Online trading: The competitive landscape.
Online trading has become a formidable force in today's investment market, thanks to recent developments in information technology. Although setbacks in the technology industry discouraged individual investors from actively trading, the total number of online trading accounts continues to grow. As the NASDAQ has dropped from its all time high of 5,000 in March 2000, and the economic situation is continuing to deteriorate, many investors have withdrawn their funds from the stock market Nevertheless, the interest in online trading is expected to increase (12,17).
In April 2002, America's third-largest discount brokerage house, Ameritrade, agreed to purchase Datek Online Holdings Corporation, a privately held online trading company, in an all-stock transaction valued at almost $1.29 billion. The move would transform Ameritrade of Omaha, Nebraska, into the largest online brokerage firm in the U.S. in terms of equity trades per day, surpassing industry leaders E*Trade Group, Inc. and Charles Schwab Corporation. The proposed combination comes as the online trading industry appears to be recovering gradually from a severe recession that has prompted consolidation (3).
On the academic side, many recent studies have shown that online brokerages have moved away from offering only online trading, and are now adding many other services (i.e., banking services) in order to survive in this volatile market This study focuses on how online brokerage firms can better serve the market from the online users' standpoint.
Online trading became huge business in the late 1990s. The lure of relatively low brokerage costs for electronic share trading, together with the capacity to monitor real-time market developments from a computer screen, have contributed to the fact that internet-based trading now comprises about 20% of all retail share trading. The online trading market has become flooded with discount brokers offering low prices and better transaction costs. Some of the most notable online discount brokers are Ameritrade, E*Trade, Charles Schwab and TD Waterhouse. Full-service firms, including banks, reacted to the emergence of online discount brokers by entering the online market with their own web sites. The full-service finns want to protect their client base and gain market share in the new online market Discount firms felt a minimal impact from full-service finns entering the online trading marketplace. Many small discount brokerage companies are niche finns, against which full-service firms do not compete directly. How ever, since the bear market started in early 2000, discount brokerage finns have been more affected by competition. Several firms attribute accelerated changes in competitive approaches to the marketplace to the entry of full-service finns. These firms explain that competition in online trading has become more similar in product offerings and pricing. The only area left for online trading firms to gain a competitive advantage is through the service provided to their clients. Firms now also compete on the basis of quality service and response to clients. In a way, the entry of full-service firms has benefited client consumers by establishing a range of product and service options from which they can choose. As a collateral benefit for investors, the convergence of full-service and discount firms' offerings has highlighted niche firms that can serve a limited client base more effectively than larger competitors (5,6,8,11,16).
Some firms in the industry state that with the entry of traditional full-service brokers, investors have become more aware of their online trading options, and online trading now appears more legitimate to investors. When customers realized that Merrill Lynch, Fidelity Investments, Paine Webber and other major full-service firms had online trading web sites, it strengthened the credibility and safety of online trading, at least in investors' minds (18,9).
With the current market conditions, firms will not win by competing on price or product because most online trading sites offer virtually the same things. Firms have to stand out on service, and the way firms serve people has to stand out on multiple channels. All the companies are offering multiple modalities: Schwab is now like a Smith Barney, and Fidelity Investments competes directly with E*Trade. This research will try to determine and rank the new features and services online brokerages need to offer or improve in order to attract new customers, maintain their current client base, and further promote online trading (19).
Discount firms are reluctant to admit that they have lost accounts after the entry of full-service firms. Different explanations are offered. Online brokerage firms point out that they have not lost more accounts than they have gained since the entry of full-service firms. An important point is that online investors frequently have multiple investment accounts, usually with different firms. Even though some of these clients have slowed their trading activity during the hear market, they have not abandoned their online accounts. Some firms note that they have grown new accounts rather than lost them over the past year (14).
There are several ways discount firms are combating competition from full-service firms. Some have instituted loyalty programs, in which clients are treated as "best customers." Others compete on speed and reliability of service, and others have added new features to the trading sites. The online customer base is unique in that online customers generally have two or more brokerage firms. Most online traders have accounts with both discount firms and full-service firms -- they trade more frequently with discount brokers, but keep the majority of their assets with full-service firms. Because of the current market conditions and status, the psychology of customers right now is to utilize the full-service firms more, because they want someone who can give them advice. When the market recovers and trading volume picks up, they will probably shift back to trading with discount brokers (2).
Firms focus on different elements that set them apart. When the online trading market started, online discount firms emphasized the speed of execution and price. Now all the online firms are competing on service and features. Discount firms claim advantages in research offered to clients, goodwill in the marketplace, website features, trade routing, and flexibility stemming from deep market penetration. Another popular discounter offering is access to IPOs and options trading which are not available as extensively with other online trading firms. Other discount firms have recognized that financial advisors are a competitive advantage, and they are offering access to financial advisors around the clock. Firms like these are no longer online brokerage firms, but are making the transition into full service capability (11).
