2. Sandoy 2
Introduction to the Industry
Commercial Bankingisawell knownandimportantIndustryinthe US economy.Accordingtothe
UnitedStatesCensusBureau'sNorthAmericanIndustryClassificationSystem,the commercial banking
industryis Commercial banksandtrustcompanies(acceptingdeposits) charteredunderthe National
Bank Act..Thismeansthat institutionsthattake depositsforthe purpose of lendingthemoutatinterest
and administeringassetsonbehalfof otherswouldfall underthiscategory.
The Commercial Bankingindustryin the UnitedStateshasbeenaroundsince the foundingof the
country.In the beginningitwascomprisedof manysmall bankslendingatthe local level.The banking
industrystayedthiswayuntil the GreatDepression.A Majorityof the Banksinthe U.S.Failedandthe
fewthatwere leftstruggled.Afterthese eventsthe Bankingindustrybecame one of the mostregulated
inthe country.Afterthe Depressionendedthe survivingInstitutionshadcompetitionrestrictionsand
smallerbanksstartedtospringup.In the 1980s and 1990s the Bankingindustrywasderegulatedand
competitionbecame intense.Due tothisthere wasa seriesof large mergersandacquisitions.While this
was happeningthe level of newbankchartersincreasedslightlybutstagnatedinthe early 2000s. With
the financial crisisof 2008, mergersandacquisitions,andnew chartershave ceased.The recessionis
overnowand while newentrantsare non existent,mergershave startedtopickup once again.
There are a total of $15.65 trillioninassets inthe bankingindustry.Around$6.5 trillionof these assets
are controlledby4 large banks.These Majorfirmsare JPMorgan Chase with2.21 trillioninassets
followedbyBankof America,WellsFargoandCitigroup:withtotal assetsof $1.60 $1.56 and $1.36
trillioninassetsrespectively.(AmericanBankingAssociation,2014) Profitabilityinthe bankingindustry
was hurtby the recessionof 2008 but has beguntocome back.The Industrynetincome was$36.9
billionduringQ4of 2014, upfrom 21.4 billion inthe Q4of 2010.
Porters Five ForcesAnalysis
The firstof the five forcesisthe threatof new entrants;thisisto whatdegree of ease others canenter
the market.The threat of newentrantsis low in banking.Inthe 90s and2000s there were a lotof new
charters,but since the recessionthere hasbeenasharpdecline.“Between2000 and 2005 there were
805 newbankschartered….between2010 and 2011 there were 13”(AmericanBankersAssociation,
2014). There are tworeasonsfor this,regulationandentry barriers.Inordertostart a banka firmneeds
large amountsof capital and a Federal Charter.Itishard forfirmsto generate enoughcashtostart a
bankand gettinga federal chartertakestime thatfirmscoulduse doingotherthings.“Startingabank
…couldtake a yearor more,and permissionfromatleasttworegulatoryauthorities…The Officeof the
Comptrollerof the Currency(OCC) …and Federal DepositInsurance Corporation(FDIC).Additional
approvalsare requiredfromthe Federal Reserve.”(Federal Reserve,2015).The nextfactoris regulation;
bankingisone of the mostregulatedindustriesinthe UnitedStates,andthismakesitunattractive for
newcomers.Banksmust complywithregulationsfromthe agenciesmentionedabove aswell as
regulationsthatinclude “DoddFrank,Basel 3,BSL/AMLect….intotal these regulationscome tomore
than 2100 pages”(AmericanBankersAssociation.2014).It is veryhard to keepupwiththismany
regulationsandthe costcan be enormous.
3. Sandoy 3
The powerof suppliersisthe nextforce,itdescribesthe abilityof those whosupplyinputsdodictate
price.The powerof suppliersinbankingissomewhatlarge.This isbecause of the labor,whichsupplies
itsservicestobanking. There ishighdemand forskilledlaborinthe bankingindustryandbanking
salarieshave beenincreasinginanattemptforfirmsto attract the bestlabor.”Accordingtoprojections
by the Bureaufor Labor Statistics,the bankingindustryisexpectedtogrow 8 percentthrough
2018.”(Bankingcareer.org,2015). Banks alsomake these salarieshighsothatrivals can’tsteal
employees. “If atalentedindividual isworkinginasmallerregional bank,there isthe chance thatperson
will be enticedawaybybiggerbanks,investment firms,etc”(InvestopediaStaff,Pg8)
The nextforce is the powerof buyers;thisishow much the consumercan dictate pricesinthe industry.
