260-The NYSE Stumble Offers a Lesson for All Leaders

Recently, the New York Stock Exchange agreed to sell itself to the German exchange, Deutsche Boerse. For generations, the NYSE was the place to trade equities of the finest companies in the U.S. Its sale to a German exchange is a sign of how desperate its market situation has become. The NYSE’s fall offers some important lessons for a market leader in any industry.

The NYSE’s market share has fallen out of bed. Six years ago, 75% of the traded shares of companies listed on the New York Stock Exchange traded on that exchange. Today, only 35% of those shares trade on the NYSE. This precipitous fall came because the NYSE fell behind in both service and price. The market changed and new competitors emerged.

First, the market changed. High frequency traders, using computerized trading algorithms, do two-thirds of share trades today. These market-dominating customers demand the highest speeds in their transactions and the industry’s lowest prices. The New York Stock Exchange struggled to meet these requirements.

Second, new competition emerged. There are roughly fifty trading venues which will provide these high-frequency traders with fast services and low prices. The majority of these venues did not even exist ten years ago. They sprang up using relatively inexpensive computers in low-cost outlying and suburban locations. These new trading venues offer newer, faster technology and lower prices than the NYSE.

The NYSE held a price umbrella over these emerging firms. The new firms grew and became ever more capable. Today, they can compete and win in competition for even small trades.

The New York Stock Exchange was a dominant market leader. Its precipitous fall holds lessons for all market leaders in any market. Among these lessons are these:

  1. Always protect your relationships with the industry’s heart-of-the-market customers. These are the key, primary and secondary role relationships with the industry’s Very Large and Large customers ( see HERE), those purchasing 80% of the industry’s unit volume. These key relationships usually hold 65% or so of the total industry sales.
  2. Avoid consistent failure with these heart-of-the-market relationships, especially failures in function and price. Customers generally will not leave an established relationship until their supplier fails them. Any failure, especially consistent failure over time, opens the customer relationship to other competitors.
  3. Parry fast-growing competitors at any price point. The fast growth of these competitors tells us that customers like what they offer. Their growth in share will not stop until the market leader itself puts an end to it. The NYSE has allowed many new competitors into its marketplace. It would have been much easier to stop them when they were much smaller or, indeed, even before they entered the market. This market will consolidate again into far fewer competitors. But now it is going to be a bloody fight.
  4. Fix the products that are losing share in the heart-of-the-market. Customer retention is important in any market, but it is critical in markets where prices are falling. The first demand of product innovation is to fix problems that cause the company to lose customer relationships. See HERE.
  5. Cover any price point your heart-of-the-market customer purchases. Companies often have price point biases, either against a low price point because it pulls down margins, or against a high price point because it makes operations less efficient. If the heart-of-the-market customers are buying the price point, you have to cover it.
  6. In a falling price environment, develop pricing that discourages competition. This pricing can, and should, involve more than simple reductions in list prices. There are several components of a price. The NYSE can use these components to beat back many of these competitors. In a low, or falling, price environment, the only real function that price serves is to discourage competitors from competing for your customers. Ultimately, low prices push competitors out of the marketplace. This takes a long period of time when there are as many competitors as the NYSE faces today.
  7. Develop and exploit economies of scale to support the falling prices the company faces and to maintain the best returns in the industry. The NYSE is still the largest competitor in the market. It no longer enjoys dominant share, but it is still large enough to create a more productive cost structure, especially by matching benefits and overhead costs to customer segments and eliminating benefits that customers do not need.

Posted 4/6/11

Update:

The stock trading industry continues to consolidate.  In 2013, ICE acquired the NYSE and remains the parent organization of the Exchange today.

The NYSE remains the world’s largest exchange. It lost a good deal of market share as the industry’s largest customers moved to one of the several exchange communication networks (ECNs).  An exchange must be registered with the SEC. It has the authority to list stocks for trading and to charge the listed companies a fee for the service.  An electronic communication network (ECN) is a computerized system that automatically matches buy and sell orders for securities in the market.  Most of these ECNs are located in low-cost areas and offer lower transaction costs to the industry’s largest customers.

The NYSE has its own ECN equivalent called the NYSE ARCA.  This service resulted from an acquisition by the NYSE in 2006.  The NYSE was slow to promote and develop its ARCA product. But the pricing pressure and high service levels offered by competing ECNs forced the NYSE to focus on this important product. By the mid-2000s, Archipelago’s fast execution speeds and liquidity pools attracted widespread usage from institutional trading firms. In 2022,The NYSE ARCA did more trading volume than the NYSE Floor.  Still, the NYSE remains under pressure from the pricing of competing ECNs.

This update reflects the power of the industry’s largest customers. The first segmentation any company must make in its marketplace is to segment its customers by their size of purchases. No other segmentation is nearly as important to the company’s long-term future. See HERE for more explanation.

12/22

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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.