« The Middle Line | Main | The Middle Line and 3D Marketing »

July 15, 2007


TrackBack URL for this entry:

Listed below are links to weblogs that reference 3D Marketing:



"I know this is not the way practitioners see banking operation, but will they be willing to accept this point of view for my analysis?"

Not sure. I think your analysis will be most convincing to the practitioners if presented with the vocabulary familiar to the practitioners. Alternatively, you can tell them why their way of viewing their business, while historically useful, is not ideal in light of current developments. They, the bankers, tend to be very practical and results oriented.

Strategic Group Definition
I spent a fair amount of time reviewing the leading commercial and investment banks -- Citi, GS, MS, MER, BAC, JPM, Deutsche Bank. It is very informative to review the business segment disclosures available in their filings with the SEC. In doing so, one will find meaningful similarities but also significant differences in the businesses in these companies.

I am not sure what percentage overlap should be considered for purposes of measurement. But as I understand your analysis gives competitors like Citi a benefit because they generate significant revenues in a business in which GS and MS do not compete. As such, this methodology would tend to overstate the strength of large companies (Citi, BAC, JPM) when compared against smaller, more focused companies (GS, MS, MER).

I think eliminating Citi from the universe and adding LEH and BSC would produce a better picture of investment banking.

If you were focused on Citi, I would probably look at the analysis excluding the investment banks and adding some more direct competitors such as JPM and BAC.

Alternatively, you could adjust by subtracting the revenues and earnings, and estimated market caps based on comparisons to peer p/e multiples. While you have said you are uncomfortable with that approach, it is a pretty standard approach to securities and company valuation analysis.


Victor Cook, Jr., New Orleans, Louisiana


You raise three important issues in your comments that I hope to resolve in this reply: (1) gross vs. net revenue, (2) interest income and customer base and (3) strategic group definition.

In your last comment you say that "...practitioners in the financial services industry focus on the line item "net revenues", as opposed to "gross revenues", because of the significant leverage in the balance sheets of financial services firms." I understand and accept your point. However, my analysis of maximum earnings market share (which I plan to do later in this series) depends on having acceptable definitions of cost, profit, and earnings in bank operations.

"Two different views appear in the literature: the *intermediation approach* and the *production approach.* The intermediation approach views banks as using deposits together with purchased inputs to produce various categories of bank assets, measured by their dollar values. Total cost is defined as the interest expense of deposits, less service charges, plus the expense of purchased inputs. In contrast, the production approach views banks as using purchased inputs to produce deposits and various categories of bank assets. The production approach measures outputs in numbers of accounts and defines total cost as noninterest operating costs (that is, the cost of purchased inputs)." SeeMitchell and Onvural, "Economies of Scale and Scope in Large Commercial Banks," Journal of Money, Credit and Banking, Vo. 28 (May, 1966), pages 184-185.

I use the intermediation approach to bank operations in my analysis. In this view, interest expense is the "cost of goods sold," net revenues are "gross profits," purchased inputs are "enterprise marketing expenses," and the residual is operating income before depreciation. Applying this definition to Goldman Sachs in their 2nd quarter of 2007: gross revenues of $20.351 less interest expense of $10.169 yields a gross profit (net revenue) of $10.182, less enterprise marketing expenses of $6,351 returns an operating income before depreciation of $3,831 billion.

I know this is not the way practitioners see banking operation, but will they be willing to accept this point of view for my analysis?

In your last comment you also say "... in a levered financial institution, a company can only prudently engage in activities which are supported by its capital and liability structure." I also accept this point. But, I would like to know if Citigroup's capital and liability structure are so much different from the other investment banks that the comparisons are not meaningful. Do you think Citi is that different?

You conclude your last comment by saying ”... I'd be interested in the results of your analysis, after adjustments to focus on markets where the commercial and investment banks actually compete with one another. I think your conclusions would be stronger if tested on the areas of direct overlap."

While reviewing the posts you pointed me to on Bankstocks.com I noticed that Tom Brown used ratios of the market cap of other banks to Citigroup's market cap. It's interesting that the break points he used were 50% or more; between 25% and 50%; and between 10% and 25% to compare return to large, medium, and small banks. These break points are very similar to those I used in assessing the "resource equivalence" of competitors on four dimensions: (1) market cap; (2) gross revenue; (3) gross profit; and (4) enterprise marketing expense. If a company had 50% or more of the industry leader's resources on any two of these measures I concluded they were "direct competitors" in the strategic group. If a company had between 20% and 50% they were "potential competitors." And if a company had less than 20% it was an "indirect competitor." For the details see my 11 minute Adobe Connect presentation at

With Citigroup as the leader, Morgan Stanley's market cap, gross revenue, gross profit, and enterprise marketing expense ratios in the latest quarter of 2007 were 36%, 51%, 58%, and 42% respectively. JPM's ratios were 65%, 80%, 76%, and 85%. Goldman's were 37%, 47%, 45%, and 50%. Merrill's were 28%, 44%, 51%, and 34%. As you can see, I stretched my own guidelines a bit by including Goldman and Merrill in the strategic group because each firm has only one dimension equal to 50% or more of Citigroup. Strictly speaking they are just potential competitors. Though on one or two others dimensions they were very close.

I know these technical points don't resolve your concerns about including Citigroup in my analysis. And unfortunately I would not be comfortable deleting non-comparable Citi revenues and adjusting for the market cap to which they contribute. In any event, doing so would require similar adjustments in interest costs, enterprise marketing expenses, and operating income before depreciation in order to estimate maximum earnings market share.