The powerof buyers’ mediuminBankingdue toswitchingcosts,whichlowerbuyerpower, and
competition,whichincreasesbuyerpower.Switchingcostsare high, especiallyif acustomerhasa lotof
businesswithabank,thenitis hardfor themto switch. “If a personhas a mortgage,car loan,credit
card, checkingaccountand mutual fundswithone particularbank, itcan be extremelytoughforthat
personto switchtoanotherbank”(InvestopediaStaff, pg8). Competitionoff setsthe benefitsof high
switchingcosts,byreducingthe interestratestheycancharge customers.“AtCommerce Bankwe can’t
reallysetthe interestrate ona loantoo highfor fearof losinga customerto a rival bank,customers
drive pricesinthisindustry”(King)
The fourthforce isthe availabilityof substitutes,whichis,canotherindustriesdowhatthisindustry
does.The availability of substitutesinbankingisextremelyhigh. Substitutesare highbecause inrecent
yearsnonbankinstitutionshave begunofferingfinancingfortheirproducts.Itusedtobe that a person
wouldgoto the bankto geta car loan of loanfor some otherpiece of expensivecapital goods.Thisisno
longerthe case “On the lendingside of the business,banksare seeingcompetitionrisefrom
unconventional companies.Sony(NYSE: SNE),General Motors (NYSE:GM) and Microsoft(Nasdaq:MSFT)
all offerpreferredfinancing …If car companiesare offering0% financing,whywouldanyone wanttoget
a car loanfrom the bankand pay 5-10% interest?”(InvestopediaStaff,Pg8).Onthe depositside Money
Market Mutual Fundshave beengainingground.Itusedto be to have liquidassetsthatwhere safe and
gaininterestadepositorwoulduse banks, while thisisstilllargelythe case ithas beenreduced.
“ResearchpublishedbyJPMorganinDecember2011 foundthat bankdepositsaccountedfor56% of
respondents’surpluscash,whileMMFsaccountedfor 21%.”(Brace)
The final force iscompetitive rivalry,whichishow competitive the industry is.The biggestforce in
bankingisthe competitive rivalry,thishoweverisdeclining.Thislevel of competitivenessisdue tothe
large amountof banks that there are in the industry;one cansee thisby lookingatbanksreturnon
assets.There are 6,509 banksinthe U.S. andthe average returnonassetsfor banksisreallylow.“The
average quarterlyreturnonassetswas0.96… down5 basispointsfroma year ago. ROA remainsbelow
the 1.27 percentaverage forthe industryfrom2000 to 2006.”(American BankersAssociation, 2014).
Eventhoughcompetitionremainshighnow,the stressthishascausedthe industryiscausingitto
consolidate,“Since 2010 there have been967 bank mergerswith63 percentof themhappeninginthe
past 3 years”(AmericanBankersAssociation,2014). A majorityof these mergersare betweensmall to
midsizedbankssothattheycan compete withthe biggerbanks whodominate the industry“The top5
of these heldabout49%of total industryassets,whilethe top10 combinedrepresented64% of industry
assets.”(Chrisman) If 10out of 6,509 institutionscontrol 64% of the industry,the smallerinstitutions
have to consolidate tosurvive.
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These 5 forceswhengroupedtogethermake the bankingindustryatoughone to be in.Competitionis
strongmakingprofitslow.Suppliers make costshighandBuyersmake priceslow.Substitutesare
startingto threatenthe industrybytakingawaycustomers.The onlypositivetothe playersinthe
industryare that barriersto entryare increasing.Iwouldsaythat due to these factorsthe industryisin
the shakeoutstage,inwhichnewplayerscease andthe small onesconsolidate tosurvive.
