CASE STUDY E*TRADE SECURITIES, INC.

This case was prepared by Chuck j

Glew, Mark Lotke, Mario Palumbo,
and Marc Schwartz, under the
supervision of Rajiv Lal, Professor
of Marketing and Management
Science, Stanford University
Graduate School of Business, as a
basis for class discussion rather
than to illustrate either effective or
ineffective handling of an
administrative situation.
INTRODUCTION
Reprinted with permission of
Stanford University, Graduate
E*Trade pioneered the electronic deep-discount brokerage busi-
School of Business, Copyright ness in the late 1980s and has experienced phenomenal growth
q 1996 by the Board of Trustees since 1992. Electronic brokerage firms make extensive use of
of the Leland Stanford Junior technology in most customer interactions and, as a result, can
University. achieve significant cost advantages over traditional brokerage
firms. E*Trade’s strategy until now has been to continually pass
these cost savings from automation on to its customers as they
amortized their fixed costs over a greater number of accounts.
The company charges a fixed commission rate on trade execu-
tions up to 5,000 shares ($14.95 NYSE, $19.95 NASDAQ), a 75%
savings compared to the traditional discount brokers. As of the
spring of 1996, E*Trade is at a critical juncture in its development
and faces many challenges. A flood of new competitors are estab-
lishing internet sites and for the first time in its history, E*Trade
has been dethroned as the price leader. In April 1996, a new
entrant, eBroker, has introduced ‘‘no frills’’ trading through the
Internet at a flat $12 per trade. In addition, Charles Schwab,
the leading discount brokerage firm, is preparing itself for entry
directly into E*Trade’s domain. E*Trade is being forced to reex-
amine its business model and choose a strategy with which to

Published by John Wiley & Sons, Inc.

CCC 1094-9968/98/010072-12
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 E* TRADE SECURITIES, INC.

address the changing environment. While some General Atlantic Partners, a New York-based
executives within E*Trade believe they should private investment firm focused on investing in
continue to lower price and go head-to-head high-growth information technology compa-
with eBroker, others believe the company faces nies, made a significant minority equity invest-
a larger challenge from Charles Schwab’s entry ment in E*Trade. These funds are being used
into the market. Defending against Schwab to accelerate E*Trade’s transition to self-clear-
would require focusing resources on enhancing ing (presently provided by Herzog, Heine,
its product/service offering, which might jeop- and Geduld), bolster E*Trade’s customer sup-
ardize E*Trade’s low-cost position. port infrastructure (systems, personnel), and
launch an aggressive marketing campaign (print,
TV, radio). In May 1996 the company filed with
THE COMPANY the SEC for an initial public offering scheduled
for that summer.
History
Trade*Plus, the parent company of E*Trade, Product
was founded in 1982 as a PC financial manage-
E*Trade provides its 50,000 customers with trade
ment service bureau by Bill Porter. In 1992, the
execution on stocks and options, and by year end,
visionary Porter launched E*Trade Securities, a
is likely to offer mutual funds. In addition to trade
pioneering on-line brokerage services provider
execution, the company provides stock quotes
based in Palo Alto, California. Initially, E*Trade
(real-time or delayed), news services, consolidated
generated most of its revenues by providing
monthly statements, and limited portfolio analyt-
back-office on-line processing services to dis-
ics. Customers can access E*Trade through vari-
count brokerage firms (Fidelity, Schwab, and
ous low-cost channels including touch-tone tele-
Quick & Reilly). Although E*Trade continues to
phone (TeleMasters), on-line service providers
service Quick & Reilly, the company has moved
(CompuServe, America Online, BOA HomeBank-
away from a ‘‘private label’’ strategy to aggres-
ing), direct modem link, and most recently, the
sively pursue a direct-to-consumer business
Internet. E*Trade launched its Internet home
model. In 1995, over 80% of revenues were de-
page in January 1996 and as of May 1996 over
rived from trading commissions by E*Trade cus-
35% of all trading is done over the Internet.
tomers. Additional revenues are generated from
interest on customer cash balances and margin
accounts, connect-time revenue sharing with Pricing
on-line service providers, and third-party pro- E*Trade’s brokerage services appeal to active,
cessing services. As a result of the shift from independent investors who routinely make their
full-service to discount brokerage, increased PC own investment decisions and do not want to
penetration in the home, and the explosion of pay full-service commissions. E*Trade offers this
the Internet, the company has experienced dra- growing customer segment a compelling value
matic revenue growth ($2 million in 1993, $10 proposition: a flat $14.95 commission rate on
million in 1994, $22 million in 1995, and bud- all NYSE trades up to 5,000 shares and $19.95
geting in excess of $50 million for 1996). for all OTC trades. As seen in the Table 1,
The company’s stated internal strategy is to E*Trade’s commissions are typically 50% to
become America’s dominant deep-discount brokerage 75% less expensive than traditional discount
firm by fully automating the front and back-office brokerage firms such as Schwab or Fidelity, par-
trade processing function and maintaining its posi- ticularly for larger trades.
tion as the low-cost provider. The company has By leveraging information technology and
made significant information technology in- passing savings on to consumers, E*Trade has
vestments in automating order entry, customer steadily lowered its commission rates from
support, trade execution, and post-trade clear- $24.95 to $14.95 over the past two years. The
ing and confirmation. In September 1995, company consistently offered the industry’s low-

