move to IP is how to leverage
existing systems. More specifically,they must be convinced that they will not
only gain new features and functionality, but will not lose existing applications or
functionalities. Equally important is the ability to select anddeploy new
functionality while retaining compatibility with a variety of new or existing
applications and product vendors.

The Strategic Role of the Contact Center in Healthcare

Healthcare providers have long understood the value of their contact centers in
providing quality patient care.Now, consumers are calling on their contact centers
to play a greaterrole in facilitating transparency in the quality and pricing of
services and providing more personalization and flexibility in healthcare
transactions.Contact centers are a way for healthcare providers to differentiate
themselves from thecompetition. Fundamental customer service goals that should
be delivered by today’scontact center include selling services by understanding
unique consumer needs for healthcare services, and running more cost efficient
operations by increasing agent productivity. Further, contact centers are now
considered a key instrument in changingthe public’s perception of an organization,
creating a great customer experience, and executing on the business goals of the
organization as a whole. Depending on contact center maturity and business
requirements, here are ten possible

Strategy 1: Facilitate Integrated and Consistent Cross-Channel Interactions

The first step in offering an exceptional customer experience is to offer a multi-

channel contact center comprised of phone, fax, e-mail, SMS, and perhaps
evenWeb chat, so thatpatients can conduct interactions with you exactly when and
how they like. For instance,the “Genesys Consumer Survey 2006 – USA”
found that 78% of consumers would like tocommunicate with a company via e-
mail, and 34% say that e-mail is their most preferred method of communication.

With well-integrated channels, healthcare providers are able to deliver better

service,improve pricing and quality transparency, and lower operating
costs.Providing consumers with a seamless experience across all channels ensures
that their interactions are as consistent and efficient as possible, which will help
build a solid relationship with the consumer. And, streamlining data exchange and
supporting collaboration across all channels promotes operational efficiency and
reduces errors.

Strategy 2: Offer an intelligent Customer Front Door

When consumers use the call center channel, the InteractiveVoice Response (IVR)
system provides the customer’s first impression of the healthcare organization and
reinforces its brand image. It also serves as a guide to the provider’s services, and
determines how well the provider can decrease handling times or the volume of
calls that agents and medical staff must handle. However,many healthcare
providers have poor IVRs that frustrate customers with confusing menus, long hold
times, misroutes, and requirements to repeat the same information. The intelligent
Customer Front Door (iCFD) is a self-service solution that reshapes call answering
by applying business logic to resolve these issues by:

• Discerning the identity and intent of a caller in the fewest steps

• Gathering relevant information from back-end data or workflow to

understand the context of their call

• Determining how to treat callers based on preferences, resource availability,

and business rules

• Connecting them to the right response including self-service, proactive

notification, automatic callback, or assisted-service. Customer Service Strategies

for the Healthcare Industry 11 of 24

Strategy 3: Offer Live Agent Assistance on Web Sites

Opportunities forWeb self-service abound in the healthcare industry. Patients can

go online and enroll in healthcare plans, request appointments, check lab results
and diagnoses, reorder prescriptions, review billing and claims status, and update
personal information. Web selfservice helps migrate calls away from expensive
call center agents and medical staff, who can then dedicate their time to providing
better customer service and quality healthcare.

As part of the new trend towards consumerism, patients can also useWeb sites to
shop for their healthcare services, and retrieve information about services, doctors,
and prices. Just like in most other industries that sell goods and services online,
healthcare organizations should encourage these online searches, as they’re a
potential source of new business.

Offering live assistance onWeb sites can make interactions go just as smoothly as
those directed to the call center, which will translate into a better self-service
experience and help patients reach favorable decisions about moving forward with
a healthcare provider. Healthcare organizations can offer-click-to-chat and click-
to call options to help consumers ask questions about health services or request
guidance for self-service use.

Strategy 4: Handle Calls More Intelligently

When taking calls, top priorities for healthcare providers are to make sure they
deliver high quality healthcare service, including the ability to quickly and easily
schedule appointments. Every time that a patient cannot get through to an
appointment scheduler or decides to abandon a call, the healthcare provider loses
revenue.Providing quality service does not have to come at the expense of cost
containment.Skills-based routing, virtual hold and business priority routing are
three key strategies for meeting service requirements as efficiently as possible,
while also making the most of opportunities to save time and money.

Strategy 6: Initiate Proactive Contact

Proactive notifications can help reduce the volume of inbound and outbound calls
and improve consumer satisfaction. For example, rather than having busy medical
staff call patients to remind them of appointments, provide pre-surgical or
medication instructions, and deliver medical test results, patients can receive these
kinds of notifications via their preferred interaction channel, such as the phone or
e-mail.

In the new world of consumerism, proactive outbound communication is a way for

healthcare providers to set their service apart from the competition. With everyone
vying for their business, consumers like to know that providersvalue them.Results
of the “Genesys Consumer Survey 2006 – USA” reveal that 88% of consumers
would have a more positive opinion of a healthcare provider after receiving a
courtesy call just to thank them for their business or ask them how satisfied they
are.

Proactive contact is also of tremendous value for improving debt collection, as

patients can receive messages when their bills are overdue. These notifications can
be sent at any time, which is especially advantageous in reaching those who are
not normally at home during contact center operating hours.Because the proactive
contact is automated, it becomes less costly for the contact center to pursue bad
debt, giving a healthcare provider more time before they have to move to the
write-off stage. Further, improved collection times on overdue or disputed bills add
directly to the free cash flow of the organization.

Strategy 7: Make More Effective Use of Customer Data and Segmentation

With increased competition and pressures on profit margins, many healthcare

providersare selecting more targeted ways to compete. For instance, a
hospital or a clinic may decide to select either a strategy that includes a narrow
product line with high value-added services or a broad product line with low
value-added services.With increased market focus, it has become more important
for contact centers to identify their customers and to understand how to meet the
specific needs and expectations of those customers. The integration of customer
relationship management systems with contact center activities gives healthcare
providers the ability to dynamically segment their callers and to customize
healthcare messages and debt collection practices accordingly.

Going one step further, demographic matching may be used to assign the patient to
an agent who has a common demographic profile. The result is that consumers get
to interact with staff who more readily relate to their needs because they share
certain commonalities, such as native language, age range, healthcare specialty,
and so on.

Strategy 8: Optimize Business Process Execution

In the healthcare industry, many interactions involve multi-step business processes

that may include multiple contacts with patients, internal departments, and third
parties. As the communications hub for the company, the contact center can be
harnessed toautomate and expedite end-to-end business processes supporting these
communications.

By directly integrating a business workflow engine, the contact center becomes an

active participant in driving business efficiency. healthcare provider can reduce the
time and effort for conducting activities such as enrolling new patients, verifying
insurance coverage, and resolving billing issues by automating the various external
interactions and notifications required to complete these processes.Contact center
agents can play an even broader role in these and other processes through
integrated workflow that enables either the routing of back-office tasks as work
items to available staff for processing, or the execution of computer-based
processes to complete transactions.

For instance, Samantha is a new patient who has called to request an appointment,
and the healthcare agent gathers her enrollment information. However, rather than
verifying her insurance eligibility manually, the automated workflow engine
accesses online
benefits information made available by Samantha’s insurance carrier and updates
Samantha’s healthcare record with her eligibility, co-pays, deductibles, and benefit
limits. If this information had not been online, a work item would have been
created and sent to an insurance verification specialist for appropriate follow up
with the insurance company and the patient. This type of automated processing
decreases enrollment time, errors that delay payments, and outright payment
denials.

Strategy 9: Deploy Workforce Management

Employee payroll in healthcare provider organizations represents the single largest

cost in the contact center by a considerable margin.Workforce management
(WFM) software is a critical requirement for effectively forecasting, scheduling,
and tracking operational needs within the contact center to help minimize these
costs.

The idealWFM environment includes real-time adherence that spans all contact
channels across the enterprise to: forecast events and staff appropriately; ensure
that agents are where they are supposed to be and doing what they are supposed to
be doing; and communicate with the contact routing engine to factor in staffing
requirements and availability as part of contact routing.Customer Service
Strategies for the Healthcare Industry 16 of 24

Strategy 10: Create a Virtual Pool of Resources

One of the major business drivers in the shift to IP technology in the healthcare
industry is cost rationalization, as well as revenue maximization, through
virtualization.AVirtual Contact Center allows geographically dispersed contact
center agents to operate as a single,winning team.Regardless of where the contact
center agents are located, they can be called upon, as available, to ensure
appropriate response levels and provide access to needed expertise. This approach
will not only help to quell concerns about providing quality healthcare service, but
it can be far more effective for utilization of agents and will also cut costs without
negatively impacting customer service. Virtualization will also allow outsourced
resources to be utilized in a way that will not jeopardize valued patient
relationships.Outsourced staff can be brought into the fold during peak periods to
handle routine types of calls, while more demanding interactions can still be
handled at local contact centers.

• Customer-Centric Routing puts an end to customer frustration by

ensuring each interaction is routed to the ideal resource with the right

information — no matter where that resource is located in your organization.

This helps you increase first-call resolution rates, meet variable call volumes

with limited resources, increase cross-sell and up-sell rates, and improve

agent satisfaction.

• Business Process Routing integrates phone, e-mail, and fax with back

office business processes to improve agent productivity and customer service.

Through this integration, contact center resources can be leveraged as

part of workflow processes such as processing a claim, fax, work order,

or other interaction. Ultimately, contact center and back-office

processes

are streamlined and agent utilization is improved.

• Workforce Management and Optimization are central to managing

and optimizing contact center resources. They give you control over your

operations by allowing you to forecast and schedule agents dynamically

based on traffic volumes and resource availability across a multi-site,

multi-channel environment.

• Proactive Contact Management provides a personalized customer

interaction experience by allowing you to send relevant outbound

notifications at any time. It also enables you to create, modify, run,

and report on voice and multimedia outbound campaigns for proactive

customer contact and sustained communications.

• Integrated Self-Service provides a holistic caller experience while

reducing handling times and service delivery costs. These capabilities

provide touch-tone or speech-enabled access for conversational exchange

to identify and resolve routine customer requests and transfer more

complex calls to the best-skilled agent.

• Internet and Multimedia Integration capabilities allow customers to

interact with you the way they want to,when they want to — through

voice, e-mail,Web chat, Instant Messaging, and even video calls.

• Branch, Remote and Expert Integration allow you to extend your

contact center to manage interactions based on business strategies and

objectives. For example, higher-valued clients might be sent to a highly

skilled resource located within a branch office, rather than being sent

to the general call center.

• The Virtual Contact Center, enabled by voice over IP (VoIP) technology,

allows geographically dispersed contact center agents to operate as a single,

winning team. Regardless of where the contact center agents are located,

they can be called upon, as available, to ensure appropriate response levels

and provide access to needed expertise.

• Real-Time Offer Management helps you capitalize on cross-sell and up-sell

opportunities by providing the capabilities to recommend an offer to an agent

in real time, based on a customer’s background, history, and interaction type.

• Reporting and Analytics allow you to assess your contact center and

customer service activity by providing real-time and historical views on the

performance metrics of contact center objectives and how these metrics

change over time.Customer Service Strategies for the Healthcare Industry 19 of 24

Genesys in Healthcare

Genesys is the world’s No.1 contact center software company.

Global leaders in 28 industries answer the call with Genesys, including:

• 4 of the top 5 healthcare companies

• The No. 1 healthcare wholesaler

• Over 40% of the Global 500

• 21 of the world’s 25 largest companies

• 63 of the world’s 100 largest companies

Below is just one of many examples of how healthcare companies in North

America

are benefiting from their Genesys solution.

Liberty Medical

An estimated 21 million Americans suffer from diabetes and

the national diabetes rate is three times what it was in 1975.

Liberty Medical provides essential healthcare services, support,

and information to thousands of Americans who live with

diabetes everyday.

The company provides diabetes patients with free home delivery

of diabetes testing devices and prescription medications, and it

also handles all of its customers’ Medicare and private insurance

billing paperwork. Patients use the testing devices and medications

to monitor their conditions and avoid complications. Since 2003,

Liberty’s patient rolls have increased 62%, growing from around

500,000 to over 900,000 today.

Liberty attracts patients with its promise of home delivery and billing

convenience, but Liberty keeps its customers through regular personal

contact.The company employs a “high-touch” communications

model that requires its 1,000 contact center agents to speak with each of Liberty’s

customers at least four times a year.

“With Genesys, we are able to

handle greater call volumes without

proportional increases in staffing, and

we can offer our patients improved

service. Genesys has helped us grow

our business.”

–John Hegner,

Vice President of

Technology Services,

Liberty MedicalCustomer Service Strategies for the Healthcare Industry 20 of 24

Liberty has differentiated itself with exceptional customer service, providing

information

and support that goes far beyond sending products to patients. In addition, Liberty
Medical stays in constant contact with its patients’ doctors and insurance
companies

to ensure that patients receive the proper supplies and that insurance coverage
remains

constant. Because of this regular contact and additional support, Liberty Medical
patients

follow their doctors’ orders at twice the rate of the national average.

“We strive to provide service beyond the simple packing and shipping of products
to our

patients,” said John Hegner, vice president of technology services for Liberty
Medical.

