Sunday, November 25, 2007

Response to Internet Broking Opportunity by Various Brokers

The short history of e-business includes many companies that were too rigid to respond quickly to the Web's disordering influence on their industries - and found themselves in a potentially unwinnable game of catch-up.

Initially deep discount brokers embraced online broking. Only after many years full service brokers changed to it.

Merrill Lynch & Company, for instance, resisted Web-based brokerage services for four years, while companies both new and extant, such as E-Trade, Charles Schwab and smaller discount brokers, stole its customers away by offering an efficient, inexpensive approach to buying and selling stocks. Merrill's public antipathy to the Internet was so strong that in August 1998 its vice chairman and brokerage chief, John "Launny" Steffens, said Internet trading "should be regarded as a serious threat to Americans' financial lives."

Merrill's paralysis, though, had nothing to do with protecting the citizenry; it was stoked by an internal culture clash. The company's powerful cadre of 15,000 brokers saw its commissions, which averaged nearly 30 percent of gross production, threatened by Internet trading and lobbied hard against it.

Merrill is far from the only high-profile company stymied by its own culture. When opened shop on the Internet in 1995, Barnes & Noble Inc., which had just gone through a feverish period of growth that included the debut of its innovative cafes and music shops within supersized bookstores, didn't take e-tailing seriously. Internally, the emphasis was so rooted in expanding the bricks-and-mortar chain that any other sales channel just didn't make the radar screen.

Merrill Lynch eventually had to cave in to the inexorable growth of online trading, even if its corporate culture wasn't ready to accept it. Last June, Merrill announced a complex plan that set Internet transaction fees at about $29.95 per trade, on a par with Charles Schwab.

Although Merrill has won plaudits for the quality of the online strategy it has disclosed, the company's halting approach to e-business is still hurting it. Its online trading site, which opened in December 1999, is not expected to be fully functional until mid-2000. Meanwhile, other Internet brokers continue to cement their presence on the Web, signing up new customers - some of them formerly Merrill's. To rally brokers around its Internet strategy, Merrill has agreed to pay them the commissions they lose from Web trading for the next five years, an amount that could total hundreds of millions of dollars.

Merrill's Internet delay is reminiscent of how the giant brokerage firm handled its significant business dislocation 25 years ago, when the U.S. Securities and Exchange Commission outlawed industry-wide fixed commissions. Merrill, like most of its competitors, used this as an opportunity to raise transaction fees. Schwab took the other route and slashed commissions, in effect creating the discount brokerage model. Schwab's idea was not unlike that adopted by Internet brokers: Attract customers with bargains on transactions, which are essentially commodities, and make money on volume as well as sales of initial public offerings, research reports, asset-allocation advice, mutual funds and, more recently, investment banking.

Merrill, meanwhile, held off cutting commissions for as long as it could. By the time Merrill launched its less-expensive Web-based trading programs, Schwab and numerous other discount brokers were well established - and much more efficient moneymakers. In 1998, Schwab's pre-tax profit margin was 18 percent, compared with only 9.5 percent for Merrill and 10.7 percent for the entire brokerage industry. Equally impressive, Schwab's return on invested capital was about five times the industry average, while Merrill's had fallen behind its competitors.

Schwab was far from the first broker to offer online trading - it started in 1996, about four years after E-Trade Securities Inc. pioneered the concept on the CompuServe online service - but unlike Barnes & Noble in its battle with, Schwab quickly outpaced its Internet rivals. Schwab's culture was prepared for change and not hardened against it. As the discount brokerage forerunner, Schwab was born from innovation: Its commission schedules were already tied to inexpensive trades, and it had extremely advanced, cost-effective networking technology that powered its vast telephone and electronic trading systems. These cultural and infrastructural strengths were indispensable in making its Web presence a success. Without hand-wringing and cultural resistance during its preparation to launch an Internet site, Schwab could focus on deploying an online trading system that would match customer expectations. Schwab has captured 42 percent of all assets traded online, even though its transaction price - $29.95 per trade - is among the highest in the category.


