Some securities brokerage firms, most notably Merrill Lynch, have used revenue velocity for many decades as a key measure of profitability. In this formulation, velocity represents the return on client assets. Originally, it was production credit velocity, or production credits divided by the client assets in custody (that is, on deposit) at the firm. Stated in another way, this version of velocity is the return on client assets enjoyed by the firm.
As Applied at Merrill Lynch
Velocity calculations were made at the aggregate firm-wide level, for the entire book of business held by a given financial advisor, and for individual clients. Fluctuations in aggregate velocity were monitored very closely by the controller's organization and the management reporting systems, and forecasts of trends in velocity were critical inputs to predictive financial models and profit projections.
As the firm's management reporting and profitability analysis systems and methodologies evolved and became more sophisticated, more focus began to be placed on revenue velocity rather than production credit velocity. This became advisable as the firm imposed an increasing number of fees that did not generate production credits, and as executive management began to recognize that, in transactions where production credits were indeed awarded to the financial advisor, the actual ratio of production credits to underlying revenue could vary significantly by product.
Velocity in Economics
Velocity, as applied in securities brokerage firms, is an application of a concept in monetary economics called the velocity of money. This fundamental theorem posits that the total value of transactions in an economy equals the stock of money times its velocity, or the rate at which it changes hands.
The theorem is written in this form:
M x V = P x Q
Where M is the stock of money, V is the velocity of money, P is the average price per transaction and Q is the total quantity of transactions.
The brokerage application can be written:
A x V = R
Where A is the value of client assets, V is the revenue velocity on those assets, and R is the total revenue earned.
Impact on Corporate Strategy
The upshot of the focus on the velocity at Merrill Lynch was the development of an asset gathering strategy, working on the theory that more client assets in custody would yield more revenue. Accordingly, the financial advisor compensation plan was adjusted, rewarding financial advisors for the collection of net new assets in their clients' accounts.
Additionally, studies by management science of revenue and profit velocity by client segment and by individual client led to yet more insights that challenged traditional marketing strategy. That is, it was found that velocity, however, measured, declined significantly as the assets of a client or client household rose. Part of this was the result of the discounts either negotiated by or automatically granted to high net worth clients. Partly this was the result of trading activity generally declining as a proportion of assets, as assets grew.
In either case, significantly lower revenue and profit velocities among high net worth clients challenged the notion that gathering assets by courting them was a preferable strategy to accumulating the same amount of assets by seeking out larger numbers of smaller clients. Going the latter route would produce significantly higher velocities on the same aggregate amount of assets.