Told ya so, Frankie: "Facing Internet Threat, Merrill Plans To Offer Trading Online for Low Fees
Customers Will Get Choice: $29.95 Rate,
Full Service or a No-Commission Plan
By CHARLES GASPARINO and REBECCA BUCKMAN
Staff Reporters of THE WALL STREET JOURNAL
At a conference in May, the chairman of online brokerage firm E*Trade
Group Inc., Christos Cotsakos, chided Merrill Lynch & Co. for failing to
understand the power of the Internet. Merrill Chairman David Komansky
held his peace, but he did remark, significantly, that if a "bunch of yuppies"
could win over investors on the Internet, so could Merrill.
On Tuesday, Merrill showed its hand. In a bold move fraught with risk, the
largest U.S. brokerage firm, anchored in tradition and costly full service,
announced plans to enter the low-cost business of online stock trading.
Merrill, whose customers pay commissions of
up to several hundred dollars per trade, will
offer online trading for as little as $29.95 per
transaction, matching fast-growing rival
Charles Schwab Corp. It's as if Bergdorf
Goodman started selling inexpensive merchandise in its basement to
compete with Wal-Mart.
Indeed, Merrill's decision -- one that every full-service Wall Street
brokerage firm will have to respond to -- shows just how profoundly the
Internet is transforming the competitive landscape in the U.S. economy.
Rarely in history has the leader in an industry felt compelled to do an
about-face and, virtually overnight, adopt what is essentially a new
business model.
In Merrill's case, the move is especially remarkable. It was less than a year
ago that Merrill's brokerage chief, John "Launny" Steffens, publicly stated
that "the do-it-yourself model of investing, centered on Internet trading,
should be regarded as a serious threat to Americans' financial lives."
Merrill instead found that scoffing at cyber-trading was a threat to its own
health. "There's not a [broker] at Merrill who hasn't lost business" to online
brokers, a senior Merrill executive confides.
Internal debate raged for months before top executives agreed they would
embrace the Internet, and figured out how to do it. Only after proponents
suggested starting a separate online unit -- which would have ended up
competing from within against Merrill's thousands of stockbrokers -- did
internal critics of online service drop their opposition to cheap Internet
trading through Merrill itself.
That trading will be offered in more than one form. Another new option
outlined Tuesday and set to begin in July is an account that will permit
unlimited free trading -- either with a broker, online or over the phone to
an order taker -- in return for an annual account fee equaling about 0.2%
to 1% of the account's assets. Its minimum fee will be $1,500 a year. This
"core relationship account," as Merrill insiders call it, is expected to include
free research reports, financial-planning help and basic banking with free
ATM transactions.
But clients who want to continue to deal with Merrill as before, advised by
a stockbroker and paying full commissions, will still be able to do so.
Merrill's new strategy is as risky as it is daring. The most obvious danger
concerns what the change will do to revenue -- how much new business
the new accounts will generate vs. how much will be lost through
much-lower commissions. Right now, online trading, like most kinds, is
booming in America. But calculations could be thrown out of whack if the
long-running bull market ends and individual investors cut back sharply on
their trading.
More immediately, Merrill's business overhaul could spark rebellion within
its army of 14,800 well-paid brokers. An internal Merrill Lynch study, for
example, suggests that brokers who are paid chiefly in commissions might
see their incomes decline by 18% initially. To offset this loss, the company
is considering issuing Merrill stock to brokers who are hurt the most by
investor switching to the low-cost accounts.
Finally, this strategy to take on the online rivals has a key weakness: delay.
The centerpiece of $29.95 trading -- also available for phoned-in orders
-- won't be offered until December. This means that competitors, some of
whom already offer deeply discounted fees of $14.95, $9.99 and even $5
a trade, will have time to counter Merrill's moves before they are even fully
implemented. Moreover, Merrill is expected to require $20,000 to open
these low-commission accounts.
But there is no turning back for Merrill, as its executives indicated when
they used the code-name "Rubicon" for their low-cost trading plans, after
the river Julius Caesar crossed on his way to overthrow Rome's rulers.
In addressing the online challenge, Merrill faced a decision that market
leaders in business often face, although rarely with so much at stake: At
what point does one stop ignoring pesky upstarts and counterattack --
particularly if doing that means cannibalizing one's existing business?