Companies like Merrill Lynch that avoid alternative sales channels tend to lean on the same reason: They don't want to cannibalize their more lucrative existing business and wreak havoc on their pricing structures. Such companies see their current business as being under siege. Moreover, manufacturers - whether they make clothing, shoes, record albums or farm equipment - are also wary about upsetting their retailing or distribution partners by selling directly via the Internet.

Fighting the Cannibals

by Glenn Rifkin

The explosive growth in online stock trading has not been a solely American phenomenon. As their economy rebounded in 1999, Koreans began to embrace online equity trading with a vengeance. With Korean stock prices rising, online commission rates plummeted through the first half of 1999. Despite these discounts, the value of trades placed online jumped from 5 percent of all trades in January to 30 percent in August 1999.

Korean consumers are now so enamored of online trading that many employers must limit Internet access in order to keep employees from playing the market all day.

LG Investments and Securities Company (LGS) has led the rush into the online trading world. With 90 branches and 1,900 employees, LGS is the $500 million brokerage services arm of the LG Group, one of Korea's largest conglomerates. Founded in 1969 and operating primarily in Korea, LG Securities is an unlikely company to have thrived in the fast-paced world of online trading. Growth over the past few years has been slow because LGS's C.E.O., Ho-Soon Oh, was reluctant to expand or hire new employees during the economic crisis that began in 1997, as were many of his competitors.

Despite a cautious corporate culture, Hong-Soop Song, an LG branch manager, saw a new market for the company in the burgeoning field of online trading. Because the Korean market was virgin territory, the first mover would undoubtedly enjoy a huge advantage. Why shouldn't it be LG Securities, he wondered. "Based on my knowledge of customer behavior as a branch manager, and my study of successful U.S. companies, such as E-Trade, I realized that online trading was a huge opportunity for us," Mr. Song says.

In November 1998, he presented Mr. Oh and C.F.O. Seong-Hyun Yoon with a proposal for a major online-trading initiative. He suggested a tenfold increase in spending on I.T. infrastructure for the online venture: New telecommunications lines and more powerful servers would be required. He also noted that the effort would require only a modest increase in employees, an attractive feature for executives who were loath to fire employees in another economic downturn. Mr. Oh and Mr. Yoon were so impressed by the proposal that they approved it in only two days - a miracle in a bureaucracy where major decisions usually take weeks or months - and allocated it a $15 million budget. The system was up and running one month later.

Beyond the speed of its development, LGS's online trading operation succeeded because it was convenient for customers. Because relatively few Koreans use the Internet from home, LGS targeted Korea's 15,000 cybercafe-like "PC Rooms," which offer high-speed online access for an hourly fee. LGS negotiated alliances with 700 PC Rooms, which eagerly promote LGS's trading services in the hope that they will increase their own revenues. LGS designed the online interface to be as simple as possible, and even dispatched staff to branch offices to explain the system and offer advice. Finally, LGS trumpeted the new service in a country-wide advertising blitz.

The initiative was not without obstacles. Unions are strong in Korea and the brokers' union protested that commissions would be cannibalized by online trading. When Mr. Song spoke with the union in November 1998, online commissions equalled those from the branches. But by January 1999, online commissions had dropped to a point a whopping 80 percent lower than branch trading commissions and the brokers feared for their livelihoods.

Mr. Song argued that since online trading was inevitable, it would be advantageous for the brokers if LGS got into the market first. Furthermore, he assured them that LGS was truly committed to the new venture and, in an attempt to sweeten the deal, he said LGS would tie brokers' income to online revenues: The more online trades placed, the more money the brokers would make.

One year later, the numbers have proved Mr. Song correct. Before the advent of online trading, LGS's 800,000 customers made about 40,000 trades per day in branches. Today, the number of trades has skyrocketed to 240,000 a day - with 40,000 still being placed at traditional branches. In the end, online trading didn't cannibalize LGS's income stream, but created an entirely new source of revenue by encouraging customers to place 200,000 more trades each day.

No comments: