Back to the Basics

Morgan Stanley Seizes the Opportunity Amid the Crisis
Posted by Leo M. Tilman, January 19th, 2009, 12:56pm

Having weathered the brush with financial ruin last year, Morgan Stanley appears to be actually gaining from the current financial crisis. The firm is doing so by radically transforming its business model — very much in the spirit of Financial


Business model transformations denote a process where financial executives continuously rebalance the business mixes of their firms based on their own strategic vision as outside economic, market and competitive forces act on the environment in which they operate. In stark terms, the very survival of financial institutions depends on their abandoning the old “static” business models that respond to disappearing earnings with blind leverage and risk-taking. Dynamic behavior is exactly the response needed to create economic value and remain agile in the face of uncertainty. And there is no more uncertain time than that of the present crisis.

What, then, is Morgan Stanley’s business model transformations? First, it converted itself into a bank holding company, inserting a new powerful source of revenue into its business model and subsequently announcing plans to grow retail deposits via acquisitions of retail banks. Now the contemplated joint venture with Citigroup’s Smith Barney unit – available because Citigroup failed to create a viable new business model – is on course to create the largest global brokerage firm. It is yet another business model transformation – of a different but equally powerful kind.

Morgan Stanley’s actions are a reversal of its direction of recent decades where, similar to other investment banks, it progressively focused on principal investments in an attempt to compensate for declining brokerage and investment banking revenues. Just think of its disastrous foray into proprietary trading. According to the Wall Street Journal (January 12, 2009), it appears to be “back-to-the-basics” time at Morgan Stanley. The firm

is trying to redefine itself as an advisor to investors and companies that takes fewer risks on its own balance sheet. “This strategy harkens back to the past, when Wall Street firms depended on their clients, not in-house traders, for the bulk of revenues and profits.”

Morgan Stanley is using the current crisis as an opportunity to transform its business model: the overall risk budget is reduced, while capital and focus are reallocated away from risk-taking into fee-based businesses and funding advantages of retail deposits. Both are businesses that will keep executives occupied with such issues as economies of scale, brand-building, customer-related activities, and thought leadership as opposed to proprietary trading and attendant risk management. If the firm gets it right, the P/E ratio of its stock is likely to increase, reflecting a more stable, less-risk-centric business mix that has characterized investment and commercial banks in recent years.

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Financial Darwinism explores the origins, drivers, and implications of the ongoing tectonic financial shift. It then equips executives and investors with actionable approaches to creating lasting economic value amidst complexity and uncertainty.

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