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.
References
Baron, D. (1995). Integrated strategy:
market and non-market components. California Management
Review. 37(2), 47-65.
Elkind, P. (2013). The trouble at
Bloomberg. Fortune Magazine. Retrieved
from
http://fortune.com/2013/12/05/the-trouble-at-bloomberg/
Ekins, E. & Calabria, M. (2012).
Regulation, Market Structure, and Role of the Credit Rating Agencies.
Policy
Analysis, 704. Retrieved from http://www.cato.org/sites/cato.org/files/pubs/pdf/PA704.pdf.
Faux, Zeke. (2011). ‘Credit Rating Fees
Rise Faster Than Inflation as Governments
Downgraded’.
Retrieved from http://www.bloomberg.com/news/2011-11-15/credit-rating-fees-rise-faster-than-inflation-as-governments-fret-expenses.html
Fimalac. (2014). Fitch Ratings.
Retrieved from http://www.fimalac.com/Fitch-ratings-GB.html
Hourigan,
Evan. (2004). The Genetic Algorithm, the Evolution of Cooperation, and
"Niceness"
in the Iterated Prisoner's Dilemma.
Retrieved from http://legacy.jyi.org/volumes/volume11/issue3/articles/hourigan.htmlInstead
Lenox, M.J. (2013). Bloomberg L.P.
Competitive Position Analysis. Retrieved
Moody’s Corporation. (2013). Annual
Report 2013. Retrieved from
https://www.moodys.com/sites/products/ProductAttachments/2013_Annual_Report.pdf
O’Connor, C. (2013). How world’s richest
politician, Michael Bloomberg, got 5
billion
richer this year. Forbes Magazine. Retrieved from
Shorter, G. &
Seitzinger, M.V. (2009). Credit Rating Agencies and
Their Regulation. Retrieved from
http://garrettforms.house.gov/uploadedfiles/credit_rating_agencies.pdf
Securities and Exchange Commission.
(2013). Annual Report on Nationally
Recognized
Statistical Rating Organizations. Retrieved from http://www.sec.gov/divisions/marketreg/ratingagency/nrsroannrep1213.pdf
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