“Reminding patients to reorder supplies and medications, and encouraging them to

follow their doctors’ instructions distinguishes us from the competition.” It was

Liberty’s

determination to preserve this level of service as patient enrollment rapidly

increased

that led it to enhance its contact center operations.

“Our goal is to employ cost-effective techniques to provide better service as we

grow

our volume,” said Hegner.“New technologies help us continue to improve

customer

service and customer retention.”

Challenges

As Liberty Medical’s television advertising campaign generated more interest in

the company’s services, new patient enrollment climbed to thousands a month,

which
increased outbound call volume. In fact, it was outbound calling in particular that
was

affecting the company’s systems, because the addition of each new Liberty
customer

necessitated calls to the patient’s doctor and insurance provider to confirm patient

needs and coverage, and then another call to the new customer to initiate service.
As

demographic trends predicted a huge and growing market for the company’s
diabetes

services, it became apparent that Liberty’s contact center technology had to be

scalable.

“The number of outbound calls we need to make each day grows with the number

of patients we service,” said Hegner.“The legacy auto dialer we had in place was

constraining our growth.”

Liberty’s previous outbound calling infrastructure could not support

inbound/outbound

call blending and could not integrate with Liberty’s homegrown CRM system.
Another

challenge lay in Liberty’s dispersed call center workforce, including one site
inVirginia

and three in Florida. Each location worked independently of the others. Duplicate
agent

queues, arranged by skills, were found in each location. Because it was impossible
to

spread call volumes evenly across the agent workforce, some sites were busy while

others were idle.Customer Service Strategies for the Healthcare Industry 21 of 24

It was clear that the architecture that worked well at low call volumes could not
keep

pace as Liberty’s business grew. Without automatic blending of

inbound/outbound calls,

supervisors had to constantly monitor call volumes and agent states to manually
switch

agents from one status to another — inbound or outbound — to match demand.

The

lack of CRM integration also undermined efficiency and customer service.

Agents had

no advance information about a caller’s identity or profile, and all customer

interactions

began with callers identifying themselves and agents accessing records.

In addition, limited call routing abilities often directed inbound callers to the wrong
agent

groups. For example, Liberty television commercials prompted prospective

customers to

call the same phone number that existing customers used. The result was that calls
from

existing customers were frequently routed to agent queues reserved for new
customer

acquisition, and these customers then had to be rerouted to customer service

agents,

which resulted in long handle times and greater frustration.

Solutions

Liberty chose Genesys for the strength of its outbound dialer and for the full range
of its
contact center software suite, which Liberty has come to rely on greatly over the
years.

“The Genesys Outbound solution has no capacity limits, except for the number of
trunk

lines available,” said Hegner.“We also wanted to integrate call handling and
routing into

our CRM applications. Genesys software solutions are ideal for this purpose.”

Liberty took advantage of a number of Genesys solutions to transform its contact

center

operations, improve service, manage growth, and control costs. The company
implemented

Genesys T-server technology to link the switches at its four contact center
locations in

Florida andVirginia.This T-server technology has transformed these separate sites

into a

single virtual center, ending unbalanced workloads and allowing Liberty to tap its
entire

workforce to deliver customer service.

To further enhance agent productivity, the Liberty CRM system was integrated
with

the Genesys Customer Interaction Management Platform. The integration

allows

the Genesys platform plus Genesys InboundVoice to deliver calls — and screen
pops

of customer data — directly to agent desktops.

“Because Genesys performs a database look-up on the caller, agents have

information
that lets them think about customer service before they even say hello,” said
Hegner.

“This has vastly improved the customer experience and agent

productivity.”Customer Service Strategies for the Healthcare Industry 22 of 24

Screen-pops also benefit agents making outbound calls. Liberty’s CRM

system generates

call lists and sends them to Genesys Outbound for routing to agents. Genesys
executes

Liberty business rules that define which agent groups make which calls, and then
Genesys

sends agents screen-pops of call information. To ensure that outbound calls result
in

instant connections, Liberty employs Genesys Progressive dialing; Genesys first

reserves

an agent for the call and only then dials the customer.

“We take advantage of Genesys’ ability to blend inbound and outbound calls,” said
Hegner.

“It is very effective.On busy days when inbound callers face long hold
times,Genesys

sends inbound calls and screen-pops to outbound agents to keep wait times brief.”

Liberty added another customer service improvement withVirtual Hold for

Genesys,

which also addresses the problem of hold times for inbound callers.WithVirtual
Hold,

callers can hang up without losing their place in the queue.When a Liberty agent
reaches
the customer’s place in line,Virtual Hold automatically calls the customer and
connects

her with an agent.

Liberty also implemented GenesysVoice Platform for its Liberty Medical Supply
Pharmacy

business. GenesysVoice Platform lets callers reorder medications in an automated

environment. Customers speak prescription numbers to the GenesysVoice Platform

and

their orders are refilled without agent help. Finally, to measure productivity, wait
times,

call durations, agent availability, and other metrics for both inbound and outbound

calling, Liberty uses Genesys CC Pulse+, CC Analyzer, and Call Concentrator.

Results

Liberty’s contact center operation is at the heart of its business. Its “high-touch”
service

model emphasizes agent time spent on the phone with customers and prospective
customers,

and this model drives Liberty’s growth. Liberty attributes customer loyalty to the
“direct

day-to-day interactions between patients and the members of our team.” Genesys

manages those important interactions.

“Genesys software is a major factor in how we operate our call centers effectively

and efficiently.The advanced call routing capabilities available through Genesys

help

us deliver a high level of service with the staffing level we have today.”
While holding the line on costs,Genesys has also been able to improve Liberty’s
customer

service.With Genesys inbound/outbound call blending, Liberty is able to

implement

business rules that keep inbound wait times to a minimum. If the Genesys system
detects

that hold times exceed an established level, it takes agents off of outbound calls to
handle

inbound. Inbound callers are greeted by prompts generated by the switch.After

selecting

billing or other category,Genesys routes them to the proper agent group.Customer

Service Strategies for the Healthcare Industry 23 of 24

“When we started using call blending, we thought it would confuse agents because
they

would receive calls that could be inbound or outbound — agents wouldn’t know
which

until they saw the screen-pop. But they had no problem adjusting to this, and the
result

has been improved productivity and reduced wait times for our patients.”

Virtual Hold for Genesys delivers the same productivity and service benefits.
During

peak calling periods, 20% of Liberty customers take advantage of the Genesys
system to

avoid holding and instead receive a call when their place in the queue has been
reached.

The product has reduced abandoned calls and the subsequent reattempts, reducing
call
volumes and associated costs.

“With Genesys,we are able to handle greater call volumes without proportional
increases

in staffing, and we can offer our patients improved service,” said Hegner.“Genesys
has

helped us grow our business.”

For the future, Liberty is considering a variety of new Genesys solutions. It is now
testing

the GenesysWeb Chat solution, which allowsWeb site visitors to initiate a chat
with

Liberty agents, and it will also extend the use of Virtual Hold so that patients who
call the

company on weekends can choose to be called back during business hours. In

addition,

Liberty is interested inVoIP telephone solutions and the Genesys SIP Server
application,

which manages contact center interactions over an IP network.

“We are looking at customer self-service offerings that let our patients interact
with

Liberty through whatever interface is best for them,” said Hegner.Customer

Service Strategies for the Healthcare Industry 24 of 24

Conclusion

As this Strategy Guide has detailed, the healthcare industry currently faces its own
unique

set of contact center challenges. Consumerism and increasing competition mean

that
customer service is increasingly important for winning new, and retaining existing
patients.

The demands of consumers are high. They want better transparency in pricing and

quality of services, as well as a choice of services that meet their specific needs.
Cost

cutting pressures have to be balanced against these escalating expectations for

customer

service — a tough task amid expensive labor costs, record levels of bad debt, and
manual

contact center processes that lack integration with front- and back-office systems.

To meet these contact center challenges, healthcare providers can strive to

transform their

operations into dynamic contact centers that ensure an excellent customer

experience across

channels, maximize revenue based on customer insights, and promote the

productivity and

Hospitality Management Strategies

As the hospitality industry has evolved from individually owned and developed
enterprises to public global corporations, management strategies have also
changed. While we still see the entrepreneur launching new brands and service
concepts, the focus is on revenue per available customer and earnings per share.
The industry and management strategies remain dynamic. Macro trends such as
labor availability, new technologies, economic ups and downs, terrorism and
security, and globalization, to name a few, are and will continue to have substantial
impact on management strategies.

The text and online support provide a perspective on how and why management
strategies are changing. They examine the external and internal “driving forces”
behind the changes. Focal points include strategy selection and positioning and
business development techniques and options. The material also provides insight
into the strategic planning process and emerging organizational and operating
concepts.

This text and support materials take a global focus on the industry. They focus on
disciplines and concepts that impact and have applicability to all sections of the
industry. Through the many examples, mini cases, and illustrations, key
managerial strategies are delineated for brands, customer service, communications,
crisis management, finance, human resources, marketing, purchasing, operations,
risk management, organizational concepts, sales and technology. All major sectors
of the hospitality industry are covered. They include: include: food service,
gaming, lodging, and most all travel and tourism related segments.

If you believe the saying "the customer is always right," you are equipped with
the right attitude for success in hospitality management. Managers of
hotels, restaurants and other service organizations must strive to provide a
comfortable experience for customers. They must also manage a hospitality
organization using the right financial, branding and service strategies for
their business model.

Financial Strategy
 According to Ronald A. Nykiel, author of "Hospitality Management
Strategies," a hospitality organization adopts financial strategies based on a central
mission and set of objectives. A hospitality organization is also driven by a need,
such as a need for cash or for return on investment.
Hospitality managers should identify the organization's most important needs and
choose financial strategies that will achieve those objectives. For example, you can
adjust pricing for products and services, and conduct seasonal promotions to
ensure a steady cash flow throughout the year.
 You can also commission a survey to understand customer needs. Using the
survey results, study the cost of implementing new services and reinventing
existing services to respond to those needs.

Branding Strategy
 Branding is a hospitality management strategy highly specific to each
company. Executive search consulting firm Spencer Stuart notes that branding for
hospitality organizations should be specific to location and property. This
conclusion is based in part on the idea that consumers can use the Internet and
other technology to target their choices for dining, travel and other services
according to their individual needs. Managers should focus on branding and
marketing based on the level of service at each location. Excellent service builds a
brand and reputation at a location and encourages consumers to visit and consume
so they can receive the same level of service.

Service Strategy for tourism

 Customer service is the crucial component in hospitality organizations. Nykiel
notes five key points for using customer service as a marketing strategy: (1)
recognize points at which employees interact with consumers, (2) make a plan for
successful customer service, (3) give employees who interact with customers many
ways to "let the customer win," (4) evaluate whether employees are following the
customer service protocols and (5) tie employee appraisals and pay to a customer
satisfaction index.

In a small business, for example, this type of customer service plan is easier to
assess because a business owner can observe how employees interact with
customers. Larger businesses can also develop a systematic plan for customer
service, spot-checking for effectiveness (for example, through the use of the
mystery customer) and holding employees accountable. An organization may have
to hire a consultant to overhaul the customer-service plan.

Tourism Policy and Strategies in Tanzania

Page 1 of 14

TOURISM POLICY AND STRATEGIES IN TANZANIA

1.0. INTRODUCTION

The United Republic of Tanzania is the 2

nd

largest country in the SADC

Region and the 1

st

biggest in East Africa. It lies in the east coast of

Africa between Latitudes 1 and 11 degrees South of the Equator. It

covers 945,234 square Kilometres comprising Mainland and the islands

of Zanzibar and Pemba.

The estimated population of Tanzania for the year 1998 was 29.9

Million with an annual growth rate of 2.8% per year.

The country has tropical climate with average temperatures of between

25 and 30degree Celsius. Long rains last from March to May, short

rains from October to December with some heavy showers in the south

and Southern Highlands from December to April. The central plateau

is dry and arid with hot days and cool nights, while the northwest

highlands are cool and temperate. Coastal areas are hot and humid

although sea breezes cool the area pleasantly between June and

September.

Tanzanians are well known for their hospitality, open and jovial sense

of humour, friendly approach and generosity to foreigners. The people

are endowed with a wealth of culture, history and artistic talent that

has put Tanzania on the world map as one of the leading nation in that

respect.

The Government of Tanzania views tourism as a significant industry in

terms of job creation, poverty alleviation, and foreign exchange

earnings. Tourism today is receiving a greater attention than ever

before from international development agencies and from national Tourism Policy
and Strategies in Tanzania

Page 2 of 14

governments. To many countries, tourism is the highest foreign

exchange earner and an important provider of employment.

According to the World Tourism Organization, in 2000 there were 698

million tourist arrivals worldwide that generated 478.0 US $ billion.

According to the statistics in 2000, Africa region showed average

annual growth rate of 4.5% in arrivals. Statistics available also indicate

that, Africa’s market share in 1999 was 2.0%. Given the size of our

continent, the beauty of Africa, the diversity and uniqueness of tourism

attractions in Africa, there is stillroom for a bigger growth in both

tourist arrivals and receipts. Tanzania is therefore determined to have

its fair share in this important industry.

