June 2001, by Professor John Kay

Big, Global, Diversified –
is this the way the financial services industry is going?


The question I pose in the title: ‘big, global, diversified’ must sound like a variant of ‘Is the Pope a Catholic?’ You simply have to read the papers every morning to know that the answer is undoubtedly yes. But in the words of Josh Billings ‘the trouble with people is not that they don’t know but that they know so much that ain’t so’.

The automobile industry is for most people the archetype of what is happening as a result of globalisation. Everyone knows that as a result of the creation of global markets for automobiles world production is being concentrated in a small number of large firms operating internationally. Everyone knows that, but it ain’t so.

The figures tell a different story. Thirty years ago, the largest three firms in the world car industry produced slightly more than half the world’s cars. In 1996 these three produced around a third of the world’s cars. The largest three producers today are different – Toyota joined the big league although its size has since been challenged by the Daimler-Chrysler merger. Thirty years ago the largest ten car manufacturers in the world produced 80% of car output. In 1996 the largest ten producers in the world car market produced just under two-thirds of all car output. You might object that this is because the big American producers have not had a particularly good time – and that’s true.

But what I have been describing has happened right across the board. Thirty years ago there were nine firms in the world who produced more than one million cars – in 1996 there were fourteen who produce more than one million cars a year. Now car output has expanded. But if you change the question slightly and ask how many firms produce at least 1% of total world car production, the answer thirty years ago was fourteen and that number in 1996 was seventeen. However you look at it, despite all the mergers and rationalisations which there have been, concentration in the world car industry has been going down, the number of major producers in the world car industry has been going up and the share of the largest producers in total world automobile output has been falling.

Competing Forces

Why has it happened like that? There are two conflicting factors at work in the world automobile industry. Economies of scale give advantages to large international producers. But at the same time globalisation has enabled firms with strong competitive advantages to be effective on a world scale, firms which could not have been successful if they were confined to their own market. Hyundai could not have been a successful car producer – or probably a car producer at all – if the company had been confined to its home market. Globalisation has enabled local firms with strong competitive advantages to become effective international competitors.

The car industry has been subject to a balance of two competing forces: one pointing towards greater concentration around economies of scale which can be exploited on a global level: the other, more important, enabling individual firms with strong competitive advantages to break in to the big league by taking the opportunities offered by a more competitive market and a global market.

You have the same tension in all industries. Competition is undoubtedly intensifying in the financial services industry. Increased competition comes from the internationalisation of capital markets and the increased competition that comes from the ability of firms in one line of business to jump into others. There is a general pattern of changes to industry structures when competition increases. The number of firms may rise or fall but the important consequence is that old industrial structures, traditionally organised around historic market position and traditional market share, are replaced by structures organised around the nature of competitive advantages and the firms that have competitive advantages.

One of the classic and most studied examples of this process was the deregulation of airlines in the United States. Regulation of airlines here - and elsewhere – had ossified the established structure. Firms remained with established positions which they had developed in the 1930s right through to the 1970s. Suddenly all of this was let loose by deregulation. With what consequence? Many new entrants. Expansion of capacity. Existing firms diversified their operations rapidly into other areas and into new forms of competition. In the end most of these entrants and a fair proportion of these established firms that expanded failed. They either disappeared from the market altogether or were absorbed into other firms.

The final outcome was a market structure which was pretty much as concentrated, no more no less, than before deregulation. Some companies – like Eastern Airlines or Pan American, which had been industry majors before deregulation, simply disappeared. At the same time, some of the early competitors with strong competitive advantages had risen to market leadership and market dominance – like American and United Airlines. The market structure did not look so different in the end from the beginning. But there was a transition from a pattern organised around historic market position to one organised around competitive advantages in operating businesses. That is the framework for understanding the way in which competitive structures are likely to evolve. Historic market position matters less – competitive market position matters more.

The story of the world automobile industry is the same. The trend of falling concentration which I described over the last thirty years didn’t start then. The peak of concentration in the world car industry was reached in the early 1950s. The long term evolution of the structure of the industry followed a pattern typical of product life cycle. When the car industry began in the first two decades of this century, there were hundreds of firms. The industry became more and more focused on a small number of producers as the nature of the market and the kind of products consumers wanted became clearer. There were large economies of scale in focusing on particular lines. So through the 1920s and 1930s this market became more concentrated, with a small number of firms producing standard products in large numbers and at low cost.


However, when the market became more sophisticated, and as the price of the product became cheaper, consumers were increasingly willing to pay a premium for differentiated products. As the market matured it became able to support more firms rather than less. Differentiation is a major part of the reason why the world car market today is less concentrated than it was forty or fifty years ago. A much smaller segment of the market buys solely on price.

This evolution is common to the development of many industries. Take washing machines. For a time, this was everyone’s classic European industry. After the creation of the European Union local producers of washing machines suffered in competition with European – mainly Italian – competitors. But in the following decade, several of the Italian washing machine producers who benefited from that EU boom went bust. Since then, the industry has renationalised itself – it has actually become less global, less international.

Because machines are cheap, consumers are now more willing to pay for differentiated products. Consumers across Europe want different things. In Italy they buy machines with low spin speeds because Italian housewives hang their washing out to dry. Irish housewives don’t. French customers like top-loading machines. German consumers prefer machines which will still be working when you go down and pick them up after dropping them from the sixth floor of an apartment block. Differences in taste in the domestic appliance market, along with a lesser emphasis on economies of scale in favour of the savings from a flexible manufacturing process, have enabled a market structure to emerge that meets these different preferences. This is a general pattern of industry evolution. Early stages of growth of many firms doing different things: standardisation on a particular pattern of development: greater differentiation over time as the market matures. That pattern is common, and can be seen in financial service industries as well as markets for manufactured goods.