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TABLE 1
Comparison of Commissions

100 Shares @ $40 5,000 Shares @ $20

Fixed Variable Fixed Variable

Component Component Component Component

E*Trade Listed $14.95 — $14.95 —

E*Trade OTC $19.95 — $19.95 —
Lombard Listed $34 — — $100
Lombard OTC $34 — — $75
e.Schwab $39 — $39 $120
PCFN $60 — $100 $100
NDB Listed* $33 — $33 —
NDB OTC* $28 — $28 —
Ceres $18 — $18 —
Schwab/Fidelity $56 $26.40 $155 $110

* Includes $3 postage fee per order.

est commissions until April 1996 when a new vidual Investor, Smart Money, Forbes) campaign.
entrant, eBroker, began offering $12 trade exe- These ads focused on E*Trade’s low commis-
cution under a ‘‘no frills/no service’’ market sion rates (with accompanying comparison ta-
positioning. bles) and featured bold tag lines such as:

Advertising-Marketing E*Trade is leading the electronic trading rev-

Advertising plays a significant role in the broker- olution.
age business not only because it creates brand In fact, we started it.
awareness, but also because it is the first step in How else could we charge just $14.95 per
the customer acquisition process. Brand aware- trade?
ness is critical in the nascent electronic broker- Your broker is obsolete . . .
age business because most of the competing (above a picture of a young boy sitting next
firms are new to the business and because many to his computer sticking his tongue out at
customers have an aversion to depositing their a tired, paper-inundated broker).
money with a firm they have never heard of.
These issues are especially important on the In- In February 1996, E*Trade altered its adver-
ternet, which has the perception of being unse- tising campaign to emphasize product/service
cured. In addition to creating brand awareness, enhancements. The new ad states ‘‘E*Trade
most advertising in this industry also compares saves you up to 78% on brokerage commissions
the advertising firm’s product-service offering (bells and whistles included)’’ and lists 24-hour
to competitors. access, free quotes, on-line portfolio manage-
In January 1996, E*Trade aggressively in- ment, free checking, and margin and IRA ac-
creased its advertising budget to raise awareness, counts.
generate new account inquiries, and unveil its These successful campaigns have positioned
new Internet site. The company placed weekly E*Trade as the electronic brokerage leader in
full-page ads in the Wall Street Journal, comple- the eyes of investors and generated significant
menting its continued television (CNBC busi- new account inquiries. Unfortunately, the com-
ness channel), local radio, and magazines (Indi- pany was not adequately prepared for the re-

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 E* TRADE SECURITIES, INC.

