How the thundering herd went astray in Japan
Merrill Lynch: The investment bank thought it had a golden opportunity to build a retail brokerage in a difficult country. But bad luck and cultural differences stood in its way, says Gillian Tett
By Gillian Tett
Financial Times
Oct 26, 2001When Merrill Lynch became the first US bank to open a retail brokerage in Japan in 1998, a customer walked into its offices and tried to buy something to eat. The broker's "bull" logo was so unfamiliar that some Japanese concluded Merrill Lunch was a Korean barbecue selling grilled beef.
These days, the "thundering herd", as the bank is nicknamed, has become relatively well known in Japan. Indeed, the windows of its Tokyo brokerages are filled with cuddly toy bulls wearing Merrill Lynch T-shirts - an attempt to appeal to the Japanese love of kitsch.
But this fame does not mean it has enjoyed outstanding success. Merrill's courage in trying to enter the Japanese retail brokerage market has been matched by disappointment at the results. Though the investment bank initially expected to break even by 2000, it has attracted only Y1,700bn (Pounds 9.7bn) of assets from investors, far less than it expected, and posted losses of about Y20bn in each of the past three years.
This has left some senior managers in Merrill's offices in New York contemplating a radical cutback in the Japanese retail business - or even outright withdrawal - as part of a global retrenchment. And although a final decision on Tokyo has yet to be announced, it will be closely watched by the rest of the financial world.
This is because Merrill's experiment in Japan is considered one of the boldest gambles on the country's potential for financial reform. "Many people are looking at Merrill Lynch and thinking, 'That could have been us'," admits one rival. "What everyone is urgently trying to figure out is what went wrong."
The answer appears to be a combination of bad luck and cultural mistakes. Merrill emerged from US retail broking, where financial consultants preach the concept of balanced, long-term financial planning with evangelical zeal - and mutual funds are viewed with reverence. However, most Japanese have preferred to put their money into bank accounts, life assurance or postal savings, rather than equities - partly because they were burned in the crash of the stock market in Japan in the early 1990s.
Having failed to make headway against entrenched Japanese brokers in the early 1990s, Merrill decided to try again in 1997. At that time, Japan's largest brokers were ailing. And the government had unveiled a set of Big Bang financial reforms that explicitly stated that the country needed to move more of its savings out of bank accounts and into securities.
Merrill, like most foreign fund managers, thought this would stimulate a mutual fund boom, of the type that the US had enjoyed in the 1980s and that was starting to gain momentum in Europe. As Filip Lein, managing director of equity capital markets in Tokyo, points out: "One reason why there was so much excitement about asset management was that everyone had experience of the equitisation that had occurred in Europe."
Until then, most asset management companies had assumed that the only way to grow in Japan was by alliance or organic expansion. But in late 1997 a heaven-sent opportunity landed in Merrill's lap: Yamaichi Securities, once Japan's fourth largest broker, collapsed. The Ministry of Finance discreetly indicated that it would let Merrill buy Yamaichi's assets - and even offered large tax breaks as a sweetener.
Merrill leapt. It announced plans to buy Yamaichi assets and rehire about 2,000 of its staff in a scheme code-named "Project Blossom". And it appointed Ron Strauss, a New York-based manager, to run the operation. Mr Strauss had just finished his honeymoon when the deal was first announced - and was so stunned that he initially told his new in-laws that the story of Yamaichi's sale to Merrill must be a joke. "Setting up this business was incredibly intense and complicated," he recalls. "After all, no one had ever done it before."
Seven months later, Merrill finally opened its doors, having taken over two dozen of Yamaichi's branches. This attracted a blaze of publicity. At one point, the broker was besieged with more than 100 requests for media interviews each day.
However, it faced cultural problems almost from the start. During the seven long months when Merrill was negotiating the complex deal, consumers had withdrawn almost Y11,000bn of their money from Yamaichi, most of the assets it managed. Although the US broker had thought that these assets would return, they did not.
