Slide 1

Dr. Michael Mainelli, The Z/Yen Group

[An edited version of this article first appeared as "“Bracing for Zero Marginal Competitive Cost: Investment Banking Restructures”  Balance Sheet, The Michael Mainelli Column, Volume 12, Number 3, Emerald Group Publishing Limited (May 2004) pages 48-51.]  

Kraftwerk or Handwerk?

Investment banking trading volumes are increasing rapidly while margins per transaction are falling.  Clients are more sophisticated and more demanding.  The link between commission and cost is breaking down as large buy-side clients break their business into smaller orders.  At the same time, regulatory changes, new legislation, new technology, financial scandals and reputational risk all put pressure on investment banks.  For volume players, the strategies are clear – efficiency, service, control.  For all players, innovation in customer service, products and operations are essential.  For marginal players with volumes below the efficiency threshold, and for all players unable to generate returns for shareholders, consolidation looms.

It actually looks as if investment banks might well reach Zero Marginal Cost (ZMC).  In a ZMC world, things change rapidly.  A number of observers have pointed out that external costs, e.g. CLS charges, general clearing & settlement fees, exchanges, etc.  mean that marginal costs will always be non-zero.  So be it; call it Zero Marginal Competitive Cost (ZMCC); no one can process at a lower cost.

Bracing themselves for ZMCC, investment banks need to move from craftwork (Handwerk) to functioning more like power plants (Kraftwerk) or sausage machines.  In many ways, intense cost pressure is a positive sign, a sign of an industry moving to the next level of maturity.  However, the pressure doesn’t stop there.  The evolutionary progress from today’s raw idea to tomorrow’s boring, high-volume commodity product line has sped up.  Products move from exotic to vanilla in a few years, not a decade.  This puts more pressure on the client-facing side to provide innovative highly structured products in advance of the wave of commoditisation.  It also puts pressure on operations & IT for bottom-up innovation that increases efficiency, service and control.

And the facts support this view of the world.  Z/Yen regularly benchmarks investment bank costs, headcounts and volumes to produce costs per trade covering:

  • FX & Money Market - Global FX, Currency Options, Money Market;

  • Equity & Debt - European Equities, SBL, Bonds, Repo, Listed & OTC Derivatives;

  • US Securities - Equities, Stock Borrow Loan, Bonds, Repo, Options & Futures.

The following four graphs of the cost versus volume curves for Global Foreign Exchange, Global Money Markets, European Processed Equities and European Processed Bonds shows that from 2000 to 2002, volumes have increased markedly while operations costs per transaction are falling:

Key:    2000    2001    2002





Source: Z/Yen Limited, 2004

The above graphs capture Operations costs, i.e. trade capture, static data, pre-settlement, settlement, exception management, projects, management & administration.  They do not include middle office or product control costs or IT costs (though separate analyses are available).  In three of the four markets, Global Money Markets, European Equities and European Bonds, “average” bank volumes in 2002 were volumes that only the largest processors handled in 2000.  Each graph clearly shows significant cost decreases and a race to economies of scale.

Some of this per trade cost reduction is due to increased volumes being handled at decreasing marginal cost, largely through automation.  For instance, the largest equity traders handled around 10M trades per annum in 1999, now nearer 25M; for bonds 250,000 trades per annum was large in 1999, now larger operations process over seven times as much at 1.8M; for FX in 2000, 3M trades was large, now an investment bank would need around 5M to be in the top league.  With the “per trade” figure as the denominator, volume matters in getting cost/trade down.  The pressure increases for those unable to get to efficient levels of capacity or unable to scale the costs of processes in line with demand.  However, larger volumes, poorly processed could well increase costs and investment banking operations are increasingly more professional, increasingly focused on reducing exception, improving controls and risk management.

“It’s getting to be more like running the space programme, much more attention to zero risk.”  (Global COO, Large Investment Bank) 

Cost reduction affects all areas, i.e. operations, operations IT, middle office/product control and middle office IT.  Focusing in just of FX, it can be seen that cost per trade was just over $11 in 2000, now under $8.  The cost squeeze has been felt in all cost components, as the following extract from the FX data shows:


Source: Z/Yen Limited, 2004

Like a Machine, With Customers

Averages can conceal more than they reveal.  The following extract from the FX data shows that there is a wide disparity in approach despite the increasing pressures to reduce cost.  Interestingly, there appears to be scope for innovation as low-cost producers seem to be pursuing different spend strategies successfully.  Moreover, there is a four-fold, unsustainable difference between the lowest cost producer and the highest cost producer:


Source: Z/Yen Limited, 2004

Pundits have long forecast the need for investment banking operations & IT to improve their performance markedly.  As cost per trade falls precipitously, one obvious question arises, “how far can this go”?  Some operations seem to be able to handle increasing volumes with little additional headcount, hitting 55,000 trades per head.  Other operations can have as few as 12,500 trades per head.  Investments in IT seem to pay off in numbers of trades per operations head, concentrated in the 2001 to 2002 period.  More returns on IT seem likely to arrive.  The following slide, albeit based on sparse FX data, suggests that things might just be taking off. 


Source: Z/Yen Limited, 2004

Cost per trade (i.e., competitive trade, ignoring external costs) may be getting close to ZMCC for commodity-like products in equities, bonds and FX.  At ZMCC the Highlander effect takes hold, “there can be only one” (from the 1986 film of that name) – a single investment bank could process all the business it wants at almost any non-zero price.  The closer to ZMCC, the more intense the pressure for consolidation.  While one can reduce cost by decreasing levels of service, it is not paradoxical that higher-volume, efficient providers tend to score well on customer service.  The pressure to perform improves the sausage machine and reduces defects, which attracts customers, which generates revenue to further improve the sausage machine.

