The title of a humorous take on Wall Street and American financial markets begins with a visitor to NYC overlooking the yacht collection owned by top bankers asking himself “Where Are the Customers’ Yachts?” A hard look at the fees financial services shops charge end clients follows over a few hundred pages and fee compression that would make an 80s eat-what-you-kill broker croak ensued over the decade and a half since its 2006 publishing date. Financial services has witnessed a deathblow to traditional active management by a tsunami of seemingly endless outflows from the mutual fund business into lower cost ETFs and index trackers. In the institutional AM space, high fee share classes are being pushed out in favor of (what the SEC claims) are client friendly alternatives. Active shops like Fidelity and Blackrock will forever continue to exist and thrive with world-class research teams and star fund managers, but the days of sticking an end client in C-share class large cap active funds while advisors collect 250 bps off the top annually are over. Clients have more investment vehicles now than ever before to invest their retirement savings. I write ‘clients’, but who am I actually referring to? It’s left ambiguous for a reason. It’s clear the ‘client’ of a financial advisor, pension plan, or defined benefits plan is the retail investor – the one putting their hard earned cash away in various investment funds until retirement age while they slowly grow that nest egg year over year. Do the fund managers have the same definition of ‘clients’ they wake up every day to work for? Eh, not so fast. The Asset Manager services the advisor or leader of each retirement plan, not the retail shareholder directly. As they say, happy wife, happy life and the institutional sales guy from you-name-it-fund-co wakes up looking to ensure their top advisor or plan contact continues to come directly to them for any market updates or outlooks. In turn the hope is for more inflows and an extra zero in the bonus check come Christmas time.
Show me the underlying incentive and I’ll show you what really drives the action each and every individual on our planet makes. This is true in every industry where incentive layers drive individual actions all bubbling up to a mismatch of who everyone is actually providing value for. Before we get into more examples I’d like to be as clear as possible: by no means am I saying active managers don’t provide value as I’m in many actively managed equity funds myself (some possibly from the big green machine previously mentioned above). This post is about the hidden realities powering our day to day interactions with the world that are easily overlooked. Our job as individuals is to constantly be looking for a hidden edge and that starts with identifying the incentives of organizations that shape our world view.
Newspaper Companies
Traditional media companies have been dominated by large publishers with editors ruling over writing staff since the establishment of the Associated Press in the mid-1800s. The Associated Press was started as a cooperative venture among six NYC newspapers that thought there must be a more cost effective and faster way of obtaining what what going on during the Mexican-American war hundreds of miles away. By pooling capital, the group was able to establish a series of riders that could get information to writers weeks faster than legacy approaches. The AP was the first of its kind to then use telegraph to transmit stories across long distances, revolutionizing the way news was distributed. The AP paved the way for hundreds of major media players to follow in their footsteps including giants that we still read today like the New York Times and Wall Street Journal.
The NYT charges $6.25 a week to subscribers topping $325 a year with the WSJ at $9.75 a week and $507 a year. One would venture a safe assumption that the readers paying subscriptions for access to content are the true customers of both these publications. But that isn’t the entirety of the story. The NYT had subscription revenues of $384 million and advertising revenue of just over $117 million for the year ended 2022. Although the total subscription revenue outweighs ad sales, each individual advertiser contributes multiples of the value of each individual subscriber. Why would this be important? Stories that piss off an individual subscriber don’t hurt if they walk away compared to if an individual advertiser jumps. When ad packages are sold in advance, each corporation is pitched on generally what the paper will contain for news coverage, demographics of readers, etc. Is it likely we ever see a critical piece of a company appear in the opinion section less than an iPhone distance away from an advertisement of said company? I’d venture to guess that is a resounding nope. This can lead to some biases leaking out of the editorial room and a lack of coverage on important issues that may not align with those of their advertisers. While we certainly see many journalists that strive for objectivity and integrity in their reporting, we also have many that have decided to go out on their own like Bari Weiss. If media outlets wanted to become truly independent and have no outside actors to answer to, they would up the individual subscription prices and get rid of the ads. But, this won’t happen as it doesn’t fatten profit margins already stretched thin by subscribers continuing to look elsewhere for faster news alerts.
