Taking Sides – A cautionary tale: At Merrill, growth is finally too costly

The nation’s largest brokerage company appears on the verge of a significant retrenchment that could signal the end of an era – for both the firm and the financial services industry.

Since Donald Reagan ran the company in the 1960s, the credo at Merrill Lynch & Co. Inc. has always been growth at almost any cost.

Mr. Reagan rightly guessed that size would matter in the developing global economy. Merrill was determined to be the biggest, and in the years since then, it has largely accomplished that goal.

Merrill has a formidable army of 15,000 brokers, and its reach truly is global. Among U.S. brokerages, its prominence in Japan is commanding, and it has also made significant inroads in Europe, India, Australia and other areas of the world.

The growth strategy was also in keeping with the corporate culture at the Wall Street powerhouse.

The route to the executive suite traditionally has been through sales or marketing, and the CEOs that followed Mr. Reagan were all hard charging and expansionist minded.

Current CEO David Komansky is cut from the same cloth. But E. Stanley O’Neal, the company’s new president and likely heir to Mr. Komansky, is anything but. His background is in finance.

It comes as no surprise, then, that Mr. O’Neal has been given the task of restructuring the company. The latest push is heavily focused on the bottom line. His mission appears to be to increase the company’s profitability even if it means a significant change in how and where Merrill Lynch does business.

“The company can’t sit back and say, `Let’s make another sale,”‘ says a knowledgeable source. “In reevaluating operations, it can’t only be based on revenue growth and market penetration.”

If that’s so, then Merrill’s new direction marks a sea of change for the company, and perhaps for the industry as well.

A couple of obvious and not so obvious trends appear to be driving its decision-making.

First and foremost among those trends has been the slowing economy.

Starting late last year and into the second quarter, it was a given that the economy was slowing, but the general consensus suggested that a turnaround would come quickly, especially with the Federal Reserve aggressively cutting interest rates. Wall Street trimmed jobs, but only reluctantly.

Then came Sept. 11.

The terrorist attacks not only dealt a direct blow to the economy, but also clouded the prospects for a quick recovery. Today the only certainty is uncertainty.

With bombs falling in Afghanistan and the nation committed to a war against terrorism that could last at least two years, if not indefinitely, Merrill executives appear to have concluded that we’re in for a prolonged period of slow or no economic growth and only modest appreciation in the stock market.

Under those circumstances, the best way to increase profits is through increased profitability. Merrill has one of the lowest profit margins in the business and one of the highest pay structures.

It also seems to have miscalculated in its attempt to create global reach.

Its instincts about the global economy were on target, but huge financial concerns such as Citigroup Inc., J.P. Morgan Chase & Co. and Deutsche Bank AG are emerging as the dominant players in that arena.

Merrill clearly is in the game, but doesn’t have enough resources on its own to compete.

One bright spot, however, is asset management.

Although the company’s revenue from brokerage commissions declined 26% during the third quarter compared with a year ago, asset management and portfolio fees were only down slightly.

Merrill may well end up being a smaller and leaner company than it was Sept. 10, but asset management is clearly its ace in the hole.

There may be a lesson in that for other financial services firms as well.