COST/BENEFIT ANALYSIS Introduction The Communications Committee believed it would be useful to include a cost/benefit study of the proposed communication network to give the NYCSDS management a preliminary view of the economic feasibility of the proposal. Because of time constraints the study, although penetrating to a considerable depth of detail, was limited to a rather narrow "slice" through the industry. In particular, data were gathered from three brokerage houses, two banks and CCS over a period of six weeks. The study developed a detailed analysis of the present method of making deliveries through CCS compared to the proposed method employing an on-line communications system "front ending" CCS. An attempt to cost analyze the use of an "interim" system employing the Bank Wire alone, without the communications computer, was dropped because of a complete lack of reliable savings and cost data, the latter especially as it applies to clerical processing of MDO's in this "interim" network. During the study critical advice was obtained from acknowledged operations experts in the brokerage industry. Their endorsement, while hardly a formal validation, leads the committee to conclude with a reasonable degree of confidence that the communications system as postulated will in fact produce cost/benefits performance in the range described. It should be noted that not all networks in the communications system are equally cost-justified. Thus, the imputed interest of $9,000,000 annually borne by brokers to finance deliveries to Pacific Coast and Midwest cities can be saved with a relatively small outlay for an inter-depository communications network. In contrast, it is also possible to provide on-line communication between NYCSDS and its membership by use of an appropriate network, thereby also producing a (smaller) saving, but only in exchange for investment in systems. It is also important to understand that certain benefits for one sector of the industry may be offset in part by a cost to another. As an example, the previously mentioned interest savings to brokers will be offset in part by the consequent loss of revenue to banks. To obtain a "ball-park" measure of the amount of collateral loans that would be lost to banks when brokers no longer have to finance in-transit out-of-town deliveries, the BASIC Task Force analyzed the X-17A-5 financial reports of five randomly-selected brokers and determined that the ratio of bank loans to equity capital of these was 65 to 35. Making the assumption that a contraction in inventory would be matched by proportional contractions of bank loans and capital, 65% or $5,850,000 of the $9,000,000 interest savings would be attributable to bank loans and would be lost to banks although saved by brokers. Only 35% or $3,150,000 would be saved by the industry as a whole. Method of Study With the cooperation of three brokerage firms, two banks and CCS, data were gathered to estimate how the postulated NYCSDS communications network might affect their operations. Assuming that implementation of a more efficient system to process Deliver Balance Orders (DBO's) has been completed, (e.g. PDQ, or DBO tape input submission by firms) Miscellaneous Deliver Orders (MDO's) will represent the method by which the majority of deliveries will be made. Therefore, emphasis was placed on isolating the cost factors in processing an MDO between Delivering Broker-CCS-Receiving Broker, and on how this process might be affected by the proposed system. An in-depth study of one firm's MDO procedures was made. Processing steps were flow charted, reviewed by firm personnel, and estimated clerical costs assigned to each function. Using these data, the effects of the postulated communications network were calculated. Projected NYCSDS transfer volume and COD institutional deliveries to Midwest/Pacific Coast depositories were applied to possible operational and interest expense reductions in determining annual savings estimates for these areas. Operating Features of NYCSDS Network The network postulated by the committee provides the following new capabilities to NYCSDS member banks and brokers. It is these characteristics that permit the savings and other benefits to be realized. 1. A participant would have a data input device on-line to NYCSDS to make deliveries and to obtain stock balance position data,* a printer to create hard copies of all deliveries sent and received, and a device to permit machine language input and output between the communications network and the participant's own computer. 2. NYCSDS would receive deliveries on-line, update positions via immediate book entry, transmit messages immediately notifying the participant of the delivery of stock to him, and send these data in a form suitable for direct input to his own system. Savings from the Postulated Network MDO Deliveries (Intra-NYCSDS) — The data obtained by interview and flow charting of the present brokerage processing procedures were used as the bases for projecting changes under the proposed systems. Costs were assigned to each clerical function and the present estimated costs were calculated for each type of MDO delivery and receipt. Once present estimated MDO processing costs were established, an analysis was then undertaken to project the possible MDO procedural changes that might occur under the proposed NYCSDS on-line communications system. Some existing processing tasks will be eliminated, some may remain basically unchanged, while in other areas, a present function may be performed as part of a separate new function; e.g., elimination of the MDO clerical form preparation might require the preparation of a transmittal form to be used in keying the delivery. Costs were then estimated for the new task and the clerical processing costs under the proposed systems were then calculated. Areas of potential savings were categorized into "hard," i.e., clearly defined, savings and "soft" savings, for areas of possible