2.0. Performance of Tourism Sector in Tanzania

Tourism in Tanzania plays a vital role in the country’s economic

development. It is one of the major sources of foreign exchange. The

industry is also credited for being one that offers employment

opportunities either directly or indirectly through its multiplier effect.

The sector directly accounts for about 16% of the GDP and nearly 25%

of total export earnings. It directly supports the estimated 156,050 jobs

(2000). Foreign exchange receipts from tourism grew from US$ 259.44
million in 1995 to $ 729.06 million in 2001. These receipts were

generated by tourists’ arrivals in the stated years, which have shown a

steady growth from 295,312 in 1995 to 525,000 in 2001. With an average

growth rate of 20%, we hope to reach the target of one million tourists

by the year 2010. The sector also plays a major role in enhancement of

national and international peace and understanding.

The table below shows Tanzania tourist arrivals and earnings (1990-

2001). Tourism Policy and Strategies in Tanzania

Page 3 of 14

Table 1. International Tourism trends in Tanzania, 1990-2001.

Year No. Of Tourists Changes (%) Foreign currency earning

us $ million

Change (%) over

previous year

1990 153000 10.96 65.00 8.33

1991 186800 22.09 94.73 45.74

1992 201744 8.00 120.04 26.72

1993 230166 14.09 146.84 22.22

1994 261595 13.65 192.10 30.82

1995 295312 12.89 259.44 35.05

1996 326188 10.46 322.47 24.26

1997 359096 10.09 392.39 21.72

1998 482331 34.32 570.00 45.00

1999 627325 30.00 733.28 29.00

2000 501669 -20.03 739.06 0.79

2001 525000 4.65 725.00 -1.90

Source: Ministry of Natural Resources and Tourism, Tourism Division

3.0. National Tourism Policy and Strategies

The first National Tourism Policy was adopted in 1991 to provide the

overall objectives and strategies necessary to ensure sustainable

tourism development in the country. Nearly a decade later, there have

been considerable changes on the political, economic and social fronts

within the country, which raised the need for regular review of the

policy. The thrust of these changes have been towards stimulating

efforts to expand the private sector, in tandem with the disengagement

of the Government from the sole ownership and operation of tourist

facilities. Knowing the potentiality of tourism sector, as a strategy for

poverty alleviation, the National Tourism Policy of Tanzania was

reviewed in 1999 to cope with the dynamism of the tourism industry.

The overall objective of the policy is to assist in efforts to promote the

economy and livelihood of the people, essentially poverty alleviation

through encouraging the development of sustainable and quality

tourism that is culturally and socially acceptable, ecologically friendly, Tourism

Policy and Strategies in Tanzania

Page 4 of 14

environmentally sustainable and economically viable. It is also sought

to market Tanzania as favoured tourist destination for touring and

adventure in a country renowned for its cultural diversity and

numerous beaches.

The Government recognises that the private sector plays a major role in

the industry’s development, with the Government playing the catalytic

role of providing and improving the infrastructure as well as providing

a conducive climate for investment.

3.1. Strategies for Tourism Development

To effect the implementation of the policy, there is an Integrated

Tourism Master Plan, which outlines strategies and programmes for

the sector. The primary focus of this plan is to obtain sustainable

benefits for the people of Tanzania by generating additional economic

activity from available resources. Six primary areas addressed by the

Integrated Tourism Master Plan are the following:

v Creating greater awareness of Tanzania in the tourism source

markets.

v Expanding tourism products

v Securing a more competitive position

v Maximizing the necessary service skills, and

v Establishing the necessary structures and controls to underpin

tourism development.

The Integrated Tourism Master Plan outlines details of each area and

how to implement it.

3.2. Promotion of Private Investment in the Economy

The Government is fully aware that increased investment and

technological advancement require deliberate promotional policies. It

is in this respect that, the Government decided to gradually pull out of

productive and commercial activities and concentrate in its traditional Tourism

Policy and Strategies in Tanzania

Page 5 of 14

role of maintaining law and order. It has been decided that the

commanding heights of the economy, which used to be in the hands of

the Government, should be in the able hands of the private sector.

The Government considers private investments (both foreign and local)

as the engine of growth. It has taken steps to provide a macro

economic framework and an enabling environment for private

investors to operate. To strengthen private sector in tourism industry

in Tanzania, the Government assisted in the formation of Tourism

Confederation of Tanzania (TCT), a private sector body that is

intended to be the representative, voice of the tourism private sector

interests. Thus, the private sector is being assigned an increasing role

in Tanzania’s overall economic development.

The Government’s role is to regulate, promote, facilitate and provide

very conducive environment for the sustained growth and

development of tourism. The private sector is thus engaged in

development, promotion and marketing of tourism products,

construction of tourist accommodation facilities; and provision of tour

packages and other related services for the sector’s sustainable

development. To encourage private investment in the country,

investment incentives have been put in place.

4.0. INVESTMENT INCENTIVE PACKAGES IN TANZANIA

Tanzania offers a well-balanced package of incentives to investors.

These include: -

v Recognition of private property and protection against any noncommercial risks.

Tanzania is an active member of the World Bank

Foreign Investment Insurance wing, Multilateral Investment Guarantee

Agency (MIGA). Tourism Policy and Strategies in Tanzania

Page 6 of 14

v Tanzania is a member of the Int ernational Canter for Investment

Settlement Disputes (ICSID) a body affiliated to World Bank.

v Zero percent (0%) import Duty on project capital goods.

v VAT exception on ground transport run by Tour Operators.

v The right to transfer outside the country 100% of foreign exchange

earned, profits and capital.

v The ease of obtaining other permits such as Residence/ Work Permit,

industrial licence, trading licence etc.

v Automatic permit of employing 5 foreign nationals on the project

holding Certificate of incentives.

These incentives have so far attracted good number of investors in the

country. For instance Tanzania Investment Centre has between

September 1990 and march 1998, approved a total of 152 tourism

projects worth $ 313 Million, out of which, 119 were new projects.

5.0. Competitive Strengths of Tanzania Tourism Development:

The strength of the appeal of Tanzania to tourist product is dominated

by natural assets of the country. The assessment is that by any

standards, Tanzania is an exceptionally beautiful and interesting

country. With its 12 National parks, 31 Game reserves, 38 Game

controlled areas, a Conservation area and Marine park, Tanzanians

wildlife resources are considered among the finest in the world and

have been widely known for many years.

They include the great Serengeti plains, the spectacular Ngorongoro

Crater, Lake Manyara and Africa’s highest mountain, Kilimanjaro, in

the north, Mikumi, Udzungwa and Ruaha National parks and Selous

game Reserve in the south.

Additional natural attractions include the sandy beaches in the north

and south of Dar es Salaam and the excellent deep-sea fishing at Mafia. Tourism
Policy and Strategies in Tanzania

Page 7 of 14

Tanzania has a rich heritage of archaeological, historical and rock

painting sites, a number of which have been designated to World

Heritage Sites. At Olduvai Gorge, in the interior Rift Valley, is the site

of discoveries of the traces of earliest man, and along the Indian Ocean
are the remains of settlements.

To a tourist, Tanzania offers interesting culture and crafts, most

notably the Maasa i culture and art and the Makonde sculptures and

carvings the list is endless.

In short the strength of Tanzania tourist product lies on:

v Abundance, diversity, reliability and visibility of wildlife

v Unspoiled environment and beautiful scenery

v Low tourist density

v Safe destination

v Beaches (European)

v Authenticity and the unique African experience

v Friendly people.

Recognizing the role tourism sector plays to the economy, the Government

is taking measures to attract more investors to invest in tourism. Some of

the measures are as follows.

v The government in collaboration with the owners of beach hotels

rehabilitated roads leading to the beach hotels.

v Construction of Dar es salaam- Bagamoyo road to encourage

investment in Bagamoyo. Tourism Policy and Strategies in Tanzania

Page 8 of 14

v In collaboration with the government of Japan, the Government is

currently constructing tarmac road between Makuyuni and

Ngorongoro gate, to attract more tourists to the northern circuit.

v In the case of air transport, there is an improvement in international

air accessibility. Currently KLM is flying daily in and out of

Tanzania. British Airways has introduced a direct flight from Dar es

Salaam International Airport to London Heathrow Airport, which

flies three times a week in the country. This has increased the

number of tourist in the country, who will need the diversified

products.

However, in order for Tanzania to succeed further in this endeavour of

improving the services, we are ready to learn what more can be done

to increase private investment in these potential tourism areas.

In Tanzania today, tourism is well developed in the Northern Circuit

while lots of potentials in the southern circuit still offer attractive areas

for investment. These tourism components of the southern circuit are

exceptionally strong, comprising

v Three primary beach resources at Bagamoyo, Mafia Island and

the beaches south of Dar es Salaam.

v The immerse wildlife resources of the Selous game reserve and

Mikumi, Ruaha, Udzungwa national parks

v Substantial cultural resources, including Bagamoyo, kilwa and

Mafia.

The Government therefore encourages investment in, both privately and

through joint ventures in these areas.

Overall, he areas for tourism investment are as indicated below: Tourism Policy
and Strategies in Tanzania

Page 9 of 14

5.1. Areas for Tourism Investment

5.1.1. Operation of tourist hotels and accommodation

Establishments

Based on updated projected foreign bed night demand of about

5 million by the year 2005, the total hotel, lodge and tented

camp accommodation requirements in Tanzania are 12,000

rooms, of which an estimated 8,500 rooms would be of

international standard. Of the 8,500 rooms required, 5,000 are

operating nearly to an international standard and approximately

500 are currently under construction or refurbishment. The

development of the remaining 3,000 rooms that are required by

2005 necessitates new capital investment either for

refurbishment of existing rooms or construction of new rooms.

(Source: Integrated Tourism Master Plan)

5.1.2. Transportation (Air, road, ocean and inland water ways)

(a) Air

The future growth of tourism in Tanzania is inextricably bound

to the development of the air transport industry. Currently there

are about 17 international scheduled airlines coming to

Tanzania. These alone, are not enough to cater for the increased
demand for the international tourists.

The internal air access has been a problem in the country due to

under capacity for scheduled and no-scheduled air services.

However, attempts made by Government to improve the

internal air access have resulted to increased domestic air

transport. According to Tanzania Civil Aviation Authority

(TCAA), there are about 3 scheduled and 13-chartered domestic

air companies operating in Tanzania today. Still these are not Tourism Policy and
Strategies in Tanzania

Page 10 of 14

enough to carter for the increased demand for tourists within

the country.

The diversity of the country, inaccessibility especially to the

southern Circuit, which has very rich in tourist attractions,

makes the need of adequate and affordable air transport to

tourist.

More urgently, southern circuit area that includes the Selous

game reserve, Mikumi, Ruaha, Udzugwa, National Parks.

(b) Water Bodies

Lakes in Tanzania are not yet fully utilized /exploited i.e. Lake

Tanganyika, Lake Nyasa and Lake Victoria. Establishment of

lake cruise and floating hotels; operation of sports fishing and

water recreation facilities are some of the areas for investment.

Development of the tourists’ facilities in these areas could even

attract more visitors in these new undeveloped destinations,

which could as well stimulate development.

5.1.3. Provision of tourism related services such as Safaris,

Photographic services and cultural tourism centres.

Government has set nearly twenty-five percent of land aside as

Wildlife and botanical sanctuaries that enjoy a high degree of

protection and management. They serve conservational,

educational, scientific, cultural and recreational purposes. The

provision of services relating to tourism such as safaris/ tour

operation, photographic services by the private sector is

encouraged. Tourism Policy and Strategies in Tanzania

Page 11 of 14

Conference Centres.

Tanzania is a peaceful country, which can attract more

conference tourism if enough of such facilities are developed

and available. Investments are therefore encouraged in congress

hotels and conference centres.

5.1.4. International Standard Hospitality and Tourism Training

Institutes.

The National Tourism Policy [1999], attaches importance to

service delivery as a key factor for tourism to succeed; quality of

service was in a recent international visitor survey singled out

[by visitors] as one area that needed improvement. Employers in

the industry attribute poor [non-professional] service delivery to

inferior formal training.

According to Cooper, Fletcher, Gilbert [1998]

“the challenges

facing the tourism industry will only be met successfully by a

well educated, well trained, bright, energetic, multilingual and

entrepreneurial workforce who understand the nature of

tourism and have a professional training”. A high quality of

professional human resources in tourism will allow enterprises

to gain a competitive edge and deliver added value with their

service.

The main tourism training facility is the Hotel and Tourism

Training Institute (HTTI) in Dar es Salaam the only Government

owned hotel institute in Tanzania. The institute still offers craft

courses in Hotel related disciplines. The school is in need of

repair, upgrading and improvement. However, the French

Cooper, Fletcher. Gilbert, D (1998); Tourism: Principles and Practices, 2nd ed.,
Addison Wesley

Longman Ltd, New York. Tourism Policy and Strategies in Tanzania

Page 12 of 14

Embassy in Tanzania has indicated interest in assisting in

building an ideal hospitality and tourism College.

This alone cannot meet the demand of the market, since the

development of tourism in Tanzania needs to go together with

the improved service delivery in hospitality and tourism

industry. Private investors are therefore encouraged to invest in

training as well.

