The Business Of
Banking | Goldman Sachs | What Are Their Margins?
Morning All!
So, yesterday we dug into how Goldman Sachs makes money. And we saw that Goldman is the #1 investment bank in the world when it comes to M&A. We saw that the company’s ECM revenues took a huge hit last year as IPO markets dried up. And we saw that market making is still Goldman’s number 1 revenue generator. Despite electronic platforms like Citadel becoming a bigger piece of the pie!
But that’s enough with revenues. Today, we’ll turn our attention to costs and look at what’s really behind an investment bank! Let’s start with a split of Goldman’s cost structure.
From looking at the chart, we can see that nearly half of Goldman’s costs are made up of ‘compensation and benefits’. Or in other words, the salaries and bonuses they pay their staff! And this is pretty unique - there’s only been two other companies we’ve covered on TBO where employee costs are more than 45% of overall costs. They were Ninety One (51%) and Man United (55%)…
But we won’t just look at this cost line. We’ll also tuck into what ‘transaction based costs’ are. And ‘provisions for credit losses’. So, without further ado, let’s dive in!
Who Earns More? A Goldman Sachs Banker or An Amazon Warehouse Worker?
Okay, so it’s probably no surprise to anyone that investment bankers make a fair amount of money. They work for companies that make billions in revenue - we saw yesterday that Goldman can make over $100m from advising on just one M&A deal. But in addition, these investment banks are very asset-light, with relatively few costs outside of their people.
More of that in a second. But first, let’s look at the figures and see how much these investment bankers actually make at Goldman.
Okay so, in 2022, Goldman Sachs had ~48,500 employees and they paid out a total of $15.1 billion in salaries and bonuses to those employees. So how much does that work out per employee? Well, it works out to a whopping $312k! And whilst this sounds an incredibly high number, it’s actually the lowest level that compensation / employee has been over the last 15 years!
The chart above shows us that the average compensation per employee was an extraordinary $569k back in 2007 - pre-global financial crisis. And the reason for this steady decline in compensation/employee is because; (i) bonuses have fallen since the 2007 financial crisis. And (ii) banks have invested more in technology over the last decade.
Now, I don’t want to get too sidetracked by tech. But for those who are interested, I really recommend giving this article a read - which is where the below headline comes from! Goldman Sachs (and other banks) are investing huge amounts of money in making their market making operations as fast as possible. And by the way, when I say ‘fast’ in this industry, I’m not talking about seconds… I’m talking about milliseconds and microseconds!
Anyway, back to salaries and bonuses. And I know what you’re thinking. An average of $312k per employee - yes it might be low vs history - but $312k is hardly anything to complain about! And you’d be right. Investment banks pay fantastically well to attract and retain the best talent. However, what we may not realise at first glance is just how hard these investment bankers have to work for their money. A survey released in 2021, revealed that the average 1st year analyst at Goldman Sachs - a person straight out of uni - was working ~100 hours a week! Most of them were sleeping at 3am and getting 5 hours of sleep/night on average!
In response to this survey, most banks decided to raise the pay for their most junior employees (analysts). And despite being late to join the party, Goldman eventually decided to follow suit and increase their first-year analyst pay to $110k + bonus.
But here’s a question. Why do Goldman Sachs have to pay guys & girls straight out of uni that much money? $110k is huge! Can’t they pay employees less, which would reduce their own costs and increase their EBIT margin? Well, probably not. Because whilst the $110k (~£80k) number is obviously a lot of money, it actually works out to ~$23/hour for employees working 100 hours/week! Which is only marginally more than the $19/hour you could earn working in an Amazon warehouse!
If Goldman Sachs reduced wages to let’s say $70k/year, they might see a huge fall in job applicants. Because who on Earth would want to work so hard for such a low hourly rate! And for Goldman Sachs, this would be serious trouble. Because as we said earlier, Goldman is an asset light business - with their main asset being their people! It’s not like Goldman need to have lots of machinery (like TSMC) or raw materials (like Huel) or content (like Netflix) to make revenues. Goldman Sachs are just selling a service - their advice! And the main thing they need for that is people! For anyone interested in knowing what Goldman salaries are all the way up the hierarchy - check out this YouTube video!
Okay, So There Is A Little More To It Than Just People!
Alrighty, so we’ve looked at employee costs. The next cost line we’ll look at is what Goldman Sachs calls ‘transaction based costs’ in their annual reports. And these costs are basically the costs that occur every time Goldman Sachs does a transaction. That’s probably slightly confusing. So what do I really mean? Fair warning – this section is a bit dry so I apologise in advance! I’ve done my best to keep it interesting!