Advantages of Discount Firms. Discount firms claim six major advantages over full-service firms. First, discount firms simply offer better pricing. The current problem is that pricing is no longer a competitive advantage against other discount brokers. Second, their services are accessible at any time. Third, online brokerage firms offer better and more easily accessible market information. Fourth, online brokerage firms are more flexible to technological developments. Fifth, they enjoy lower overhead. And, sixth, they are better attuned to the broad online trading marketplace and do not spend extensively (instead they attempt to develop accounts from target investor profiles). The greatest advantage that discount firms have to offer over full-service firms is focus. The full-service firms are trying to take their top customers and go after their power assets. Full-service firms don't know how to reach out to investors with fewer assets, who are already malting their own trades (8).
Advantages of Full-Service Firms. What advantages do full-service firms have over discount firms on the online market? Most commonly, the advantage of full-service firms lies in advice. This includes both the benefit of advice to the customer and the retention value of personal contact and service. Online brokerage firms generally agree that these are full-service strengths. For this reason, discount firms want to add financial advisors to their service offering. Full-service firms also have advantages in name recognition and research resources. An important fact about online traders is that many are often uneducated about investment markets; they may not be well served by online brokers, and would get better information and advice from full-service firms. The full-service firms have been in the advice business for a longtime. They have a big book of business, and know their customers well. Most firms attribute their greatest advantage to their advisors, who offer personal contact, as well as sound advice, ba cked by extensive investment experience. They believe that their advisors are even more essential during a bear market. Some firms also cite the depth of full-service firms' research, multiple access methods for clients and financial and personnel resources that support long-term competitive efforts. The lines between full-service and discount firms are becoming blurred, as many discount brokers are beginning to offer advice (1).
Full-service firms form alliances, including partnerships with and investments in vendor companies, primarily for peripheral services and discrete software applications. Firms are allying with specialized companies most commonly for account aggregation services, software such as financial calculators and check tracking applications and wireless access. Firms are not currently forming alliances to broaden their client bases or add products; these activities remain in-house for most major full-service firms. Most full-service firms have implemented online services to add value and retain current clients. Several firms expect this to remain their justification for online activity. Some full-service firms, like Merrill Lynch, claim that their online services have already become revenue generators in their own right Other full-service firms anticipate that their online services will become profitable in the near future.
Both full service and discount firms are concentrating more on breadth of service and quality customer service than other service-improvement attributes. Full-service firms have emphasized their breadth of service more strongly. Quality of customer service has become a more important attribute over the past year for both categories of firms.
Pricing is not a major variable. There have been several changes in pricing of trades for both full-service firms and online brokerage firms. Pricing changes among full-service firms have followed service developments, moving from commission charges to payments for value-added services. Among online brokerage firms, service features also created opportunities to change pricing. Some online brokerage firms have changed pricing to reflect segmentation of customer account types by services requested or by account value. Online brokerage firms have attempted to identify what services and account options their investor clients want, and allowed pricing to adapt This is a continuation of the 1999 trend toward service-based pricing among online brokerage firms, as well as consolidation of the same service-oriented trend among full-service firms. But some online brokerage firms have lowered their prices to respond to simple price competition, and to attract new accounts to better transaction pricing. As mentioned before, pricing is not a major variable in determining a competitive advantage between online trading firms. For this reason, this variable will not be included in this research study.
Key Growth Areas Since 2000. Both full service and discount firms have grown most over the past year in basic online brokerage business. This is consistent for full-service firms' growth since 1999, when online brokerage was the single largest growth area. But banking, the largest growth area for online brokerage firms in 1999 and the second largest for full-service firms, was not a growth area for firms in either category in 2000. Instead, some full-service firms have expanded their securities offerings and begun to add mutual funds and insurance to complement existing product lines. Online brokerage firms have seen growth in bringing their services to new international markets, such as Canada, England and Australia. Online brokerage firms have also noted growth resulting from wireless access and from value-added services, including research and cash management. These are variables that will be used in this study.
Increasing Competition Leads to New Marketing Strategies
As competition grows tougher in the online trading market, firms react with different marketing strategies. Three strategies characterize full-service firms' marketing over the past year. Some firms remain dedicated primarily to attracting new clients. These firms use their value-added services, especially advice, to carry their marketing initiatives forward. Other firms concentrate mainly on client retention. Still others focus on emphasizing the benefits of their own services to their current clients. Some firms target their brand awareness for improvement, and are intent on increasing awareness of the full range of online services that they offer (13).
There are also major marketing strategies among online brokerage firms. Some of these firms claim that their marketing focus has not changed since the beginning, and that they are primarily interested in attracting more trading volume through new accounts. Other online brokerage firms, such as E*Trade and Datek, focus on brand awareness. And some online brokerage firms are concentrating on advertising service value through better customer service and value-added services like financial advising. These are also variables that this research will explore (4,13,15).