Responding too quickly, before a new business method catches on, can
unnecessarily damage both profits and reputation. But waiting too long can
allow the upstarts to become entrenched, as Sears, Roebuck & Co.
discovered with discount retailers and as U.S. auto makers learned when
Japanese rivals won a big piece of the American car market.
Most traditional Wall Street firms regarded online trading as a curiosity or
a small niche when it first appeared in 1994. That was when a discount
broker named K. Aufhauser & Co. executed the first trade over the
Internet, with little fanfare. Aufhauser has since been absorbed by
Ameritrade Holding Corp.
Booming Business
Far from a curiosity, it has led to a securities-markets upheaval, as a new
generation of investors -- attracted both to the surging Internet and to the
much-publicized returns of this long bull market in stocks -- took to
cyberspace to buy and sell. Discount broker Schwab, quick to recognize
how the game was shifting, switched from its branch-office and
telephone-based order-taking to an emphasis on online trading. Its
bet-the-ranch strategy paid off, as increased volume more than made up
for lower commissions. Schwab's own stock soared, and last December
its total stock-market value topped venerable Merrill's, astonishing the
securities world.
With the Internet now accounting for 30% to 35% of all stock trades by
individuals, Merrill executives finally decided they couldn't afford not to
embrace such trading.
In moving aggressively, Merrill is seeking to act from a position of strength
rather than weakness. The firm is also a powerhouse in underwriting, in
mergers and acquisitions and in asset management. Analysts estimate that
less than $2 billion of Merrill's 1998 revenue of $17.5 billion came from
commissions paid by individual investors for stock and bond trades.
Moreover, Merrill's brokerage business isn't shrinking but growing, with an
increase in commissions of 7% in the first quarter. Still, that is far below the
rate of growth of Schwab and other online brokerage firms. Schwab's
commission revenue surged 59% in the first quarter.
Merrill's online plans represent its biggest initiative since 1975, when the
firm unveiled its hugely successful Cash Management Account, an
all-in-one brokerage account with banking features that was widely
copied. The online move will no doubt prove a major legacy of Mr.
Komansky. In his two years as chairman, he has overseen a rapid
international expansion in various business lines, but he came to realize that
the growth of Merrill's core brokerage business was threatened if it took
too slow an approach to the Internet.
Many Ways to Go
Merrill's multitiered strategy aims to offer something for everyone.
Customers who aren't comfortable with trading online still will be able to
have their stockbrokers handle things and give advice, although Merrill
expects that business to shrivel over time.
ML Direct -- Merrill's internal name for the account with a $29.95 base
commission for trades of up to 1,000 shares -- will compete with the
discount brokerage business, online and otherwise. Its customers will be
able to get the same commissions on phone orders by calling an
order-taker at a Merrill customer-service center. Though some rivals may
charge less, Merrill believes investors won't mind paying a bit more for its
reputation, combined with some additional services such as free research
reports.
But Merrill hopes that most customers will choose the new relationship
account, offering unlimited free trading for an annual fee based on the
assets held. (If customers do an extreme amount of trading, Merrill
reserves the right to tell them this isn't the account for them.) Some existing
fee-based accounts are to be converted to the new model. Clients will
have access to a broker and such other services as mortgage preapproval.
Executives had to cross a cultural, as well as a business, divide in deciding
to shift to offering a full array of online-trading options. Unlike
entrepreneurs at E*Trade and some other new rivals, many Merrill
executives only recently became attuned to the Internet. The 60-year-old
Mr. Komansky, for instance, finally realized that the Federal Express
packages frequently arriving at his home were from his adult children's
Internet shopping sprees, according to a Merrill insider. He was surprised
to find that his daughters could actually buy their mother flowers online.
And after Mr. Steffens, who is 57, publicly assailed Internet trading last
June, his son Drew, a Merrill stockbroker in North Carolina, called,
imploring that his father "get his act together," Merrill insiders say.
Limited Move
Now it is Mr. Steffens who is leading the charge. And he faces the
unenviable task of winning over the brokers he oversees to a plan he
himself would have opposed a year ago. (Some time after his 1998
speech, Mr. Steffens said he hadn't actually been criticizing online trading
itself, but rather its use for the rapid, in-and-out investing known as day
trading.)