sponse as wait times for customer service surged. brokerage houses is their participation in all as-
This upset both current customers who had pects of the investment process, from initial de-
questions concerning their trades as well as new cision through execution and follow-up. These
customers who were less than impressed with services may include the following: suggesting
their first interaction with the company. In addi- investment opportunities, providing research
tion, competitors have begun to locate and pub- reports, executing the trade, offering customer-
licize holes in the E*Trade service offering. For service support, and issuing monthly reporting
instance, Lombard, an electronic brokerage statements. Brokers tend to be proactive, mak-
competitor, includes a column in its advertise- ing suggestions to their clients and trying to in-
ment comparing the minimum check amount fluence their investment choices, as well as in-
that can be written from the account. Lombard creasing their investment and trading activity.
has no minimum while E*Trade will only honor The brokerage could be a stand-alone institu-
checks written on the account in excess of $500. tion or a separate department or trust division
As E*Trade and its competitors continue to of a larger entity. Typically, these services are
advertise nationally in an attempt to build brand used by households with more than $100,000 in
awareness, customer acquisition costs are rising. assets. Brokers are paid a significant percentage
In addition to the advertising component, cus- of their compensation through commissions
tomer acquisition is generally a several-step pro- (typically $150 to $300 per trade), thus they are
cess consisting of an initial inquiry, often by em- rewarded for spurring this activity, and poten-
ail or telephone, and often a follow-up conversa- tially are able to collect additional fees de-
tion, either to answer specific questions or to pending on the extent of their financial-plan-
check on the status of the application. These ning advice. The broker-client relationship is
customer service-intensive interactions are quite often a long-standing one-on-one relationship
costly for E*Trade. With low margins per trade, in which word-of-mouth referral plays a large
E*Trade’s new customers must trade frequently role in new-client development.
to recoup total customer acquisition costs. Full-service brokers tend to offer their own
line of products, and when they go outside of
their family of products, they will usually only
THE MARKET sell ‘‘load’’ funds which generate additional
commissions. Products offered include retire-
Segmentation ment accounts, credit products, insurance, and
The market for trading and brokerage services portfolio planning. Full-service brokers provide
is divided between three primary segments: full- newsletters and industry-specific and company-
service brokers, discount brokers, and deep-dis- specific research reports written by a team of in-
count brokers. The increasing presence and use house analysts. Full-service brokers sometimes
of technology as the primary vehicle of trade provide access to initial public offerings (IPOs)
execution has led to the creation of a fourth of stock and secondary offerings that are being
segment, the electronic deep-discount broker. underwritten by the investment banking arm of
This distinction is not entirely clean as a number the firms. Examples of full-service brokers are
of firms including large discount brokers like Merrill Lynch and Smith Barney Shearson.
Schwab and Fidelity have introduced on-line of-
ferings alongside and in conjunction with their Discount Brokers. Discount brokers, such as
traditional products and services. Charles Schwab and Fidelity Investments, offer
limited services for investors who do not need
Full-Service Brokers. A full-service brokerage specialized product offerings and who do their
provides a broad range of services, from helping own research. These institutions make their rev-
to develop an investment strategy through per- enues primarily on the number of trades they
formance measurement of the executed strat- execute and on margin account charges. The
egy. The important distinction of this class of financial profile of a discount brokerage client

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is broader, ranging from minimal assets to about ment was conducted through the telephone or
$250,000 in assets on average. Clients typically in PC-based on-line environments such as
tend to be more active traders who do not re- America Online (AOL) or CompuServe. Much
quire specialized and personalized service and of the current trading volume and expected
are willing to make this trade-off for lower com- growth, however, is coming through the in-
missions (typically $80 to $100 per trade). Cus- ternet. Current commission levels range from E-
tomers in this segment make their own trading Broker’s $12 and E-Trade’s $14.99/$19.99 per-
decisions without the support and advice of the trade offering to the $40 range with very mini-
broker. mal customer-service levels. This might result in
Recently, discount brokers have become a limited number of quotes, shorter hours of
closer in service to full-service institutions, with operation, longer waits for making contact, po-
the exception of the personalized service and tentially less advantageous trade execution, less
investment advice. They have been moving detailed account correspondence, restrictions
more and more to differentiating themselves on margin account trading, and fewer product
through increased service offerings to the point offerings (mutual funds, bonds, 401(k) ac-
where 800 telephone numbers, monthly ac- counts). Many deep-discount brokers conduct a
count summaries, quotes, and general invest- large percentage of their business through
ment advice are the norm and not points of means that minimize the labor component, in-
differentiation. However, information tends to cluding electronic on-line services or through
be general in nature and is not geared toward automated telephone lines. Examples of elec-
specific investments, industries, or portfolios. In tronic deep-discount brokers are Lombard, Na-
fact, even when asked directly, representatives tional Discount Brokers, and e.Schwab.
will not lend their advice with respect to specific
trades. Examples of discount brokers are Value Chain
Charles Schwab and Fidelity. The value chain for investment services from
the customer’s perspective includes the follow-
ing activities: investment strategy, investment
Deep-Discount Brokers. Deep-discount bro-
decisions, trade execution, portfolio servicing,
kers take the discount concept one step further
and performance measurement. As one would
and provide even fewer service offerings and
expect, the different brokerage firm types span
less flexibility in trading, but for a measurably
various sections of this chain. The full-service
lower price (typically $40 to $60 per trade). His-
broker participates in investment decisions and
torically, price has been the primary means of
is more likely to offer a higher level of service
differentiation in this segment, but there is
at other points in the process, as well as more
some indication that the minimum threshold
detailed statements. Discount brokers, on the
level of service has been increasing lately. Origi-
other hand, operate in a more focused area of
nal deep-discount outlets were cheap alterna-
the chain, primarily providing trade execution
tives set up in the midwest, where low-cost labor
with limited support, customer service, and per-
allowed even further price declines. Examples
formance measurement.
of deep-discount brokers are Quick & Reilly,
The value chain as it relates to the brokerage
Waterhouse, and Olde.
firms includes the following areas: marketing,
research provision, investment advice, trade in-
Electronic Deep-Discount Brokers. Electronic put, trade execution, and account servicing (see
deep-discount firms include companies that Exhibit 1). There are two ways in which these
were founded as electronic-only trading outfits activities differ by firm category. First, it is possi-
(PC Financial Network, E*Trade), as well as dis- ble that one aspect of the value chain is missing
count and deep-discount brokerage firms that entirely for a particular type of firm. As men-
offered a portion of their services through the tioned earlier, this is the case with investment
electronic medium. Initially, trading in this seg- advice as it relates to the discount brokerage

