The recent bid for Ameritrade by rival E*Trade Financial put the online brokerage world on the front page, as two of the largest firms in the business involved in a potential merger might say something about the current state of the brokerage industry.
Since the heyday of click-through trading in the late 1990s, business at the virtual transaction houses has withered. But with millions of customers, the cheaper dealers aren't going away. Consolidation and broad product offerings keep the ball rolling.
The proposed E*Trade Financial-Ameritrade union would give Ameritrade shareholders 47.5 percent fully diluted ownership of the combined company, plus approximately $1.5 billion in cash. Based on today's numbers, the resulting brokerage would have over 7 million customers, with total client assets of $170 billion.
Ameritrade is publicly stating that it is not for sale. A company spokesperson declined to comment.
Whether the deal occurs or not, the industry is consolidating. Ameritrade alone has acquired seven firms over the preceding four years. With less competition, industry watchers fear higher commissions and lower service. In fact, commissions have not gone up, and growing demand for investment advice may be driving all virtual brokers in the direction of offering more, not fewer, services.
"Since 9/11 and the Internet bust, fewer people use multiple brokers and more seek advice on trades," said Jeff Taylor, director of financial services at J.D. Power and Associates, of Troy, Mich. "We have not returned to the high level of trading we had when many of these firms started."
J.D. Power and Associates covers the industry and reports on traditional as well as online brokers. The 2004 Online Trading Investor Satisfaction Study revealed that 59 percent of online investors deem it "extremely" or "very" important to be able to speak with a broker in person. "Affluent investors place a higher percentage of their assets with traditional retail brokers than the average individual investor," said Taylor. "They also invest more deeply and buy more than one investment than through their online brokerage accounts."
Industry consolidation hasn't affected commission structures in the expected manner. To attract customers, the online world is keeping charges low. Revenue growth must be coming from the plethora of new product offerings. Industry granddad Schwab, for instance, now clocks only a small portion of revenue from their original discount brokerage efforts.
"It's hard to build a business around discounted commissions," said Mark Balasa, CPA, CFP, of Balasa Dinverno & Foltz LLC, in Itasca, Ill. "Everyone now is looking for a revenue stream of basis points off assets."
Online firms might also be following a strategy of product specialization to gain market share. E*Trade Financial captured business serving corporate executives with cashless stock option exercises. The firm's banking activities grew in the low-interest mortgage environment.
Ameritrade has been carving out institutional business. "Ameritrade is trying to make their mark with the smaller advisors that Schwab won't take," Balasa said. "They might not have something like a deep fixed-income trading desk, but the smaller firms don't need it."
So many choices ...
With online brokers offering deeper product lines and retail brokers extending online trading services, the lines between new age and traditional are blurring. Customer demand for both services creates more demand for advice. According to Sheryl Garrett, investors' need for advice started to increase a decade ago. The range of choices in 401(k) plans and other sorts of saving vehicles force even modest-sized investors to make decisions. "Individuals are unprepared to make these kinds of decisions," said Garrett, founder of the hourly fee Garrett Planning Network Inc., in Shawnee Mission, Kan.
Calling the online trading frenzy of the late 1990s a "blip in this trend," Garrett referred to business futurist Peter F. Drucker's prediction that our age will be defined not by the technology boom, but by the fact that for the first time in human history, great numbers of people have great numbers of choices.
"We see the demand for advice largely from people who know they can't afford to lose this money," Garrett said.
If investment firm profitability is what's driving the consolidation, then CPA advisors are equally affected by the industry challenge of how to serve customers' demands efficiently. E*Trade claims that if the bid for its larger competitor is successful, the company expects to reduce overall costs by at least $650 million.
"It's an expensive thing to build and keep adding tools and toys to these platforms, on both the advisor and the retail side," said Balasa. "The technology is behind the real push to getting market share, and that takes a lot of money."
The merging companies maintain expensive technology, but surveys indicate that it is not much to their customers' satisfaction. According to J.D. Power's 2004 report, E*Trade and Ameritrade rank last and third to last, respectively, in customer satisfaction levels.
Advisors who are now working with Ameritrade's institutional side might favor the proposed merger. The deal is driven by E*Trade's ability to "cross-sell a raft of banking products and services to Ameritrade's current customer base," according to Forrester Research analyst Bill Doyle.
The deal might be timely for the two firms. J.D. Power's recent retail brokerage survey showed customers returning to the online world for the first time in three years, with 8 percent of Internet-connected families investing online, up from 7 percent in 2003. Newer online investor demographics mirror the characteristics of those who were quickest to bail out after the tech bubble burst - investors who are younger (aged 18 to 34), female, and who have smaller portfolios, a more conservative approach to investing and a lower risk tolerance.
Consolidation, the blurring of lines between online and traditional brokers, and serving the increasing demand for investment advice are likely to drive the online world for some time.
Said Taylor, "Investors today have a higher degree of wealth, and we're seeing their interest in utilizing the services of the online brokerage firms."
