Lessons from Salomon Brothers may be useful to other firms
The radical corporate restructuring announced by Salomon Brothers last month drew wide attention, not just because of the size and success of the bond dealer-turned-investment banker, but because what happens to Salomon may be a preview of changes in the entire financial market. Any one of the moves by Salomon Brothers would have been noteworthy, but taken together, they were very dramatic:
The firm abrubtly dismissed about 800 highly paid employees and shut down its municipal finance department Oct. 12. Many puzzled Wall Street veterans wondered why ``Solly'' would suddenly close what had long been thought to be a consistently profitable operation, which was No. 1 in municipal underwriting.
Salomon Brothers simultaneously abandoned the commercial paper market and the market for bank certificates of deposit.
On Oct. 13, Thomas Strauss, the president of Salomon Brothers, flew to London to announce a cutback of some 150 Salomon employees there, bringing about a 15 percent reduction of the firm's total work force in just two days.
Perrin Long of Lipper Analytical Services notes that ``Salomon Brothers primarily serves institutional clients. What they seem to be saying to their clients is that they will no longer make secondary markets in securities that are, at best, marginally profitable. They will no longer maintain activities in those areas that are now loss leaders.''
The stock market's dive Oct. 19 generated persistent and widespread rumors that the firm might lay off all employees who had been there less than 12 months. The slide in stocks will make a return to profitability even more difficult.
In the past, ``Solly'' has been very profitable. Founded in 1910, the firm prospered for many years as a small dealer in United States government bonds. It gradually branched out into corporate and municipal bonds. In 1969, a change in tax laws induced commercial banks to become committed investors in municipal bonds, so the firm aggressively marketed its bond expertise in the underwriting, selling, and secondary trading of these arcane instruments and soon gained a leading role in this complex financial arena. Thus, it consistently reaped large profits in municipal bonds.
But it also grew in personnel. The collapse of the municipal bond market this spring was one of several signs that personnel cuts might be expected on Wall Street. Only the rising stock market delayed the event.
Some analysts noted that if the dismissed employees were each receiving an average salary and bonus of $125,000 annually, the firm would cut annual overhead by more than $100 million. Still, after years of aggressive effort and consistent profit, abruptly abandoning a franchise it worked so hard to establish was hard for Salomon to accept.
Salomon's chairman and chief executive, John Gutfreund, says the firm will focus on four goals to increase profitability: cutting overhead; redeploying trading efforts to concentrate on government bonds, mortgage-backed securites, and financial futures and options; increasing its investment banking activities; and concentrating more on merchant banking.
Salomon has long prided itself as a trader of secondary market securities, primarily bonds. For almost two decades the firm traded more and more aggressively, applying the same effort to trading as it did to sales. Earlier this year, its overall securities portfolio was sometimes as large as $40 billion.
But by April, this strategy backfired. The firm's bond losses were reported to be $100 million in that month alone.
``Markets do not always reward aggressiveness. You can only take from them what they are willing to give you. You will be punished if you try to take more,'' comments Michel de Chabert-Ostland, senior vice-president of Chilmark Commodities in New York, a veteran trader of financial instruments.
Concentrating on the fee-based area of investment banking indicates the company believes the bull market, begun in August 1982, will continue. But last month's decline in stock prices could be the beginning of a cyclical downturn in business activity. If so, opportunities for investment bankers will be fewer.
Salomon Brothers is in the upper bracket of companies advising financial businesses for fees, the core of American investment banking. But it could take the firm several years of work to chip its way to the top. Dumping the commercial paper department may destroy the trust that some corporate clients had in the company. Without this trust, Salomon may have difficulty converting a core of them to valued investment-banking clients.
The firm is abandoning markets in which it was an acknowledged leader because, Mr. Long noted, ``None of these markets have been really profitable for the last two or three years.'' But will a shift to merchant banking be profitable for the firm?
``Merchant bankers,'' comments Christopher Wright, senior vice-president of Kleinwort, Benson (North America) Corporation, a leading global merchant banker, ``can perform three functions. Historically, they were traders in physical commodities who lent their names and capital to other traders in commodity and shipping transactions, and still do. Merchant bankers can act as advisers and may lend capital in the form of short-term or bridge loans to effect transactions for their clients. Finally, merchant bankers may also take equity positions alongside their clients.''
Salomon Brothers will have a fourth burden to bear as a new merchant banker. Fierce global competition will force it to climb the learning curve very quickly. It will need large and secure sources of capital to participate in deals. And it will have to show consistent and acceptable corporate profits each quarter while waiting for longer-term merchant banking deals to mature.
How well Salomon Brothers manages these formidable tasks will be a useful lesson in financial management for companies in similar positions in the future.