Broker.com
Fred Lizotte
Vocabulary
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Full-service Broker - A broker that provides a
large variety of services to its clients, including
research and advice, retirement planning, tax tips,
and much more. Of course, this all comes at a
price, as commissions at full-service brokerages
are much higher than those at discount brokers.
 Discount Broker – A stockbroker who carries out
buy and sell orders at a reduced
commission, compared to a full-service broker,
but provides no investment advice.
Definitions cont.
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Online Broker - A brokerage which provides trading
services to its clients over the internet. An online
broker may or may not be a unit of a traditional
brokerage.
Bp – Base point is 1/100 of a percent (100 bp = 1%)
May Day -May 1, 1975 – U.S. Securities and
Exchange Commission deregulated brokerage
commissions
Underwriting - The process by which investment
bankers raise investment capital from investors on
behalf of corporations and governments that are
issuing securities (both equity and debt).
Impact of the Internet on the
Brokerage industry
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Between 1997 and the end of 1999 the number of
trades executed on the Internet has grown at an
annually compounded rate of 111%.
 The U.S. Retail commission revenues grew online
from 2.2% in 1996 to almost 10% by 1999.
 The internet posed a threat to existing brokers
– It became cheaper in both fixed and variable costs
– New companies could create new systems to easily
compete with the larger companies legacy systems.
– These new companies were able to charge as low as
1/10 of what the larger competition was charging for
full-service brokers.
Internet impact cont.
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Lombard and E*Trade and other online Brokers challenged
discount brokers in price.
 A price war broke out and both the online brokers and
discount brokers cut their per trade cost many times.
 The average charged by online brokers changed from $53
to $18.50 just between 1996 to the end of 1997
 Online brokers could now bridge the gap between fullservice and discount brokers. This led to a new breed of
investors. These investors could generate their own
strategies from the vast information resources these online
brokers offered and trade for less then the discount broker
could give them.
 The full-service and discount brokers started realizing the
added benefits, or at least the pain of not jumping on the
Internet Cont.
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Merrill Lynch a full-service broker jumped on
board. They offered $29.95 per trade fee for
trading online. By this time Charles Schwab, a
discount broker, also offered the same price.
 This is when we realize that there is a crossroad in
this industry, and something big is going to have
to change for things to work out.
 Merrill Lynch was realizing a loss of revenue by
taking on this venture, and it showed. Their stock
went down 10% almost immediately after the
announcement.
Brokerage industry
Developments
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Traditional model of Brokering before May Day.
 Full-service brokers offered a bundle of all of this
together.
 A large commission was realized on every trade
to be able to provide this bundle of services.
Brokerage Industry
Developments cont.
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After May Day brokerage commissions were
deregulated.
This change caused a new breed of brokers to come
up. These were called the discount brokers.
These brokers got the benefit of grabbing consumers
who were looking for a low price, and offered them
the basics; price quotes and trade execution.
By the end of the 1990’s online brokers broke down
this whole value chain into separate pieces and offered
them each at a cost so investors can pick and choose
what they wanted.
Investment research – 2-5bp, asset allocation advice
Brokerage Industry
Developments cont.
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By the end of the 1990’s it was obvious that
full-service brokers had to change in order to
keep up with its competition.
One large problem faced with these traditional
full-service brokers was the fact that legacy
systems did not fit in with new technology that
was emerging fast.
Investment Growth
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There was something big on the horizon in the
1990’s. A new breed of customers were emerging.
Baby-boomers became the new consumers in this
industry.
These were a hard bunch to keep happy, mostly
because they demand high quality and low price.
The good thing for the brokers is that this
generation is holding most of the money in
America.
There was a great opportunity for the brokers to
gain an increase in the amount of money that is
Characteristics of Investors
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Online Investors
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Offline Investors
– Average age was 39
– Average age was 52
and about 44% of them
completed 4 years of
college.
– 78% of online
investors use personal
computers at work.
and about 36% of them
completed 4 years of
college.
– 43% of offline
investors use personal
computers at work.
Characteristics of Investors
Cont.