Strategiesof Major Firms
There are 4 major firmsas I have mentionedearlier,JPMorganChase,Citigroup,WellsFargoandBank
of America. These firmsare the biggestinanindustrythathas reachedshakeoutstage,andhave
developedstrategiessothattheystayaroundduringthese times. The strategythatthese majorfirms
have gone withisbroad cost leadership.Broadcostleadershipisdeliveringlow pricestoabroad range
of consumers,andreducingcostsalongthe value chain;while atthe same time notinstigatingaprice
war and sacrificingquality.Thisstrategyworkswellwithlarge firmsinconsolidatingindustriesthatsell
commodities.Asmentioned throughoutthe paperMergershave beenincreasinginthisindustry,these
firmsare aroundone thirdof the entire industry,andsell acommoditycalledmoney.These Firmsare
able to reduce costs throughprovidingmore servicestofirms inadditiontocredit.Theycandothis by
usingeconomiesof scale,thisishowtheycreate value. “6Large banksare prolificlenders….provide an
estimated$10 billionto$20 billionindirectvalue tocustomersannually”(AmericanBankersAssociation,
2014). Theyare alsoable to service Broadrange of clientele.Inadditiontoindividualsandnormal
businessestheycanservice multinationalsandGovernments”Some large companieshave substantial
creditneeds—abilliondollarcreditfacilityestablished bythe endof the dayis notuncommon….
supportingAmerica’sgloballyactive companies –whichemploy20percentof U.S. workers…. The
largestfourU.S. banksheldover$36 billioninloanstostatesandothergovernments,overathirdof all
such loansmade in2013”(American BankersAssociation2014).
Competitive Dynamics
Because the industryisinthe shakeoutstage,the industryhasinterestingcompetitive
dynamics.Small andmid-sizedbanks,asImentionedearlier,are consolidatingbymeansof
horizontal integration.TheseBanksare buyingupfirmsinthe same industryforpurposes
reducingcompletion,becomingmore competitive withbigbanks,reducingcosts andbeingable
to complywithregulations.“The mediansizedbankhasonly43 employeesand$170 millionin
assets……A majorityof small bankstendtohave just one compliance officerwhomust
understandandimplementall the newregulations”(AmericanBankersAssociation,2014) Being
small isnot sustainable whencosts,especiallydue toregulations,are increasing,the firmisnot
large enoughtodeal withthese regulationsand ROA isLow. The solutiontothese issuesis
reducingcostsand Consolidation isthe paththatthe industryistaking.
Othercompetitive dynamicsare involvedinthe industryandtheyapplytolarge banks.These
firmsare involvedinrelateddiversification.AsImentionedearlierthesefirmshave entered
global markets andhave createdeconomiesof scope in ordertoprovide awide range of
servicestotheirclientsandreduce risk.Bothof these factsare evidentif one looksatthe
servicestheyprovide. “Some large companies…dependonawide arrayof productsand
services,includingcashmanagement,cross-borderpaymentsandsettlement,international
5. Sandoy 5
trade finance andthe managementof theirinterestrate,creditandforeignexchange
risks.”(AmericanBankingAssociation).
Industry Recommendations
Thisindustryisconsolidating,andbecause of thatI wouldrecommendthat the current
strategiesanddynamicsbeingused, continue beingused.The mergersandacquisitionsbeing
done bya lotof firmswill helpthembecome competitive.Itwill helpthembe competitiveby
allowingthemtodevelop the broadcostleadershipstrategiesusedbythe industryleaders.Iwill
warn these firms,however, because alotof mergersfail anddestroyvalue,sothese firmswill
needtobe cautiousmovingforward.Ithinkthatlarge firmshave leadthe waywhenitcomesto
strategy, the broadcost leadershipstrategytheyhave developediswell suitedforthe current
industrystructure.Ithinkthat these firmsare creatingvalue throughrelateddiversification.
Theydo this by beingable toputthe broad,inbroad cost leadership througheconomiesof
scope, andby reducingrisks. WithThese factsbeing true though,Ithinkthe bankingindustryis
only forthose firmsthat have alreadyenteredinit.Firmswishingtoenterintothisindustry
shouldnotbecause the five forcesare unfavorable.The costsof entryare highthe costsof
inputsare high,marginsare low,there are manysubstitutesanditisreallycompetitive.
6. Sandoy 6
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