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 E* TRADE SECURITIES, INC.

firm—it simply does not exist. The other point ing an alternative to customers who did not re-
of differentiation is the degree to which the par- quire the level of service offered by a full-service
ticular part of the chain is emphasized. For in- brokerage house, and hence, did not want to
stance, full-brokerage firms are likely to spend pay for services that were not being utilized.
more absolute dollars on account servicing than Discount brokers could employ less labor (and
deep-discount brokers, although this relation- less skilled labor) because a variety of services
ship may not hold as a percentage of the trading and hand holding was not required of them.
commission. Although a number of players entered the mar-
ket with this strategy, it was Charles Schwab that
Market Size gave wide-scale credibility to the approach and
Brokerage firms generate their revenue from institutionalized the discount broker concept.
commissions, margin accounts, and auxiliary At a time when firms were offering low prices
services. A significant portion is generated from but skimping on service, Schwab’s strategy and
commissions, and in 1991 total industry com- eventual scale allowed it to ‘‘gentrify’’ the mar-
missions were estimated to be in the neighbor- ket by providing a truly professional approach
hood of $12 billion. Although this figure is not to what at one time was a ‘‘bucket shop’’ mental-
expected to change significantly through 1998 ity. Its approach was to remain neutral in the
(slight increase in volume, slight decrease in investment decision and simply execute trades.
average commission), the distribution between Over time it sought to decrease its dependency
segments is projected to change. Full-service on trading volume by offering more products
brokers’ commissions are estimated to decline and services to enable it to generate charges for
from $10 billion in 1991 to $8 billion in 1998, ‘‘assets under management.’’
while discount brokers’ share is expected to in- The increasing use of technology is rapidly
crease from $2 billion to roughly $4 billion over
transforming the security brokerage business,
the same time period. On-line discount commis-
which was once a sleepy, relationship-based, pri-
sions are expected to comprise almost 10% or
marily local industry. Technology has helped to
$400 million of the discount brokers share by
increase economies of scale and to permit ratio-
1998.
nalization in the industry. Increasingly, dis-
From 1994 to 1998 the number of trades con-
counters such as Fidelity and Charles Schwab
ducted is estimated to increase from 100 million
have leveraged technology to substantially re-
to 144 million. Full-service brokers will see their
trading volume hover around the 65 million duce the cost of executing a trade and per-
mark over this period, while discount brokers forming account-related servicing. A major com-
volume will increase from 30 million to 65 mil- ponent of this cost-reduction strategy has been
lion, and on-line services will account from 13 the severing of the personal relationship be-
million trades in 1998 up from 5 million in 1994. tween a particular broker and a particular cli-
According to Forrester Research, growth in on- ent. Customers of these two discounters use na-
line brokerage accounts is anticipated to in- tional toll-free numbers as their primary inter-
crease at 30%, from 550,000 in 1995 to 1.3 mil- face with the firm. They speak to a different
lion in 1998. The two largest players, Schwab representative each call. This aggregation of
and PCFN, account for about 60% of the market customer inquiries helps to reduce total variabil-
(or 150,000 accounts each) with Fidelity con- ity in demand patterns, allowing far fewer cus-
trolling 13% and E*Trade with 6%. The re- tomer-service representatives and brokers to be
maining 20% of the market is divided up among employed. However, through sophisticated uses
a number of the smaller players. of technology, these firms are able to maintain
high customer-service levels because each repre-
Market Evolution sentative has access to the customer’s entire ac-
The market has evolved in a fairly straightfor- count history. In addition, significant econo-
ward manner, with the discount brokers provid- mies are realized by aggregating the functions

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dealing with the collection and manipulation of

