Research unbundling in the Age Of Content

Dan Davies is a managing director at Frontline Analysts, a research firm. He is the author of “Lying For Money” and, somewhat inevitably, has a Substack.

Pretty much all media and information services are subject to an economic paradox — you only want to consume the good if it’s high quality, but you can’t tell what quality it is until you’ve consumed it.

Or from the seller’s point of view, the only way that the customer can be sure that they want to pay for it is to get into a position where they don’t need to pay for it any more. This fundamental economic problem is at the root of the collapse of sellside research in Europe over the past five years.

It came about as a result of provisions in the Second Markets in Financial Instruments Directive (MIFID 2), which were initially put in there on the insistence of the UK, but which the UK appears to have changed its mind about and is proposing to remove post-Brexit.

In order to understand the problem, think about the ways in which people might try to monetise their content.

The first way is the “paywall”. Quite simply, you solve the paradox by rejecting it; anyone who wants your content has to pay for it, up front. The advantage is that it’s simple to execute and understand; the disadvantage is that lots of people will just say no and your circulation might be small. Call this the “Bloomberg” approach, because it’s easiest to do if you have a massive brand and/or a quasi-monopoly on information that people really really need.

At the other end of the spectrum, you have “begging”. Give away the information for free, but keep reminding people that it costs money to produce, and that if at least some of them don’t pay up for it, the flow of content will cease. The advantage is that you can get wider distribution, the disadvantage is that you’re trying to push water up hill in terms of normal pricing economics. Call it the “Guardian” approach, because it’s more likely to succeed the more susceptible your audience is to emotional blackmail.

Neither of these approaches are great, which is why historically, media organisations have tended to bite the bullet and support themselves with advertising. If you have a big audience, then you can influence people to direct their purchases towards advertisers. Most of the time, they’re buying stuff anyway, the price and quality aren’t that different, so it costs them little to help you, solving the economic paradox that way. That might be the “YouTuber” approach.

You can push it a bit further though. Somewhere between begging and branding is “develop a slightly weird parasocial relationship with your readers, such that they will look after you through other channels, hire you for jobs, pay you consulting fees and so on”.

This approach is surprisingly widespread across new media from Substack to LinkedIn, but it arguably originated in investment banking.

Sellside research is to a very small extent advertisement for brokerage services (which are barely profitable themselves these days), and mainly a way to build the kind of buddy networks with companies and investors that are essential if you want to do advisory or have a capital markets business.

It’s noticeable that Deutsche Bank still has an equity research department even though it doesn’t have an equity trading department, and that it appears to have acquired Numis for its network of UK corporate brokerage relationships (of which the provision of research coverage is an important part).

One of the things which reliably surprises newcomers to the industry (particularly if they have economics degrees) is that despite everything being based on transactions, nothing is transactional.

It’s really gauche to ever mention to a client that their employer pays money to your employers and that’s why you’re talking to them. It’s just friends doing favours for friends; a coverage banker will think nothing of entertaining a CEO with lunch, golf and expensive proprietary analysis for a decade, in the hope of getting an advisory mandate when the occasion arises.

Why do they do this? Partly because that’s the way we’re socialised; clients are typically rich people, and the richer you are, the less likely you are to ever be presented with a bill and asked to pay it there and then. That’s the way it works; you or I might need to settle up at the Holiday Inn, but if we were Anna Sorokin we might stay for ages before they asked for a credit card.

It’s an industry that works on trust, and one great way to build trust is to give away valuable stuff and indicate that you trust the recipient to pay for it when it suits them.

But also, because it works. This set of social customs survives among bankers because it has an economic role; it solves the central paradox of selling information and advice for money. Only a small number of big providers could get the paywall model to work, and the begging model is very difficult to make profitable. If you want to have a full ecosystem with a wide variety of high-quality product, you have to take part in the parasocial relationships that support the LinkedIn/Substack kind of approach.

Regulators, unfortunately, hate this. There is no open market, no arms-length pricing information, and consequently no objective way of knowing whether the business that flows through the buddy networks is value-generating in itself, or just a massive industry-size slush fund.

And since the people who pay for everything are, in the final analysis, the investing public, there’s no way to be sure that the fees are fair or competitive.

Consequently, MIFID 2 banned all research business models except the paywall. (Even begging was disallowed — you’re not allowed to distribute research for free because the regulators assume that you would sneakily use it to build a relationship). And as a consequence of that, banks massively reduced their research teams.

Whether this was a good or bad thing is a debate for another day. It certainly wasn’t an unintended consequence — a key belief of the UK authorities a decade ago was that the market produced much too much research, because the people who consumed it were using their investors’ money to reward their kind-of-friends in an opaque way.

But now the regulatory pendulum has reversed and research bundling might come back to the London market. And the new generation of bankers and investors might not be so awkward about monetising content — they’ve grown up in the knowledge that their internet friends are going to keep shouting “don’t forget to hit like and subscribe!”.