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To: Dusty who wrote ()4/26/1998 6:16:00 PM
From: Dusty   of 71
Online Brokerages Article: Interesting



E-trading places

THE clever young things in Silicon Valley have made a fortune by selling shares in Internet-based firms. But will companies that offer Internet share trading make anything like as much money? There are now more than 70 online brokerages in America. Last year, calculates Credit Suisse First Boston, an investment bank, the number of Americans investing using the Internet more than doubled, to 3.3m. Online trades increased by 181%, to 26m, and accounted for one-fifth of all retail trades by some estimates. Yet fears are growing that there will be few profits in online trading unless the brokerages that provide it also succeed in invading more lucrative bits of the personal-finance business.

So far, Internet trading has thrived because it is cheap. E*Trade led the way, offering $20 trades compared with the $60-plus charged by traditional discount brokerages such as Charles Schwab. Then E*Trade was itself undercut by firms such as Ameritrade, which spent $25m in the fourth-quarter of 1997 advertising its "eight bucks" Internet trade. E*Trade says that many of its new customers used to be with Schwab; Schwab says that the sort of customers it once lost to E*Trade now mostly go to cheaper rivals such as Ameritrade.

Talk of $8 trades is a bit misleading, as the lowest charges apply to only the most basic transactions. Ameritrade's customers pay an average of almost $20 per trade, for example. But margins have shrunk. And the cost of winning new business has been rising for both E*Trade and Schwab, the market leader in Internet trading.

The electronic traders face a more basic challenge. The cash that Wall Street market-making firms pay brokers to send trades their way, known as "payment for order flow", has been a vital source of income for E*Trade and others, says Bill Burnham, an analyst with Piper Jaffray. But this is now drying up, because new rules imposed by the Securities and Exchange Commission have shrunk the profits that market makers earn on the spread between buy and sell prices. A year ago, market makers paid brokers more than $10 a trade. Now they pay less than $3. Mr Burnham expects such payments to dry up completely.

The leading Internet brokers now want to move upmarket by offering customers far more than cheap trading. Schwab has been trying to do this for years, and thinks it can also use the Internet to add to its services. Next week will see the launch of "Destination E*Trade", a souped-up web site which will offer research and other financial services, such as bill payments. The web site will also offer other companies' products, from mutual funds to mortgages. "This product is critical to E*Trade's future prosperity," says David Readerman, an analyst with NationsBanc Montgomery Securities, who is worried by the firm's recent lacklustre performance. Ameritrade this week said it will launch a fancier web site of its own.

If this strategy works, it will threaten those full-service brokerages that have so far largely left Internet broking alone. The cost advantages of the Internet could force margins down across all brokerage businesses. The full-service firms say that they are confident that the personal advice offered by their brokers, along with the quality of their research, justifies their much higher costs. But they cannot offer a competitive Internet product because it would upset their armies of stockbrokers. Even Merrill Lynch, the doyen of full-service brokerages, has postponed plans to offer its customers online (but fully priced) trading.

The banks, on the other hand, are likely to pose a much bigger threat to the Internet brokerages. They have no established broking business to lose and the Internet could help them win valuable customers from the full-service brokerage firms. They also have other tempting products to offer alongside share trading. Next month Wells Fargo, a Californian bank that has pioneered online banking, is expected to roll out an online brokerage service for its banking customers. Other banks are sure to follow. If they succeed, both the new breed of online brokerages and Wall Street's long-established offline ones may find profits increasingly elusive.

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