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Brokerages on resizing spree in clueless market
September, 05th 2008

They are among the biggest critics of companies with high and unsustainable cost structures. However, they appear to have fallen prey to the same. The fall in trading activity, due to a sharp downturn in stock markets, has resulted in brokerages being loaded with unduly high costs, mainly personnel and office rent, which are not commensurate to their current revenue flows. Analysts note that brokerages higher fixed expenses in comparison to revenues, which are variable given that their prospects are directly linked to the performance of stock markets, will leave them with little option but to relook at some of their cost priorities, especially staff. The current slowdown has already affected the profits of brokerages, with several of these seriously looking at rationalisation and restructuring, said Bandi Ram Prasad, a consultant at research firm, Dun & Bradstreet India.

While brokerages have already embarked on some cost-cutting measures by shutting down unprofitable branches, officials feel it is the question of time before they resort to trimming their staff, if the existing market conditions remain. A top official at a leading domestic brokerage said, most brokerages were well-capitalised after raising money through public issues and private placements in the last couple of years, but agrees that they would not wait for the tap to run dry. We will look at the market situation for another three-to-six months, before taking up any major cost-cutting, the official said.

Staff at brokerages that service retail clients would be most vulnerable to these cost-cutting measures, as this category of investors have stayed away from the market after the recent crash. In fact, if grapevine is to be believed, some top retail brokerages have already started asking their sales officials to leave, though their managers choose to remain tight-lipped about it. Staff at institutional brokerages may have some more breathing space, as domestic institutions still remain active in the market. But, the high competition in the segment and higher staff costs is squeezing margins at institutional brokerages. Deutsche Bank, in a recent report, said, broking companies typically have high operating leverage with approximately 50% of their costs being fixed. Operating leverage refers to the extent of a companys operating risk with regard to fixed expenses as against its variable costs. So, higher the fixed costs as a percentage of total expenses, grater would be companys operating leverage.

We believe declining volumes, coupled with high operating leverage embedded in their business, is likely to exert severe pressure on earnings in the near term, said Deutsche Bank analysts.

But, analysts feel higher costs for brokerages may not be limited to staff expenses. Cost structures generally are increasing across all the financial services segments in the background of increasing technology, distribution, product offerings, investor services and also compliance. In this perspective, business slowdown will pinch profit margins, said Dun & Bradstreets Mr Prasad.

To cut costs, brokerages are believed to be shifting their office locations to cheaper areas. In Mumbai, some brokerages are looking to shift core operations from prime office locations to suburbs. One institutional brokerage, which had booked an office space in a prime location during the market peak, has decided against moving, especially at a time when rentals are showing signs of easing. Some others are said to be in the process of renegotiating rentals.

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