Online Stock Trading

A Case Study for E106

CCCC.COM Team

Chunghui Mo, Hongyu Ran

Huazhang Shen, Pin Wang, Lili Yang

Online Stock Trading

A case Study

Executive Summary / 3
Industry background / 4
Why invest online / 4
Online trader / 5
Business Renovation / 5
Customer and online service segmentation / 8
Market projection / 9
E*Trade / 10
The story of E*Trade / 10
Business description / 11
Stock, option, fixed income and mutual fund trading / 12
Market data and financial information / 12
Portfolio tracking and records management / 13
Cash management services / 13
Financial summary / 14
Summary / 15
Charles Schwab / 16
Company background / 16
Schwab online / 18
Information systems / 20
Global presence / 21
Problems Associated with Online Trading / 22
Type of fraud / 22
Regulatory agencies for online trading / 24
Market volatility / 25
Difficulty to make sound online Trading Decisions / 26
Make a trade does not equal to execution / 26
Future directions to solve the problems / 26

Executive Summary

In last four years online stock trading has emerged as the leading edge of e-commerce in retail financial services. While Web banking and electronic bill payment have made slow and uncertain progress, online trading has grown rapidly, seizing market share and forging a dynamic new business model for the brokerage industry.

In this case study we first overview the industry background of online stock trading. The main reasons that people invest online are due to its extraordinary simplicity, extensive service, extraordinary saving and excellent security. We found that online traders are mainly men between the ages of 25 and 34 with household incomes of $75,000. The reinventing of brokerage industry due to online is described and market share distribution is provided, showing that six firms including Charles Schwab, E*Trade, Waterhouse, Fidelity, Datek and Ameritrade accounted for more than 80% of business. Online customers can be segmentated into three kinds: delegators, validators andself-directed individual investors and online brokerage can be divided into deep discount, mid-tier and full service. Market projection shows that 9.7 million US households will manage more than $3 trillion online in 20.4 million online accounts by year 2003 and online brokerage firms will have average 60% growth rate.

After the background description, we highlight two representative companies on this industry to try to research their business. They are E*Trade, a pioneer of Internet stock trading service provider, and Charles Schwab, a largest discount broker. As a deep discount broker and offering real time stock information online, E*Trade enables small investors to take control of their financial assets rather than through traditional brokers. The basic advantage of E*Trade includes low transaction fee, simple to use interface, real time stock quote, 24 hours service, online community, E*Trade game and detail tax report. In order to maintain its competitive advantage, E*Trade is moving to offer full financial service online rather than brokerage only. Now E*Trade offers banking, bill management, financial advice, retirement manage, collage savings, real estate insurance, taxes calculator and E*Trade visa. For Charles Schwab, we focus on that how the large traditional discount broker successfully manage to change its business into online. We describe the company background, Schwab online, its information systems and global presence. A key factor behind Schwab’s strategy and success is that fact that they are a multichannel company. We conclude that the breadth of functionality and availability on their site, as well as the commitment they have to develop the online offering, has contribute to Schwab.com’s popularity.

At last we bring up those problems associated with online trading. They are general fraud problems, regulatory agencies for online trading, market volatility and some technological issues.

Industry Background

"The Internet is giving individual investors access to more resources than they’ve ever had before."

Smith Barney analyst Jonathan Cohen

Why Invest Online?

There are a number of reasons that could explain this online trading phenomenon. We particularly cited the approach provided by Xolia.com, which specializes in guiding consumers through complex commerce decisions with vast experience in online trading. Xolia.com developed what they call “XOLIA’s click’nvest pyramid advantage” in order to explain the basis that sustains the satisfaction experienced by online-trading consumers. The pyramid is shown as exhibit 1[1].

Exhibit 1: Xolia.com’s pyramid advantage of online trading.

One of the main benefits of investing online is its extraordinary simplicity. This means being very convenient and easy to use. Online investors can trade from home, from the office, or even while lying under the sun at the beach. Online support, phone support, chat rooms and message boards are also available for users to ask questions and discuss problems with fellow account holders.