For a time, it appeared that a go-slow Internet approach would prevail at
Merrill. Earlier this year, the firm introduced online trading, but only to
about 55,000 customers in two types of accounts requiring at least
$100,000 in assets; that was only about 1% of its five million brokerage
customers.
The gradual approach had isolated Mr. Steffens, according to people
familiar with the debate inside Merrill. Herbert Allison, Merrill's president,
began asserting in a series of executive meetings that the firm should
embrace the Internet more quickly. Within the Merrill power structure, Mr.
Allison, 55, is regarded as something of a house technologist, intrigued by
the Internet.
At several points, Mr. Allison and others raised the issue of whether
Merrill should create an online unit outside of Mr. Steffens's "retail"
brokerage group. The suggestion touched off an intense exchange,
according to people familiar with the discussions, who say that essentially,
some executives were questioning the commitment of Mr. Steffens and the
rest of his group to make an Internet strategy work. Mr. Steffens's
response to the idea of a separate unit: No way. The strategy, he insisted,
must be under his control. Ultimately, both he and Mr. Allison agreed that
this was the way to go.
There was evidence that the go-slow approach had been damaging the
firm. Some of Mr. Steffens's allies, such as Maddy Weinstein, who deals
with retail-brokerage technology, reported that the news from the field was
getting increasingly bad: More and more stockbrokers were complaining
that they were losing customers to online trading.
Losing Clients
Mr. Steffens began receiving e-mail messages, about 10 a day, from
concerned brokers. One afternoon in January, people at Merrill say, he
got a call from Donna Di Ianni, a veteran New Jersey broker, who said
three of her best clients had taken chunks of their money out of Merrill to
open accounts at online firms. Soon, another top-producing broker
remarked with frustration that this had just happened to him.
Mr. Steffens and his top advisers started touring the country, talking to
clients as well as leaders in the technology business. It was an eye-opener.
A client from Austin, Texas, with a 20-year relationship with the firm told
Mr. Steffens that he used a separate, online account for his frequent
trades. Among stocks he traded in that account: Merrill Lynch.
The experience humbled Mr. Steffens. He is a fierce competitor, the kind
of man who, for example, loves to ski at high speed without wearing a
helmet. But in recent months, he faced sleepless nights and began thinking
of his legacy, according to people familiar with the firm.
Tired of symbolizing Merrill's problems in the new world of online
investing, Mr. Steffens and his aides began to hash out the details of the
new strategy. One early issue: Should Merrill target Schwab and its prices;
should it go lower and compete with the deep-discount firms; or should it
possibly price its online service a little higher than Schwab's? The third
option was quickly rejected after executives concluded that any prices
higher than Schwab's would be interpreted as a halfhearted move.
'Rolling Thunder'
Slowly, Merrill began to put the pieces together. In February, top
executives decided to buy the online-trading-technology unit of D.E. Shaw
& Co. for $25 million. The move wasn't considered all that significant; at
the time, Mr. Komansky wasn't even sure he needed to mention it to the
board. But on the day of the announcement, Merrill's stock initially surged
four points.
In March, Mr. Steffens made an eight-hour presentation to Merrill's
executive committee, providing the outlines of a new Internet strategy. The
code name was "Rolling Thunder" -- coincidentally, the name the U.S.
military gave to its bombing campaign against the North Vietnamese in the
1960s.
The committee approved the proposal to make discount online trading a
core business, but for more than two months the plan remained a closely
held secret. That wasn't easy, as Mr. Komansky found when chided by
the E*Trade chairman, and as Mr. Steffens learned, too, at a recent
conference. The vice chairman managed to restrict himself to saying that
Schwab "had won round one," but the battle for online business was far
from over.
A few big accounts were given an early heads-up that something was in
the works. Mr. Steffens, for example, recently got the investor in Austin to
switch his Internet trading back to Merrill by crafting a deal similar to the
new percentage-of-assets option. But not until last Tuesday did Mr.
Steffens present the plan to Merrill's full board of directors.
Tuesday it will get lots more reaction, as more than 14,000 stockbrokers
and millions of customers learn what the future holds. |
