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Banks’ strategic behaviours unleashing waves of job cuts

December 18th, 2008

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Since the credit crisis first erupted 15 months ago, the problem was mainly confined to the financial side of the economy. Today, we are seeing signs of the crisis spreading to the real economy in far-flung countries like Australia. As Australian banks expected to sack staff reported,

Jobs are disappearing at the four major retail banks, and staff freezes have been ordered at investment banks and struggling fund management groups.

There are news reports that 10,000 banking jobs could go in the months ahead. While we will not be investigating the credibility of this number in this article, we will explore the concept of Game Theory using banking jobs as an example.

In essence, Game Theory is…

… a branch of applied mathematics that is used in the social sciences (most notably economics), biology, engineering, political science, international relations, computer science (mainly for artificial intelligence), and philosophy. Game theory attempts to mathematically capture behavior in strategic situations, in which an individual’s success in making choices depends on the choices of others.

In the banking jobs example, what if one of Australia’s major banks decide to cut staffs? What will be effect of this strategic decision on the other banks?

To put it simply, if XYZ bank restructures its business and cut, say 15% of its workforce, it will have a competitive advantage against the other banks in terms of costs. During hard economic times, people are tightening their belts and consumer spending will be down. Naturally, consumers will care less about product differentiations and care more on finding the cheapest bargains. Therefore, businesses that can lower their costs will have a price competitive advantage against their rivals. So, in this case, what will the rivals of XYZ banks do? They will follow XYZ’s lead of restructuring and cutting staffs.

That’s why in the months ahead, as the economy slows further, we will see waves of corporate restructures and staff cuts. Unfortunately, these actions by businesses will further depress the economy, which in turn will provoke the next wave of cost cuttings.

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This entry was posted on Thursday, December 18th, 2008 at 9:00 pm and is filed under Analysis - Business, Looking Forward, Market Observations. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

  • MPC
    Game theory also predicts that once one bank starts lay-offs, the rest will start lay-offs as well. In the war for talent, the banks want to offer the most service to clients and make the most from proprietary investments for the lowest price. If a certain number of employees offer a certain level of service, then each bank must maintain that level in order to stay competitive. Further, if a certain investment return bears a certain compensation price, then each bank again will have to price that price to stay on par. These conditions create a price war for talent, quite like the US airlines' price wars.
  • A few more game theory thoughts - saving during a recession is the defect choice in prisoner's dilemma.

    If everyone spends and borrows to buy assets, it is advantageous for you to do so too. However, if everyone saves (defects) then it will be a disaster for you to spend and go long as you will see capital losses and have less of a buffer for job losses (which are now more likely).

    Another example - banks deciding to tighten lending which causes the debt inflated asset prices to fall in value. CBA was dragged into giving a loan extension to the walking dead Centro. However, at one point this can fall away and everyone realises that the sooner they tighten, and start selling off assets, the less risk and higher prices they will be able to obtain.

    That decisions depend on what other people do and alter outcomes causes magnification to small decisions, leading to virtuous and vicious cycles - and booms and busts.
  • Casso
    I do agree with that :p
  • Casso
    Lol, of course the world isn’t simple, but do you think the auto companies in the US are worried about competing with each other right now? I think their immediate thought is survival – shut down the machines for a month while we work out what’s going on, and use the time to plan some systematic cost reduction strategies.

    If things get really tough then I don’t think the banks will be looking to grow their business through competition for new loans. They’ll be looking to maximise their returns on the set of loans that already exist (ie reduce costs, and increase product prices where possible)
  • Casso
    In these times many organisations will drop their long term strategic visions and adopt short term survival practices – cutting staff at the cost of function and long term competitiveness. But the experienced organisations usually recognise that cutting jobs on a large scale without thought to strategy and operational effectiveness is suicide in a competitive industry.

    So will the big banks be cutting these jobs in an attempt to be more competitive (ie game theory)? I suspect not… I believe that they will make these cut backs purely as survival tactics; systematic cost saving processes such as killing redundant / marginal projects, renegotiating supplier contracts, reducing non-core services and bought-in goods and services, etc, etc.

    I suspect that they will be reducing these costs as survival tactics in a world that’s been turned upside down, not because they’re gaming against each other.
  • Pete
    You are right, but I am not sure the emphasis will only be on the banking sector. Retail will surely get hammered.

    These strategic behaviours you speak of have a certain irony to them in this case - as it was these same strategic behaviours that got the financial sector into this mess in the first place.
    Imagine if you were the CEO of a bank five years ago. If you did not invest in dodgy mortgages and securities, your shareholders would be very upset as your bank would not be realising the same increase in profits of your competitors. Not that the banks are innocent of stupidity, it is just another way to consider the situation.

    I will try to explain game theory to everyone who has not heard of it (I did this in one of my strategy classes at Uni, for what thats worth):
    Game theory is a process whereby you assign values (usually -10 to 10) to different actions and reactions for a particular issue. You then total these assigned values (both positive and negative) to determine what the total positive (or negative) effect will be. The goal is to typically find the path with the most positive effect and take it.

    For example: Lets say one path the banks are considering taking is to reduce staff. Then we would assign a value to all the actions/reactions that occur, such as '-8 public backlash', +10 'reduce overheads', +6 'increase competitive advantage', and so on.

    The supposed advantage of game theory is to enable a quantitative approach to strategy. It has many flaws, but I see value in its use as a rough guide for a course of action.

    So there you go...
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