Defini ng Moment: Online Stock Sales

Investors are being drawn to the speed and convenience of Net-based trading

By John Thackray

isten up, all of you who are down on Internet commerce. There is one Net niche that has lately experienced an enormous surge of revenue and-yes, you're reading it right-profits: online stock brokerages.

"Stock brokering has led the way in terms of user acceptance of online commerce," says K. Blake Darcy, CEO of DLJdirect, an online subsidiary of New York investment bank Donaldson, Lufkin & Jenrette. His company has a stable of 350,000 customers, ranking it among the top four in online volume, along with Charles Schwab, Fidelity Investments, and E*Trade.

"There are very few commercial offerings that are working on the Internet today," Darcy a dds. "Yes, buying books is one, and flowers are another. But beyond that, there are not a lot of applications. Brokering is clearly a major winner."

Michael Gazala, an analyst at Forrester Research, figures that in the last year, about half the 40 online discount brokers have become profitable or at least reached break-even status.

"People are making money, so that distinguishes brokering from most Internet businesses," he says.

Gazala predicts that the total population of online investing accounts will reach 3 million by year's end, a 100% surge over 1996. He says online investment accounts should reach 14.4 million by 2002. That increase, Gazala says, will be fueled by many new entrants from the ranks of full-service brokers, mutual funds, and commercial banks.

Few anticipated the force of the online trading boom. "The revolution of the Internet caught most participants by surprise," says Joseph Konen, president of AmeriTrade Holding Corp. in Omaha, Neb., one of two public companies in the group ( E*Trade is the other). "Nothing has ever come about faster in the discount brokering field in terms of technological transformation and its effect on consumer and investor behavior."

Unlike many Internet startups, AmeriTrade and E*Trade are both profitable. E*Trade earned approximately $3.1 million on revenue of $37 million for the third quarter of 1997, ended June 30. Earnings would have been even higher if the Palo Alto, Calif., company had not had to absorb a charge resulting from a late securities registration in the state of Ohio.

E*Trade also ranks among the most expensive half-dozen of all Internet plays. Since it went public in August 1996 at $10.50, the company's stock price has shot up more than 400%. By contrast, AmeriTrade's stock, issued at $20 this summer, promptly fell below $12. It now sits at around $22.

Bargain Basement
The discount feature of online trading is clearly a primary customer lure. Depending on the provider, commissions range from one-third to one-tenth of thos e charged by traditional firms.

Yet many argue that the online trading experience is quantitatively different and better, and that this is what powers the growth. "People are gravitating to invest on the Internet because it is such a different experience from working in the traditional way of calling a broker and asking, `How is the market today, and what's the price of IBM?'" says Rebecca Patton, senior VP of E*Trade. "Online, you get all this information at a glance. You can find out if anything is going on with your stocks, and you can move very quickly if the market moves."

Early adopters of Internet-based brokering were self-directed, hyperactive traders who were already converts to discount brokering. But there is some evidence to suggest that the speed and convenience of the Internet has increased the trading frenzy among run-of-the-mill investors, as well. "In the stocks I cover, day trading-quick ins and outs-is starting to have an effect on the market," says William Burnham, a technology analys t with Piper Jaffray, a Minneapolis investment banking firm. "In a sense it's a form of entertainment, a form of legalized gambling."

E*Trade's Patton notes that the company's new customers trade at roughly the same pace as older customers-about two trades a month. "Which is very active," she adds. "We've talked to some focus groups on this point, and what seems to happen is that as people come online, they get more active. First of all, they don't think about the cost of commissions anymore. Second, they have all these tools and feel really connected, so they get more engaged. It satisfies that interest and need to be more involved."

In essence, the Internet has made available to the average trader a type of behavior that was once entirely the privilege of Wall Street professionals. Consequently, warn those same Wall Street pros, tyro investors who should be prudently investing over the long term are instead playing with fire.

Not Foolproof
"A lot of people are trying to act like pros, but they don't have the real-time connectivity of the pros," says Burnham. The Internet's sense of immediacy is mostly an illusion, he adds: "It used to be that day trading consisted of buying in the morning, then selling in the afternoon, before the close. Now with the Internet you can buy and try to sell at a profit a minute later, because you've followed an eighth of a rising spread. While this tactic may work a lot of the time, it's not foolproof. The Internet is a fairly complex system for getting an order from the desktop all the way to the trading floor."

Another drawback is system dysfunction, which can affect both site access and response speeds. "Everyone has had difficulty keeping their site up and running at top speed with all features operating as they should," says DLJdirect's Darcy. E*Trade reportedly paid more than $1.5 million to its investors a year ago because of system dysfunctions that cost investors missed market trends. It experienced an additional outage in early October.