TABLE 2
account data.
Revenues by Cost Type*
Although Schwab and Fidelity served a spe-
cific market need, its relatively high level of cus- Schwab E*Trade
tomer service created the potential for another
layer of firms beneath it. Because the discount- Compensation per Trade $39.61 $8.22
ers’ increasing scale enabled them to substan- Communications/DP per Trade $8.57 $2.83
tially enhance customer service without increas- Occupancy & Equipment per
ing price, the remaining firms were left with Trade $7.40 $1.52
price competition as the only viable strategic Marketing & Selling per Trade $3.53 $4.10
alternative. As they began to compete on price, Operating Income per Trade $11.46 $6.63
they created a third-tier price umbrella. This
third tier was initially satisfied by deep-discount Average Number of Trades per
brokers and is increasingly served by electronic Account 4.41 18.18
deep-discount brokerage firms. Operating Income per Account $50.60 $120.00
E*Trade, and the new breed of electronic * Estimates from Industry Experts and Company Records.
brokerage firms, have been able to dramatically
reduce costs beyond the discounters by lev-
eraging technology not only in the back office traders. Second, E*Trade has a substantially
but also in the customer interface. To reduce lower cost structure, primarily because of lower
compensation costs and greater use of technol-
costs, E*Trade’s relies upon pure electronic or-
der intake, which results in lower compensation ogy. Because a lower level of support is pro-
costs per trade. However, to make the model vided, E*Trade needs far fewer employees per
work, E*Trade must also attract high-volume trade, increasing productivity. Finally, E*Trade
traders who can generate high profits per ac- is much more profitable on average, with twice
count, even with low per-trade margins. the profitability per account of Schwab.

Cost Structure
The importance of leveraging technology to re- CUSTOMERS
duce costs cannot be overstated. The primary
benefit comes in the form of labor cost savings. Segmentation
The average spent on employee compensation Customers can be segmented based on a num-
per trade executed is $40 for Schwab, and $8 ber of different characteristics, each of which
for E*Trade. These dramatic cost reductions, affects how a particular company should address
in conjunction with a much lower commission the market. The following are potential criteria
schedule, produce an average operating income with which to analyze the customer pool: fre-
per trade of only $6.63 for E*Trade versus quency of trading, size of trades, wealth, tech-
$11.46 for Schwab. However, in terms of op- nology usage, time/knowledge constraints and
erating income per account, E*Trade’s more information/service needs (hand holding).
frequent traders generate an average income of An investor can be judged more or less likely
$120, versus only $50 for Schwab’s (Table 2). to utilize the services of a particular type of firm
E*Trade has much lower commissions and costs based on the degree to which he or she fits
that are counterbalanced by the frequency with these criteria. One would suspect the full-service
which its customer base executes trades. broker client to have low to moderate frequency
In summary, there are major differences be- of trades, a higher-than-average size of trade,
tween the economic models employed by the significant wealth, less comfort with technology,
various brokerage firm segments. First, E*Trade and less available time or business knowledge.
has much lower commissions that tend to attract These investors are not impacted by the higher
more frequent (and, hence, more profitable) cost of the trade because they value the addi-

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tional service they are receiving and because the work, E*Trade has no control over its speed.
commission will comprise a lower percentage Often the Internet is quite slow, or demand
of the actual dollars traded. Additionally, their peaks in such a way that customers get locked
greater wealth is likely to make it difficult for out of E*Trade’s web site. This can create an
them to rely on themselves to ‘‘put their money enormous amount of frustration for investors,
to work.’’ especially if they are intra-day traders. Finally,
At the other end of the spectrum, one would the least tangible of these factors is the percep-
expect the electronic deep-discount broker cli- tion that electronic deep-discount brokerages
ent to have a higher frequency of trades, a mod- provide less advantageous trade execution for
erate average size of trade, moderate wealth, customers. Discounters such as Schwab and Fi-
comfort with technology, and more time and delity have been emphasizing their better trade
business knowledge. Although at the outset execution through superior position, volume,
these are likely to be the pools they will attract, and more personal approach. There is no em-
the challenge for each of the market segments pirical data to support the claims by the dis-
is how to attract those customers who fit several count brokers; however, in focus groups and in
of the categories but not all of them. For in- Internet chat areas, customers have mentioned
stance, how can a firm like E*Trade appeal to trade execution as a concern.
a customer who, based on his/her trading size
E*Trade’s Customers
and volume, will benefit from E*Trade’s service
offering, but may not have much comfort with E*Trade customers are active, independent,
technology? empowered investors who are comfortable in
The issue of customer segmentation is espe- the on-line services world. They are attracted to
E*Trade’s low commission rate for two primary
cially important for the trends associated with
reasons: these investors make their own invest-
the increasing penetration of electronic trading.
ment decisions and resent paying high broker-
As more firms vie to gain share as well as capture
age fees, and they trade frequently (five to six
new growth, it will be important for firms to
executions per month) so that the commission
identify which customer-segments are most valu-
savings quickly become significant. E*Trade’s
able to them and then develop a strategy to
high-volume customers trade in excess of 10
ensure that they will gain a disproportionate
times a month and hold 75% of their disposable
share of their business.
investment assets in individual equities and 25%
There are certain obstacles to Internet trad- in mutual funds, whereas E*Trade’s lower-vol-
ing that will permanently discourage a large set ume customers trade 3 to 4 times a month (still
of potential customers (those who might other- above average for the industry) and hold 25%
wise be inclined to select E*Trade’s price/ser- of their assets in individual equities and 75% in
vice offering). First, there are concerns about longer-term-oriented mutual funds.
the security of the Internet. More technically- E*Trade’s demographic analysis shows their
savvy customers know that it is much easier for typical customer household to have dual annual
a thief to steal a carbon copy of a credit-card incomes above $75,000, professional/technical
receipt than it is to intercept and decode an occupation(s), graduate school education(s),
encrypted message on the Internet. However, children, a single-family home worth in excess
the popular press has made much of the poten- of $200,000, and over-represented interests in-
tial for hackers to intercept credit-card num- cluding stocks/bonds, PCs, investing, science/
bers, and by logical extension, brokerage ac- technology, and real estate investments. Over
count information, on the Internet. The elec- 75% of E*Trade’s customers have been discount
tronic brokerage firms must continually fight and deep-discount brokerage customers, and
this misperception, which will likely be fueled the majority of them still maintain accounts at
by mass publicity, should a break-in ever occur. their other brokerage firm (primarily with
Second, because the Internet is a shared net- Schwab and Fidelity). Customers have several

