How IT analyst firms can learn from investment bank research pricing models


Gideon Gartner has just posted a great article titled Advisory Industry, a future redesign: the “Payment” Model, in which he draws on investment banking research pricing as a model for IT analysts and their clients. Gideon writes:

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; and when this process is completed and the numbers added up, the decision is made as to the percentage of trading volume (e.g. money) to be generated for each of the brokerage ?rms for the next year! Thus the compensation will vary somewhat each year based upon trading volumes and perceived relative performance. Most important perhaps, new sell-side firms and analysts are added to the list since innovative and effective research and interactions will be recognized! (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).

He wraps up:

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.

There are some great comments on the article, and given this is something I’ve looked at for a long time, I had to add my own:

Very interesting Gideon!

Coming out of my role as Global Director – Capital Markets at Thomson Financial, I closely tracked the rise of the sell-side research ratings systems in the late 1990s, writing about them in my book Developing Knowledge-Based Client Relationships. I wanted to dig into this unique method for valuing and paying for content.

There was no payment for research at the time, only for transactions. However if the buy-side firms did not value the research, and allocate transactions to the firm on their panel that produced the best research, there would be no incentive to provide research. The buy-side firms wanted there to be a clear link between how they allocated transactions and the quality of research. However it is important to note that the rating mechanisms often favored custom research, conversations with analysts, and timely information rather than access to the printed research that everyone else had access to.

Then a whole array of factors shifted the industry, not least the rise of hedge funds as the most profitable clients, with their total disinterest in sell-side research.

Relating this model to IT research is difficult. There are no associated transaction fees, except for IT products and services, and any tie with vendors cast doubt on the independence of content. A stock or interest-rate spread trade is vendor-neutral, IT strategies often are not.

Voting on relative quality of research requires seeing it all. There are currently few analyst firms that would be willing to give all their research to a key client, on the basis that the key client would decide on the value it perceived at the end of the process.

So while a few lead clients could adopt this kind of model and convince their analysts to play, it is hard to see how there could be a broader-based adoption of these models. Which means that the problem of smaller and niche players not getting the recognition they deserve will remain.

Cost of sales is one key reason why analyst firms will remain significantly aggregated, despite many of the pressures pushing outwards mentioned by Ray Wang above.

In any case, a great analogy, food for thought, and hopefully a stimulus for new models in analyst remuneration.

What do you think? How can the IT research and analysis industry find new pricing models that increase the quality and value of the industry?