Changing capital markets industry structures : the Internet challenge to incumbent leaders

Abstract

In his 1997 book, The Innovators Dilemma, HBS Professor Clay Christensen discusses the impact of "disruptive technologies" on leading incumbent firms in various industries. In many ways the phenomena of the Internet and the World Wide Web threaten to become the most disruptive technology to many industries in many decades, and perhaps much longer. This thesis examines one such industry: that of the institutional capital markets. The institutional capital markets industry consists primarily of broker-dealers, serving issuers and investors in concert with asset collectors, organized exchanges and regulatory bodies in various, but interlinked, geographical and product-defined capital markets. The size and economic impact of the industry, which transacts in excess of $1 trillion daily, is enormous. The trend in the industry since the global depression of the 1930' s has been one of consolidation and increased integration of product offerings. Beginning in 1997 new, Internet-enabled business models began to pose a serious threat to the existing industry structure. Traditional product bundles are being dis-aggregated and re-priced. New agents are re intermediating traditional brokers and exchanges. Networks are dramatically improving the efficiency of information. Barriers to entry are falling fast. This thesis examines the developments in electronic, institutional capital markets primarily from the perspective of leading incumbent firms. The legacy market structure is examined and new changes to that structure are analyzed. Three leading firms in particular are employed as examples. Electronic Communication Networks ("ECNs") are discussed as the primary challenger to the status quo. Incumbent strategies and potential scenario outcomes are discussed and evaluated. Some recommendations are ventured. The thesis is based upon a) a review of the academic literature of technology innovation, b) a survey of current media reporting and, where available, proprietary research, and c) interviews with the management of two of the leading incumbent firms. Some internal, proprietary material was also provided by Merrill Lynch, Inc. The academic literature referenced herein focuses on the legacy of work in innovation in technology and includes most notably Porter's work on competitive advantage and industry analysis, particularly the famous "five forces"; Foster's introduction of the technology 'S' Curve; Christensen's work on disruptive technologies and the responses by leading incumbent firms; and Henderson's teaching in technology strategy and managing the innovative process. Secondary references are made through these scholars to earlier foundation-building work by Tushman, Clark and others.