Select Committee on Treasury Minutes of Evidence


Examination of witnesses (Questions 140 - 157)

TUESDAY 18 APRIL 2000

MR MATTHEW BARRETT, MR BILL DALTON and MR PETER ELLWOOD

  140. We have gone through this whole morning with people talking about cost structures and now when I ask about cost structures it is all very indeterminate and not very measurable.
  (Mr Barrett) No, we know what it costs us. We know what these operations cost. We allocate costs and we know what volume of business we have to develop for something to be profitable. We know our costs.

  141. But you were the person who said, "How do we know the difference between cost and price?". You made that remark earlier.
  (Mr Barrett) Yes, I did.

  142. I put that back to you. How do you know the difference between cost and price?
  (Mr Barrett) I do. The point I was making earlier was that the notion that price is a function of cost is not technically correct. I was making the point that if that were true the Mona Lisa would sell for £1.10 if you took the canvas and the paint. Price and cost are not related. What cost tells the businessman is whether, based on what price is in the market and given this cost, he will go into the market or not? In other words, can he develop a business model where his cost base is lower than the prevailing price in the market; then cost becomes important, only in that sense. It does not become a base from which you determine price except that obviously the price cannot be lower than the cost because you lose money and go out of business.

  143. Price is what you can get away with.
  (Mr Barrett) Yes, the market decides on price.

  144. But price is what you can get away with. You do not know the costs and price is what you can get away with.
  (Mr Barrett) No. We do know the costs and price is a function of the value that a consumer places in the proposition before them and the interplay of competitors in the market for their business. This is economics.

  145. How can the consumer make that choice?
  (Mr Barrett) They make the choice though they could use more transparency. I agreed with Mr Cruickshank on that. The consumer makes that choice every day. If you watch the average person in the aisle of a supermarket they are choosing between no-name brands at a cheaper price and named brands at a higher price and they are actually making quite sophisticated choices routinely up and down that supermarket. In the same way, it is the perception the customer has. Why do they pay more for a branded can of peaches than they do for a no-name one? Because deep in their mind they are ascribing more value to the quality or whatever of that product than that one. These are sophisticated choices which consumers are routinely making every day of their lives.

  146. How can the consumer make those sophisticated choices when it comes to banking?
  (Mr Barrett) When there are sufficient numbers of players and there are. This is one of the most overbanked markets in the world. There are almost unlimited choices and competitors. Show me a street in the UK where there are not five to ten competitors going head to head for the business of those clients. The customer can shop around between competing rivals. That is how they do it, at least that is how I see it.

  147. Let me ask you, Mr Ellwood, because I happen to be one of your customers. January, the euro comes, we move towards monetary union. Lloyds TSB introduces currency handling charge of 2.25 per cent and a transaction charge for using a teller machine outside the UK. How do I know about that? How do I know whether that is worthwhile? How do I know whether that is good value for money or not?
  (Mr Ellwood) Under the banking code, when we open an account we send details of tariffs to customers. If those tariffs change we write to customers. Where the tariff has changed you should have heard from us. The pricing does have a reflection on the cost. If we use the example we were talking about earlier of a cash dispenser unit cost, we say it is 38p and therefore we have said that the price we shall charge is 50p. Clearly if we thought the unit cost was 60p we would not charge 50p. There is a very clear and close correlation between cost and price. The transparency in the UK market is higher now than it has ever been. Every single newspaper carries details of savings rates, loan rates, mortgage rates.

  148. They do not have details of the costings and the prices they are attaching to those costings for bank transactions.
  (Mr Ellwood) They do have details of pricing, what it is going to cost them. If they can see that one company is offering something for three and somebody else is offering it for four, they can make up their mind about where they want to go for their choice. There are so many suppliers now, 140 suppliers of mortgages, that I believe the transparency is very real.
  (Mr Barrett) The fixation on price struck me as odd as it is only one element of seven or eight in the marketing mix which makes a company successful or not. An overfixation on the notion that price is the only element of competition is a mistake. The only other thing that I would ask you to ask yourselves is: what do you buy any day, anywhere, any place, where the cost of that product is posted? I would submit not one thing. It does not exist. Nobody knows the cost of the products they are buying. They only know whether the price they are seeing makes it worthwhile for them to make that purchase or not and if they want it then they will check around to see whether they can get it more cheaply.

