Financial involution and evolution of economic patterns: Demise of leading banks and opportunities for the “Italian system”

The current financial crisis will go through the necessary ‘mutations’ of major main market players, the previous excesses will be rectified, and, notwithstanding the dangerous turbulences, it will find a positive solution in the next 24 to 36 months. The capitalistic system will come out of it different but stronger. New opportunities present themselves and have the capability to generate deep changes. Emerges strongly the need of an operating enterprise model based on sustainability, on a more gradual and reasonable growth and a more solid development, guided by a longer term horizon: these are the new necessary ingredients to succeed 2.

We live in an era of transition of the western societies from industrial to post-industrial economies in which the main driving force is epitomized by the information factor. A period of dangerous turbulences and deep financial and economic crisis began. An involution that highlighted the non sustainability and limits of the American-Anglo-Saxon banking model. New technologies and market advancements eliminate ‘dimensional discrimination’ and factors that were determining economies of scale – large dimensions and a ‘vertical’ presence. Technology allows that specialization and product innovation can occur in a small entity with the addition of an important risk diversification. The rationale for numerous mergers, seemed to be reduced. In this context, an alternative enterprise operating model emerges and it appears to be the winning weapon: the Platform Company. A new enterprise model already in part tested in the industrial sector, and which consists for a company of focusing ‘horizontally’ instead of ‘vertically’ in its own area of operation, deepening its expertise in the highest value added phases.

All of this determines important consequences. For the Co-Operative Banks, as for any medium size independent enterprise, it opens an opportunity that could not present itself at a better time. The criticisms addressed not only to them but to the whole of the Italian sector, have to face the fact that both come out unscathed from the mentioned crises contrarily to leading world banks now crumbling. The Italian financial and industrial sector could therefore now fill the gap with global competitors, something that was so far unthinkable of.

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The Macro Environment

In the recent past prevailed a model of financial services firm typically inspired to the principles and culture of the American/Anglo-Saxon market, originate to distribute and so several market participants have expanded vertically. The success of such a corporate approach brought to believe that became impossible even to think that a small bank could survive. We have therefore witnessed a strong consolidation process.

Without entering into an analysis of the extremes due to the unbalanced attention to short term results, to excesses and greed , it appears evident the non sustainability of this business model  aimed to create giant banks which revealed a lack not only of vision, but also of agility and maneuverability in situations of difficulty and of market stress, and, above all unable to implement appropriate control procedures, risk diversification and risk management. The issues extend to how analytical performance and information models have been adopted and applied . It emerges how damaging it has been to focus such financial institutions on operating models and top managers’ short term profitability incentives, while the life cycle of the underlying transactions required much longer periods 3.

It is instead foreseeable a reconsideration of the proper enterprise banking model. The latter must be focused on managing its principles according to medium to long term goals but in any way matching the “entire risk life cycle (of the underlying transactions) and that the market be able to reward the right balance between innovation, performance and financial ethic”. 3; 2.  Thus, the more contained dimension of the Co-Operative Banks, their close links with the ‘glocal’ economies in which they operate, the one shareholder one vote policy, could be seen as advantages, as a good model to improve.

Post-Industrial progression and Information Society

The industrial world, that of the large manufacturing capabilities, of the machinery for mass production, of the manual factory workers, of the fixed capital, it has ‘de facto’ moved and migrated further east. It is now those countries and regions that are progressing in their development and are experiencing the transfer from agricultural to industrial economies. China is the best example of this trend.

The western economies are progressing into the heart of the “post-industrial” era thanks to globalization, further opening of the markets, reduction in transportation and shipping costs, logistics improvements and, most of all, thanks to the revolutionary impact of information spreading in real time, thanks to electronic technology and telecommunication advances, with ‘continuous’ connectivity now almost at zero cost, (the marginal cost of communication is falling towards zero).

The entire concept of work has changed and without all means there is more scope and space for a more selective and well reasoned of the way we use our time and resources. This will undoubtedly result positively for ethic and humanity. I find the prediction of John Maynard Keynes on the future of the lifestyle in the western economies 100 years later, strikingly accurate .

The new society is characterized by the globalization of the information factor that can substitute, ‘mingle’ and become ‘embedded’ into most of the material resources and so became the main element of work for ‘thinking workers’ rather than manual once. “Cognizant employees rather than proletariat” .  As the industrial revolution with the creation and utilization of the machines, multiplied the human physical working power, the post-industrial revolution increases infinitely the mental  human ability to think, to elaborate and calculate, giving birth to an incredible power and creating dynamics whose consequences and results are of a value and capacity never imagined before¹.  Technology is though bringing back the human element and the true quality, giving them a central importance that has been lacking in previous periods where the dimension and short-termism seemed to be the driving factor. Hence here comes an unprecedented opportunity for sustainability and ethic².

Why is the information factor so important? Because real time information, which marginal costs falls lower and lower to become free and unlimitedly available, revolutionize all of the manufacturing and also services production systems.

Information is an ingredient that enters in all of the processes and it alters significantly their results and the dynamics of its resulting values.  Its features differ significantly from all of the other production factors: information tends to be available in an unlimited quantity, is intangible but it can be manipulated, it is not linear, (a small advancement can lead to huge results), it is relation-able, different and non correlated piece of information can be still matched and give birth to different and new considerable results, it can spread fast and it is difficult to hide, highly portable, and at the same time it can be stored without needing space and it is not perishable 5.

