Win/Win in the Financial Marketplace

I am now working my way through Guy Kawasaki’s “Art of the Start”, and I enjoyed his section on establishing a business model. The truth, he asserts, is that there aren’t many business models left to be discovered. A better bet is to take an existing business (let’s take the financial markets for instance) and apply a new business model to it. Some interesting ideas come up.

What about having a you-win, we-win (or win/win) financial market? Currently, market participants are charged a flat rate for execution, regardless of effectiveness of execution. You buy where you wanted to? You pay X. The market moved based on your order, and you bought above where you wanted to? You pay X.

Obviously there is something wrong with this situation. The executor (most likely a brokerage as well as an exchange) is not rewarded for filling your order and a best-in-class way. In a market that supposedly is the poster child for meritocracy, I don’t really see it in action.

What if instead, you were able to offer clients a guarantee – execution at a price that is acceptable to their guidelines, or a lowered fee? Obviously the reverse holds, a superior execution would require a superior payment. Think of it as the hedge fund model applied to execution (one plus ten, or two plus twenty). Keep in mind these numbers are fictional (and unrealistic) but bear with the example. In the later, two percent is charged for the service, in this case, the execution. That payment keeps the lights on in the offices of the executor. The twenty is a sliding scale that is received based on quality and accuracy of execution. The client comes in with a market moving order. That order is executed perfectly, with no material effect on the market price. The client wins because they were able to execute at their desired price without information leakage, and the executor wins because they now receive a ‘bonus’, depending on the agreed upon terms.

This is a win-win for both sides. If a client gets their order executed where they wanted it, they save money from the market not moving, which is paid to the executor. If the market gets away from the individual executing the order, the client does not have to pay the bonus amount. Order executors are incented to act in the best interest of the client. By executing orders in a way that helps the client meet their goals, they get a monetary incentive.

Now, obviously it would be hard to determine a system for measuring what a ‘proper’ execution was. What the rate to benchmark against is, how to determine what a quality execution looks like, and in return change that into a numerical bonus, but it’s important not to get buried in the weeds. With some market research and data analysis (see my earlier post on Google, transparency, and leveraging data) one could develop a method for doing the above in a calculated way.

Like Guy says, it can be very interesting applying a new business model to an old business. Who knows, it just might catch on.

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