Such blemishe s notwithstanding, online brokering is a success because it offers more than mere electronic replication of the still-dominant voice-to-voice or touch-tone interactions with discount customers. "You can't think of the Web as a simple substitute for traditional ways of doing business," says AmeriTrade's Konen. "You must add value." The way online brokers have done this is to provide a higher level of information services. Just a few years ago, quotes were difficult to get; now they're easy to get, and free, from several Web sites. Also, brokerages have used the technology to lower their costs, and they've passed along those economies to the investors. "We didn't just go out there and slap an existing product on the Web," Konen says.

Indeed, prices have fallen by nearly half over the past year. Three price points exist within the industry: $29 for a market order at Schwab, $14.95 at E*Trade, and $9.95 at Datek onlin e. The lower prices target the hyperactive trader, and E*Trade's customers reportedly have twice the trading frequency of Schwab's customers. Some providers, such as newcomer Web Street Securities in Northbrook, Ill., charge no commission on most of their trades in the over-the-counter market.

Pricing matters a lot, as customers seem to have scarcely any loyalty to brokerages. Rather, they've shown a willingness to be easily lured by new price come-ons and interface changes. "We're all realizing that customers leave and come back and then jump for the next best thing that's out there," says John Holman, managing director of National Discount Brokers. Also, because trading access can be erratic, shrewd customers have learned to maintain two or even three online accounts at any one time.

Safer Than You Think
The early days of Internet brokering were marked by apprehension about security breaches. But such fears have proved to be much exaggerated.

"You don't hear a lot about security problems w ith online brokers," says Joseph Fox, CEO of Web Street. "What's a hacker going to do? Go into one of my customers' accounts and make a bogus trade? There's no way he can get to or redirect cash to himself." To be sure, Web Street relies on firewalls, and a lot of socket layering. "We've got everything needed to keep out the small-time hacker," Fox insists.

One lesson from the growth of Internet brokering is that early birds win definite competitive advantages. Both Fidelity Investments and Charles Schwab experimented with dial-in order-placement software almost a decade ago. In the late '80s, DLJdirect and E*Trade set up partnerships that survive to this day with online service providers like Prodigy, America Online, and CompuServe. These offer more dependable access than the Web.

Industry leaders have also had sufficient cash flow to invest big-time in content enrichment. In 1995, aside from trade execution, the only extra that most brokers offered was time-delayed quotes. Today, support and decision-m aking tools have become a competitive free-for-all, with each provider claiming to have the best package.

At DLJdirect, for example, customers get free real-time quotes, charting services of every variety, Reuters news, Standard & Poor's data on companies, Zacks earnings estimates, a mutual fund, and a stock search engine. E*Trade also has a large portfolio of information feeds, including individualized home pages within the site. "Two years from now, there will be much more," says E*Trade's Patton.

Heavy Maintenance
But some sites already seem to be suffering from info-glut. "You are looking at some navigational nightmares," notes Julio Gomez of Gomez Advisors, an industry consulting firm in Boston. "If you go to Schwab, for example, you'll find a lot of dead ends on sites and probably experience field changes when switching from one content section to another."

As a result, heavy site maintenance and organization has become a necessity. Two years ago, for example, DLJdirect had no designer s; now it has six. "Design elements are critical. Just throwing content up there doesn't do it," says Darcy.

Relevant, timely, and well-integrated supporting information is a critical tool in the industry's next maturation phase. So far, customer acquisition has not been a costly activity. About a third of discount brokerages' customers have shifted to online without much prompting. The other two- thirds, who pay more for voice or phone connections, may be more recalcitrant. "The hyperactive investor who isn't online by now must have been out of the country in the last year," says Gomez. "All the early adopters are on." Now will come the harder sells-and the lower profit margins.

Forrester's Gazala believes the next wave of those to buy stock online will be less bold and self-sufficient in the online environment. The challenge for the industry will be to find ways of attracting the mainstream investor with hand-holding features and advisory services that are currently absent from most sites. Special feat ures will be needed, too: The latest wrinkle in attracting customers at E*Trade, Charles Schwab, Fidelity, and DLJdirect is a chance to buy into hard-to-get initial public stock offerings. Another gimmick is frequent-flyer miles in return for balances and transactions.

To step up the business, both E*Trade and AmeriTrade have announced $25 million ad campaigns for online, television, and print. DLJdirect and Discover Direct, formerly Lombard Institutional Brokerage, will be among those launching aggressive campaigns in the media this winter.

Getting into the business seems to be getting more expensive, too. Industry sources say American Express blew many millions of dollars last year and got only a handful of customers with a launch campaign for the online brokerage called American Express Direct.

At the same time, AmeriTrade Holding is consolidating three of its four online discount brokerages because, explains president Konen, "Since we're going after folks who are not yet familiar with discount onl ine brokering, it's going to be increasingly important to develop a single brand awareness."

The stakes in this marketing battle could be significant. "The potential for online brokering is much bigger and more powerful than most people realize," says Paul Farrell, author of Expert Investing on the Net: Making More Money Online (John Wiley & Sons, 1996). "It signals a real revolution and a shift of power away from the Wall Street establishment into the hands of the Main Street, do-it-yourself investor."

See related story, " Online Brokers Turn To Banks ."

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