6. 0. CONCLUSION

The development of tourism in Tanzania is a process involving all

stakeholders to ensure its sustainability. Private sector is encouraged to

use the investment incentives provided by the government in the

country to invest more in tourism in the country. The areas discussed

above need to be treated with utmost importance. Accommodation,

tour operations, transportation and training are among the most

important areas for investment.

Tanzania boasts of its unsurpassed natural, cultural and historical

resources, which are still under-utilised. Most investors are competing

for the overdeveloped Northern Circuit and few have discovered the

potentiality of the Southern Circuit. The Government is calling for

diversification of the tourism sector is reducing the pressure on the

Northern Circuit. Private sector is therefore encouraged to invest more

in the Coastal and Southern Circuit either individual or in

partnerships.

The Government of Tanzania will continue to take required

institutional measures to improve the performance of the economy and

to create conducive environment for private investment in the country. Tourism

Policy and Strategies in Tanzania

Page 13 of 14

It will also to ensure that development and promotion of tourism is

done in a sustainable manner in order to conserve and preserve our

natural and cultural resources. To this end, cooperation between all

players is called upon in order to develop a sustainable tourism

destination. Tourism Policy and Strategies in Tanzania

Strategies in Financial

Services, the Shareholders and the System

Is Bigger and Broader

Better?

Ingo Walter

HWWA DISCUSSION PAPER

205

Hamburgisches Welt-Wirtschafts-Archiv (HWWA)

Hamburg Institute of International Economics

2002

ISSN 1616-4814Hamburgisches Welt-Wirtschafts-Archiv (HWWA)

Hamburg Institute of International Economics

Neuer Jungfernstieg 21 - 20347 Hamburg, Germany

Telefon: 040/428 34 355

Telefax: 040/428 34 451

e-mail: hwwa@hwwa.de

Internet: http://www.hwwa.de

The HWWA is a member of:

• Wissenschaftsgemeinschaft Gottfried Wilhelm Leibniz (WGL)

• Arbeitsgemeinschaft deutscher wirtschaftswissenschaftlicher Forschungsinstitute

(ARGE)

• Association d’Instituts Européens de Conjoncture Economique (AIECE)HWWA

Discussion Paper

Strategies in Financial Services,

the Shareholders and the System

Is Bigger and Broader Better?

Ingo Walter

HWWA Discussion Paper 205

http://www.hwwa.de

Hamburg Institute of International Economics (HWWA)

Neuer Jungfernstieg 21 - 20347 Hamburg, Germany

e-mail: hwwa@hwwa.de

Paper presented at a Brookings Institution conference on “Does the Future Belong

to

Financial Conglomerates?”, a joint US-Netherlands Roundtable on Financial

Service
Conglomerates, Washington, D.C., 24-25 October 2002. Draft of October 25,
2002.

Prepared in the author’s co-operation with the HWWA Research Programme

"International Financial Markets".

Edited by the Department World Economy

Head: PD Dr. Carsten HefekerHWWA DISCUSSION PAPER 205

October 2002

Strategies in Financial Services, the Shareholders

and the System

Is Bigger and Broader Better?

ABSTRACT

The financial services industry is “special” in a variety of ways, including the

fiduciary

nature of the business, its role at the center of the payments and capital allocation
process with all its static and dynamic implications for economic performance, and
the systemic nature of problems that can arise in the industry. So the structure,
conduct and

performance of the industry has unusually important public interest dimensions.

One

facet of the discussion has focused on size of financial firms, however measured,
and

the range of activities conducted by them Is size positively related to total returns
to

shareholders? If so, does this involve gains in efficiency or transfers of wealth to

shareholders from other constituencies, or maybe both? Does greater breadth
generate sufficient information-cost and transaction-cost economies to be
beneficial to shareholders
and customers, or can it work against their interests in ways that may ultimately
impede

shareholder value as well? And is bigger and broader also safer? This paper starts
with a

simple strategic framework for thinking about these issues from the perspective of
the

management of financial firms. What should they be trying to do, and how does
this relate to the issues of size and breadth? It then reviews the available evidence
and reaches

a set of tentative conclusions from what we know so far, both from a shareholder
perspective and that of the financial system as a whole.

JEL Classification: G20, L10

Keywords: financial services, shareholders, size of financial firms.

Ingo Walter

Charles Simon Professor of Applied Business Economics

& Sidney Homer Director, New York University Salomon Center

Stern School of Business

New York University

44 West 4th Street (Room 9-60)

New York, N.Y. 10012 USA

Tel. (212) 998-0707

Fax. (212) 995-4220)

Email: iwalter@stern.nyu.edu1

The classic structure-conduct-performance approach to industrial organization

centers on three questions. First, why is does an industry look the way it does, in
terms

of numbers of competitors, market share distribution and various other metrics?

Second, how do firms actually compete, in terms the formation of prices, product
and

service quality, rivalry and collaboration within and across strategic groups, and
other

attributes of economic behavior? And third, how does the industry perform for its

shareholders, its employees, its clients and suppliers, and within the context the
system

as a whole in terms of its impact on income and growth, stability, and possibly less

clearly defined ideas about such things as social equity? In the financial services

industry, these same questions have attracted more than the normal degree of

attention. The industry is ìspecialî in a variety of ways, including the fiduciary

nature of

the business, its role at the center of the payments and capital allocation process
with

all its static and dynamic implications for economic performance, and the systemic

nature of problems that can arise in the industry. So the structure, conduct and

performance of the industry has unusually important public interest dimensions.

One facet of the discussion has focused on size of financial firms, however

measured, and the range of activities conducted by them. Exhibit 1 depicts a

taxonomy

of broad-gauge financial services businesses. What are the strategic opportunities

and
competitive consequences of deepening and broadening a firmís business within
and

between the four sectors and eight sub-sectors? Is size positively related to total
returns

to shareholders? If so, does this involve gains in efficiency or transfers of wealth to

shareholders from other constituencies, or maybe both? Does greater breadth

generate

sufficient information-cost and transaction-cost economies to be beneficial to

shareholders and customers, or can it work against their interests in ways that may

ultimately impede shareholder value as well? And what about the ìspecialness,î
notably

the industryís fiduciary character and systemic risk -- is bigger and broader also
safer?

This paper begins with a simple strategic framework for thinking about these

issues from the perspective of the management of financial firms. What should
they be

trying to do, and how does this relate to the issues of size and breadth? It then
reviews

the available evidence and reaches a set of tentative conclusions from what we
know so2

far, both from a shareholder perspective and that of the financial system as a
whole.

A Simple Strategic Schematic

Exhibit 2 is a depiction of the market for financial services as a matrix of clients,

products and geographies. [Walter, 1988] Financial firms clearly will want to
allocate
available financial, human and technological resources to those cells (market
segments)

in the matrix that promise to throw-off the highest risk-adjusted returns.

In order to do

this, they will have to appropriately attribute costs, returns and risks to specific
cells in

the matrix. And the cells themselves have to be linked-together in a way that
maximizes

what practitioners and analysts commonly call ìsynergies.î

● Client-driven linkages exist when a financial institution serving a particular

client

or client-group can, as a result, supply financial services either to the same client

or to another client in the same group more efficiently in the same or different

geographies. Risk-mitigation results from spreading exposures across clients,

along with greater earnings stability to the extent that income streams from

different clients or client-segments are not perfectly correlated.

● Product-driven linkages exist when an institution can supply a particular

financial

service in a more competitive manner because it is already producing the same

or a similar financial service in different client or arena dimensions. Here again,

there is risk mitigation to the extent that net revenue streams from different

products are not perfectly correlated.

● Geographic linkages are important when an institution can service a particular

client or supply a particular service more efficiently in one geography as a result

of having an active presence in another geography. Once more, the risk profile of

the firm may be improved to the extent that business is spread across different

currencies, macroeconomic and interest-rate environments.

To extract maximum returns from the market matrix, firms need to understand

the competitive dynamics of specific segments as well as, the costs ñ including

acquisition and integration costs in the case of M&A initiatives ñ and the risks
imbedded

in the overall portfolio of activities. Especially challenging is the task of

optimizing the

linkages between the cells to maximize potential joint cost and revenue economies,
as

discussed below. Firms that do this well can be considered to have a high degree
of3

ìstrategic integrityî and should have a market capitalization that exceeds their
standalone value of their constituent businesses.

So is bigger and broader better in the financial services industry? If so, why? And

what is the evidence? Here we shall consider each of the major arguments, pro and

con.

Economies and Diseconomies of Scale

Whether economies or diseconomies of scale exist in financial services has been

at the heart of strategic and regulatory discussions about optimum firm size in the

financial services industry. Are larger firms associated with increased scale
economies

and hence profitability and shareholder value? Can increased average size of firms
create a more efficient financial sector? Answers are not easy to find, because they

have to isolate the impact of pure size of the production unit as a whole from all of
the

other revenue and cost impacts of size, discussed below.

In an information- and transactions-intensive industry with frequently high fixed

costs such as financial services, there should be ample potential for scale
economies.

However, the potential for diseconomies of scale attributable to disproportionate

increases in administrative overhead, management of complexity, agency problems

and

other cost factors could also occur in very large financial services firms. If
economies of

scale prevail, increased size will help create financial efficiency and shareholder
value.

If diseconomies prevail, both will be destroyed. Scale-effects should be directly

observable in cost functions of financial services firms and in aggregate

performance

measures.

Many studies of economies of scale have been undertaken in the banking,

insurance and securities industries over the years -- see Saunders [2000] for a
survey.

Unfortunately, examinations of both scale and scope economies in financial

services

are unusually problematic. The nature of the empirical tests used, the form of the
cost
functions, the existence of unique optimum output levels, and the optimizing
behavior of

Much of the following discussion relies on Walter [2003].4

financial firms all present difficulties. Limited availability and conformity of data
present

serious empirical issues. And the conclusions of any study that has detected (or
failed

to detect) economies of scale and/or scope in a sample of financial institutions does

not

necessarily have general applicability. Nevertheless, the impact on the operating

economics (production functions) of financial firms is so important that available

empirical evidence is central to the whole argument.

Estimated cost functions form the basis most of the available empirical tests.

Virtually all of them have found that economies of scale are achieved with
increases in

size among small commercial banks (below $100 million in asset size). A few
studies

have shown that scale economies may also exist in banks falling into the $100
million to

$5 billion range. There is very little evidence so far of scale economies in the case
of

banks larger than $5 billion. More recently, there is some scattered evidence of
scalerelated cost gains for banks up to $25 billion in asset size. [Berger and Mester,
1997]

But according to a survey of all empirical studies of economies of scale through

1998,
there was no evidence of such economies among very large banks. Berger,
Demsetz

and Strahan [1998] and Berger, Hunter, and Timme [1993] found the relationship

between size and average cost to be U-shaped. This suggests that small banks can

benefit from economies of scale, but that large banks seem to suffer from
diseconomies

of scale, resulting in higher average costs as they increase in size. The consensus

seems to be that scale economies and diseconomies generally do not result in more

than about 5% difference in unit costs. Inability to find major economies of scale
among

large financial services firms is also true of insurance companies [Cummins and Zi,

1998] and broker-dealers [Goldberg, Hanweck, Keenan and Young, 1991]. Lang
and

Wetzel [1998] found diseconomies of scale in both banking and securities services

among German universal banks.

Except for the very smallest among banks and nonbank financial firms, scale

economies seem likely to have relatively little bearing on competitive performance.

This

is particularly true since smaller institutions are sometimes linked-together in

cooperatives or other structures that allow harvesting available economies of scale

centrally, or are specialists in specific market-segments in Exhibit 2 that are not5

particularly sensitive to relatively small cost differences that seem to be associated

with

economies of scale in the financial services industry. A basic problem is that most
of the
available empirical studies focus entirely on firm-wide scale economies when the
really

important scale issues are encountered at the level of individual businesses.

There is ample evidence, for example, that economies of scale are significant for

operating economies and competitive performance in areas such as global custody,

processing of mass-market credit card transactions and institutional asset

management.

Economies of scale may be far less important in other areas such as private
banking

and M&A advisory services. Unfortunately, empirical data on cost functions that
would

permit identification of economies of scale at the product level are generally

proprietary,

and therefore unavailable. Disturbingly, it seems reasonable that a scale-driven

strategy

may make a great deal of sense in specific areas of financial activity even in the

absence of evidence that there is very much to be gained at the firm-wide level.
Still, the

notion that there are some lines of activity that clearly benefit from scale
economies

while at the same time observations of firm-wide economies of scale are

empirically

elusive, suggests that there must be numerous lines of activity (or combinations)
where

diseconomies of scale exist.

Cost Economies of Scope

Beyond pure scale-effects, are there cost reductions to be achieved by selling a

broader rather than narrower range of products? Cost economies of scope mean
that

the joint production of two or more products or services is accomplished more

cheaply

than producing them separately. ìGlobalî scope economies become evident on the
cost

side when the total cost of producing all products is less than producing them

individually, while ìactivity-specificî economies consider the joint production of

particular

pairs or clusters of financial services. Cost economies of scope can be harvested

through the sharing of IT platforms and other overheads, information and

monitoring

costs, and the like. Information, for example, can be reused and thereby avoid cost

duplication, facilitate creativity in developing solutions to client problems, and

leverage

client-specific knowledge. [Stefanadis, 2002]. On the other hand, cost

diseconomies of6

scope may arise from such factors as inertia and lack of responsiveness and
creativity

that may come with increased firm breadth, complexity and bureaucratization, as
well as

"turf" and profit-attribution conflicts that increase costs or erode product quality in

meeting client needs, or serious cultural differences across the organizational

ìsilosî

that inhibit seamless delivery of a broad range of financial services.