NFL
The National Football League was founded in 1920 and has since grown to become one of the most popular and financially successful sports leagues in the world. The 32 franchises are each valued at over a billion dollars and collectively drive mind-blowing revenue numbers yearly for a sport that finds a way to dominate television, podcast, social media, and even news coverage. Ticket sales drive a large portion of revenue for NFL franchises, but this pales in comparison to broadcasting rights. The NFL has found a way to collectively dominate Sundays for 6 months of the year airing games from 1:00pm ET – midnight watched by tens of millions across the US. Games are also sprinkled in on Thursday and Monday nights with the league expertly diving up viewership across Fox, CBS, ESPN, NBC, and Amazon Prime. Streaming networks now entering the live sports broadcasting game has added zeros to the deals the NFL is able to secure for just the rights to exclusively broadcast each game. The burden of the entire broadcast is then up to the network after forking over hundreds of millions of dollars! It’s one of the best business entertainment strategies of our lifetimes and Ben & David at Acquired have an even better breakdown here. Roger Goodell is the acting commissioner of the NFL and is responsible for overseeing all aspects of its operations. He is elected by the owners of all 32 teams and handles duties like deciding on rules and negotiating broadcast and media rights.
Often emotions conflate into objective reasoning for sports at fandom alters the reality – the NFL is purely a business, and a wildly successful one by any measure. What continues to draw viewership and in turn advertising dollars are narratives. And each season is a story starting in early spring with the apex in February at the Super Bowl. Every year there are heroes, villains, mistakes, character progression, setbacks, and triumphs. All of these narratives are debated over hours of sports talk online and provide fodder for fans to go back and forth on who should have done what during which play. Take my New England Patriots, for instance. The recent departure of the greatest NFL player of all time to Tampa has left a dominant franchise floating in the wind. Expectations have reset from “we expect to contend for the Super Bowl every year, no questions asked” to “let’s make the playoffs and see what happens”.
As long as there are games to play, there will be fans ready to predict and debate future on-field performance. These fans purchase tickets to games, buy merchandise, but most importantly they provide eyeballs. Not just for the games, but for what goes on in between whistles. This past season, viewers were serenaded by the tune of, “WHOPPER, WHOPPER, DOUBLE WHOPPER” from Burger King in an advertisement that was so successful it continues to go viral on social media to this day in tweets that point out the humor of how often it was played during games. Barron’s magazine had an excellent cover story on the NFL a few years back that highlighted the importance of what NFL rights meant to each of the networks able to broadcast games. The shift in television viewership from live events to streaming has resulted in skyrocketing value of live sports. For television shows, viewers can simply record the episode and watch at a later time skipping over the commercials. This isn’t possible for live sports where your friends, family, and coworkers all watched the game in live time and want to talk about the outcome. With so many viewers virtually forced into watching in live time, networks fork up so much cash to drive ad sales they barely break even by going through the burden of airing each live broadcast. What each network hopes for in return are additional viewers into their exclusive programs that come on after the games. A classic example of this is 60 Minutes “Coming to you live after the 4:25pm games for East coast viewers”. In a perfect world CBS breaks even with their NFL broadcasting investment and drives large amounts of spillover viewership into an exclusive program following their final game each Sunday thereby creating a consistent audience. In between segments of 60 Minutes come commercials and we wash, rinse, and repeat… Again, on the surface level the customer for the NFL seems to be the fan but taking a closer look at the product reveals advertisers purchasing airtime on the individual networks are a much larger driver of who is really paying for the largest revenue by any sport in North America.
Summary
The underlying motives of individuals and organizations shape the decisions they make in various industries. For example, in the financial services industry, the interests of asset managers, advisors and plan contacts can sometimes be misaligned with the retail investor, who is the end client. The incentive layers that drive individual actions in the industry have led to a shift away from traditional active management towards alternative lower cost ETFs and index trackers. Similarly, the NFL franchises generate significant revenue for their owners through various sources, including sponsorships, broadcasting rights, and merchandise sales. The commissioner of the NFL serves the interests of each franchise owner, as they have the power to remove him from his position if they are not satisfied with his performance. Thus it is in the best interest of the commissioner to make decisions that please a majority of 32 owners, rather than a majority of NFL fans that tune in on Sundays. Taking it a step further, it is in the NFL’s best interest to deliver a product that convinces fans to tune in just enough to keep their eyeballs directed at ads from the companies who really pay for multi-billion-dollar television deals.
This piece isn’t written to be critical of any of the above industries, quite the opposite. I’m an investor in actively managed funds and will continue to be. I’m a diehard Patriots fan and don’t plan on stopping even if we end up like the mid 2010s Cleveland Browns for a bit. What I have tried to point out is the underlying mis-match of incentives that don’t appear until we take a slight look under the hood. It is something I am consistently on the lookout for throughout my daily life as it impacts how every product ends up in our hands. World-class product market fit is no mistake and we are extremely fortunate to live in a time where it is seemingly impossible to reach true boredom. Let’s all make a promise to continue to hunt for how each of these companies execute and find our own edge.
mike murphy 