Let’s start with market making. When Goldman Sachs’s traders are buying and selling Tesla shares for clients, where is this all happening? Well, it’s happening on the New York Stock Exchange’s (NYSE) platform. Usually a digital platform. And does the NYSE allow market makers to use their platform for free? No! Goldman Sachs will have to pay exchange fees to the NYSE for executing those trades. These fees are usually incredibly small, the NYSE will only take ~$0.0025 per share. But obviously, if you’re trading billions of shares a year, these exchange fees will start to add up!
Another cost Goldman faces is clearing fees, paid to clearinghouses. Now, what are clearing fees and clearinghouses? Well, let’s go back to Tesla. Once Goldman and a client agree on and execute a trade, there needs to be a middleman to ensure the party selling Tesla gets their cash. And the party buying Tesla get their shares! This middleman role is played by clearinghouses.
We won’t go too deep into this now. But these clearinghouses are actually super important. Because what if Goldman’s client doesn’t actually have the funds ready to buy Tesla shares? Goldman would lose money! And it’s clearinghouses that reduce these risks. To read more about clearing and settling of trades, check out this article.
Okay, so we’ve seen the transaction based costs that occur in Goldman’s market making segment. But what about asset management? Well, in asset management, it’s a similar kind of thing! Goldman Sachs manages ~$2.7 trillion in clients’ assets. And they’ll use these funds to buy shares, bonds, currencies, etc. This will involve exchange fees and clearing fees. But it’ll also involve a couple of other costs…
… including brokerage fees. When a portfolio manager at one of Goldman’s funds wants to buy an asset (e.g. Tesla share), they’ll ask their trader to buy that share for them. This trader will contact market makers (e.g. at J.P.Morgan or Goldman Sachs themselves) who will help them buy the Tesla shares. And Goldman Sachs Asset Management will pay them a brokerage fee in return. A little bit like how we pay Hargreaves Lansdown a broker fee when we buy shares on their platform.
So, that’s exchange fees, clearing fees and brokerage fees. But there’s one final cost that comes under transaction-based costs. And that’s distribution fees. And these fees are slightly different because they aren’t fees paid by Goldman when assets are traded. But these fees are paid to ensure the marketing of their mutual funds.
Let’s look at the screenshot below. Hargreaves Lansdown (HL) is the UK’s number 1 ‘fund supermarket’. It’s the go-to website for retail investors who are wondering which fund to invest in. And because of its popularity, Goldman Sachs, Ninety One, Schroders and pretty much every asset manager will pay Hargreaves Lansdown to have their fund on HL’s website.
It’s a little bit like Rightmove. Where do the majority of people in the UK go to look for houses? Rightmove. So estate agents across the UK pay Rightmove to advertise their homes on their website. But not only Rightmove, UK estate agents will pay Zoopla and On The Market too.
Similarly, where do the majority of people in the UK go to look for funds? Hargreaves Lansdown. So asset managers pay Hargreaves Lansdown to advertise their funds on their website. But not only Hargreaves Lansdown, asset managers will pay AJ Bell and Fidelity too. I love cross-industry comparisons like that!
Provision For Credit Losses
Alrighty, so we’ve talked about salaries and transaction costs. There’s one more cost that’s important to talk about for banks - called provision for credit losses - but we’re going to discuss that on Friday. One, because this newsletter’s already quite long now - well done if you’ve made it to here!
But also, on Friday we’ve got another TBO special where we’ll be looking at credit cards. And this cost line will fit perfectly into that topic!
Cyclical Revenues + Stable Costs = Fluctuating Margins
Okay, time to wrap up! We’ve covered the main costs that Goldman Sachs has in their business model. In the chart below, we can see how Goldman’s EBT margin has progressed over the last 2 decades. And the most striking thing is that Goldman has astonishingly never had a year with a negative EBT margin. Actually, forget negative EBT margin, the company’s never had a year in which EBT margin has been less than 11%! By the way, the reason I’m using EBT instead of EBIT margin will be revealed in The Business of Barclays!
The company’s margin tends to be between the 20-50% level - which is incredibly impressive. But here’s a question - why is it a little up and down? When we looked at TSMC and McDonald’s, we saw nice, smooth margin increases. But at Goldman, it’s different. Why?
Well, the main reason for this is because Goldman’s revenues tend to fluctuate a fair amount, but their costs are much more stable. We saw yesterday that revenues are cyclical, they depend greatly on the economic environment. But today, we’ve seen that ~50% of Goldman’s costs are people. And these costs are much more fixed. Of course, in a bad revenue year, Goldman can fire some employees to save costs. But if revenues fall 30% one year, you can’t fire 30% of staff, because you’re going to need them all again when the economy recovers!
25th Oct 2023
And that’s a wrap for today! I hope you enjoyed diving into Goldman’s cost structure. Tomorrow we’ll look at how the US banking giant actually spends all its profits, and we’re in for a few surprises!.
Have a fabulous day!
The Business Of Team