High percentages of both full-service and discount firms report value-added services such as investment research, both free and paid. However, a distinction still remains between these two categories. Full-service firms are much more likely to offer access to financial advisers and many other services, such as banking, mortgages and loans. These differences will become less pronounced as each category implements services currently dominated by the other category. Once a particular feature or service converts into competitive advantage, competitors will react and start offering that feature or service. The study intends to identify which specific features traders are demanding the most from online trading firms. With a better understanding of these customer needs, online trading firms can gain new competitive advantages (4).
This study surveyed the opinions of a group of online traders. A questionnaire was designed to investigate the features that were most important for the traders. Based on the literature review, the following variables were selected.
Variable Selection. Fifteen research variables were identified from the review of literature. They represent new value-added features and services online trading firms are experimenting with, and customers are demanding. The respondents were asked to evaluate the relative importance of each variable. A five point Likert scale was applied, with 5 representing the most important, and 1 representing the least important Responses represent key strategies that the brokerage firms need to attract new customers, and to retain the existing ones, particularly in a bear market, where the trading volume has dropped substantially. A better understanding of these variables will enable brokerage firms to gain market share and establish a competitive advantage. Included variables are presented below:
1. Cheaper trading fees
2. Availability of free research
3. Availability of advice
4. Speed of trade execution
5. Website is easy to use
6. It is easy to open an account and access it
7. Reputation of brokerage firms
8. Trading security
9. Product variety (financial planning, options, loans, margins, mortgages, etc.)
10. Capable of using wireless devices
11. Real time quotes
12. Offer off-hour trading
13. Customer service and tech support
14. Access to IPO
15. Reliability of online trading
Sampling. The targeted sample respondents were the attendees of business seminars the authors conducted in early 2002. The survey questionnaires were distributed to them to obtain their opinions.
Findings. Three hundred and ten questionnaires were distributed, and 149 of them were returned. Of these, 139 questionnaires were usable. This represents roughly a 44% response rate.
Ninety-six percent of the respondents fall into the age category of 21 to 35. Respondents' investment amounts ranged from $1,000 to $1.3 million.
Exhibit 1 presents gender and income levels. Forty-two percent of the respondents trade online, while 58% trade offline. It is notable that the average trade dropped substantially as compared to the trades two years ago. Not surprisingly, 86% of the respondents believe online trading will replace offline trading in 10 years.
Research variables are ranked according to the means of their relative importance in Exhibit 2.
The respondents ranked trading fees and security the two most important variables for their brokerage firm selection. The following top-ranked variables are customer service and tech support and product variety (options, loans, margins, mortgages, etc.). Apparently, the respondents want more services from the brokerage firms. Contrary to previous studies, the execution time and real-time quotes of the trade were not ranked high, because most of the brokerage firms have already eliminated the restriction of obtaining real time quotes for their customers.
The sample size for this study is relatively small, but the results seem to be on track with current market conditions. The generalization of these results should be cautious, as the variables studied can only represent the opinions from the respondents.
However, this study does provide some useful insights about the needs of traders. Despite the market downturn and sluggish trading volumes, customers of brokerage firms still have needs and preferences that the firms should remain aware of. The relative importance of the variables studied can provide brokerage firms with new strategies that focus on customer services. Brokerage firms should also concentrate on enhancing security features, and moving away from a trading-only approach. Many of the online brokerage firms have already offered packages of services that were traditionally defined as banking services, such as mortgages and loans. In the next few years, more online brokerage firms may move into the banking industry -- where they should be able to generate more profits. Financial advice and research are also in demand according to the survey respondents. Brokerage firms should plan to offer expanded research services, including portfolio modeling and research alerts, as well as increased access to fin ancial advisors.
EXHIBIT 1 BACKGROUND OF THE RESPONDENTS Variables: % Male 63 Female 37 Income level: <$50,000 29 $50,000-75,000 54 $75,000-100,000 15 >$100,000 2 Trading on line? % Yes 42 No 58 # of trades per month 7.03 two years ago # trades per month at the present 1.33 Believe that online trading will replace offline trading in 10 years: % Yes 86 No 14 EXHIBIT 2 RANKING OF VARIABLES BY MEANS Variables Mean Cheaper trading fees 4.74 Trading security 4.61 Customer service and tech support 4.42 Product variety (financial planning, options, loans, margins, mortgages, etc.) 4.27 Availability of advice 4.22 Availability of free research 4.17 Capable of using wireless devices 4.16 Offer off hour trading 4.04 Access to IPO 3.66 Speed of trade execution 3.47 Real time quotes 3.12 Reputation of brokerage firms 2.83 Website is easy to use 2.56 Reliability of online trading 2.17 It is easy to open account and 1.99 access it
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|Author:||Chao, Chiang-Nan; Mockler, Robert J.; Dologite, Dorothy|
|Publication:||Review of Business|
|Date:||Sep 22, 2002|
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