Forrester Research
Active affluent (AA) – Young, middle aged
investors who possess the highest household
income and net worth. Rely on Magazines and TV
for information. They are traditional and have a
hard time adjusting to the online industry.
 Active moderate-wealth (AMW) – Young,
moderate to high income, well educated investors
grew up on the internet. Strongly self-directed and
were risk tolerant. These are the “get rich quick”
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Forrester Research cont.
Buy and hold affluent (BHA) – Oldest and have a
great net worth. These are the people who are the
most risk-adverse and the least self-directed
segment. This group traded infrequently. If they
did trade, they preferred in person transactions.
 Buy-and-hold moderate wealth (BHMW) –
Average, middle-class American families and
accounted for neatly half of all investors. This
group wont want to pay for professional advice
and are forced to be self-directed. This group
traded on average less than one trade per year. The
web had a very little affect on this group.
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Characteristics of investors
cont.
Self-directed – 15% of population. They wanted to
make their own decision and found low-cost, doit-yourself brokers.
 Opinion-seeking – about 50% of all investors.
They make their own decisions, but sought some
information and advice.
 Fully-dependant – about 33% of investors. They
preferred relationship-oriented brokers, who
would become their financial guardians.
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Brokers and Advice
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Traditionally Investment advice was offered
by commission based brokers and by
Registered Investment Advisors.
 RIA’s would charge an hourly fee or a fee
based on the assets under management.
Commission-based Brokers
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Full-service brokerages had these people on board
because they made the customer want to trade and
in turn pay a commission for it.
 Brokers also promoted the firms proprietary and
profitable products and received a large
commission for it.
 Top performers were sought after and paid very
generously
 Even average performers were making $175,000
in 1999
Registered Investment
Advisors
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1940 Registered Investment Advisors Act came
into affect. This allowed only qualified, and
educated people to be able to advise.
RIA’s do not work on commissions, they are paid
either hourly or by a fee based on the assets under
management.
Unlike Commission-based Brokers RIA’s do not
promote proprietary products for companies.
RIA had a small chunk of the pie, holding 120
billion in 1992 for the entire RIA industry.
To compare, a single company Merrill Lynch had
RIA’s Cont.
By 1999 RIA’s managed more than $700
billion in assets.
 RIA’s were sole proprietor ships or
partnerships.
 Most RIA’s charged an annual fee of about
1-2% of the size of the portfolio that they
managed.
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The Internet
In the late 1990’s the huge change of trading
online became a reality, challenging both the
discount and full-service brokerages.
 Online brokers were well on their way leaving the
brick and mortar brokerages behind.
 Discount brokers such as Charles Schwab and
full-service brokers Merrill Lynch, Morgan
Stanley Dean Witter, and PainWebber all
responded to the Internet in various ways that we
will find out.
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Charles Swab & Company
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Charles Schwab, a Stanford M.B.A., founded
Charles Schwab & Company in 1971.
This Company was known to be an innovator.
May Day in 1975, created a change in Charles
Schwab. This was the moment that they became a
discount Broker.
Schwab took apart the value chain and offered the
basics to investors. It was simple, they offered
investors a place to buy and sell securities.
Schwab was on the leading edge of technology, so
they came up with Telebroker.
Schwab cont.
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Telebroker was a fully automated telephone system that
allowed customers to retrieve real-time stock quotes and
place orders.
SchwabLink was a service to provide fee-based financial
advisors with back-office custodial services and the
capability for RIA’s to plug into Schwab’s computers to
trade.
RIA’s became a very key part of Schwab. By 2000 Schwab
had 5,900 affiliated RIA’s and controlled about 30% of
Schwab’s assets.
Mutual Fund OneSource program –1992, this allowed
customers to purchase no-load mutual funds without
paying commissions.
Shwab and the Internet
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By 1995 Schwab realized the benefits of the
online channel.
 e.Schwab was launched January, 1996
– e.Schwab charged a fixed price of 39.95 for up to 1,000
shares.
– e.Schwab customers had to open a new account
separate from the brick and mortar Schwab.