Another benefit of online investing is extensive services. Users can track their portfolio from anywhere and at anytime. Users can obtain free real time quotes and continuous portfolio updates. They can also receive periodic updates by alphanumeric messages on a mobile phone or via e-mail. Exhaustive research services are also available. Users have access to financial statements, analyst opinions, stock ratings, historic information, and company specific information such as managerial discussions, company announcements, and recent company news.

Online investing alsoprovides users with extraordinary savings. Instead of paying fees and commissions at a traditional "full service" brokerage, you pay a discounted commission for each trade. Nearly 10 million people actively trade stocks online and pay $6 - $35 per trade, while a traditional broker charges an average of $80 per trade.

The last benefit, according to the Xolia pyramid, is excellent security. All information, which is transferred electronically instantly, becomes encrypted. Late-breaking technologies are able to use 128-bit encryption. Clearly, technology is the driving force behind all of these benefits. Information that once was only available to professionals on Wall Street is now available to almost anyone who has access to a computer and the Internet. New investment options can be offered online. Investors are no longer limited to the traditional investing method of finding and paying a full service brokerage firm, and actually they can conduct their investment by their own.

Online Traders

Approximately 13% of people on the Internet today have added to mutual funds or traded stocks, bonds, or options online. However, despite increased advertising and news coverage about the phenomenon, this percentage stayed flat for most of last year, according to a new study by Wilton, Conn.-based market research firm Greenfield Online Inc. But 25% of 3,036 respondents say they are extremely or very likely to trade online in the future. People who have been on the Internet for more than two years are significantly more likely to be in this group of future traders, says Greenfield. The research shows that hose participating online are mainly men between the ages of 25 and 34, and are individuals with household incomes of $75,000 or more. The study, part of Greenfield's Digital Consumer Shopping Index, provides six quarters of online trading statistics. The latest fielding of this ongoing quarterly study was November 12 to November 24, 1999. The sample is drawn from Greenfield's 1.4 million person research participant community, and the data has been weighted to represent the U.S. Internet population in terms of age, gender and geographic region”[2].

Business Renovation

The following materials are extracted from Xolia.com[3]. These statements serve as a perfect introduction of the revolution change this industry has been experienced and the segmentation effect.

q  “To know the price of a stock or the latest news about any company or how much of the company you owned you had to call up your broker, probably wait on hold for a while, and then quickly ask all of your questions. Today, you can access this information right away.”

q  “Not all investors are alike. For one new online investor, the most important consideration might be that his online broker has a long-standing reputation for ease-of-use and customer service; whereas a highly-experienced day trader would probably want her online brokerage to offer the lowest possible commission rates and quickest trade executions.”

The exhibit 2 shows the way this brokerage service was previously given to customers. The market was segmented into two categories. Large customers, represented by institutional investors, companies, and wealthy individuals, and small customers, represented by less wealthy individuals. The high quantities of money involved with large customers required the relation between them and full service brokers be based on trust and advice. Customers need and trust in the wisdom of these firms, and the firms provide the advice needed and many times they will manage their portfolio, making all the necessary decisions. Commissions could cost hundreds of dollars, and the cost per trade was about $80 each. Therefore, the field of finance and investing remained something of an elitist's pastime. Access to real time information was also expensive and thus could only be afforded by wealthy investors and institutions who rented special information systems.

Exhibit 2: Previous brokerage service provided

Small customers did not provide the volume or dollar amounts required to have access to this personalized advice and management. Thus their sources of information were press media, special cable channels, any information of public access and their own wisdom. Small customers either paid full service brokers, or they looked for discount brokers who were only channels or retailers that could place a trade on behalf of the small investor.