savings not readily quantified. Illustrated on EXHIBIT VI are the areas of hard savings used in determining reduced cost per delivery, and soft savings, which were not developed into specific dollar savings figures. Potential hard savings in the proposed communications system are in the areas of messengers, reduced clerical preparation, keypunching and forms. Soft savings in the area of money management and stock management may be of substantial importance. By the broker's ability to know his receipts faster, his daily settlement requirements will be known earlier in the day (less expensive loans), and his ability to re-deliver the stock that is available will be increased. Even though potentially large, soft benefits have not been treated further. EXHIBIT VI illustrates the percentage reduction in clerical costs by type of MDO delivery and receipt. It is estimated that the proposed communications system could reduce clerical processing costs per MDO by 11% to 31% ($.10 to $.26). Depository savings are estimated to be $.21 per MDO processed. Elimination of forms, envelopes, and credit lists may effect additional savings of .01-.02 under each system. Thus total hard savings are estimated to be in the range of $.32 to $.49, say $.40 per MDO. Using statistics developed by the BASIC Task Force in the January 19, '71 study of potential deliveries in a NYCSDS, it was estimated that 30,000 to 40,000 MDO's might be processed daily in such a system. The average saving of $.40 per MDO was then used in estimating the annual MDO processing savings of $3,000,000-$4,000,000, say $3,500,000, if 100% of NYCSDS deliveries were made using the communications system. However, Task Force statistics also indicate that perhaps 70% of these are contributed by the 50 brokers, 56 banks and others in the postulated network. Thus the postulated network savings become 70% of $3,500,000 or $2,450,000 split almost evenly between brokers and banks. *An inquiry capability as to stock position is not part of the postulated network nor the dollar savings derived therefrom. However, it is a highly desirable feature that could be added later possibly producing substantial "soft" savings and other benefits. 78-429 - 72 - 36 The number of MDO's processed represents both bank and broker deliveries. Bank cost figures for processing MDO's were incomplete, so the committee applied the broker costs to the banks' share of the total volume. This was believed to be a financially conservative approach. Interdepository Deliveries - The January 19, 1971 BASIC Task Force study of securities movements indicated that about 3,330 deliveries would occur daily between the NYCSDS and the Pacific Coast and Midwest depositories as described in Table 5. Assuming these deliveries are for payment on delivery (C.O.D.) then it is believed the NYSE statistics on institutional trades (644 shares each) could be applied. The Task Force assumed a price of $30 per share, an effective interest rate of 10% (including the value of minimum balance requirements) and one to two days transportation prior to delivery. These assumptions yield an estimate of $6,000,000-$12,000,000 (say $9,000,000) in interest annually that is borne by the deliverer. Transfers - Withdrawals-by-transfer have been considered in two separate parts: those that occur in the NYCSDS between its participants and the fifteen largest New York transfer agents, and those that occur between NYCSDS participants and twelve of the largest out-of-town transfer agents. Transfers between NYCSDS participants and New York agents were cost studied by a major New York agent. It was estimated that the clerical costs of a transfer could be reduced by about $.10 if the transfer instruction were received by the agent on magnetic tape. Thus, automation of the 127,500 (Table 4) daily transfers into private name, would produce substantial benefits to the financial community. These are not considered further here because they are not a communications network problem. However, if the $.10 per transfer figure can be applied to transfers delivered through NYCSDS to the twelve out-of-town agents then the 3,250 to 6,140 estimated daily transfers could produce a gross annual saving of $80,000-$150,000 (say $115,000). Costs of the Postulated Network The costs associated with the postulated network are estimated as follows: *See Appendix D People and procedures, including reprogramming, that must be here. had the time or expertise to attempt cost estimates $2,000,000. 100,000. 75,000. 50,000. 75,000. 100,000. 100,000. $2,500,000. $ 75,000. 75,000. 337,320. 665,620. 64,740. 33,600. $1,251,280. Cost Unknown AREAS OF POTENTIAL SAVINGS UNDER POSTULATED EXHIBIT VI HARD SAVINGS* 1. Eliminate delivery/pick-up of MDO's (by messengers). 2. Eliminate preparation of delivery envelopes and credit lists (offset partially by a control function on deliveries transmitted). 3. Eliminate keypunching of MDO forms. 4. Eliminate or reduce cost of: a. MDO Forms b. Delivery Envelopes c. Credit Lists d. Data Processing Cards 5. Reduced time to key-in delivery vs. manual preparation of an MDO. SOFT SAVINGS** 1. Interest on loans reduced the ability to determine earlier than at present, the day's general dollar settlement requirements would enable the brokers to obtain loans earlier in the day, and thus at a cheaper rate. 2. Increase in Stock Loan business - knowledge of stock delivered to broker would enable him to loan out excess, if desired. 3. Increased ability to turn around the stock that is received. 4. Reduced internal paper flow. 5. Space and equipment saved. 6. Efficiency generally increased. *Areas of potential saving readily quantified. COMMUNICATIONS CAPABILITIES COMPARED • Ability to input deliveries electronically via an on-line device. • Printer at broker/bank for hard copy of receive/deliver data. • Machine language input/output device at broker/bank. Ability to make direct inquiry into stock balance positions. 16% 18% 20% 26% 35% 23% |