– They could trade through a toll free number
– e.Schwab customers were kept separate from Schwab
customers, e.Schwab customers couldn’t go to Schwab
branch and receive service.
Schwab and the Internet cont.
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Web trading went live on March 31, 1996.
– Initially web trading customers could only check
balances, buy and sell stocks, and get real-time stock
quotes.
– Schwab was aiming for 25,000 customers by the end of
the year, but got this goal in two weeks.
– Schwab dropped the price of Web Trading down to
$29.95, but kept the restrictions that e.Schwab had.
Schwab Internet cont.
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One thing that Schwab quickly realized is that their dualpricing strategy only confused and irritated customers who
didn’t want to decide whether they wanted service or price.
In 1998, Schwab offered Web Trading for $29.95 for
everyone for up to 1,000 shares.
Schwab made a bold move and pushed all of their
customers to their online channel.
They maintained a brick and mortar presents and allowed
the customer to choose how they wanted to trade freely
between these channels.
Schwab’s brokers now earned a salary instead of
commissions.
Schwab Internet
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For more growth Schwab looked into purchasing its
growth.
 U.S. Trust and CyberCorp was aquired and used
extensively.
 These acquisitions allowed Schwab to sell more broad
securities and gain enough technology to keep up with
active traders trading online.
 Schwab encouraged active traders, by giving them a
smaller commission of 14.95.
 More programs were put into play to also encourage
traders with large amounts of investment wealth.
Merrill Lynch & CO., Inc.
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Full-service Broker
Charles Merrill, a wall street bond salesman,
opened an underwriting firm in 1914. Edmund
Lynch joined him as a partner.
During the Great Depression, the firm sold itself
to E.A. Pierce.
Merrill came back in 1940 and made Merrill
Lynch a great success.
Merrill Lynch invented the Cash Management
Account.
– This combined Money Market checking account and
Merrill Lynch cont.
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The CMA is said to be one of the greatest retail financial
product and it also generated tremendous growth for
Merrill Lynch.
In the 80’s Merrill Lynch’s underwriting business
skyrocketed, making them a global leader in new offerings.
In 1990’s, They acquired Smith New Court and Mercury
Asset Management.
Merrill Lynch also established its presents in many other
countries.
By 1999 Merrill Lynch was the leading brokerage, with
15,000 brokers serving over 5 million accounts.
Merrill and the Internet
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Merrill Lynch was slow to embrace online brokerage
Global Advisor – 1996 Merrill Lynch had many legacy
systems that were going to get in their way with the online
channel. They got the TGA to replace their current systems
with new terminal applications.
TGA could do financial and portfolio modeling, news,
market data, analysis, research, e-mail, fax, and
multimedia tools.
Brokers could view research reports and historical data
side be side with external databases and news sources,
enabling them to plan, help clients, and manage money
more effectively.
Merrill Lynch and the Internet
cont.
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November 1996, Merrill Lynch Online was
launched.
 This allowed clients to view multiple accounts,
examine their portfolio positions, and browse
statements and research reports
 On November 1998, AskMerrill was launched,
this allowed clients to be able to see research. This
was launched as a way to gain more clients and
give them the research they need to make
decisions on trading.
 By 1999, with 90,000 AskMerrill registered users,
2,000 of them became new Merrill clients.
Merrill Lynch Internet cont.
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In February, 1999 Merrill Lynch aquired D. E.
Soft, providing a platform for investors to actually
trade stock.
In 1999 Merrill Lynch offered Unlimited
Advantage, which charged .2-1% annual fee
starting at $1,500.
This provided full-service, and unlimited trading –
online or offline.
Merrill Lynch Direct, in 1999; This offered
investors to trade for $29.95 per trade.
Services were optional, and with each additional
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Merrill Lynch Transition
Merrill Lynch restructured its entire business. They used
the technology as much as possible to provide the
consumer with a choice of how they want to do business.
 Merrill Lynch also started doing business in Europe,
especially for the online channel.
 Merrill Lynch used partnerships extensively, they also had
some e-commerce services for these partnerships to sell
through Merrill Lynch’s online portal.