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reasons for maintaining multiple accounts, in- switching costs in this business, barriers can ac-
cluding easy access to mutual fund investing, tually be quite high, and E*Trade is working
existing 401(k) plans established by their em- hard to increase them. First, reputation is criti-
ployers, and prior relationships (applies to full- cal in this business. Because most investors are
service brokers only). Many customers establish quite careful with their money, they are no more
an E*Trade account on a trial basis with the likely to place their account in a fly-by-night bro-
intent of gradually transferring their higher kerage firm than they are to buy a risky penny
turnover stocks into the account over time. stock. A brokerage firm must carefully cultivate
E*Trade’s customer base has roughly dou- its reputation. Established firms have a major
bled each year over the past four years. The advantage in the process of attracting new cus-
company expects future growth in new accounts tomers. Second, many of the electronic deep-
to come from active investors who are becoming discount firms, including E*Trade, are trying
increasingly comfortable with technology, and to follow the discounters’ lead of building an
to a lesser degree, younger technology enthusi- investment ‘‘home’’ for its customers. The more
asts who begin to fit the demographic profile hooks a firm gets into a customer’s wallet, the
of an individual investor. Because the annual more likely he is to stay. Fidelity and Schwab
commission savings increase with trading activ- provide a wide enough range of services to serve
ity, it is no surprise that E*Trade’s core, early- as a customer’s only financial-services vendor.
adopter customers were high-volume traders. Many customers are reluctant to leave Fidelity
Over time, E*Trade has established a brand im- or Schwab because the firms provide everything
age as the leader in the electronic trading seg- from checking to tax planning. Also, the consol-
ment, and once customers make the decision idation of financial information on a single
to switch, E*Trade appears to be one of the statement is very important to most customers.
most respectable, reliable options. This has They value the simplicity of receiving all finan-
helped them attract medium to low volume cus- cial information from one company. Third,
switching assets in and out of a brokerage firm
tomers who might not benefit as greatly as the
can be quite difficult. Some firms charge fees
high-volume traders. It is the company’s belief
or otherwise try to prevent transfers out. In
that as more services become available and cus-
many cases, however, the actual barriers are
tomer service improves, price will become less
much smaller than either the psychological or
of a reason for switching. Customers have, for
perceived barriers. Third, because there are sig-
the most part, been satisfied with their E*Trade
nificant differences between the customer bases
experience. Recently, however, the flurry of new
of the firms, there are some services that are
accounts generated by the national advertising easy for one firm to provide but difficult for
campaign has created some severe customer-ser- others to duplicate. For instance, most of
vice problems, including excessive telephone E*Trade’s customer base is on-line, allowing for
wait times (often greater than 20 minutes per fast and customized electronic communication.
call), difficulty logging onto the web site, and For Schwab or Fidelity to communicate with
sign-up delays. Customers typically keep their their customers in the same way requires sig-
old account (usually with Fidelity or Schwab) nificant manpower in the customer-service cen-
open, and any major problem is likely to cause ters. Finally, because tracking customer activity
them to return to their old brokerage firm. In is relatively easy in this business, there is also
this sense, the electronic discount brokerage the possibility of creating loyalty-incentive pro-
firms, as a group, get only one shot every few grams, modeled on the airlines’ frequent-flier
years at each of the discount brokerage custom- programs. Such programs might reward fre-
ers. A single service gaffe can drive that cus- quent traders with enhanced customer service,
tomer away from the electronic brokerage sec- free investment products (such as free invest-
tor for years. ment research reports or a subscription to the
Although it may seem that there are few Wall Street Journal) or free real-time quotes.

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Potential Future E*Trade Customers With the explosion of the World Wide Web
Because many high-volume traders have already (Web), the graphical portion of the Internet,
joined an electronic deep-discount brokerage and easy-to-navigate web browsers, barriers to
firm and because of national, mainstream adver- access were virtually eliminated. Brokerage
tising, the next wave of customers who join firms were no longer required to establish rela-
E*Trade are likely to have a profile very differ- tionships with on-line service providers, as they
ent from current customers. First of all, they are could reach customers directly over the In-
more likely to be lower-volume traders, who do ternet. The deep-discount brokers embraced
not receive as large a cost savings from trading this paradigm shift more rapidly than the dis-
electronically. Therefore, they are probably less count brokers, who were hesitant to cannibalize
price sensitive. In addition, because of the pro- sales from their installed base. Drawn by the
liferation of firms offering fixed commissions opportunity to regain their price-leadership po-
between $12 and $34, having the lowest commis- sition and lower their cost structure, deep-dis-
sions might not be as important as it used to be count brokers established their own home pages
when they lowest competitive firms were priced (Aufhauser), whereas other less technologically
in the high $30s or low $40s. They also tend to savvy brokers (National Discount Brokers, Jack
be less technologically savvy and feel that In- White) relied upon Security APL’s Internet bro-
ternet security is not at a level sufficient for them kerage electronic storefront.
to feel comfortable. This group of customers The discount brokers entered the electronic
also tends to need more handholding, and val- brokerage market gradually because they had
ues greatly the ability to speak to a live person to consider the effect of lending credibility to
when they have a question or want to get more the emerging market, thus accelerating cus-
information. So the next wave of customers may tomer migration. Schwab and Fidelity first ex-
be less profitable (because they trade less fre- perimented with touch-tone trading, offering a
quently) but may be more costly to serve be- 10% discount on commissions. This discount
cause of the high advertising costs needed to was then expanded to include trades that were
attract them and the higher service levels re- entered via branded front-end trading software
quired throughout the relationship. that accessed the brokerage firm by modem.
Both Schwab and Fidelity have yet to offer trad-
ing over the Internet, citing security reasons. A
brief description of E*Trade leading competi-
COMPETITION tors are provided below:
E*Trade faces significant competition from a
growing set of competitors, which come in three PC Financial Network
varieties: (1) electronic pure plays, (2) deep- Founded as an electronic brokerage firm in
discount migrators, and (3) discount migrators. 1988, PC Financial Network (PCFN) is jointly
The electronic pure plays (PC Financial Net- owned by an investment bank, Donaldson, Luf-
work and E*Trade) pioneered the industry, as kin & Jenrette (DLJ), and Pershing & Company,
these firms were incorporated as technology-fo- a leading clearinghouse and market-maker. An
cused, electronic-only brokerage firms. During on-line trading pioneer PCFN claims to have the
the early 1990s, E*Trade and PCFN competed largest number of on-line brokerage accounts
primarily on access through the on-line service (over 300,000); however, industry insiders esti-
providers. PCFN was the first to establish a pres- mate the number of active accounts to be closer
ence on Prodigy, and as a result, signed up many to 150,000. The company currently limits its on-
of Prodigy’s customers. Likewise, E*Trade dom- line trading services to America Online and
inated on CompuServe. E*Trade and PCFN es- Prodigy. PCFN’s commissions are toward the
tablished relationships with America Online high end for on-line brokers. PCFN currently
about the same time and basically split AOL’s charges a minimum of $40 per trade up to
customers 50/50. $2,500 in principal value, with commissions ris-

