This section is mainly my work - though I received input from teammates as well.
Firms and Markets Assignment
Section 2: Breaking into the Credit Rating Market
To recap, the main barriers to entry to the credit rating market are firstly, the reputational mechanism that causes firms to rationally seek widely respected firms to rate their debt; secondly, the regulatory barriers to becoming a NRSRO; thirdly, the network externalities that give higher value to the services of firms with greater penetration of the market, which in turn necessitates high initial investments; and fourthly, the possibility of an aggressive and coordinated strategic response by the Big Three. Any successful entry strategy must overcome these formidable barriers and they are few firms that possess the necessary pre-requisites.
We model the entry of Bloomberg L.P. into the credit rating market through an integrated strategy (Baron, 1995) with market (Porter’s generic strategies of cost leadership and differentiation) and non-market components (exploiting political pressure). We use the Bloomberg archetype to illustrate how new entrants may overcome the formidable barriers of the credit rating market. Figure 1 applies systems dynamics to represent our strategy, which should result in S-shaped growth [not shown]:
Breaching the Reputational Great Wall
Bloomberg L.P. enjoys a worldwide reputation for being a reliable information provider. It commands 30.82% of the market data market in 2012, and the Bloomberg terminal commands 57% of its sub-market. It also provides information through Bloomberg News, Television and Businessweek (Lenox, 2013). Thousands of firms thus rely on Bloomberg for vital business intelligence.
To augment its brand name, it can use its vast financial resources to acquire one of the smaller debt raters. Morningstar heads the list, being one of the most respected financial information firms. It has a market cap of only 3 billion (Nov 2014), while Bloomberg’s estimated market cap is 27 billion, with 2013 revenues of 8.3 billion and profits of 2.7 billion (O’Connor, 2013; Elkind, 2013). Assuming the acquisition is successful, Bloomberg Morningstar Debt Rating will be a formidable brand name. In addition, Bloomberg can save on the costs and time of NRSRO registration.
Blitzkrieg for Growth
Even though Bloomberg already enjoys wide recognition, few may initially use its debt ratings, minimising network externalities.
Bloomberg needs to blanket the market quickly by offering heavily discounted or free debt rating services as part of its Bloomberg Professional Services (available through its Terminals). As such, it will be natural to offer a differentiated subscriber-pay model (already employed by Morningstar), where investors pay to obtain ratings, unlike the somewhat discredited issuer-pay model of the Big Three (Appendix B). While both can lead to conflicts of interest, the subscriber-pay model potentially has less such (SEC, 2013) - and in any event, it can be marketed accordingly.
To attain cost leadership, Bloomberg could rely on rating methodologies that leverage its core competencies in information aggregation and analytic technologies, and rely less on analysts. Indeed, Moody’s has identified this approach as a competitive threat (Moody’s, 2013). By reducing labour usage and focusing on upfront capital expenditure, Bloomberg could quickly achieve economies of scale. The Big Three will likely be caught flat-footed as collusion has protected them from cost pressures. Their methodologies have also been severely questioned (e.g. Ekins and Calabria, 2012) and Bloomberg can market a cost-effective and impartial subscriber-based approach.
Most importantly, proprietary debt ratings provision should greatly differentiate its Terminals, allowing it to capture a greater share of its core market - and given low marginal costs, increase profits dramatically. This can then cross-subside aggressive pricing for the debt rating market, which may entail an overall profit increase.
Getting Help from Uncle Sam
Given their contribution to the financial crisis, the Big Three are vulnerable political targets. Michael Bloomberg is one of the most powerful businessmen in the world, being former Mayor of New York and a possible Presidential candidate. He could use his connections to quietly lobby for regulations that compel the financial sector to consult subscriber-pay ratings, with issuer-pay ratings as an added option. Such regulations should be politically popular, as it can save businesses much money. This will create demand for Bloomberg’s services, allowing it to charge a reasonable price to cover expenses (increasing profits overall), while forcing the Big Three to invest huge amounts to react.
If necessary, Bloomberg can exploit political sentiment against the Big Three to become a NRSRO. The reputation of Bloomberg L.P. already makes approval practically a certainty, given that far less established players have obtained it.
Crushing Collusive Competitiors
As argued above, there is likely tacit collusion between the three major players. As such, some kind of coordinated response by the three players is very possible – i.e. a reduction of prices that can hinder Bloomberg’s ability to capture market share. Yet Bloomberg has little to fear from any price war. It possesses reliable profits from its core markets and being privately owned, can endure many quarters of lower overall profits. Theoretically, it can also launch a ‘nuclear strike’ to devastate the undiversified Fitch and Moody by offering free debt ratings to all its Bloomberg Terminal subscribers. And as mentioned, Bloomberg will likely enjoy increased profits from its core market that can be ammunition in any price war.
As such, especially when combined with a successful political strategy, Bloomberg has the bargaining power to divide and conquer, striking up partnerships with one of the 2 smaller players, perhaps through a cross-branded rating (which eliminates the need for the Morningstar acquisition), while lowering prices aggressively to completely eliminate the other - allowing a Bloomberg Moody or Bloomberg Fitch to become the biggest player. If well executed, Bloomberg can devastate one of S&P’s core businesses, weakening this rival which competes with it in the business information market and strengthening its dominant position in its core market. This allows it to plow even more money into the credit rating market to attack S&P.
Our discussion indicates the possibility of defeating the Big Three, but only with an unusual combination of political, reputational, ‘distributional’ and financial power. No challenger has succeeded – for now.
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