In this environment, a new operating model appears to be the driving force behind the post-industrial revolution. In Italy, unanimously seen as one of the most incredible “Factory of Ideas”, its features are particularly apt to the inner DNA, nature, dimensions and operating way, of the majority of its firms.

The Italian Goldmine

The vertical integration of design, manufacturing, distribution/sales has been the model adopted for the past 50 years by the most successful companies. Some of these firms became multinationals: each started as a domestic firm and then started to produce anywhere and to sell anywhere. Yet this was yesterday’s operating pattern. The new model is not to retain all of the production phases but to expand the sales horizons. In recent years, we witnessed the birth a new type of enterprise that has been called: Platform Company¹. Platform Companies keep those phases of the production process that are of more added value like research, design, product development, treasury, marketing, and source from the outside the remaining less critical and less value added parts. Typical examples include: DELL computers, Wall-Mart, Ikea, Carrefour, Li&Fung and others. Among important Italian firms: Dell’Orto, Technogym, Giugiaro, and Mondo. Much more than what is simplistically defined in the so called ‘delocalization’ came to life a specialization process focusing on the non cyclical phases, with higher added value, of the production process: design, development and research, marketing and sales. The new companies can operate with more emphasis on these important stages and to free substantial capital previously utilized mainly for the manufacturing functions.

It is likely to have come to a superior level of the division of labor, and the specialization’s triumph. The new kind of enterprise is more agile, needs less capital, it is more capable of following rapid market changes, to modify its route and to avoid losses. If properly applied the operating model of the Platform Company appears proficient to generate stable profit flow, satisfy adequately the invested capital, and first of all to keep a medium to long term vision. Competition has increased but so has the ability to reach areas of sale unreachable before.

The potential meaning of this for the whole ‘fabric’ of the Italian economy, made mostly by small and medium, and often family owned companies, with a strong potential for ‘horizontal expansion’, could not be more favorable. In fact, the new technology offers the Italian firms a very important factor: the possibility of reaching global and far away market niches, up to now difficult or impossible to reach. If to this we add the considerable amount and variety of ‘goodwill’ of the ‘Italian Product’, we can come close to understanding the huge dimensions of this ‘hidden’ economic potential. This cannot do without the strategic support of deeply rooted local banks that know and interpret the features, requirements, follow the dynamics, the expansion potentials, and needs  of these local firms: medium local banks for medium local firms.

Not to underestimate that while globally the “Italian Liking Rating” is at an historical maximum in a variety of sectors of excellence: food, design, fashion, textile, furnishing, machines, equipment/utensils, luxury goods, tourism, logistic, advanced technologies, life styles,…

What to do for the Co-Operative Banks (and for the Italian companies)

However, the one shareholder-one vote, the more manageable dimensions, the immunity from the current financial crisis, being strongly rooted to the local economies, even if represent good ingredients to face the new market challenges, are not enough. To win, to remain independent, to keep its own dimensions, to continue in a growth path, it is necessary a high level of specialization, acquisition of know how, a quality improvement in all of the stages of the banking enterprise model, the widespread application of meritocracy criteria, a proper widening of the profit sources. In appropriate ways and forms, it is necessary to start a sensible internationalization process.

Two are the factors to create long term added value: to have the economical resources, and second to have the ability to acquire know how and to decide what are the specialties to buy and the synergies to develop. The multiples of price of several financial services firms could not be more attractive. Yet, the most important aspect will be how to manage these entities and how to develop precious synergies. That would ‘reopen’ the way to medium size companies, strengthening their independence and give to those bigger the “right” to compete at the European level, which should be considered like their domestic market.

The banks will have to support the business plans for a necessary globalization of the Italian companies in the areas of strong economic growth, to have the courage to adopt a widespread process of meritocracy, to find outside the system the  complementary skills and talents which are necessary to produce a growth sustainable and specific. I wish that the Co-Operative Banks will take on board this challenge, to fill the gap with the main competitors that up to a year ago seemed impossible to fill. This will be the way to follow to defend, the dimension, the independence, the features of firms with a local presence.

Conclusions

Not to do anything is the highest risk that the Italian banking and industrial system is facing today. Capital availability, and immunity from the current crisis, represent today an opportunity, if not a must, of geographical strengthening and quality improvement. Therefore, it is necessary to ‘raise the sails’, to assume calculated risks, not inertia, not restitution of capital to the shareholders, but most of all action especially towards the markets outside the domestic boundaries, to diversify the sources of profit and to acquire missing skills and expertise that are complements to the existing business. Leveraging on the Platform Company model seems to favor the deep ‘fabric’ of the typical Italian companies and their turnaround also for what concerns the Financial Services sector. Technology and markets are now justifying and making necessary the interaction of medium size banks.

Nevertheless, it will not be an easy job to be able to catch these opportunities.  Yet, generally it has been in situation of difficulty that Italy found the strength to give the best of it, starting from the bottom positions, and being able to do the impossible. In any case, it is certain that when the competition, the giants of the financial services industry, come out of their current ‘coma’, they will not return any favor.

Tribute to Professor Bob Kavesh  .

The World Belongs to Optimists

“The world belongs to optimists.”

That’s all you have to say.

Just keep your eyes on those blue skies

And you will find the way…

To climb the mountain of success-

Now here’s the magic key:

That while you earn, you have to learn

To help humanity

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