"One of the problems was the time gap between Yamaichi closing and us opening," admits Hidemi Fukuhara, deputy president of the Merrill Lynch private client group. "In that time all the investors who were intelligent and savvy - in other words, the ones we really wanted - took their money out."
This was partly because Japanese culture dislikes failure. Another problem was that in Japan broker loyalty depends more on the company brand than on the individual - meaning that the account managers who moved from Yamaichi to Merrill did not bring all their clients with them.
"One of the biggest challenges we have had is making ex-Yamaichi staff into Merrill Lynch-ers," admits Mr Lein.
However, the single biggest problem was image. In Japan, the reputation of brokers is not much better than that of casinos. This is partly because Japanese brokers have traditionally "churned" accounts - persuaded their customers to switch in and out of stocks or mutual funds rapidly, so that the broker can earn more commission. But Merrill insisted - with puritan zeal - that it would not engage in account "churning", but would encourage long-term financial planning instead. And it refused to accept cash, which Japanese brokers prefer, because this went against its global anti-money laundering policy.
This was applauded by many foreign investors. But Japanese consumers were unhappy. Some disliked using bank transfers to open accounts with Merrill, because this exposed them to criticism for being "disloyal" from Japanese bankers.
And it was difficult for Merrill to shed the "casino" image, because under Japanese law it had to label itself as a shoken, or broker. "In the US we are operating in a space between a bank and broker," says Mr Strauss. "But that space just doesn't exist in Japan's regulatory system."
Throughout 1998 and 1999, Merrill plodded on, convinced that its mission would eventually bear fruit. It embarked on a heavy advertising campaign featuring Sammy Sosa, the baseball player. And as the Nikkei rose, its assets slowly grew.
However, its customers refused to listen to advice that they should diversify stocks and insisted on gambling heavily on the fast-rising technology sector. When the markets crashed in early 2000 - and the technology stocks tumbled - its assets stagnated. And by mid-2000 the business was bleeding cash. Mr Strauss imposed swingeing cost cuts and a shift in strategy.
Instead of trying to target the retail mass market, the broker would now target high-net-worth individuals. Since these clients were unlikely to walk in off the street, they needed to be visited at home. So Merrill decided to shut down some of its offices and create a network of travelling consultants. This, coupled with a radical consolidation of information technology systems, halved operating costs.
"I would say we have found our way now - in the last two years we have recognised who our clients are. We are not aiming to be the biggest securities company in Japan, but we want to be the smartest," says Mr Strauss. "Having a street-level presence is not really what our model is about now. If Sammy Sosa was to walk through that door today I don't know if we would use him."
But just when this strategy appeared to be working came the September 11 attacks. After the stock market tumbled to an 18-year low, it suddenly looked doubly unlikely that Merrill would ever achieve the rapid growth in assets that it had been seeking. "In the last three years we have confirmed that there is a mountain of opportunity," says Mr Fukuhara. "But we have also confirmed that it will not move as quickly as we had expected."
To withdraw would be disastrous for the broker's reputation in Japan. Those, such as Citibank, that have enjoyed clear success in Japan's financial sector have usually done so only after years of struggle.
It would also endanger Merrill's corporate banking. This is because the retail broker has supported the expansion of the wholesale business in Japan, helping it win mandates such as the sale of shares in NTT, the telecommunications company, and Acom, the consumer finance group.
"Our Japanese retail network allows us to offer something that practically no other US-based firm can in this market: the combination of significantly local Japanese retail and global distribution," says Jesse Cosso, Tokyo head of investment banking.
But in the new cost-cutting climate it has become harder for the head office in New York to tolerate a business that continues to bleed cash. And Mr Strauss has now been promoted into a new post back in New York. He remains convinced that the adventure was worthwhile - and insists that the business can be made viable.
"Given the restructuring (in recent months), by the summer of next year the business will break even, even at current market levels," he says.
"But," he adds, sadly, "that may not be good enough any more. External events may have overtaken us."
Copyright: The Financial Times Limited