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ing to $100 plus 0.1% of the principal value for savings vs. traditional discount brokers, Lom-
trades in excess of $40,000. In addition, PCFN bard’s advertisement also emphasize its invest-
provides its customers with 100 free real-time ment information, charts and graphs, and acces-
stock quotes for every trade execution. Initially a sible customer service. In April 1996, Lombard
technological leader, the company has recently announced its intent to spin off its Advanced
become more of a follower. PCFN’s lack of in- Technology Group (ATG) as an independent
ternet presence, coupled with the decline of company focused on providing turnkey Internet
Prodigy, has significantly reduced the com- software/transaction processing systems. These
pany’s growth rate. third-party solutions are designed to enable
banks and brokerage firms to more easily enter
National Discount Brokers the on-line brokerage business. Lombard’s 1995
revenues are estimated at $24 million. The firm
Founded as a traditional deep-discount broker-
is privately-held and is considering an IPO in
age firm, National Discount Brokers (NDB) is
early 1997.
a wholly owned subsidiary of The Sherwood
Group (NYSE: SHD). In October 1995, NDB TransTerra
launched its on-line services on the Web
TransTerra, an Omaha-based financial-services
through the PAWWS Financial Network, a fi-
corporation, has four separate subsidiaries
nancial web site established in March 1994 by
which target distinct price points in the on-line
Security APL, a Chicago-based portfolio ac-
brokerage market, three of which offer trading
counting software and service-bureau vendor.
services over the Internet. Only its highest-end
The PAWWS home page serves as a single inte-
offering, AccuTrade, is not available over the
grated site for financial information, real-time
Internet. AccuTrade charges $48 per transac-
quotes, portfolio accounting, securities and
tion, is available over AOL and Windows direct
market research tools, and on-line trading. Cus-
modem link, and offers ‘‘power tools for the
tomers can chose among several brokerage firm
active investor.’’ In September 1995, Trans-
besides NDB including Jack White & Company’s
Terra acquired Aufhauser, the first brokerage
Path On-line and Howe Barnes’ The Net Inves-
firm to launch a stand-alone web site (February
tor. NDB is among the more aggressive on-line
1995). TransTerra charges $34 per trade
brokers with respect to low price. NDB currently
through Aufhauser’s WealthWEB site; however,
charges $20 per trade for OTC stocks or up to
recently the company has started experimenting
5,000 shares of any listed stock for $25 plus $3
with a combination $800-per-year unlimited
postage and handling.
trading commission and $20-per-month for real-
time quotes in targeting active traders. In Febru-
Lombard Institutional Brokerage ary 1996, TransTerra launched Ceres Securities
Founded as a traditional deep-discount broker- On-line with the help of NetBroker’s Broker
age firm in 1992, Lombard Institutional Broker- On-line, an electronic toolkit for the construc-
age aggressively embraced on-line brokerage tion of full-featured electronic brokerage ser-
services. In October 1995, Lombard began offer- vices. Ceres charges $18 per trade. Finally, in
ing its customers the option of placing orders April 1996, with substantial advertising in fi-
over the Internet through its own designed and nancial publications, TransTerra launched its
managed web site. By March 1996, on-line cheapest on-line trading subsidiary, eBroker.
trades accounted for about 15% of total transac- Designed to capture the rock bottom price seg-
tion activity. The company estimates that by ment of the market, eBroker offers the lowest
1998, 50% of Lombard’s trades will be executed commission per trade of any on-line broker (in-
on-line. Lombard positions itself as a premium cluding E*Trade) at $12 per trade. Advertise-
service provider at $34 per trade (whether ments feature the $12 commission and tell in-
placed on-line or with a live broker over the vestors, ‘‘Don’t call. Don’t write,’’ implying
telephone). In addition to promoting its cost there is absolutely no customer service pro-

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vided. Using a scaled-back version of Aufhaus- reputation for customer support, and breadth
er’s trading engine, eBroker is attempting to of products and services. Its full-page ads in the
skim away the most valuable high-volume trad- Wall Street Journal declared the ‘‘end of the com-
ers and also test the elasticity of demand for mission compromise.’’ Presently, e.Schwab is
possible market expansion. only available by direct modem link, but the
internet product is operational in beta release
(80% of the modem functionality has been
Charles Schwab
ported) with a full-scale internet rollout sched-
Charles Schwab, a NYSE listed company, is the uled for July.
market leader in traditional, nonelectronic dis-
count brokerage services, serving slightly more
than 50% of the total discount brokerage mar- DECISION
ket. Schwab is known for its high levels of cus- E*Trade must decide how to react to the grow-
tomer service and its reasonable prices. Schwab ing competitive pressure from e.Schwab on the
began testing more limited service offerings at high-end and eBroker on the low end. With sev-
lower prices with its touch-tone telephone trad- eral competitors offering commissions below
ing system, TeleBroker, in 1994 and with its di- $20, E*Trade has lost its historic point of differ-
rect modem, on-line interface, StreetSmart, in entiation. Some executives within the senior
1995. Customers trading through either of these management team argue that E*Trade should
less-labor-intensive options received a 10% dis- quickly and decisively regain its price-leadership
count off Schwab’s typical $60 to $80 commis- position. Other managers believe that price dif-
sion rate. However, customers always had the ferences at this level are indistinguishable to the
fall-back option of speaking to the highly- customer and that E*Trade should increase its
trained customer-service representatives. In value proposition by enhancing its product and
1996, Schwab crossed over the threshold into service offering while maintaining its current
electronic brokerage with the launch of its commission structure. The company must de-
e.Schwab, a premium-priced ($39 per trade) on- cide where it can create a profitable and sustain-
line brokerage option. E.Schwab advertising able position along the price/quality (service)
emphasizes the Schwab name, well-established trade-off.

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