Shakeout Time for Internet Brokerages – Part II

There is an age-old theory that stock brokerages do not need to worry about how the market is doing, because they get paid on commission whether the order is a buy or a sell. However, the rise and fall of the New Economy has challenged that assumption.

With so many brokerages — traditional, pure-play and multichannel — clamoring for business in a sector of e-commerce that is primed for a shakeout, boosting the number of client accounts and the revenue per account is no longer a matter of desire, but a matter of survival.

In Part I of its two-part series on the likely shakeout facing Internet brokerages, the E-Commerce Times detailed the difficult, sometimes contradictory customer expectations that these brokerages must satisfy.

Here in Part II, the E-Commerce Times explores the current cost-cutting and revenue-boosting strategies of the Net brokerage arena.

One World is Enough

When Internet brokerages first appeared, traditional brokers took pains to distinguish themselves from online-only competitors — and vice versa.

However, as the multichannel theory of Web and real-world selling started to take hold, the distinction between Internet brokerages and traditional brokerages broke down.

“Traditional brokerages have gotten over their fear of diluting their revenue streams, and are now offering self-directed trading as a component of their full-service offering,” Chuck Callan, head of the North America financial services practice for the Boston Consulting Group, told the E-Commerce Times.

Bricks and Bucks

At the same time, some Web-only brokers, such as E*Trade (NYSE: ET), decided that developing a real-world presence would boost consumer confidence.

The former pure-play has opened a brick-and-mortar “superstore” in New York City, and is expanding its alliance with offline retailer Target by putting more than 1,000 new automated teller machines and 20 additional sales and service centers in Target outlets nationwide.

“The distinction between online brokerage and offline brokerage is getting less meaningful,” Forrester Research senior analyst Kenneth Clemmer told the E-Commerce Times. “It’s just a channel. For example, Merrill Lynch — is it an online or an offline broker? There are different kinds of accounts, but to classify different firms as online or offline is not meaningful.”

Make New Clients …

Just as brokerages have started to explore more channels of service, they have also sought ways to augment account volume.

In early 2000, when the market started to bloat with Internet fever, the ensuing horde of day traders sent trading volumes through the roof.

However, the dot-com shakeout soon followed, with stock values plummeting and many a dot-com closing its virtual doors.

Now, analysts are saying that the growth in new accounts for online trading is over and not likely to resume.

… But Keep the Old

“Those people who were the early adopters of online trading are basically tapped out,” Clemmer said. “They are an important group, but they are not going to be a growth factor for brokerages.”

Still, there is an untapped market, according to Clemmer.

“We only have online trading at 7 percent, and when you consider that 50 percent of investors have investments in addition to their 401k accounts, the task for brokerage firms is to make the online channel work for those investors,” Clemmer said.

For Net brokerages to survive, according to Callan, they must target “higher net worth individuals and older individuals, because two-thirds of the millionaires in the U.S. are over 50.”

Trading Places

Although the leading Internet brokerages may agree on the need for more accounts and more revenue, two of the better-known names in the Net brokerage business, E*Trade and Ameritrade (Nasdaq: AMTD), are taking distinct paths to fulfill that need.

E*Trade, when it announced its first-quarter 2001 results in April, said it would begin cross-selling bank and brokerage services. E*Trade also said it intended to target high net worth individuals through its Club E*Trade service.

In contrast to E*Trade, Ameritrade has started to charge its existing customers more — for example, billing US$15 per quarter in maintenance fees for accounts with less than $2,000 in assets or fewer than four trades in six months.

Clemmer believes that Ameritrade’s recent red ink (the firm reported a net loss of $54 million in its last quarter) can be attributed to wasting a lot of money on OnMoney, its personal financial manager site. Clemmer said that “if you take the OnMoney mistake out of the equation, Ameritrade is doing fine.”

Message in a Brokerage

On the cost-cutting side, both Ameritrade and E*Trade have slashed their advertising budgets in recent weeks. However, what distinguishes their advertising strategies is the message each is sending out.

“The Ameritrade message is not going to be attractive to the mainstream investor, while the E*Trade message might,” Clemmer said. “The E*Trade message is that ‘this is a smarter way to do things,’ while Ameritrade’s message is ‘get in and out and make a lot of money.’ The ‘smarter way to do things’ message is going to have more resonance with mainstream investors.”

According to Clemmer, the get-in-and-out message is not likely to appeal to mainstream investors “who are not ready to sling their money around that quickly.”

Slim Fast

Although widespread closures have not yet started for Internet brokerages, most of the online brokers are consolidating forces. Ameritrade, Charles Schwab (NYSE: SCH) and Datek have all cut jobs in recent weeks.

Analysts generally agree that if Net brokerages have to cut costs to keep them in line with revenues, then trimming staff — and even server capacity in a time of low trading volume — is the way to go.

“The difficulty is that if you pull back too hard and things start to turn around, you’re going to have incur costs to build up again,” Clemmer said. “If you’re not an agile company, that’s going to take you longer, so it might be better to just weather the storm and not try to follow the market up and down.”

Ultimately, people are starting to doubt that the storm hitting Internet brokerages is one that all the brokerages will successfully weather.