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New York—As 'best execution' and electronic trading increasingly unbundle research payments from trading commissions, investment banks are receiving more requests for explicit pricing for their research services.  Some investors use the price of alternative research as a metric in determining a value for proprietary research.  Is this a valid approach?  Price comparisons between proprietary research and alternative research need to be made with care given differences in the respective products.  Paradoxically, alternative research's ability to price its services is becoming a competitive advantage that alternative research enjoys over proprietary research.

The lower cost alternative?

Alternative research is generally perceived to be less expensive than proprietary research.  Fees for fundamental alternative research typically range from US$25,000 to US$85,000.  There are notable exceptions.  Some prominent alternative research firms (such as Sanford Bernstein) participate in the broker vote process.  Expert networks such as Gerson Lehrman Group charge fees which begin at US$120,000 and can exceed seven figures.  Firms which limit distribution of their research, such as Cleveland Research or Arete in Europe, tend to charge a premium, with fees often ranging from US$2-300,000.

It is received wisdom that alternative research is cheaper than proprietary research, in part because it has a lower cost structure.  Closer examination suggests that this is not the case.  Propietary research consists of a variety of components:  core services (including reports, alerts, etc.), access to analysts, sales support, access to company management.  Alternative research offers some of these services--not all--and typically on a more limited basis.  Most alternative research specializes in a specific sector or geography.  It has limited, if any, sales support.  With the exception of small cap companies, alternative research generally does not offer access to company management.

Component pricing

Alternative research is well priced for its niche. Or said another way, it does a good job of pricing components of proprietary research.  Let's do the math: if a one-person boutique is charging US$25,000, the fee is equivalent to US$5 million for research from a house with 200 analysts.  Or, if sector specialist is charging US$45,000, the fee is equivalent to US$3 million from a house that covers all sectors.

Alternative research has developed services (and pricing) for virtually every service banking research provides.  Even in the provision of access to company management, an area the investment banks dominate, there are a few specialist firms seeking to monetize company access. 

Pricing & Innovation

Conventional wisdom also says that bundled pricing is an advantage that proprietary research has over alternative research.  Historically, this has been true, but it comes with two major drawbacks.  First, proprietary research is struggling to cope with the increasing demands of clients for more price transparency.  Even more importantly, under a bundled price regime, proprietary research has little incentive to develop new services.  Case in point was Credit Suisse's acquisition of Holt Value Associates in 2002.  Holt, a popular quantitative research provider of cash flow oriented Economic Value Analysis, suffered revenue losses as clients began cancelling their separate Holt subscriptions, arguing that Holt should be offered as part of Credit Suisse's bundled research services. 

Custom surveys are another example.  Custom surveys are an increasingly important research tool for hedge funds and mutual funds as a source of primary research to supplement fundamental research.  Surveys are also of interest to quantitative funds seeking proprietary model inputs.  Custom surveys generally have variable pricing since the cost varies with the size, length and frequency of the survey.  Consequently, most investment banks either do not offer custom surveys—ceding the service to alternative research providers—or bundle the service into full offering for premium clients. 

Alternative research firms have responded.  Market research is one of the fastest growing areas of alternative research.  Alternative research providers offer clients a variety of pricing options for custom surveys.  'Channel Checking' specialists offer wholesale packages or 'by the drink' and expert networks have increasingly been offering surveys as an add-on service.

Conclusion

Pricing is a competitive advantage for alterative research.  Most alternative research firms have been operating in an unbundled world, and have learned how to price their services.  Because they operate in a market environment, they get clear and consistent feedback from clients on what clients want.  In the bundled research environment, sell side research gets very imperfect information, filtered through sales people and broker voting systems.  Worse, sell side research has historically had no incentive to launch new services since they generally would not expand the pool of commissions paid. 

This is changing as proprietary research providers adapt.  One reason that investment banks are developing their own alternative research platforms, such as Goldman's Hudson Street or Merrill's Open Minds, is to better understand the alternative research space and profit from its growth.  The platforms also provide vehicles to launch new services, such as Merrill's promotion of its own Primary Sources—an internal research capability relaunched as alternative research to facilitate payment.  Morgan Stanley's Alphawise service is similarly separated from its proprietary research and Goldman placed its own expert network, Vantage Marketplace, within the Hudson Street platform.

As unbundling progresses, alternative research will benefit less from its pricing prowess.  On the other hand, proprietary research will be subject to market forces rather than the protection of bundled pricing.  Both will change, but it is likely that the change will be more dramatic for proprietary research.