June 14, 1999
CHANNEL CONFLICT
For full-service brokerage firms, entering the
online business raises all sorts of internal dilemmas
By Randall Smith
Baseball fans who watched the World Series on TV last fall were treated over and over to the same ad for the online brokerage firm E*Trade Group Inc.
As the camera lovingly tracks along the exterior of a luxurious stone chateau, the announcer purrs, "Your investments helped pay for this dream house." As the camera follows a well-dressed young couple inside the mansion's front door, the young man smirks. "Unfortunately," the announcer adds, "it belongs to your broker."
This saturation ad campaign, promoting commission rates of only $14.95 and appealing to customers' resentment of lavishly compensated full-service brokers, helped boost E*Trade's share of the online trading business to 13.3% in this year's first quarter from 10.8% in the third quarter of 1998, according to U.S. Bancorp Piper Jaffray Inc.
But that kind of pitch wouldn't have been possible for an online broker like Discover Brokerage Direct, whose parent securities firm, Morgan Stanley Dean Witter & Co., employs 11,500 of those full-service brokers. "I don't think we would ever do that [kind of ad] for obvious reasons," says John Yost, a founding partner of Discover's San Francisco ad agency, Black Rocket.
Indeed, many industry experts say the growth of Discover Brokerage Direct has been constrained by its uneasy coexistence in the same organization with an army of full-service brokers who make their living charging hundreds of dollars a trade. The presence of those brokers, these experts say, exerts a huge influence over the firm's online strategy.
Changing Channels
In business, the problem is known as channel conflict: distribution through competing channels that offer different prices and service levels. It affects all types of industries, from bookselling to computer retailing, and is becoming increasingly common as more businesses try to harness the money-making power of the Internet.
Executives of Morgan Stanley Dean Witter declined to be interviewed on the topic of how they have managed the conflict. But experts say the impact on Discover Brokerage Direct has been undeniable. Bill Burnham, an electronic-commerce analyst at Credit Suisse First Boston in San Francisco, says that in plotting Discover's strategy, executives at Morgan Stanley Dean Witter "spent a lot of time sitting around the table figuring out how not to step on each other's toes."
Mike Gazala, an analyst at Forrester Research Inc. in Cambridge, Mass., adds that Morgan Stanley Dean Witter executives have kept the Discover online brokerage "completely separate" from their full-service operations so they "don't alienate their high-performance brokers who would say, 'What are you doing, trying to undercut us with cheap trades?'"
Since the third quarter of 1997, when Piper Jaffray began compiling market-share data, Discover's share has fallen to 2.8% from 5%. In that period, the biggest market-share gains have been scored by such all-discount firms as Datek Online Holdings Corp., Ameritrade Holding Corp. and Toronto-Dominion Bank's Waterhouse Securities Inc., none of which employ full-service brokers.
What's in a Name?
One of the clearest indications of how channel conflict influenced management decisions was in the way the online unit was named. The online operation is a descendant of a firm called Lombard Brokerage, which Dean Witter acquired a few months before agreeing to merge with Morgan Stanley & Co. in early 1997.
After the merger, rather than extend the Morgan Stanley or Dean Witter brand names -- which carried considerable clout in the securities business -- to the online operation, the combined company instead gave it the name of the Discover credit-card operation. The parent company's name is part of the Discover Brokerage logo, lending the operation credibility among investors, but it's in much smaller type underneath.
Analysts chalk up that decision to a reluctance by the firm to antagonize the brokers who prize the prestige calling cards of Morgan Stanley or Dean Witter, and hate the idea of their own firm offering a low-price alternative under the same name.
"The name is clearly the No. 1 issue," says Scott Appleby, who follows online brokers for ABN Amro Inc. Using the Morgan Stanley Dean Witter name for the discount service could be viewed as "diminishing the value to your brokers of that brand," he adds. "It's much more difficult if I'm a broker and I'm providing this value-added service, and I turn around and my client can get a trade for $16 a share" from the same company.