Like economies of scale, cost-related scope economies should be directly

observable in cost functions of financial services suppliers and in aggregate

performance measures. Most empirical studies have failed to find significant

costeconomies of scope in the banking, insurance or securities industries [Saunders
2000].

They suggest that some cost-diseconomies of scope are encountered when firms in
the

financial services sector add new product-ranges to their portfolios. Saunders and

Walter [1994], for example, found negative cost, economies of scope among the
worldís

200 largest banks ñ as the product range widens, unit-costs seem to go up, although

not dramatically so.

However, the period covered by many of these studies involve firms that were

shifting away from a pure focus on banking or insurance, and may thus have
incurred

considerable front-end costs in expanding the range of their activities. If these

outlays

were expensed in accounting statements during the period under study, then one
might

expect to see evidence of diseconomies of scope reversed in future periods. The

evidence on cost-economies of scope so far remains inconclusive.

Operating Efficiencies

Besides economies of scale and cost-economies scope, financial firms of roughly

the same size and providing roughly the same range of services can have very
different
cost levels per unit of output. There is ample evidence that such performance

differences exist, for example, in comparisons of cost-to-income ratios among

banks,

insurance companies, and investment firms of comparable size. The reasons

involve

differences in production functions reflecting, efficiency and effectiveness in the

use of

labor and capital, sourcing and application of available technology, and acquisition
of

inputs, organizational design, compensation and incentive systems ñ i.e., in just

plain7

better or worse management. These are what economists call X-efficiencies.

A number of studies have found rather large disparities in cost structures among

banks of similar size, suggesting that the way banks are run is more important than
their

size or the selection of businesses that they pursue. [Berger, Hancock and
Humphrey,

1993; Berger, Hunter and Timme, 1993] The consensus of studies conducted in the

United States seems to be that average unit costs in the banking industry lie some
20%

above ìbest practiceî firms producing the same range and volume of services, with
most

of the difference attributable to operating economies rather than differences in the

cost

of funds. [Akhavein, Berger and Humphrey, 1997] Siems [1996] found that the
greater
the overlap in branch networks, the higher the abnormal equity returns in U.S.
bank

mergers, while no such abnormal returns are associated with other factors like
regional

concentration ratios ñ suggesting that shareholder value gains in many of the US

banking mergers of the 1990s were associated more with increases in X-efficiency
than

with reductions in competition. If true, this is good news for smaller firms, since
the

quality of management seems to be far more important in driving costs than raw
size or

scope. Of course, if very large institutions are systematically better managed than

smaller ones (which may be difficult to document in the real world of financial
services)

then there may be a link between firm size and X-efficiency.

It is also possible that very large organizations may be more capable of the

massive and ìlumpyî capital outlays required to install and maintain the most
efficient

information-technology and transactions-processing infrastructures. [Walter 2003]

If

extremely high recurring technology spend-levels results in greater X-efficiency,

then

large financial services firms will tend to benefit in competition with smaller ones.

Smaller firms will then have to rely on pooling and outsourcing, if feasible.

In banking M&A studies, Berger and Humphrey [1992b] found that acquiring
banks tend to be significantly more efficient than the acquired banks, suggesting
that

the acquirer may potentially improve the X-efficiency of the target. Akhavein,
Berger,

and Humphrey [1997] found mega-mergers between US banks increase returns by

improving efficiency rather than increasing prices, suggesting also that acquiring
banks

use acquisitions as an occasion to improve efficiency within their own

organizations.8

Houston and Ryngaert [1994] and DeLong [2001b] found that the market rewards

mergers where geographic overlap exists between acquirer and target, presumably
due

to expected X-efficiency gains.

Revenue Economies of Scope

On the revenue side, economies of scope attributable to cross-selling arise when

the all-in cost to the buyer of multiple financial services from a single supplier is
less

than the cost of purchasing them from separate suppliers. This includes the cost of
the

services themselves plus information, search, monitoring, contracting and other

costs.

And firms that are diversified into several types of activities or several geographic
areas

in addition tend to have more contact points with clients. Revenue-diseconomies of

scope could arise from management complexities and conflicts associated with
greater
breadth.

Some evidence on revenue economies of scope come from historical studies.

Kroszner and Rajan [1994] found that U.S. bank affiliates typically underwrote
better

performing securities than specialized investment banks during the 1920s, when
US

commercial banks were permitted to have securities affiliates. Perhaps commercial

banks obtained knowledge about firms contemplating selling securities through the

deposit and borrowing history of the firm. If so, they could then select the best
risks to

bring to market. Likewise, Puri [1996] found that securities underwritten by

commercial

banks generated higher prices than similar securities underwritten by investment

banks;

this suggests lower ex ante risk for those underwritten by commercial banks.

Most empirical studies of cross-selling are based on survey data, and are

therefore difficult to generalize. Regarding wholesale commercial and investment

banking services, for example, Exhibit 3 shows the results of a 2001 survey of
corporate

clients by Greenwich Research regarding the importance of revenue economies of

scope between lending and M&A advisory services. The issue is whether
companies

are more likely to award M&A work to banks that are also willing lenders, or
whether the

two services are separable ñ so that companies go to the firms with the perceived
best
M&A capabilities (probably investment banking houses) for advice and to others9

(presumably the major commercial banks) for loans. The responses suggests that

companies view these services as a single value-chain, so that banks that are
willing to

provide significant lending are also more likely to obtain M&A advisory work.
Indeed,

Exhibit 4 suggests that well over half of the major M&A firms (in terms of fees) in
2001

were commercial banks with substantial lending power. This is sometimes called
ìmixed

bundling,î meaning that the price of one service (e.g., commercial lending) is
dependent

on the client also taking another service (e.g., M&A advice or securities
underwriting),

although the search for immediate scope-driven revenue gains may have led to
some

disastrous lending by commercial banks in the energy and telecoms sectors in

recent

years.

However, it is at the retail level that the bulk of the revenue economies of scope

are likely to materialize, since the search costs and contracting costs of retail
customers

are likely to be higher than for corporate customers. There is limited US evidence
on

retail cross-selling due to the regulatory restraints in place until 1999, and evidence
from

Europe, where universal banking and multifunctional financial conglomerates have

always been part of the landscape, is mainly case-based and suggests highly
variable

outcomes as to the efficacy of bancassurance or Allfinanz.

In any case, the future may see some very different retail business models. One

example is depicted in Exhibit 5. Here clients take advantage of user-friendly home

interfaces to access Webservice platforms which allow real-time linkages to

multiple

financial services vendors. For the client, it could combine the ìfeelî of single-
source

purchasing with access to best-in-class vendors ñ the client ìcross-purchasesî rather

than being ìcross-sold.î Absent the need for continuous financial advice, such a

business model could reduce information costs, transactions costs and contracting

costs while at the same time providing client-driven open-architecture access to the

universe of competing vendors. Advice could be built into the model by suppliers
who

find a way to incorporate the advisory function into their downlinks, or through

independent financial advisers. If in the future such models of retail financial

services

delivery take hold in the market, then some of the rationale for cross-selling and

revenue economies of scope could become obsolete.10

Despite an almost total lack of hard empirical evidence, revenue economies of

scope may indeed exist at both the wholesale and retail level. But they are likely to
be

very specific to the types of services provided and the types of clients served. So

revenue-related scope economies are clearly linked to a firmís specific strategic

positioning across clients, products and geographies depicted in Exhibit 2. Even if

cross-selling potential exists, the devil is in the details ñ mainly in the design of

incentives and organizational structures to ensure that it actually occurs. And these

incentives have to be extremely granular and compatible with employee real-world

behavior. Without them, no amount of management pressure and exhortation to

crosssell is likely to achieve its objectives.

Network economies associated with multifunctional financial firms may be

considered a special type of demand-side economy of scope. [Economides, 1995]

Like

telecom-munications, relationships with end-users of financial services represent a

network structure wherein additional client linkages add value to existing clients
by

increasing the feasibility or reducing the cost of accessing them. So-called

ìnetwork

externalitiesî tend to increase with the absolute size of the network itself. Every
client

link to the firm potentially ìcomplementsî every other one and potentially adds
value

through either one-way or two-way exchanges. The size of network benefits

depends on

technical compatibility and coordination in time and location, which universal

banks and

financial conglomerates may be in a position to provide. And networks tend to be

selfreinforcing in that they require a minimum critical mass and tend to grow in
dominance

as they increase in size, thus precluding perfect competition in network-driven

businesses. This characteristic may be evident in activities such as securities
clearance

and settlement, global custody, funds transfer and international cash management,
and

may to lock-in clients insofar as switching-costs tend to be relatively high.

What little empirical evidence there is suggests that revenue-economies of scope

seem to exist for specific combinations of products in the realm of commercial and

investment banking, as well as insurance and asset management. Empirical

evidence

concerning the existence of certain product-specific revenue economies of scope is

beginning to materialize. For example, Yu [2001] showed that share prices of

US11

financial conglomerates as well as specialists responded favorably when the

Financial

Services Modernization Act of 1999 was announced. The study found that the
market

reacted most favorably for the shares of large securities firms, large insurance

companies, and bank holding companies already engaged in some securities

businesses (those with Section 20 subsidiaries allowing limited investment banking

activities). The study suggested that the market expected gains from product

diversification possibly arising from cross-product synergies. Another study by

Lown et

al. (2000) similarly found that both commercial and investment bank stocks rose
on

announcement by President Clinton on October 22, 1999 that passage of the

Gramm
Leach Bliley Act was imminent.

Market Power

In addition to the strategic search for operating economies and revenue

synergies, financial services firms will also seek to dominate markets in order to
extract

economic returns. This often referred to as economies of ìsizeî as opposed to

classic

economies of ìscale,î and can convey distinct competitive advantages that are
reflected

in either business volume or margins, or both.

Market power allows banks to charge more (monopoly benefits) or pay less

(monopsony benefits). Indeed, many national markets for financial services have
shown

a distinct tendency towards oligopoly. Supporters argue that high levels of market

concentration are necessary in order to provide a viable competitive platform.

Without

convincing evidence of scale economies or other size-related efficiency gains,

opponents argue that monopolistic market structures serve mainly to extract rents
from

consumers or users of financial services and redistribute them to shareholders,

crosssubsidize other areas of activity, invest in wasteful projects, or reduce
pressures for

cost-containment.

Indeed, it is a puzzle why managers of financial services firms often seem to

believe that the end-game in their industryís competitive structure is the emergence
of a
few firms in gentlemanly competition with nice sustainable margins, whereas in
the real

world such an outcome can easily trigger public policy reaction leading to breaks-
ups12

and spin-offs in order to restore more vigorous competition. Particularly in a

critical

economic sector that is easily politicized such as financial services, a regulatory

response to ìexcessiveî concentration is a virtual certainty despite sometimes

furious

lobbying to the contrary. In the case of Canada, for example, regulators prevented
two

megamergers in late 1998 that would have reduced the number of major financial
firms

from five to three with a retail market share of perhaps 90% between them.
Regulators

blocked the deals despite arguments by management that major US financial

services

firms operating in Canada under the rules of the North American Free Trade
Agreement

(NAFTA) would provide the necessary competitive pressure to prevent

exploitation of

monopoly power.

Financial services market structures differ substantially as measured, for

example, by the Herfindahl-Hirshman index. This metric of competitive structure

is the

sum of the squared market shares (H=∑s

2
), where 0<H<10,000 and market shares are

measured for example, by deposits, by assets, or other indicators of market share.

H

rises as the number of competitor declines, and as market-share concentration

increases among a given number of competitors. Empirically, higher values of H

tend to

be associated with higher degrees of pricing power, price-cost margins, and returns
on

equity across a broad range of industries. For example, despite very substantial

consolidation in recent years within perhaps the most concentrated segment of the

financial services industry, wholesale banking and capital markets activities, there
is

little evidence of market power. With some 80% of the combined value of global
fixedincome and equity underwriting, loan syndications and M&A mandates
captured by the

top-ten firms, the Herfindahl-Hirshman index was still only 745 in 2001. This
suggests a

ruthlessly competitive market structure in most of these businesses, which is

reflected in

the returns to investors who own shares in the principal players in the industry ñ in
fact,

there has been a long-term erosion of return on capital invested in the wholesale

banking industry. [Smith and Walter, 2003]

Another example is asset management, where the top firms comprise a mixture

of European, American and Japanese asset managers and at the same time a
mixture
of banks, broker-dealers, independent fund management companies and
insurance13

companies. Although market definitions clearly have to be drawn more precisely,

at

least on a global level asset management seems to be among the most contestable
in

the entire financial services industry, with a Herfindahl-Hirshman index of 540

among

the top-40 firms in terms of assets under management. And it shows very few
signs of

increasing concentration in recent years.

