Broker Wars: BofA's Freebie Bet
The shrinking fee to buy and sell stocks sank even further with Bank of America's free online trade offer. The Street blasted rivals' shares.
In the world of online brokerages, price is everything. At least, that is, until you start worrying about how long it takes to execute a trade, or how much money the brokerage will lend you, or how useful the site is, or how quickly the customer-service people respond, or…or…or… And then suddenly commission isn't the primary consideration for a trader.
Online brokerages tout all these attributes as superior, but in their marketing, price remains at the forefront of the battle as they trumpet ever-shrinking commissions. That descent reached a new low on Oct. 11 when Bank of America (BAC) said it would offer free online equity trades. They want your retail business and if free stock trades will nab it, so be it.
The Charlotte (N.C.)-based financial-services giant serves around 54 million households, or about half of those in the U.S. On Oct. 11, its primary retail brokerage unit, Banc of America Investment Services, said it will offer up to 30 free online equity trades per month for self-directed investors with a combined balance of $25,000 or more in Bank of America, N.A. deposit accounts.
Wall Street reacted swiftly and negatively, selling down shares of major rivals anywhere from 4.5% to 12%. Competitors yawned, and at least one analyst called the response overdone. None of the brokerages rushed to match BofA's move.
"NO FREE LUNCH." "I don't see pricing as the battleground. I see functionality as the battleground," says Jarrett Lilien, president of New York-based E*Trade Financial (ET). He considers the industry's prices already low, so brokerages must compete by providing better services, such as advanced order types that automatically sell stocks at predetermined price points (see BusinessWeek.com, 1/17/05, "E*Trade Rises From the Ashes").
For its part, Charles Schwab (SCHW) said it had no plans "at this time" to change its price structure. "Knowing there is no free lunch, consumers look carefully at the whole picture—rates on their cash, trading costs, quality of services and investment advice, etc.," founder and CEO Charles R. Schwab said in a statement on Oct. 11. A smaller player, Zecco Holdings, said on Oct. 9 it would offer customers 40 free trades monthly with a minimum account deposit of $2,500. The Ontario (Calif.) company began operating in February as a social-networking online brokerage supported by advertising.
"We're interested in building quality relationships with customers," said Liam McGee, president, Bank of America Global Consumer & Small Business Banking, and Brian Moynihan, president, Bank of America Global Wealth & Investment Management, in a conference call with reporters. The new plan, which started on Oct. 11 with promotions in Northeastern cities such as New York, Philadelphia, and Boston, is expected to expand across the country by February of next year.
INVESTORS DUMP COMPETITORS. When asked how much revenue they expect to lose initially from the new plan, Moynihan and McGee declined to quantify it, calling the amount "not a material number." The bank cares far more about grabbing customers—particularly those who already have deposit accounts with Bank of America but conduct their stock trades with other firms. Standard & Poor's analyst Mark Hebeka agreed the free trades may help BofA consolidate its client base, and draw a few new customers, but the pitch won't radically alter the industry's landscape. "It's not a big material event for them. I'm not looking for it to be a home run," Hebeka says. "It could bring in some outsiders, but I'm not looking for them to gobble up market share" (see BusinessWeek.com, 4/10/06, "The Check Cashed Around the World").
Still, the news spooked investors who feared that lower, or zero, commissions across the industry would vaporize profits. Shares of TD Ameritrade Holding (AMTD) plunged 11.9%, to $16.82, and Charles Schwab's share price slipped 4.7% to $17.22, while E*Trade Financial lost 8.8% to close at $22.31 per share on the New York Stock Exchange.
"It's largely an overreaction," Patrick O'Shaughnessy, an equity analyst at the Chicago investment research firm Morningstar (MORN), said of the sell-off. When online brokerages began their price war after the dot-com bubble burst, critics wondered whether the industry could survive. But now, discount brokerage firms have largely resolved that problem by devising other ways to collect revenue, such as selling margin loans or assessing asset-management fees.
FEELING THE PRESSURE? Brokerage trading revenue accounted for only about 16% of Charles Schwab's total net revenue as of the second quarter, 22% of E*Trade's, and 39% of TD Ameritrade's. Now that Bank of America has started giving free trades, O'Shaughnessy expects commissions to fall further industrywide. "But I don't think it's catastrophic," he added.
S&P pointed out that TD Ameritrade might have a tough time winning market share, in spite of synergies from Ameritrade's $2.9 billion purchase of TD Waterhouse announced last year (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Cos. (MHP)). Equity analyst Royal Shepard downgraded the stock to hold from buy on Oct. 11, explaining that TD Ameritrade "faces challenges from Bank of America's announced offer" given competitive pricing conditions and ongoing industry consolidation.
TD Ameritrade disagrees and has no plan to change its pricing, which is currently $9.99 per online equity trade. "Zero commission pricing is not new within our industry," said Katrina Becker, a spokeswoman for the Omaha (Neb.)-based brokerage, which has around 6 million clients. Before buying TD Waterhouse, Ameritrade had charged $10.99 per online equity trade. Ameritrade tried free online equity trading for some customers in 2000, only to discontinue it in early 2005. Winning market share "is about more than the price," Becker says. "It's things like the tools, the trade execution, and the service" (see BusinessWeek.com, 6/12/06, "From Pigskin to Portfolios").
The online business performance services firm Keynote Systems found that Web site service levels in the brokerage industry far exceed other industries, with an average reliability of 99.5%, the highest reliability rating of any industry measured by the company. According to the study, Web pages that take more than 1.5 seconds to download—a benchmark considered excellent in other industries—fall outside best of class for online brokerages.
PRICE CUT 2.0. "Investors have very high expectations of online brokerage Web sites both in terms of the customer experience and in terms of service levels," says Bonny Brown, director of research and public services for Keynote. "Given the very competitive state of the brokerage industry, performance problems and customer-experience frustrations can translate into problems in attracting new investors." Ameritrade and Schwab were among those judged to provide the industry's best overall service levels.
This isn't the first time Bank of America has gunned for more customers with a price cut. On Dec. 1, 2005, for example, Bank of America established a plan to charge Bank of America personal checking account holders $7 or $10 per trade for online self-directed equity transactions. Customers who had only the self-directed brokerage relationship got charged $14 per trade, reduced from $19.95, which had previously been the cost for everyone.
Wells Fargo (WFC) offered a free online equity trading component for the first time in mid-2005, when customers with more than $250,000 deposited with the San Francisco bank were offered 50 online trades annually at no charge. "We don't have plans to change our fees," says Kathleen Golden, a spokeswoman at Wells Fargo.
Ryst is a reporter for BusinessWeek.com in New York
With Pallavi Gogoi |
