104-High Growth and Falling Profits

Recently, Europe passed legislation aimed at breaking long standing monopolies in Europe’s equity trading systems. As a result, a number of alternative trading systems poured into Europe’s equity markets.

The new market entrants are offering new technology and lower prices. They have succeeded in shifting significant market share away from the former industry leaders. In fact, four of the new entrants now control 16% of the trading in Europe’s equity markets. (See the Symptom and Implication, “Most share shifting in the industry seems to be coming from volume gained within existing customer relationships rather than from new customers” on StrategyStreet.com.) There is one problem, however, the margins are razor thin. The problem is pricing. While all these new entrants poured into the market, the prices fell as they jousted with one another to gain their market shares. One of the companies has reduced its prices three times within the last four months. Industry prices are now down about 20%. What are these new firms going to do about their poor profits? What any self-respecting low-end competitor would do if it has the opportunity. They are going to expand into other more complex markets and other asset classes that carry higher margins. This expansion will add relatively little cost because most of their trading systems’ costs are fixed. (See Video #6: Competition and Low-Cost Expansion on StrategyStreet.com.) In addition to improving margins, at least temporarily, this move into new asset classes and customer markets may help them in another way. These new trading systems will become more attractive because they become more of a one-stop shop for customers in the industry. The ability to offer one-stop shopping is usually a benefit offered by the industry’s leaders, whom we call Standard Leaders. This is one important reason that Standard Leaders dominate an industry.

Posted 5/28/09

Update:

Despite the cited deregulation, the European market is highly fragmented and inefficient. Some relevant statistics: the US has 7 exchange groups, 3 listing exchanges and 16 trading exchanges. These exchanges serve 4563 listed companies with a market cap of $38 trillion at the end of 2019. Europe operated 22 exchange groups, 35 listing exchanges and 41 trading exchanges, serving 6202 listed companies with a market cap of $17 trillion at the end of 2019. The number of listed companies is falling significantly in Europe while it rises in the US.  The European model is far less efficient than that of the US.

THE SOURCES FOR STRATEGYSTREET.COM: For over 30 years we observed the evolution of more than 100 industries, many hostile.  We put their facts into frameworks applicable to all industries and found patterns.  Strategystreet.com describes the inductive results of these thousands of observations and their patterns.