The Obvious

“You need good people to get good technology.  Good technology is what we want, but we can’t have it without good people.” (Global CIO, Large Brokerage)

The implications are clear.  There is likely to be a shakeout among high cost providers.  High cost might well become anything more ZMCC.  While cost saving measures such as offshoring or outsourcing will be important, IT excellence is crucial for continued marginal cost reduction.  Among the obvious implications for operations managers are the need to embrace:

  • sausage machine paradigm: focus on input/process/output, as well as innovation, strategic thinking, simplicity of design and ruthless execution, while somehow maintaining and motivating excellent staff;

  • monitoring: a thirst for comparative intelligence & measurement:

    • external: more detailed operational benchmarking and customer satisfaction benchmarking (e.g. Z/Yen’s Operational Performance of Brokers benchmarks, combined with special comparisons issue-by-issue;

    • internal: ‘right’ measures, simple MIS, ruthlessly applied;

  • feedback: clear customer targets, service levels, activity-based costing and customer profitability, slick product control with virtually instant global reconciliation;

  • feedforward: planning volumes more closely with front-office, better strategic planning.

Against all of this, global operations & IT management need a clear performance framework.  Based on interviews with over 25 leading players, the following framework probably sets the competitive agenda for the next few years:







External Client(what the client values)

Delivery        Low Cost        Quality/Consistency        Brand (perceived values, integrity)

Innovation        Product Range        Reliability        Market Share (%)        Personal Relationship

Internal Business Client
(what the business values to deliver client values)

Change-the-Bank Delivery (time-to-market, confidence in delivery)       Run-the-Bank Delivery (quality)        Low Per Unit Cost        Reliability        Availability/Easy-to-work-with        Innovation        Business Understanding        Asset Protection




Operating Model



Operations & IT level(what operations & IT value to deliver bank values)


 security/reliability; efficiency;

 alignment to the business
 model; speed of delivery;   ability to grow rapidly

Technical Skills
Business understanding
Change and project management skills
Client service and partnership skills
Leadership and innovation
–Service Quality
–Delivery (time-to-market, confidence in delivery)
–Controlled environment
–Investment decisions and management

 –Low per unit cost
–Scalable down
–Scalable up
–Customer relationship management
–Partnership with the business

Too many investment banks seem to pursue similar strategies.  Reduce cost, seek volume.  Most of the industry leaders grew up in the industry and have shuffled around so much that the gene pool for ideas is interbred.  Leading players are looking to other industries for ideas.  Some have already tapped into the ‘machine’ paradigm of “measure, control, improve”.  Six Sigma or Total Quality Management, “people, processes, results = quality”, programmes were adopted by some of the leaders a few years ago.

However, in an era of ZMCC, technological excellence in innovation, design and delivery becomes even more of a differentiator.  The big issues range from highly technical developments in grid computing or risk/reward engines, e.g. PropheZy for predicting and correcting Straight-through-Processing exceptions, to radical project management techniques seeking step changes in IT productivity or restructuring the sales incentive link to portfolio structures.  Innovation from the operations & IT areas “upwards” is happening in areas such as netting, and this innovation must continue.

Organisations must change as well.  To paraphrase Chandler [1962], structure follows strategy as surely as strategy follows structure.  The organisational model cannot be ignored in the quest for improvement.  Some of the leading players are exploring scenarios such as:

  • splitting volume operations from high-margin operations so that differing management techniques can be applied;

  • splitting IT from operations in order to give greater degrees of freedom on issues such as client proximity, skillbases, cost management and training;

  • bringing more and more of operations & IT into contact with outside customers so that a client service ethos can be intensified.

“Our big issue is the cost/control balance.  We’ve done all the tactical cost savings.” (Global COO, Global Commercial Bank)

ZMCC may well be the most challenging issue facing the investment banking industry.  Few other industries face such ‘weightlessness’, i.e. having the potential to hit Zero Marginal Competitive Cost levels.  At the same time, as the above quote shows, too ruthless cost cutting starts to increase risk.  If ZMCC takes hold, it will be a very rough, perhaps fatal, ride for investment banks that are unable to balance cost per trade appropriately against risk.

The author would like to thank Giles Wright of Z/Yen for providing the background analysis.


Z/Yen Limited, Competitive Cost Comparison Studies, 1999, 2000, 2001, 2002, 2003.

Chandler Jr, Alfred D., Strategy and Structure: Chapters in the History of the Industrial Enterprise, The MIT Press, 1962.

Michael Mainelli, FCCA, originally did aerospace and computing followed with seven years as a partner in a large international accountancy practice before a spell as Corporate Development Director of Europe’s largest R&D organisation, the UK’s Defence Evaluation and Research Agency, and becoming a director of Z/Yen (This email address is being protected from spambots. You need JavaScript enabled to view it.).

Michael’s humorous risk/reward management novel, “Clean Business Cuisine: Now and Z/Yen”, written with Ian Harris, was published in 2000; it was a Sunday Times Book of the Week; Accountancy Age described it as “surprisingly funny considering it is written by a couple of accountants”.

Z/Yen Limited is a risk/reward management firm helping organisations make better choices.   Z/Yen undertakes strategy, finance, systems, marketing and intelligence projects in a wide variety of fields (, such as developing an award-winning risk/reward prediction engine, helping a global charity win a good governance award or benchmarking transaction costs across global investment banks.