Advisory Industry Future Redesign: The “Payment” Model

Some day the Advisory Industry may look different than today, and an example of what’s possible may be the manner in which vendor and user clients compensate their Advisory providers. It seems worthwhile for segments of our industry to study this alternative compensation model, as it has been implemented successfully in the Wall Street Research space over many decades, being both useful and arguably more performance-based than what we’re used to in the Advisory space.

Discussion of an “alternative” payment model for the advisory business may seem quite theoretical, since its implementation seems unrealistic in today’s environment; yet lessons can be learned and a gradual conversion to the alternative approach described below is at least theoretically feasible.

On Wall Street, brokerage firms like Morgan Stanley employ analysts who produce content and advice for consumption by investment firms – all the banks, insurance companies, pension managers and foundations (called the “buy-side”) which purchase content and advice from the Wall Street brokers (the “sell-side”) because they rely upon the brokerage firm analysts for inputs to their stock-picking, selling, hedging, optioning, and strategic decision-making. In fact the structure is almost a perfect mirror image of the IT Advisory industry!

Every buy-side firm employs financial traders who can trade with many or most of the dozens of sell-side firms, while the latter employ even craftier traders who are skilled in executing large orders quickly and at at the best price. The buy-side traders determine which sell-side traders to deal with, but no investment firm, for example BofA (“buy-side” Bank of America), would think of funneling most of its commission dollars to a single large and responsible brokerage (say Goldman Sachs) for its advice. There are simply too many top analysts dispersed among the dozens of other brokerage firms, from the largest to the smallest, including Wall Street boutiques with specialized and very useful human resources.

Here’s the point of this discussion: trading volumes aside, how do BofA and the other buy-side firms pay the sell-side firms for their research and sales competencies? Through an interesting value-based system. In this system, research payment allocations from the buy side are simply divided up among quite a few sell-side firms that are also their trading partners. (Note for clarity, in our Advisory space an example of a sell-side firm would be Forrester and a buy-side firm would be any of Forrester’s clients).

So in the Wall Street model, the buy-side “analysts” will work closely with their most helpful and favorite sell-side analysts, and buy-side “portfolio managers” will work with sell-side salespeople who funnel ideas and information from their research departments to the buy-side clients. During the year, when investment issues arise (many dozens of times each day), the BofA money managers and staff analysts will call several appropriate sell-side analysts, and may even effectively triangulate among them until a level of understanding an issue, or a decision to buy or sell stocks or other investing instruments with traders, can be reached.

Not until the end of the year do the buy side money managers and analysts “vote” for those individual sell-side analysts and salespeople who were most helpful and influential during the past twelve months. When this process is completed and the numbers are added up, the decision is made as to the percentage of trading volume (e.g. money) to be generated for each of the brokerage firms for the next year! Thus the compensation will vary somewhat each year based upon trading volumes and perceived relative performance. Most important perhaps is that new sell-side firms and analysts are added to the list since innovative and effective research and interactions will be recognized! Thus, the sell-side firm will have sent all its research, and its analysts will accept phone calls hoping or expecting that content and interactions will be recognized and therefore compensated for their value.

The IT Advisory Industry payment system is admittedly much simpler. The buy-side firms (vendors or users and in some cases investors) purchase one or several annual or multi-year contracts in expectation of services to be received. But these services may or may not meet the buy-sides up front expectations. Granted, without careful monitoring the buy-side generally cannot estimate the value received, and is often short-changed.

A cynic might conclude that some sell-side Advisories may laugh all the way to the bank as its clients get used to and/or depend upon the same analysts, content formats, and events year after year. Most sell-side analysts will have had industry experience, but as time passes can become somewhat obsolete as our technology evolves rapidly. Also, the best analysts will not be available to speak to many of the buy-side IT professionals because of growing management responsibilities, demand for speaking engagements,  attendance at many vendor briefings let alone industry conferences, and simply being too busy to do much creative research (most reports may have been written by relatively junior personnel). They may not wish to ”waste” time providing un-leveraged support for individual clients. Also, working with a single firm exposes the client to the old “80/20 rule” (80% of staff will produce 20% of a firm’s market impact), although I’ll concede that the ratio might be  70/30 or even less. There’s no question that some unknown fraction of a particular Advisory’s clients obtain their moneyʼs worth (in the old days, one mainframe rent/lease/buy decision could save a large client >$1M).  The bottom-line is:  the added-value which any Advisory firm provides via its deliverables seems difficult to measure, and very few clients including the large ones track or even guess the value/cost ratio of their purchased advisory services.

Many buy-side firms (IT vendors, users, even investors) ignore most of the hundreds of alternative research sources, for example the many small advisories with very competent staff, and independent analysts. Like the Wall Street firms, a new pricing model could be quite effective for the marketplace, especially if the buy-side uses the occasional but significant Wall Street technique of discussing a single issue with several vetted analysts in order to help converge on a better buy/hold/sell decision.

The increasing use of the web for IT inputs works for some, but not for complex or key decisions. New semantically-oriented technologies, plus what I call “intelligent aggregation” (recently and reasonably labeled by Magnify Networks as “curation”) may help to some extent at the content level but not for decision-support needs. Increasingly, the client buy-side has been paying Advisories for “verification” of their already-made decisions but a more valuable use of Advisories is what we used to call “exploration”, where triangulating among several appropriate analysts or analyst firms in order to obtain “second opinions” before deciding,  should be much more valuable!

My conclusion is that if the Advisory Industry were to shift from annual contracts to end-of-year payments based upon evaluation of sell-side firms’ relative level of prior assistance, then the buy-side, which in making decisions must deal with hundreds of IT niches, would benefit from its broader choice of appropriate and available analysts.

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