In short, although monopoly power created through mergers and acquisitions in

the financial services industry can produce market conditions that allow firms to

reallocate gains from clients to themselves, such conditions are not easy to achieve
or

to sustain. Sometimes new players ñ even relatively small entrants ñ penetrate the

market and destroy oligopolistic pricing structures. Or there are good substitutes

available from other types of financial services firms and consumers are willing to
shop

around. Vigorous competition (and low Herfindahl-Hirshman indexes) seems to be

maintained even after intensive M&A activity in most cases as a consequence of

relatively even distributions of market shares among the leading firms in many
financial

services businesses.

Berger and Hannan [1996] found that loan rates were higher and deposit rates
were lower when banks operated in concentrated markets. These increased
revenues,

however, did not result in higher profits ñ instead, the study showed evidence
consistent

with higher cost structures in such banks than their counterparts in less
concentrated

markets. Akhavein, Berger, and Humphrey [1997] found that banks which merge

charge more for loans and pay less on deposits before they merge than other large

banks -- banks that merged charged 17 basis points more for loans than the average

large bank prior to merging. After the merger, however, this difference fell to
about 10

basis points. This suggests that merging banks do not tend to take advantage of
their

increased market power. The authors contend that antitrust policy is effective in

preventing mergers that would create market power problems. Siems [1996]
reached a

similar conclusion. In a study of 19 bank megamergers (partners valued over $500

million) in 1995, he rejected the market power hypothesis although he found that
inmarket mergers create positive value for both the acquirer and the target upon

announcement. There was no relationship between the resulting abnormal returns

and14

the change in the Herfindahl-Hirshman index. Still, concentration seems to affect

prices.

Beatty, Santomero, and Smirlock [1987] found that the higher the market
concentration

of the banking industry in a given region, the higher the premium paid to acquire a
bank
in that area.

Proprietary Information and Imbedded Human Capital

One argument in favor of large, diverse financial services industry is that internal

information flows are substantially better and involve lower costs than external

information flows in the market that are accessible by more narrowly focused
firms.

Consequently a firm that is present in a broad range of financial markets, functions

and

geographies can find proprietary and client-driven trading and structuring

opportunities

that smaller and more narrow firms cannot.

A second argument has to do with technical know-how. Significant areas of

financial services ñ particularly wholesale banking and asset management ñ have

become the realm of highly specialized expertise which can be reflected in both
market

share and price-effects. In recent years, large numbers of financial boutiques have
been

acquired by major banks, insurance companies, securities firms and asset managers
for

precisely this purpose, and anecdotal evidence suggests that in many cases these

acquisitions have been shareholder-value enhancing for the buyer.

Closely aligned is the human capital argument. Technical skills and

entrepreneurial behavior are embodied in people, and people can and do move.
Parts
of the financial services industry have become notorious for the mobility of talent
to the

point of ìfree-agency,î and people or teams of people sometimes regard themselves

as

ìfirms within firms.î There are no empirical studies of these issues, although there
is no

question about their importance. Many financial services represent specialist

businesses that are conducted by specialists meeting specialist client requirements.

Knowhow embodied in people is clearly mobile, and the key is to provide a

platform that

is sufficiently incentive compatible to make the most of it. It seems unclear

whether size

or breadth has much to do with this.15

Diversification of Business Streams, Credit Quality and Financial Stability

Greater diversification of earnings attributable to multiple products, client-groups

and geographies is often deemed to create more stable, safer, and ultimately more

valuable financial institutions. The lower the correlations among the cash flows
from the

firmís various activities, the greater the benefits of diversification. The

consequences

should include higher credit quality and higher debt ratings (lower bankruptcy
risk),

therefore lower costs of financing than those faced by narrower, more focused
firms,

while greater earnings stability should bolster stock prices. In combination, these
effects
should reduce the cost of capital and enhance profitability.

It has also been argued that shares of universal banks and financial

conglomerates embody substantial franchise value due to their conglomerate nature

and importance in national economies. Demsetz, Saidenberg and Strahan [1996]

suggest this guaranteed franchise value serves to inhibit extraordinary risk-taking.

They

find substantial evidence that the higher a bankís franchise value, the more prudent

management tends to be. Such firms should therefore serve shareholder interests,
as

well as stability of the financial system ñ and the concerns of its regulators ñ with a

strong focus on risk management, as opposed to financial firms with little to lose.
This

conclusion is, however, at variance with the observed, massive losses incurred by

financial conglomerates universal banks in recent years in credit exposures to

highly

leveraged firms and special-purpose entities, real estate lending and emerging
market

transactions.

Studies that test risk reduction often look at how hypothetical combinations could

have reduced risk using actual industry data. In an early study, Santomero and
Chung

[1992] found that bank holding companies which existed from 1985 to 1989 could
have

reduced their probability of failure had they been permitted to diversify into
insurance
and securities. Of the ten combinations the authors examined, the best combination
is

the bank holding company linking to both insurance and securities firms. The only

combination that would have increased the probability of bankruptcy over a stand-
alone

bank holding company is one encompassing a large securities firm. Boyd, Graham,
and

Hewitt [1993] tested whether hypothetical mergers between bank holding

companies16

and non-banking financial firms decrease risk. In their sample of data from 1971 to

1987, they found that mergers between bank holding companies and insurance
firms

could have reduced risk while mergers between bank holding companies and
securities

firms or real estate firms could have increased risk. Saunders and Walter [1994]
carried

out a series of simulated mergers between US banks, securities firms and insurance

companies in order to test the stability of earnings of the pro-forma ìmergedî firm
as

opposed to separate institutions. The opportunity-set of potential mergers between

existing firms and the risk-characteristics of each possible combination were

examined.

The findings suggest that there are indeed potential risk-reduction gains from

diversification in multi-activity financial services organizations, and that these

increase

with the number of activities undertaken. The main risk-reduction gains appear to
arise
from combining commercial banking with insurance activities, rather than with
securities

activities.

Too Big to Fail Guarantees

Given the unacceptable systemic consequences of institutional collapse, large

financial services firms that surpass a given threshold will be bailed-out by

taxpayers. In

the United States, this policy became explicit in 1984 when the Comptroller of the

Currency testified to Congress that 11 banks were so important that they would not
be

permitted to fail. [O'Hara and Shaw, 1990] It was clearly present in the savings and
loan

collapses around that time. In other countries the same policy tends to exist, and
seems

to cover even more of the local financial system. [US General Accounting Office,
1991]

There were numerous examples in France, Switzerland, Norway, Sweden, Finland,

and

Japan during the1990s. Implicit too-big-to-fail (TBTF) guarantees create a

potentially

important public subsidy for major financial firms.

TBTF support was arguably extended to non-bank financial firms in the rescue of

Long-term Capital Management, Inc. in 1998, brokered by the Federal Reserve

(despite

the fact that a credible private restructuring offer was on the table) on the basis that
the
firmís failure could cause systemic damage to the global financial system. The
same

argument was made by JP Morgan in 1996 about the global copper market and one
of17

its then-dominant traders, Sumitomo. Morgan suggested that collapse of the copper

market could have serious systemic effects. The speed with which the central
banks

and regulatory authorities reacted to that crisis signaled the possibility of safety-net

support of the copper market in light of major banksí massive exposures in highly

complex structured credits to the industry. And there were even mutterings of
systemic

effects in the collapse of Enron in 2001. Most of the time such arguments are
selfserving nonsense, but in a political environment under crisis conditions they
could help

throw a safety net sufficiently broad to limit damage to shareholders of exposed

banks

or other financial firms.

It is generally accepted that the larger the bank, the more likely it is to be covered

under TBTF support. O'Hara and Shaw [1990] detailed the benefits of TBTF
status:

Without state assurances, uninsured depositors and other liability holders demand a
risk

premium. When a bank is not permitted to fail, the risk premium is no longer
necessary.

Furthermore, banks covered under the policy have an incentive to increase their
risk in
order to enjoy higher equity returns. Kane [2000] investigated the possibility that
large

banks enjoy access to the TBTF guarantees in a study of merger-effects, although

he

did not distinguish between the stock market reaction to increased TBTF
guarantees or

the likelihood of increased profitability. He suggested further study to determine

whether

acquiring banks increase their leverage, uninsured liabilities, non-performing loans

and

other risk exposures, all of which would suggest that they are taking advantage of
TBTF

guarantees.

One problem with the TBTF argument is to determine precisely when a financial

institution becomes too big to fail. Citicorp was already the largest bank holding

company in the United States before it merged with Travelers in 1998. Therefore,
the

TBTF argument may be a matter of degree. That is, the benefits of becoming larger

may be marginal if a firm already enjoys TBTF status.

Conflicts of Interest

The potential for conflicts of interest is endemic in all multifunctional financial

services firms. [Saunders and Walter,1994] Classic conflict of interest

arguments18

include the following: (1) When firms have the power to sell affiliatesí products,

managers may no longer dispense "dispassionate" advice to clients and have a

salesman's stake in pushing ìhouseî products, possibly to the disadvantage of the

customer; (2) A financial firm that is acting as an underwriter and is unable to

place the

securities in a public offering may seek limit losses by "stuffing" unwanted

securities into

accounts over which it has discretionary authority; (3) A bank with a loan
outstanding to

a client whose bankruptcy risk has increased, to the private knowledge of the
banker,

may have an incentive to encourage the borrower to issue bonds or equities to the

general public, with the proceeds used to pay-down the bank loan;

(4) In order to

ensure that an underwriting goes well, a bank may make below-market loans to
thirdparty investors on condition that the proceeds are used to purchase securities

underwritten by its securities unit; (5) A bank may use its lending power activities
to

encourage a client to also use its securities or securities services; and (6) By acting
as a

lender, a bank may become privy to certain material inside information about a

customer or its rivals that can be used in setting prices, advising acquirers in a

contested acquisition or helping in the distribution of securities offerings

underwritten by

its securities unit. [Smith and Walter, 1997A] More generally, a financial firm may
use
proprietary information regarding a client for internal management purposes which
at

the same time harms the interests of the client.

The potential for conflicts of interest can be depicted in a matrix such as Exhibit

6. Many of the cells in the matrix represent various degrees and intensities of
interestconflicts. Some are serious and basically intractable. Others can be
managed by

appropriate changes in incentives or compliance initiatives. And some are not

sufficiently serious to worry about. But using a matrix approach to mapping

conflicts of

interest demonstrates that the broader the client and product range, the more
numerous

are the potential conflicts and interest and the more difficult the task of keeping
them

under control -- and avoiding possibly large franchise losses.

One example is the 1995 underwriting of a secondary equity issue of the Hafnia
Insurance Group by Den Danske

Bank. The stock was distributed heavily to retail investors, with proceeds allegedly
used to pay-down bank loans

even as Hafnia slid into bankruptcy [Smith and Walter, 1997B] The case came
before the Danish courts in a

successful individual investor litigation supported by the government19

Shareholders of financial firms have a vital stake in the management and control
of conflicts of interest. They can benefit from conflict-exploitation in the short
term, to the

extent that business volumes and/or margins are higher as a result. And preventing

conflicts of interest is an expensive business -- compliance systems are costly to

maintain, and various types of walls between business units can have high
opportunity

costs because of inefficient use of information within the organization. On the

other

hand, costs associated with civil or criminal action and reputation losses due to
conflicts

of interest can weigh on shareholders very heavily indeed, as demonstrated by a

variety

of such problems in the financial services industry during 2000-2002. Some have

argued that conflicts of interest may contribute to the price to book-value ratios of
the

shares of financial conglomerates and universal banks falling below those of more

specialized financial services businesses.

Conflicts of interest can also impede market performance. For example, inside

information accessible to a bank as lender to a target firm would almost certainly

prevent that bank from acting as an M&A adviser to a potential acquirer.

Entrepreneurs

may not want their private banking affairs handled by a bank that also controls
their

business financing. A mutual fund investor is unlikely to have easy access to the
full
menu of available equity funds though a financial conglomerate offering
competing inhouse products. These issues may be manageable if most of the
competition is coming

from other financial conglomerates. But if the playing field is also populated by

aggressive insurance companies, independent broker-dealers, fund managers and

other specialists, these issues tend to be a continuing strategic challenge for

management (and a source of comfort for clients).

Should a major conflict of interest arise, the repercussions for a firmís reputation

can be quite detrimental.

Recent well-reported examples include equity analyst

conflicts of interest in the late 1990s and early 2000s. Analysts working for

For example, J.P. Morgan simultaneously served as commercial banker,

investment banker, and

adviser to Banco EspaÒol de CrÈdito (Banesto) in Spain, as well as being an

equity holder and fund

manager for co-investors in a limited partnership holding shares in the firm.

Additionally, Morganís Vice

Chairman served on Banestoís Supervisory Board. When Banesto failed and the
conflicts of interest

facing JP Morgan were revealed, the value of the firmís equity fell by 10% ñ see
Smith and Walter [1997].20
multifunctional financial firms wear several hats and are subject to multiple
conflicts of

interest. They are supposed to provide unbiased research to investors. But they are

also expected to take part in the securities origination and sales process centered in

their firmsí corporate finance departments. The firms argue that expensive research

functions cannot be paid-for by attracting investor deal-flow and brokerage

commissions, so that corporate finance has to cover much of the cost. This fact,
and the

astronomical compensation packages commanded by top analysts (occasionally

exceeding $20 million per year) is the best demonstration of which of the two hats

dominates. Prosecution of Merrill Lynch by the Attorney General of the State of

New

York in 2002, a $100 million settlement, and a frantic scramble by all securities
firms to

reorganize how equity research is organized and compensated simply validated

facts

long known to market participants.