Some industry rivals argue that the Discover name itself was a poor choice. The Discover credit card, they note, was established in the 1980s with a core group of customers of Sears, Roebuck & Co., Dean Witter's former parent. And within the credit-card field, the Discover name is associated with a middle-class, downscale customer base similar to that of Sears.
"They've always been a middle-market card," says credit-card expert Robert McKinley, president of CardWeb.com Inc. in Frederick, Md.
But others say that's precisely what Morgan Stanley Dean Witter executives wanted: a brand name with proven appeal to ordinary individuals who may be more attracted to do-it-yourself, online trading than affluent investors who can afford a full-service broker. (At the same time, Morgan Stanley Dean Witter is taking steps to move the Discover brand upscale -- for instance, offering a platinum-level card this year.)
A similar balancing act can also be seen in the way Morgan Stanley has managed access to two of its most prized products: research reports and initial public stock offerings.
Discover Brokerage Direct began offering its clients stock research last summer, in response to competing online and discount brokerage firms that were teaming up with other securities firms to provide their clients with research.
But the research Discover clients get is different in several ways from what Morgan Stanley's full-service clients are entitled to. For one thing, it costs extra -- $4.95 a month for information on one company and $34.95 a month for as many as 40 companies -- whereas full-service clients can get the reports free as part of their broker relationship. Also, the Discover reports are edited versions, not the full reports that the full-service clients get. And the Discover product has a distinct name: Discover Brokerage Equity Research.
To be sure, the reports -- like Discover's TV and print ads -- do note that Discover Brokerage is "a Morgan Stanley Dean Witter Company." But the fact that the research is prepared by Morgan Stanley analysts appears only in the footnotes of the reports. The Discover Web site's section on research, meanwhile, says only that the reports come from "a leading research institution."
The intent of that, according to Thomas O'Connell, Discover Brokerage's executive vice president for operations and technology, was to not upset the Dean Witter brokers by making their research seem like a cheap commodity. "We don't want to do something to make life hard for them," he said at the time.
With its IPOs, the task was a little tougher. IPOs are coveted by Wall Street's best customers because they tend to surge in price immediately after the stock offering, and brokers like to reserve these issues for their best full-service clients to build goodwill and business.
But as an underwriter of IPOs, Morgan Stanley has also been eager to curry favor with the Internet community, which has produced some of the most impressive stock debuts in recent years. So this year it wound up handing over IPO shares of Ziff-Davis Inc. and Priceline.com Inc. for resale to online underwriters E*Trade and Wit Capital Group Inc. Meanwhile, it denied those IPO shares to its own online customers at Discover Brokerage Direct.
In late April, with E*Trade and Wit going full force with their IPO programs and Discover's own clients chafing, Morgan Stanley finally announced plans to give Discover customers IPO access as well. But the access remains limited, available only to certain customers who have at least $100,000 in their trading accounts.
Segregation Forever?
Some experts believe that the segregation of the online and full-service businesses will fade over time as the Internet comes to be seen as a mainstream medium for investing rather than a discount outlet. As Morgan Stanley takes more steps to coordinate the two businesses, they say, full-service brokers will notice some of the benefits and are less likely to resist.
Indeed, some securities-industry executives say, brokers' attitudes toward online trading are already changing fast. Six months ago, the brokers might have said: "How can you contemplate giving away what I make a living selling?" Now, the same brokers are more inclined to want to be able to offer online trading as part of their full-service menu.
Peter C. Davis, a partner who specializes in financial services at Cambridge Group, a consulting firm in New York, says Morgan Stanley Dean Witter should consider Discover "part of its brokerage offering, very much in the mainstream along with its full-service brokers, and route the customers appropriately based on their needs."
Morgan Stanley Dean Witter, he explains, should "use Discover as a separate channel within the brokerage offering to appeal to self-directed investors who have an affinity for online trading and online advice, online delivery of brokerage services basically, and encourage the migration of customers to that channel if in fact they prefer that."
Although Morgan Stanley isn't planning to offer Discover online services to Dean Witter clients, it is working on a separate system called ClientServe that will allow some full-service customers to trade online.
--Mr. Smith is a staff reporter for The Wall Street Journal in New York.
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