There is another way around this issue that may be useful. I could rerun my analysis of 3D marketing metrics without Citigroup. Would this create results where the four remaining investment banks compete with each other more-or-less across the board?

Thank you for your comments. With best regards,



I think you'll find that practicioners in the financial services industry focus on the line item "net revenues", as opposed to "gross revenues", because of the significant leverage in the balance sheets of financial services firms.

Thus, while gross revenues are reported in 10-Qs, everyone discussses net revenues in their press releases, and internally when evaluating business performance. While GS reported gross revenues of $20.351bn for the second fiscal quarter ended May 2007, its press release and MD&A commentary focuses on the $10.182bn of net revenues.
The same is true of Merrill Lynch.

If you still doubt the importance of net revenues compared to gross revenues, just look at how the people are paid. It's as a perentage of net revenues.

The "investor who follows Citi" is Tom Brown, a former equity research analyst and now hedge fund manager. In addition to investing, and unlike most other hedge fund managers, he blogs, for attribution, about some of his ideas.

The Citi numbers were taken from one of his write-ups.

You write that "a bank's interest income is totally independent of its customer base". I'd disagree because in a levered financial institution, a company can only prudently engage in actvities which are supported by its capital and liability structure.

Thus, you don't find many investment banks trying to fund and hold 5 year coporate loans on their balance sheet because on average they have less stable funding (liability sources) and better uses of capital.

Occassionally you will see financial institutions pursuing an investment strategy independent of their funding, without due regard for asset liquidity and liability structure. Those circumstances usually end up being memorable because they lead to spectacular failures -- Drexel Burnham, Executive Life, Providian, New Century, etc.

So, I'd be interested in the results of your analysis, after adjustments to focus on markets where the commerical and investment banks actually compete with one another. I think your conclusions would be stronger if tested on the areas of direct overlap. Then you can build the case for comparison on other apparently contiguous markets.


Victor Cook, Jr., New Orleans, Louisiana


Four of the investment banks in my analysis reported their interest income separately from non-interest income. Citigroup in the 1st quarter of 2007 had revenues of $43.0 billion. About 65% of Citi's revenue was interest income ($17.6 billion). Goldman's 2nd quarter revenue was $20.4 billion. About 55% of that was from interest income. Merrill's interest income was about 60% and JPM's about 56% of total revenues.

If 55% to 65% of your revenues are due to interest income, it makes exploring what goes on at the edges of your market even more interesting -- a bank's interest income is totally independent of its customer base. So this interest income "cushion" gives anyone (even Wal*Mart) the freedom to expand in any customer or service direction management thinks will grow shareholder value by capturing it from current vendors. What you suggest simply requires the analysis of future opportunities be limited by the past. Have you read "Value Migration?"

By the way, I think introducing estimates of 2007 earnings by "an investor who follows Citi" as evidence in this discussion adds little of value without more information. On what revenues are these earnings estimates based? What percentage of earnings by segment is due to interest income?

You also stretched my grocery store metaphor beyond reasonable limits. After all I didn't include PayPall as a member of this strategic group!

Even so, I too enjoy the conversation. With best regards,



I agree that competitors will change as time passes.
Whole Foods and Kroger compete. They both offer food for individuals to feed themselves. Kroger also competes, to a lesser extent, with McDonalds, and other quick-serve restaurants, and to an even lesser extent with Blockbuster, which also sells snack items at its checkout stand.

Sysco is also in the food business, but it distrbutes goods as a wholesaler to restaurants. And McLanes, a subsidiary of Berkshire Hathaway, distributes snack goods to grocery and convenience stores. Sysco and McLanes are both in the food business, but I don't think we'll learn much by comparing them to Kroger.

That's my point with Citi and GS. They both are in "investment banking", but in fact they business are very similar in some respects and not at all related in others. I think analzing the both as if they are both serving the same customers is a mistake, bacause they do not serve the same customers. And to extend the food industry metaphor, Citi's activities are focused in retail food retailing and GS's activties are centered, almost exclusively, in food wholesaling.

Just to be clear, here are some figures from an investor who follows Citi. The numbers shown are estimated 2007 earnings:

Investment banking $7.8bn
Domestic consumer finance $8.5bn
International consumer finance $4.7bn
Retail wealth management $1.6bn

So Citi's investment banking business represents about 1/3 of its total earnings. By the way, I think you can, as I mentioned in my earlier post, fairly ascribe a market value to the activities of Citi that are not related to GS's activities.

While such an exercise may not lead to a precise valuation, it will lead to a better informed decision.

In fact, that's what Morgan Stanley's board did prior to deciding that it would best serve the interests of Morgan Stanley shareholders to spin-off it Discover credit card business.

I again repeat that I think it is valuable to assess market position by looking at which firms are capturing which share of the market. At the same time, you can't define the market so broadly that you end up comparing a very large firm in a wide range of actvities with a large, but smaller firm, in a more constrained set of activities.

I enjoy the conversation.
Kind regards.

Verify your Comment

Previewing your Comment

This is only a preview. Your comment has not yet been posted.

Your comment could not be posted. Error type:
Your comment has been saved. Comments are moderated and will not appear until approved by the author. Post another comment

The letters and numbers you entered did not match the image. Please try again.

As a final step before posting your comment, enter the letters and numbers you see in the image below. This prevents automated programs from posting comments.

Having trouble reading this image? View an alternate.


Post a comment

Comments are moderated, and will not appear until the author has approved them.