Never mind the width, feel the quality
City & Business
Sunday 02 March 1997
NatWest Markets, it transpired, had dropped pounds 50m on the overvaluation of some interest-rate options. Meanwhile, Simon Robertson had decided to drop out of Dresdner Kleinwort Benson because of a dispute with his colleagues in Germany over how best to effect integration of the investment banking resources in London and Frankfurt. Mr Robertson, who was chairman of Kleinwort Benson, felt it was best to have all the resources under one roof in London. His colleagues disagreed.
The two events highlight the problems of investment banks with global ambitions. Being global in this industry means being big. To be big you have to grow. The two primary sources of growth are a wider range of products and services or a wider range of geographical exposure. The pursuit of each has pitfalls.
Interest-rate options are not the simplest of financial instruments. Valuation is clearly a subjective matter. They may represent a profitable income stream, but their complexity makes them difficult to oversee. The incident at NatWest Markets is no re-run of Barings. The problem has been identified, quantified and rectified. Yet it still cost pounds 50m. It is not material to the group as a whole but should do untold damage to the bonuses this year of the interest-rate options department.
As ever more complex products are invented and understood by ever fewer people, so the associated risks increase. They may generate profits, but the quality of those profits must be questioned.
The falling out at Dresdner Kleinwort Benson reflects the difficulties facing all investment banks with ambitions to be global. The management and organisational structure is crucial. However, there is no great consensus on how this should be done. The Dresdner view is that global markets demand a global perspective, unencumbered by physical location. The key, it believes, is building a common culture, not a common headquarters. I would agree. But I am unsure whether that common culture is more readily adopted in two centres than one.
While there is a high degree of consistency in the industry on the need to be global, there is a high degree of inconsistency on how best to achieve this. That inconsistency is to be found not only within the industry but also within firms. This will not always lead to resignations, but it does expose the organisation to a lack of harmony that will undermine the facade of a one-team approach. The successful banks will be those that manage and control their growth most successfully. That is not as snappy as dynamic expansion. But it is the sustainability of the growth, not the speed of growth, which is the crucial factor.
Battle to get a burger
MCDONALD'S has created something of a burgers muddle for investors with its plans to embark on a fast-food price war. News of its 55 cents Big Mac sent McDonald's shares tumbling and dragged others, notably Grand Metropolitan which owns rival Burger King, down with it. It is Grand Met's AGM this week, and the last thing the board needs is a hall full of grumpy investors who have seen their shares fall by 5 per cent over the last three trading days.
There is no doubt that a price war is damaging for everybody, but not that damaging. To start with, the 55 cents Big Mac is more of a clever marketing trick than a dramatic cut. The normal price is $1.90; however, to qualify for the cheaper price the customer must first purchase fries and a drink, which are profitable lines.
Fans of those golden arches know that fries, a drink and a Big Mac can already be purchased as a Combo Meal at a price of $2.99. The cost of a full-price fries and drink and cut-price Big Mac will be $2.87. The discount then is 12 cents, not $1.45. That is a price battle, not a price war.
Grand Met insists it will not fight a price war, but I am sure it will fight a price battle. It owns only 10 per cent of its Burger King network in the US against the 40 per cent owned by McDonald's. That gives it much greater protection against the impact of price-cutting. After all, it was the introduction of the Burger King 99 cents Whopper three years ago that contributed to McDonald's current predicament. That promotion has helped Burger King to grow much faster than its bigger rival. While Burger King can boast of like-for-like sales increases of around 2 per cent in 1996, McDonald's experienced a decline of a similar magnitude.
It is less than a year since Grand Met took a decision not to sell Burger King. Having made the commitment to keep it, Grand Met will not stand idly back and allow McDonald's to regain the initiative. Yes, there will be a hit but it will be small. Last week's share fall at McDonald's and Burger King was overdone. A buying opportunity presents itself.
All is not lost in the US
ALAN GREENSPAN, the Federal Reserve chairman, is not the first person to express concern about share prices on Wall Street, and he won't be the last. The only crash has been in the reputation of those of us who have predicted a dramatic decline.
The problem is that the US private investors are still enjoying their love-in with the equity market. There has been a slow-down in US mutual fund investment, but US investors still ploughed $4.1bn into equity funds, down from $4.9bn the week before. They are becoming more discerning in their fund selection, but there is as yet no wholesale retreat from the market. Without that retreat we will be treated only to corrections, not a crash.
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