More broadly, both Citigroup and JP Morgan Chase in 2001 and 2002 were

touched by just about every US corporate scandal that was revealed, often
involving

conflicts of interest, and both lost well over a third of their equity value in a matter
of

months (see Exhibit 7) no doubt in part as a consequence of conflicts of interest.

Conglomerate Discount

It is often argued that the shares of multi-product firms and business

conglomerates tend to trade at prices lower than shares of more narrowly-focused
firms

(all else equal). There are two basic reasons why this ìconglomerate discountî is

alleged to exist.

First, it is argued that, on the whole, conglomerates tend to use capital

inefficiently. It is argued that the potential benefits of diversification against the

potential

costs that include greater management discretion to engage in value-reducing

projects,

cross-subsidization of marginal or loss-making projects that drain resources from

healthy businesses, misalignments in incentives between central and divisional

managers, and the like. For a sample of U.S. corporations during the period 1986-
91,21

Berger and Ofek [1995] demonstrated an average value-loss in multi-product firms

on

the order of 13-15%, as compared to the stand-alone values of the constituent

businesses. The bulk of value-erosion in conglomerates was attributed by the

authors to

over-investment in marginally profitable activities and cross-subsidization. This

valueloss was smaller in cases where the multi-product firms were active in
closely-allied

activities within the same industrial sector. In other empirical work, John and Ofek

[1995] showed that asset sales by corporations result in significantly improved

shareholder returns on the remaining capital employed, both as a result of greater

focus

in the enterprise and value-gains through high prices paid by asset buyers. The
evidence suggests that the internal capital market within conglomerates functions
less

efficiently than the external capital market.

Such empirical findings across broad ranges of industry may well apply to

diverse activities carried out by financial firms as well. If retail banking and
wholesale

banking and P&C insurance are evolving into highly-specialized, performance-

driven

businesses, for example, one may ask whether the kinds of conglomerate discounts

found in industrial firms may not also apply to financial conglomerate structures --

especially if centralized decision-making is becoming increasingly irrelevant to the

requirements of the specific businesses.

A second possible source of a possible conglomerate discount is that investors in

shares of conglomerates find it difficult to ìtake a viewî and add pure sectoral
exposures

to their portfolios. Investors may want to avoid such stocks in their efforts to
construct

efficient asset-allocation profiles. This is especially true of performance-driven

managers of institutional equity portfolios who are under pressure to outperform

cohorts

or equity indexes. Why would a fund manager want to invest in yet another
(closed-end)

fund in the form of a conglomerate ñ one that may be active in retail banking,
wholesale

commercial banking, middle-market lending private banking, corporate finance,

trading,
investment banking, asset management insurance and perhaps other businesses as

well?

Both the capital-misallocation effect and the portfolio-selection effect may

weaken investor demand for shares of universal banks and financial

conglomerates,22

lower their equity prices, and produce a higher cost of capital than if the
conglomerate

discount were absent. This higher cost of capital would have a bearing on the

competitive performance and profitability of the enterprise. It may wholly or

partially

offset some of the aforementioned benefits of conglomeration, such as greater

stability

and lower bankruptcy risk through diversification across business lines.

From Book Value of Equity to Market Value of Equity

From a shareholder perspective, all of the pluses and minuses of size and

breadth among financial services firms can be captured in a simple valuation

formula:

++

t
t

tt

tt

EREC

NPV

(1 )

()()

NPVf

denotes the risk-adjusted discounted present value of a firmís after-tax earnings,

E(Rt

) a represents the expected future revenues of the firm, E(Ct

) represents expected

future operating costs including charges to earnings for restructurings, loss

provisions

and taxes. The net expected returns in the numerator are then discounted to the

present using a risk-free rate it

and a composite risk adjustment α t

-- which captures

the variance of expected net future returns resulting from credit risk, market risk,
operational risk, and reputation risk, and at the same time captures the correlations

between such risks associated with the firmís various activities.

Strategic initiatives in financial firms increase shareholder value if they generate:

(1) Top-line gains which show up as increases in E(Rt

) due for example to marketextension, increased market share, wider profit margins
or successful cross-selling; (2)

Bottom-line gains related to lower costs due to economies of scale or improved

operating efficiency, -- reduced E(Ct

) -- usually reflected in improved cost-to-income

ratios, as well as better tax efficiency; or (3) Reductions in risk associated with

improved risk management or diversification of the firm across business streams,

client

segments or geographies whose revenue contributions are imperfectly correlated -

and

therefore reduce the composite αt

This relationship can be depicted in a different way in Exhibit 8. The left-hand bar

represents the adjusted book value of equity (ABVE). This starts with the book
value of23

equity (BVE) ñ the sum of: (1) The par value of shares when originally issued; (2)
The

surplus paid-in by investors when the shares were issued; (3) Retained earnings on
the

books of the bank; and (4) Reserves set aside for loan losses. [Saunders, 2000]
BVE
must be written-up or written-down by unrealized capital gains or losses associated
with

the mark-to-market values of all balance sheet items. This calculation yields the

adjusted book value of equity (ABVE). Its value may depart significantly from
BVE for

banks and insurance companies due to a general absence of market-value

accounting

across major categories of balance sheet items, although it may come pretty close
for

securities firms and asset managers.

After all balance sheet values have been taken into account and marked to

market there may still be a material difference between ABVE and the actual
market

value of equity (MVE). This difference represents the marketís assessment of the

present value of the risk-adjusted future net earnings stream, capturing all known
or

suspected business opportunities, costs and risks facing the firm and captured in
the

above equation ñ the ìfranchise valueî of the firm.

A simpler version is ìTobinís Q,î defined as the ratio of the market value of a

firmís equity divided by a firmís book value. If the Q ratio is significantly below 1,
for

example, it may be that breaking-up the firm can serve the interests of shareholders
if

the book value of equity can be monetized. The Q ratio for well-run financial firms
having a positive franchise value should normally be well in excess of 1, and is
clearly

susceptible to enhancement through managerial action.

In Exhibit 8, each of the factors related to the size and breadth of financial

services firms is identified in successive bars in the diagram ñ scale and scope
effects,

operating and tax efficiencies, stability and TBTF premiums, conglomerate

discount,

and the rest ñ in building to the value of equity observed in the market, MVE. The

difference between book value or market-adjusted book value could be highly

positive,

as it has been in the case of AIG in the insurance sector, for example. Or it could
be

significantly negative, with the firmís stock trading well below book value or even

notional market-adjusted book value (its presumptive liquidation value). For

example, in

late September 2002 JP Morgan Chase stock was trading below book value,
reflecting24

concerns of large exposures (especially in the telecoms sector) and questions about

the bankís strategy and its execution.

When strategic initiatives are undertaken, such as mergers or acquisitions, it is

possible to add some empirical content to this kind of construct. In terms of US

completed deals during a period of intense M&A activity in the 1980s and early
1990s,
commercial bank acquisitions occurred at price-to-book value ratios of about 2.0,

sometimes as high as 3.0 or even more. In eight of the eleven years covered by one

study [Smith and Walter, 2000], the mean price-to-book ratio for US commercial

banking acquisitions was below 2.0, averaging 1.5 and ranging from 1.1 in 1990 to
1.8

in 1985. In two years, the price-to-book ratio exceeded 2.0 ñ in 1986 it was 2.8 and
in

1993 in was 3.2. These values presumably reflect the opportunity for the acquired

institutions to be managed differently and to realize the incremental value needed

to

reimburse the shareholders of the acquiring institutions for the willingness to pay
the

premium in the first place. If in fact the potential to capture value for
multifunctional

financial firms exceeds that for the traditional US-type separated commercial
banks

reflected in such studies, this should be reflected in higher merger premiums

outside the

United States as well as within the US after the 1999 liberalization of line-of-
business

restrictions.

Event study methodology [Brown and Warner, 1985] can also be used to

determine investor reaction to events such as the announcement of a presumably

value-enhancing merger that adds either size or scope. The technique controls for

conditions in the general market and tries determine the relationship that a
particular
stock has with the market under ìnormalî conditions -- that is, before the event
occurs.

This relationship can be established by regressing the returns of the stock on the

market index and a constant.

One then determines what the stock ìshouldî have

“Strategy Worries Hit JP Morgan Share Price,” Financial Times, 19 September

2002.

We obtain the following relationship: a

+b

iRMt, where RMt

= the return on the market at time t; ∀i

egression result on the constant; ∃

= relationship between the market and stock i, also known as the beta

of stock i.25

earned (total return) given the state of the general market as well as the stockís past

relationship with that market. These hypothetical returns are compared with actual
returns to determine the abnormal returns -- that is, how much more or less the
stock

actually earns as a result of the announcement.

Abnormal returns are added together over various time periods, usually several

days before the announcement to several days after. One needs to look at a few
days

before the event in case any news about the event has leaked and affected the value
of

the stock. Looking at the abnormal returns for a few days after the announcement

allows one to take ìsecond thoughtsî into account. The market may be so surprised
by

an announcement that the market may need a few days to digest the news. One

cannot know for sure the ideal length of the pre- or post-event periods. Extending
either

period leads to problems, since other events such as earnings reports or changes in

management could have occurred and the market could be reacting to them instead
of

the one being examined.

As an example of how the event study approach can be used, we applied it to the

seven strategic M&A deals undertaken by UBS AG and its predecessor

organizations

during the period 1992-2000. These include the Swiss Bank Corporation
acquisition of

O'Connor (9 January 1992), the SBC acquisition of Brinson (31 August 1994), the
SBC
acquisition of S.G. Warburg (2 May 1995), the SBC takeover of Dillon Read (15
May

1997), the merger of Swiss Bank Corporation and Union Bank of Switzerland to
form

the present UBS AG (8 December 1997), the UBS acquisition of Global Asset

Management (GAM) announced in 13 September 1999, and the UBS acquisition

of

PaineWebber announced on 11 July 2000. The first four deals were undertaken by

Swiss Bank Corporation, and can therefore be viewed in terms of SBC share price

impacts, the SBC-UBS merger in 1997 can be examined in terms of both SBC and
UBS

That is, ARit

= Rit

- (∀i

∃+

iRMt

), where ARit

= abnormal return for stock i at time t; Rit

= return on stock

i at time t; and RMt

= the return on the market at time t.26

cumulative abnormal returns, while the GAM and PaineWebber deals would have
affected the shares of the new UBS AG.

We estimated alpha and beta using daily returns from 500 to 10 days before the

merger announcement by regressing the returns of the stock on the returns of the
Swiss

SMI index. To determine the extent to which a particular merger was perceived by
the

market to have created or destroyed value, we cumulated the abnormal returns for

various event windows for each SBC and UBS transaction beginning with
OíConnor in

1992 and ending with PaineWebber in 2000. As mentioned above, no scientific

way of

determining the ideal event window exists. No confounding events (earnings

reports,

changes in management, other major mergers) occurred around the time of the
merger

announcements. We therefore conclude that the market was reacting only to the

announcement of the particular merger. The respective calculated abnormal returns

are

as follows:

No regularity is obvious from the marketís reactions to SBC or UBS merger or

acquisition announcements based on the seven cases examined here. That is, the

market appears to judge each merger on its own merits. Market reaction to the
merger

of UBS and SBC, for example, was highly positive for shareholders of both firms,

possibly reflecting costs cuts (especially in the domestic banking business) that
could
be made possible by the merger together with the presumably stronger competitive

position of the new UBS AG in its various lines of activity, notably private
banking and

investment banking. This in line with earlier event study research such as DeLong

[2001b] and Houston, James and Ryngaert [1999] who find that in-market
(focusing)

mergers tend to create value upon announcement based on the US financial

services

Abnormal Returns for Acquiror

Merger Date Event Date [-1,+1] window [-3,+3] window [-5,+5] window

SBC O'Connor 9-Jan-92 0.444% 0.930% -2.587% 0.902%

SBC Brinson 31-Aug-94 -0.713% 1.084% -3.704% -5.205%

SBC Warburg 2-May-95 -0.012% -2.515% -5.170% -7.127%

SBC Dillon Read 15-May-97 -0.413% -1.551% -1.842% 5.231%

SBC-UBS (for SBC) 8-Dec-97 4.108% 7.756% 5.929% 4.936%

SBC-UBS (for UBS) 8-Dec-97 9.368% 13.133% 12.813% 10.256%

UBS-GAM 13-Sep-99 -0.082% 0.977% 1.452% -0.899%

UBS-PaineWebber 11-Jul-00 -0.244% -7.306% -2.795% -3.509%27

deal-flow -- targets of in-market mergers gain and acquirers do not lose. On the
other

hand, market reaction to the UBS acquisition of PaineWebber was strongly

negative,

probably in large part due to the high price paid.

