New York, NY – In the past few years, pricing sell-side investment research has gone from a topic that most sell-side investment banks wanted to avoid, to one which a growing number of firms are starting to think about and a few are even starting to address. The following commentary was distilled from the presentations and general discussion offered at this week’s AQ Research Conference held in London.
Historically, institutional research has been sold on a “value received” basis. This means that brokers and independent research firms have given their services away for “free” with the expectation that after a money manager has used it for 3 to 9 months they will willingly pay the research provider “what it is worth to them” in commission dollars.
Unfortunately, this pricing model has become extremely difficult to justify in the UK where a more “transparent” environment exists. This has also become hard to explain in the U.S. when you paid twice as much for the same research in one year as you did in the prior year for no other reason than the commission pool doubled?
Many money managers in the UK responded by asking their brokers to give them a “price card” for their research, a request that was ignored by all investment banks. As a result, asset managers have been forced to “value” the research they used absent any meaningful guidance from the investment banks. Consequently, most buy-side firms have had little help to determine if the price they are paying for their research is “fair”.
UK Study Gets Lukewarm Acceptance
Based on these trends it looked as if UK money managers would be more than open to participate in a syndicated study to determine if they were paying a fair amount for investment research when compared to their peers. UK based consultancy Investit, in collaboration with Integrity Research Associates, decided to produce just such a buy-side study.
Despite the lack of clarity on this topic, many UK institutional investors were loathe to participate in this study. Some argued that they could not produce the type of data required to produce meaningful results from such a study. Others were concerned about the confidentiality of their data or the price of participating in the survey. However, the overall sense was that many fund managers truly did not want to know if they were paying a “fair price” for their sell-side research because this might cause them to have to do something about it if they discovered they were paying too much. As a result, Investit could not obtain an adequate sample to run the study.
U.S. Survey Shows Times Changing
In the first quarter of 2008, Integrity Research Associates conducted a survey of 95 U.S. investment banks, broker-dealers, and boutique research providers to determine whether they offered buy-side clients their research on a “fixed-fee” or “hard-dollar” basis versus the more traditional bundled commission model.
Surprisingly, 64% of those polled said that they currently would provide clients with a “fixed fee” price for their research, although they noted that only 17% of their buy-side clients had pushed for such an arrangement. Of those that provided a fixed-fee option, 95% of these arrived at this price through a negotiation process based on recent commission spending, while 5% provided price lists. All of those who provided price lists were alternative research providers who traditionally price their services in this manner.
However, 13% of those interviewed said that they are considering or planning to implement a menu based pricing model in the coming twelve months rather than a negotiated “fixed fee” or a bundled commission model.
In our minds, this survey was meaningful in that it revealed that sell-side firms are starting to deal with their client’s concern that they could not justify research payments that rose purely because commission volumes rose. In addition, this survey clearly showed that most sell-side firms do not believe that a menu or “price list” makes sense for the various research services they provide clients.
Research Pricing Models Revealed
In fact, both panelists and the audience were involved in a vigorous discussion about how investment research should be priced in the coming years. While most agreed that research would probably not continue to be priced in a bundled manner as it is today, there was strong disagreement about what type of model would make the most sense in the future.
A number of participants from the buy-side commented that they felt sell-side firms should price their research on a “menu-based” model, taking into consideration the costs or production and some mutually agreeable profit margin, much like how shop keepers price a loaf of bread or an automobile. However, most representatives from the sell-side strongly disagreed.
In fact, Barry Hurewitz from Morgan Stanley explained that there were three general pricing models that are typically used to price products and services. This included Menu (or List) Pricing. He noted that this model works when there is an established market for a good or service that is a relatively small expenditure, and the product or service is not a critical part of the buyer’s value chain. Products that are sold with a transparent price list typically have a well understood, established market, with lots of referent points that do not vary considerably. In these markets supply can also vary to meet demand. This approach is a pricing model that is in effect a take-it or leave-it offer. Mr. Hurewitz did not think this model applied to investment research.
A second price model includes Bi-lateral Negotiation. This type of pricing is typically appropriate for items that are critical to the value chain of the buyer and are a relatively expensive input for the buyer. Negotiated prices are often used for products that include some degree of customization or service. One example is Southwest Airlines buying a plane from Boeing. The quality of these products often varies quite a bit between suppliers and there are fewer comparable referent points.
A third price model involves Price Discovery or an Auction. The perception of value of the products or services varies considerably across buyers, but the good is considered to be unique and special with few direct comparable reference points. This pricing model only works when demand for the product outstrips supply, and the supply of the product or service is limited or finite. Mr. Hurewitz felt that clients valued access to their analysts or access to company managements most highly. Consequently, he felt that the best model to price access to these limited resources is an auction-based model.
James Birch from Goldman Sachs had a different perspective. He suggested that investment research should be priced in a hybrid manner. This would include one component which is based on the hours of interaction between analysts and the client, much like a lawyer or accountant charges for their time. The second portion would be a “value-based” bonus where clients reward research providers for their overall contribution to the returns of the asset manager. This way, clients that received considerable value from the research provider could reward the provider appropriately.
Some Sell-Side Firms Working on this Topic
Despite this discussion, various buy-side panelists expressed frustration that the sell-side investment banks were unwilling to “give them a price” for their research. However, the detailed responses from executives at Goldman Sachs, Morgan Stanley, and UBS showed that at least some sell-side firms have been working quite diligently to (1) better understand the cost of producing their research, and (2) better understand the research consumption of their clients, (3) better understand the profitability of all their clients, and (4) put themselves in a position to intelligently offer their clients a “fixed-fee” price for their research if they demanded it.
In fact, it was interesting to see the surprise on the faces of a few buy-side participants as they were not aware that the sell-side had been doing so much detailed work that would enable them to provide clients with a price for their research, albeit not the kind of pricing menu that many of them hoped for.
Based on these developments, it is clear that a growing number of research firms have started grappling with how to price their research. Buy-side clients, however, don’t seem to be terribly prepared to deal with this increase in transparency. In fact, many buy-side firms still seem to be living in a world where they don’t really care what they pay for sell-side and alternative research – as long as their clients are footing the bill and not complaining about it.