Is Consolidation Inevitable?

The history of cars and washing machines and rivets should tell us not to presume consolidation in financial services is inevitable. If history and market position matter less, and competitive advantage more, the outcome will be greater concentration only if size is the main source of competitive advantage. There are not many industries of which that is true. But is the financial services industry one of them?

We should not generalise. There are many parts to the financial services industry. The merger of UBS and SBC made the combined bank the largest in the world, measured by net assets. In achieving this, it pushed the Japanese bank Dai-Ichi Kangyo into tenth place in the world banking league. It is not long since Dai-Ichi Kangyo was the world’s largest bank. Not much longer since Citicorp held that position. Once, Bank of America was the biggest bank. And, within living memory, that title was held by Britain’s Midland, who ceded it to Barclays. Soon after, each of these banks not only lost their leading position, but dropped out of the top ten.

This story has several important lessons for today’s ambitious bankers. Size has never been the key to future success in banking. Indeed size has almost invariably been a warning of problems to come. In most markets, you have to persuade customers to give you money: in lending, you only have to persuade them to accept it. That makes it rather easy to grow, but the growth can be subsequently reversed if the customers fail to pay it back. And that has happened rather often in banking history.

We also see the insatiable herd instinct of bankers. Citicorp has constantly eyed Bank of America, Barclays vied with Lloyds TSB, SBC with UBS and Credit Suisse. Not daring to be left behind, they all made the same mistakes together. Much safer, in the banking world, to be wrong in good company than to be right alone. Accountancy has seen dramatic consolidation but for different reasons. The world market for accountancy has become polarised around a small number of large firms, American or Anglo-American in origin, operating worldwide. Will that same sort of polarisation and globalisation inevitably happen in law and investment banking?


What people mean by globalisation differs from industry to industry. There is a major difference between globalisation as it is for Boeing, who produce for the world market from a single Seattle location, and globalisation as it is for PricewaterhouseCoopers, who attach an international brand to output which of necessity is locally produced. Investment banks are like Boeing, and hotel chains are like PricewaterhouseCoopers. The model of centralised production is driven by economies of scale, and the model of international branding by the doubts and hesitations of customers who need to buy worldwide in unfamiliar environments. That is why there are no local manufacturers of jumbo jets but – since hesitant cross-border purchasers of accountancy and hotel rooms are only a part of the market – there are many successful small local accountants and hoteliers. And even these analogies need to be unpicked carefully.

There are economies of scale in access to capital markets, which is why that side of the investment banking business is becoming more concentrated and going global. But investment banks also act as financial consultants, and there are no scale economies in that. So smaller boutiques will continue to thrive: large and small investment banks will just do different things.

How industry structures evolve depends therefore, on specifics of technology and conditions of supply and demand. Audit – the product which remains the direct and indirect key to the profitability of accounting firms – is a very particular commodity. No one really wants to buy it. You buy audit only because others require it of you, and therefore your incentive is to buy the minimum that satisfies these requirements.

It is this need for certification that explains why accountancy is characterised by tiers of firms with little to differentiate firms with the tiers. You can choose between Price and Young, Peat and Touche, Deloitte and Waterhouse, confident that each of them can do the job, and feeling no need to have more than the job done. And since audit is a function placed by the corporate head office, you want to entrust it to a single firm with global reach. Preferably one with a principal office in London or New York, the cities with the largest concentrations of corporate head offices.

But there is not one other industry to which that particular combination of factors applies. Insurance broking probably comes closest. Even law – an industry obsessed by the accounting analogy – is in reality very different. The distinction between the best and the good matters far more in law than in audit. And while there are some areas of legal practice – like multinational acquisitions – for which a single centrally controlled process is necessary and appropriate, there are rather more areas of law for which this is not true. That is why law is and will remain less international and less concentrated than accountancy: why major law firms are much more differentiated from each other than are major accountancy firms: and why their profitability is based not on size but on their specialist skills. The most lucrative legal services businesses – tiny measured by their share of the world legal services market – are the chambers of the leading commercial barristers.


Ambitious managers are so anxious to believe that everything is becoming larger and more international that everything is assumed to point in that direction. Yet if the changes in technology which increase scale economies in investment banking and aviation point towards greater concentration, it can hardly be true that the changes in technology which reduce scale economies in publishing and telecommunications have the same effect. The point is not that there are no valid generalisations about business. It is that there are no valid generalisations about business which are independent of the specifics of different industries.

About the Author

John Kay is one of Britain’s leading economists. His work is mostly concerned with the application of economics to the analysis of changes in industrial structure and the competitive advantage of individual firms. His interests encompass both business strategy and public policy.
John Kay began his academic career when he was elected a fellow of St John’s College, Oxford at the age of 21, a position which he still holds. As research director and director of the Institute for Fiscal Studies he established it as one of Britain’s most respected think tanks. Since then he has been a professor at the London Business School and the University of Oxford. He was the first director of Oxford University’s Said Business School. In 1986 he founded London Economics, a consulting business, of which he was executive chairman until 1996. During this period it grew into Britain’s largest independent economic consultancy with a turnover of £10m and offices in London, Boston and Melbourne. He has been a director of Halifax plc and remains a director of several investment companies. He is the first (and still the only) Professor of Management to receive the academic distinction of Fellowship of the British Academy. In 1999 he resigned his position at Oxford and sold his interest in London Economics. A frequent writer, lecturer and broadcaster, he contributes a fortnightly column to the Financial Times. His most recent books are Foundations of Corporate Success (1993) and The Business of Economics (1996), and another major work on the successes and failures of market economies is in preparation.

Website: www.johnkay.com