Exhibit 3: Brokerage service with online

Exhibit 3 shows the method that the brokerage service joined by online is currently provided to customers. Pioneered by E*Trade, Internet stock trading service providers have initiated since early 1996. The user-friendliness, accessibility, speed and low fees of online trading have challenged the established full-service and discount brokers and changed the way people invest. Even Charles Schwab, a firm that invented the concept of a discount broker, has not gone unchallenged. More than 60 online brokerage firms have emerged within the first two years and now more than 140 brokerage firms offer online trading to their customers. With fees in a downward trend and advertising spend increasing, this fast growing segment, which holds about 7 million of the approximately 80 million accounts up to year 1998, is managed by full-service brokers and traditional discounters. And the market share is distributed to several leading companies: Charles Schwab leads with 27.4% market share; next comes Waterhouse with a 12.4% market share and E*Trade with 11.8%, both beating a traditional giant such as Fidelity, which commands 9.4% of the market. As shown in exhibit 4[4], the six firms (Schwab, E*Trade, Waterhouse, Fidelity, Datek, Ameritrade), all of which entered the market before June 1997, accounted for more than 80 percent of the business.

Exhibit 4: Market share of online brokerages

As previously mentioned, new technology has greatly increased people's access to information. With the use of the Internet, real time online information is now available at no or little cost. As mentioned in the “XOLIA’s click’nvest pyramid advantage”, there are now extensive research services available. There is also a disintermediation effect. By allowing the online investor to directly place orders and initiate his own trades, online cyber-finance service providers have greatly reduced the need for a full-service broker. No one will be telling you what to buy or sell, unless you request such advice.

Online investing also has a control factor involved. There are many Americans who want to be in their own seat, in control of their financial destiny. Placing their own trades, tracking their favorite stocks, managing their own portfolio, 24 hours a day, 7 days a week - aspects of the control factor associated with online trading.

Customer and Online Service Segmentation

The Internet opens a wide array of possibilities in providing trading services. Different online brokerage firms will provide different services, participating to a more or less degree in the processes of developing investment strategies and deciding about specific trades, therefore, appealing to different segments of customers.

From an interview with David Pottruck of Charles Schwab, three different groups of customers have been identified[5]

q  Delegators: Do not want to handle their money; do not want to make any financial decisions.

q  Validators: Want to have control over their transactions; want to discuss their investment strategy with professionals; require some advice on buying and selling stocks

q  Self-Directed Individual Investors: Financially literate; do not need advice to invest; know the financial market; want fast and easy transactions; want adequate investment tools

Forrester research has also identified three groups of online trading services[6].

q  Deep Discount: No or little advice; $8 to $16 a trade; all research tools and information provided.

q  Mid-Tier: Advice with specific limitations; about $30 a trade; all research tools and information provided.

q  Full Service: Total advice with respect to any investment issue; costly in commission; trading fees about $80; research tools and information provided.

Market Projections

Exhibit 5: Market projections

The market projections were provided by forrester.com6, a leading market research firm with extensive research in online trading. Exhibit 5 clearly shows us the dramatic market growth in next couple of years.

q  By 2003, 9.7 million US households will manage more than $3 trillion online in 20.4 million online accounts.

q  Assets managed by online full-service brokerage firms will grow at 115% in the upcoming years. Assets managed by mid-tier providers will grow at 62% and assets in deep-discount will grow at 26%.

q  By 2003, mid-tier providers will control 47.7% of the assets invested online. Full Service brokers will control 44.6% and deep discount providers 7.7%.

In this case, we will review E*Trade - the pioneer, Charles Schwab - the leader in the online trading business.

E*Trade

“A slick interface, a solid portfolio manager and a wide variety of access options put E*Trade at the top of a growing heap of online investment services.”

PC COMPUTING while announcing the winner of the Most Valuable Product Award for 1997 Internet Financial Services.

The Story of E*Trade

On July 11, 1983, a doctor in Michigan placed the first online trade using E*Trade technology. What began with a single click over 16 years ago has now taken the world by storm. Today, E*Trade customers can be found in all 50 states and 119 countries from Aruba to Zambia.