  149. What appears to be different about this situation is that the supplier of the product does not seem to know the cost either.
  (Mr Barrett) We do. If you look at the cost base we know the expense to revenue, we know for example the aggregate level of the total dollar of sales made, what the total expenditures are to run the bank. In our bank it is too high, if you want the truth. It is about 64 per cent. So 64 cents of every dollar goes out on your cost base right at the start. We know what the macro level is and then we decompose that down into various distribution channels, different manufacturing units, different products and services. Yes, we do know our costs.

  150. How much do you cost and why do you cost so much?
  (Mr Barrett) I am a bargain.

  151. Would you mind explaining that? In general terms you have talked about your bank's costs. Now let us come to your costs. Let us talk about how much you cost. Let us talk about your share option schemes. How do they work?
  (Mr Barrett) Let me stand back from it and say first of all that the principles which inform compensation philosophy are not unlike my arguments on the market determining price. The price of your products is a function of the market which you are selling them in. Similarly when it comes to employees and you are competing to attract and retain different kinds of employees, you are obliged to pay a competitive market price for the employees which you are recruiting. In my own case, I was recruited from North America and that was the price it cost to recruit me from North America.

  152. How do your share options work?
  (Mr Barrett) Let me first say that there were sensational headlines on my share options which was one of the few times in my life that I wished what the media said about me was true. I should love that it were true. It was of course a grotesque exaggeration but I guess it made good copy. It overestimated by orders of magnitude tenfold the potential payout which was possible under those schemes. We have a strict performance related, one of the most politically correct performance related, compensation schemes which I know of in the world and the hurdle rates for performance for any payout under those stock option schemes are as tough as I have seen anywhere in the world.

  153. What are the measures of performance?
  (Mr Barrett) Two. The first deals with economic profit, in other words we only count profit which is made above the cost of capital. At 12 per cent there is nothing, less than 12 per cent there is nothing, no bonus, no L-tips, no nothing. You have to make an economic profit which doubles every four years and the plan is designed so that if you do not meet that first test then half the options disappear off the face of the earth. The second test is, notwithstanding that you made the economic profit, it then has to have been reflected in the stock market by you being in the top quartile of best performing Stock Exchange companies for those options to kick in. If they kick in, both of those conditions are met, they will kick in at about one tenth of what was put in the newspaper. I would submit this compensation scheme to any smell test in the world with respect to its correctness for shareholders and its performance related standards which are very, very tough to achieve. In fact they were much tougher than the ones we had in place before; we would have had one third less payout under the new scheme than if we had kept the old scheme of the past five years.

  154. Do you understand how people feel when they are faced with declines in service as they perceive it and this information about economic rewards to the people who are making those decisions and the drivers for those economic rewards being to do more of the same?
  (Mr Barrett) Yes, I do. I understand. I am not sure I take all of it together but do I understand that people think that what I earn is a lot of money? The answer to that is yes, of course I do, especially as someone who started off at £500 a year in this city. I know very much how the average man and woman in the street must look with some awe at the incomes associated with senior people who have risen to the top of their profession. My approach is that it is not ill-gotten gains it was worked for over a 37-year period and it is the market operating; the market dictates the price of my salary. I do not, the board does, the shareholders do and if I do not provide value for them they will throw me out, which is what they should do, they have a fiduciary obligation to do so.

  155. What value do you put on the loss of good will of the business over the last month or two?
  (Mr Barrett) In general?

  156. Yes.
  (Mr Barrett) It is difficult. That is a difficult thing. I responded to this question earlier. I wished it had not happened and we will produce a stream of customer friendly initiatives which demonstrate we have in fact customercentricity at the core of our values and we will hopefully repair any of the damage caused by the imbalance in reporting.

  157. Are the three of you prepared to see a Government commission which looks at the cost structures which you attempted to describe to us not very precisely and attempts to put some disciplines and rules and numbers on it?
  (Mr Ellwood) The rules and disciplines and numbers are there. I speak for my own bank. We actually have a very clear handle on the cost of a variety of things and we just used the example of a cash dispenser earlier. I do not see the need for a Government commission to look at that. The costs of any business have to be fully understood, they do reflect what in part the price is going to be but also that price is affected by the value and the perceived value by the customer. I do not see the need for a Government commission on costs.
  (Mr Dalton) We have to share Mr Ellwood's view on that. We do know our costs, we know what our costs are and I do not see any value added to anyone by having a Government investigation into the costs of the bank.
  (Mr Barrett) I am afraid I cannot even see where it would lead you to. What is the endgame? It would be an extraordinary intervention to say that now we know the costs we, the Government, will set prices for you. I thought those days were gone. No, I do not see any value in it. It would strike me as an extraordinary thing for the Government to do in any industry.

  Chairman: Thank you very much.


 
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