Conclusions
Assessing the potential effects of size and scope in financial services firms is as

straightforward in concept as it is difficult to calibrate in practice. The positives

include

economies of scale, improvements in operating efficiency (including the impact of

technology), cost economies of scope, revenue economies of scope, impact on

market

structure and pricing power, improved financial stability through diversification of

revenue streams, improvements in the attraction and retention of human capital,

and

possibly TBTF support. The negatives include diseconomies of scale, higher

operating

costs due to increased size and complexity, diseconomies of scope on either the
cost or

revenue sides (or both), the impact of possible conflicts of interest on the franchise

value of the firm, and a possible conglomerate discount in the share price. Bigger
and

broader is sometimes better, sometimes not. It all depends.

The evidence so far suggests rather limited prospects for firm-wide cost

economies of scale and scope among major financial services firms in terms of
overall

cost structures, although they certainly exist in specific lines of activity. Operating

economies (X-efficiency) seems to be the principal determinant of observed

differences

in cost levels among banks and nonbank financial institutions. Revenue-economies

of
scope through cross-selling may well exist, but they are likely to apply very
differently to

specific client segments and product lines. Conflicts of interest can pose major
risks for

shareholders of multifunctional financial firms, which may materialize in civil or

even

criminal litigation and losses in franchise value, There is plenty of evidence that

diversification across uncorrelated business streams promotes stability, although

unexpected correlation spikes (as between insurance and investment banking) may

arise from time to time.

Exhibit 9 shows the most valuable financial services in the North America and

Europe in terms of market capitalization. Two observations could be made. First,

the28

largest by whatever measures are used in the major industry segments are not

necessarily the most valuable. Indeed, rank correlations between size and market
value

are low. And second, both lists are highly diverse. Generalists and specialists
cohabitate at the top of the financial services league tables in both regions of the
world.

Both observations suggest that the key is in ìhowî things are done rather than
ìwhatî is

done. While the burden of proof tends fall on bigger and broader firms, a few cases
like

GE Capital Services (a conglomerate within a conglomerate) shows that specialist

businesses run by specialists on a highly-rated capital platform -- subject to

unrelenting
pressure to sweat the equity by a demanding corporate owner insisting on market

dominance together with benchmark attention of service quality, cost control and
risk

control, shows that it can be done and that it can be done on a sustained basis.

Although even here the issue of transparency eventually forced a breakup of GE

Capitalís organizational structure in 2002.

In a way, the absence of clear signs of ìstrategic dominanceî ñ generalists

gaining the upper hand over specialists or the other way round ñ is encouraging.
Any

number can play, and there are no magic formulas. The devil remains in the
details,

and there is a premium on plain old good management. From a systemic

perspective as

well, diversity in the financial system is probably a good thing, as firms competing

across strategic groups as well as within them put a premium on both efficiency in

financial allocation and innovation in the evolution of financial products and

processes.31

SECURITIES ASSET MANAGEMENT

INSURANCE COMMERCIAL BANKING

Whole- Retail

sale

Life

NonLife

Brokerage
Investment

Banking

Retail &

Private

Clients

Institutional

Exhibit 1

Multifunctional Financial Linkages32

Client Segments

Products

Geographies

Exhibit 2

Product-Specific. Client-Specific and Geographic Strategic Linkages33

24%

28%

32%

16%

Exhibit 3

Importance of Lending to Earn M&A Business*34

3
6

10

11

12

10.81%

8.43%

8.20%

9.65%

6.99%

4.99%

10.35%

3.83%

5.58%

5.29%

3.12%

1.41%

1,873,452

1,462,301

1,422,292
1,672,698

1,212,275

864,778

1,794,838

664,468

967,104

917,702

540,445

406,207

1,236,248

1,268,177

1,283,288

1,163,164

1,085,050

418,807

1,295,220

483,986

481,574

409,417

448,538

162,425

Citigroup ¡ á

Goldman, Sachs
Morgan Stanley

Merrill Lynch

Credit Suisse First Boston ¡ á

Lehman Brothers

J.P. Morgan Chase ¡ á

Bank of America Sec. ¡ á

UBS Warburg ¡ á

Deutsche Bank ¡ á

Dresdner Kleinwort Wasserst. ¡ á

Barclays ¡ á

= Wholesale banking units of universal ¡ á

banks or financial conglomerates.

2001

Rank

2001

Market

Share

2001

Wholesale

Banking

Volume

2000

Wholesale
Banking

Volume Bank

o bookrunner, Wholesale banking volume comprises loan syndications (full credit

to lead manager, debt and equity underwriting (full credit t

Thomson Financial Securities Data Platinum. Medium-term notes (full credit to

dealer) and M&A advisories (full credit to lead adviser). Data:

Exhibit 4

Comparative Wholesale Banking Volumes, Top-12 Firms3536

Exhibit 6

Indicative Financial Services Conflict Matrix

Commercial lender

Loan arranger

Debt underwriter

Equity underwriter

M&A advisor

Strategic financial advisor

Equity analyst

Debt analyst

Board member

Institutional asset manager

Mutual fund distributor

Stockbroker

Private banker
Retail lender

Credit card issuer

Information processor

Transactions processor

Clearance & settlement

Custodian

Life insurer

P&C insurer

Reinsurer

Commercial lender

Loan arranger

Debt underwriter

Equity underwriter

M&A advisor

Strategic financial advisor

Equity analyst

Debt analyst

Board member

Institutional asset manager

Mutual fund distributor

Stockbroker

Private banker

Retail lender
Credit card issuer

Information processor

Transactions processor

Clearance & settlement

Custodian

Life insurers

P&C insurer

Reinsurer37

CiticorpTravelers

Merger

ChaseJP Morgan

Merger

Citigroup one-day share price

losses exceeding 10%

Exhibit 7

Comparative Share Prices, Citigroup and JP Morgan Chase38

50

100

150

200

250

Exhibit 8
Valuation Gains and Losses Attributable to Size an Scope

Value of Equity

ts Conglomerate Other MVE ABVE Scale Scope

X-efficiency Market TBTF Conf lic

Power Support of Interest Discount

MSS\unibkg.ppt

Principal Sources of Value Gain or Loss39

Exhibit 9

THE 15 MOST VALUABLE FINANCIAL SERVICES BUSINESSES IN

NORTH AMERICA AND EUROPE

(market capitalization in US $ million, July 2002)

EUROPE NORTH AMERICA

Citigroup

AIG

GECS

Bank Of America

Berkshire Hathaway

Fifth Third Bancorp

J P Morgan Chase

American Express

Wachovia

Morgan Stanley
Banc One

Wells Fargo

U.S. Bancorp

Washington Mutual

Fleet Boston

223.04

174.09

155.74

117.09

114.36

89.64

71.55

57.00

52.49

50.00

47.70

45.29

37.93

37.84

36.99

HSBC

RBS Group

UBS AG
Lloyds TSB Group

Barclays

Allianz AG

ING

BNP Paribas

Deutsche Bank AG

CS Group

BSCH

Munich Re

BBVA

Swiss Re

AEGON

116.34

83.40

69.56

60.25

57.42

54.66

52.70

49.92

44.86

44.14

44.06
 41.39

38.55

31.56

30.56

38

References

Akhavein, Jalal D., Allen N. Berger and David B. Humphrey, ìThe Effects of

Megamergers on Efficiency and Prices: Evidence From a Bank Profit Function,î

Review

of Industrial Organization, 12, 1997.

Beatty, R., A. Santomero, and M. Smirlock, ìBank Merger Premiums: Analysis

and

Evidence,î New York University Salomon center for the Study of Financial
Institutions

Monograph Series on Economics and Finance, 3, 1987.

Berger, Allen N., Rebecca S. Demsetz and Philip E. Strahan, The Consolidation of
the

Financial Services Industry: Causes, Consequences, and Implications for the

Future

(New York: Federal Reserve Bank of New York, 1998).

Berger, Allen N., Diana Hancock and David B. Humphrey, ìîBank Efficiency
Derived

from the Profit Function,î Journal of Banking and Finance, April 1993.

Berger, Allen N. and T.H. Hannan, ìUsing Measures of Firm Efficiency to

Distinguish
Among Alternative Explanations of the Structure-Performance Relationship,î
Managerial

Finance, October 1996.

Berger, Allen N. and David B. Humphrey, ìMegamergers in Banking and the Use
of

Cost Efficiency as an Antitrust Defense,î The Antitrust Bulletin, 37, 1992B.

Berger, Allen N., William C. Hunter and Stephen J. Timme, ìThe Efficiency of
Financial

Institutions: A Review of Research Past, Present and Future,î Journal of Banking

and

Finance, April 1993.

Berger, Allen N. and L. Mester, ìInside the Black Box: What Explains Differences
in the

Efficiencies of Financial Institutions?î Journal of Banking and Finance, 21, 1997.

Berger, Philip G. and Eli Ofek, ìDiversificationís Effect on Firm Value,î Journal
of

Financial Economics, 37, 1995.

Boyd, John, Stanley Graham, and R. S. Hewitt, ìBank Holding Company Mergers
with

Non-bank Financial Firms: Effects on the Risk of Failure,î Journal of Financial

Economics, 17, 1993.

Brown, Stephen J. and Jerold B. Warner "Using Daily Stock Returns: The Case of
Event

Studies," Journal of Financial Economics, 14, 1985.

Cummins, J.D. and H. Zi, ìComparisons of Frontier Efficiency Levels,î Journal of

Productivity Analysis, June 1998.39

DeLong, Gayle, ìStockholder Gains From Focusing Versus Diversifying Bank

Mergers,î

Journal of Financial Economics, 59, 2001B.

Demsetz, Rebecca S., Marc R. Saidenberg and Philip E. Strahan, ìBanks with

Something to Lose: The Disciplinary Role of Franchise Value,î Federal Reserve

Bank of

New York Policy Review, October 1996.

Goldberg, L.G., G.A. Hanweck, M. Keenan and A. Young, ìEconomies of Scale

and

Scope in the Securities Industry,î Journal of Banking and Finance, 15, 1991.

Houston, J., C. James, and M. Ryngaert, ìWhere Do Merger Gains Come From?
Bank

Mergers From the Perspective of Insiders and Outsiders,î Working Paper,

University of

Florida, Gainesville, 1999.

Houston, J. and M. Ryngaert, ìThe Overall Gains From Large Bank Mergers,î
Journal of

Banking and Finance, 18, 1994.

John, Kose and Eli Ofek, ìAsset Sales and Increase in Focus,î Journal of Financial

Economics, 37, 1995.

Kane, E., ìIncentives for Banking Megamergers: What Motives Might Regulators
Infer

from Event-Study Evidence?î Journal of Money, Credit, and Banking, Vol. 32,
August,
2000.

Kroszner, R. and R. Rajan, ìIs the Glass-Steagall Act Justified? A Study of the
U.S.

Experience with Universal Banking Before 1933,î American Economic Review,

84,

1994.

Lang, G. and P. Wetzel, ìTechnology and Cost Efficiency in Universal Banking: A

Thick

Frontier Approach,î Journal of Productivity Analysis, 10, 1998.

OíHara, M. and W. Shaw, ìDeposit Insurance and Wealth Effects: The Value of
Being

ëToo Big to Failíî Journal of Finance, 45, 1990.

Puri, M. ìCommercial Banks in Investment Banking: Conflict of Interest or

Certification

Role?î Journal of Financial Economics, 40, 1996.

Santomero, A. and E. J. Chung, ìEvidence in Support of Broader Bank Powers,î

Financial Markets, Institutions, and Instruments, 1, 1992.

Saunders, Anthony, Financial Institutions Management: A Modern Perspective,

Third

Edition (Burr Ridge, Ill.: Irwin, 2000).40

Saunders, Anthony and Ingo Walter, Universal Banking in the United States (New
York:

Oxford University Press, 1994).

Siems, Thomas F. ìBank Mergers and Shareholder Value: Evidence from 1995's
Megamerger Deals,î Federal Reserve Bank of Dallas Financial Industry Studies,
August

1996.

Smith, Roy C. and Ingo Walter, ìJP Morgan and Banco EspaÒol de CrÈdito:
Teaching

Noteî, Case Studies in Finance and Economics, Second Edition C53, New York

University Salomon Center, 1995.

Smith, Roy C. and Ingo Walter, Street Smarts: Leadership and Shareholder Value
in the

Securities Industry (Boston: Harvard Business School Press, 1997).

Smith, Roy C. and Ingo Walter, Global Banking, Second Edition (New York:
Oxford

University Press, 2003).

Stefanadis, Chris, ìSpecialist Securities Firms in the Gramm-Leach-Bliley Era.

Federal

Reserve Bank of New York. Working Paper, 2002.

US General Accounting Office, ìDeposit Insurance: overview of Six Foreign

Systemsî

Washington, D.C.: GAO/NSIAD-91-104, 1991.

Walter, Ingo (1988). Global Competition in Financial Services (Cambridge:

BallingerHarper & Row, 1998).

Walter, Ingo, ìUniversal Banking: A Shareholder Value Perspective,î

Schriftenreihe des

Instituts fuer Kapitalmarktforschung as der Johann Wolfgang Goethe-Universitaet,

Frankfurt am Main, Germany, 42, 1998.

Walter, Ingo (2003). ìMergers and Acquisitions in Banking and Finance ñ Whereís
the

Value? (New York: Oxford University Press, 2003).

Yu, L. ìOn the Wealth and Risk Effects of the Glass-Steagall Overhaul: Evidence
from

the Stock Market,î Working Paper, New York University, 2001.