 Merrill Lynch in 1999 had 15,000 brokers, the largest U.S.
broker force.
 Merrill Lynch was the first full-service brokerage to
change its broker organization fundamentally in response
to the internet and other industry forces.
 In 2000, Merrill Lynch lost a large amount of brokers due
to this change.
Morgan Stanley Dean Witter
Discover & Co.
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In 1997 Morgan Stanley and Dean Witter Discover
companies merged.
By late 1999 MSDW was offering financial services and
products ranging from traditional brokerage and asset
management to mortgage loans and insurance.
Dean Witter was one of the early movers in online
brokerage.
In 1995 it was already offering transactions through its
website.
It charged 14.95 for electronic trading.
When the merge occurred this online electronic exchanges
was renamed Discover Brokerage Direct.
MSDW cont.
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Dean Witter purposely kept its online channel separate
from its offline channel.
 MSDW was not publicizing that they were connected to
Discover Brokerage Direct.
 They believed that the customers in the online channel
were in a distinct demographic group and connecting the
business’s would not give any added value
 It would in fact, delute the Brand of MSDW being a fullservice brokerage.
 The difference that DBD did was they did not compare
traditional brokers to online brokers, of course MSDW
wouldn’t do that to their own company, they instead
explained in terms that a person off the street could go and
make a couple of bucks.
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MSDW cont.
The Problem that DBD ran into is that it lost ground to
competitors like E*Trade, despite its online channel being
more sophisticated than the competition.
One of the reasons could be that DBD was in coexistence
with MSDW. This could of constrained their growth.
In 1999, MSDW started iChoice. This was a fee-based
account and a self-directed account with online trading in
addition to the traditional full-service account.
DBD was thrown out and iChoice became the new
platform.
This platform costed the user a minimum of $1,000 for
unlimited trades. Fees varied based on the size of assets,
level of service, and type of investment.
Their broker force was watched closely, they did not want
them to loose money. Once the fears of the online channel
were resolved, their brokers were happy to be a part of it.
PainWebber Group, Inc.
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Founded in 1879, it was one of the largest and
best-known full-service securities firms in the
United States.
By 1999 it moved to the 4th largest.
Its primary mission was to serve the investment
and capital needs of individual and institutional
clients through its broker-dealer subsidiary.
PainWebber decided to stay small while other
brokerages were offering a broad range of things.
They stayed focused on the domestic market and
retail segment.
PainWebber cont.
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PainWebber went out of bounds in its traditional
way of doing business
They targeted customers that had a net worth of
between $100,000 and $500,000 net worth. This
group was growing at a rate of 9% per year.
This proved to be successful and the companies
assets grew at a compound rate of 24% from 1994
to 1999.
Most of their success and revenue was from the
fee-based accounts that paid commission.
In 2000 UBS AG bank bought PainWebber for
PainWebber and the Internet
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In 1997 Painwebber used the internet as a channel
to provide communication and information on
trading.
In 1999 Painwebber turned this online channel
into one that was able to do online trades as well.
It was called InsightOne
They needed to have a minimum account balance
of $100,000 and pay a fee of at least $1,500.
PainWebber exploded the high income middle age
class, by taking care of the 401K, and stock of
many companies.
PainWebber also used these employees investment
data to learn about their trading behavior.
PainWebber’s Broker Force
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By 1999, PainWebbers Broker force reached 7,500
with an average assets per broker of $60 million.
They had to change how they paid their brokers
They took a 1% payout cut for the year and
offered another 1% if they surpassed the goal set
for them for the year.
Some brokers were happy, and others were more
realistic
Some brokers realized that the unrealistic goal was
not motivating at all.
Summary
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This case demonstrates a great channel conflict that
technology brought on.
 In the beginning there was only full service brokers, then
discount brokers became to be.
 When technology and the internet came to be, online
brokers came in and took customers out of the
competitions hands.
 Full-service brokers and discount brokers were left with
the fact that they needed to change or they would get eaten
up by the competition.
 Each of these companies reacted in different ways, all had
a hard time reacting to the changes that have changed how
trading works.