E-Brokers Look Beyond Wall Street
Lured mostly by price, investors have been flocking to electronic brokerages by the millions. But analysts say the Internet's impact on the securities industry will eventually go well beyond cheap trades. And, eventually, beyond Wall Street.
In the first half of the year, 22 percent of all retail trades were conducted on the Internet, compared to 17 percent last year, according to Piper Jaffray senior analyst Steve Franco. More than half of the trades processed by discount broker Charles Schwab (SCH) have come from online customers this year, says spokesman Tom Taggart.
That's just the beginning.
"The (online trading) industry's going to get much bigger, no doubt about it," said Bill Burnham, e-commerce analyst for Credit Suisse First Boston. He sees the percentage of online trades reaching 60 percent or more of the total within a decade.
Observers say the power of online trading eventually will reach from the nebulous depths of cyberspace to shake the brick and marble foundations of Wall Street.
Full-service brokers like Merrill Lynch (MER) and PaineWebber will soon start feeling the pinch from the online players. As online brokerages start focusing less on price and more on giving customers access to valuable investing tools and information, the advice for which full-service brokers charge dearly will drop in value.
"The online trader in 10-15 years, on his desktop PC, will have whatever the largest institutional investor has on their desktop today," Burnham said.
Despite the Internet threat, most full-service players have done nothing yet as they ponder a perplexing puzzle: How to move online without alienating their large armies of personal brokers.
This "head-in-the-sand-defense is not going to work," for much longer, Burnham argues. Jupiter Communications analyst Nicole Vanderbilt believes we should see companies like Merrill launch huge online sites sometime within the next year to 18 months.
The traditional brokerages will have to come up with some innovative pricing schemes to make the move online economical. Piper Jaffray's Franco said that full-service discount brokers will likely drop transaction-based pricing in favor of set fees based on account size.
Vanderbilt also expects an a-la-carte offering that lets investors pick and choose how much advice they want from a broker.
The new model will mean margins will be sacrificed, but business could actually expand. Much like the travel industry, online trading "will allow financial advisors and brokers to focus what they're good on," Vanderbilt said.
Schwab's Taggart agrees that many customers will always want some kind of human contact when making important investment decisions: "This is not like buying a book," he argues, pointing out that Schwab last year added 37 new brick-and-mortar branches.
Institutional investor-minded brokerages could also see some of their business depart to the online guys, althougnot to the degree of the retail banks. Institutions already process a lot of their trading with electronic communication networks, or ECNs, like Reuter9s' Instinet, and analysts say additional ECNs formed by online brokerages, such as Datek's Island service, could capture more of the institutional order flow.
And while online brokers may also get more involved in corporate financing (Wit Capital has already done much to jump-start the process), analysts believe the capital and expertise investment banks like Goldman Sachs and Morgan Stanley bring to the table will be hard to replace.
Other traditional hallmarks of Wall Street may not be as fortunate. CS First Boston's Burnham said many of the country's bustling exchanges and pits will disappear through mergers while the ones left will resemble the Nasdaq exchange, which is basically one large online market.
New York's importance as the hub of finance may also be diminished. After all, the Internet's reach has no limits, and analysts believe geographical distinctions will prove far less important in the future. E-Trade (EGRP), for instance, is already aggressively trying to establish a global network so that one day Australians will be able to buy stock in the United States "without worrying about currency or having to pay lot of extra money," Burnham said.
Common markets among different countries could become more, well, common thanks to Internet technologies. "If Europe can pull off a common currency, which is challenging, maybe we can pull off a common market," said Ameritrade Inc. (AMTD) President Mike Anderson, who cautioned that the markets in many countries still don't have nearly the same sophistication of those in the United States.
But just because online investing succeeds doesn't mean that today's pioneers in the sector will also flourish. The top 10 of the 80 or so electronic brokerages operating already control about 90 percent of the online retail transactions, according to Franco.
Even many of these leaders will fall by the wayside or get scooped up by larger institutions, such as Merrill Lynch or banks like Wells Fargo (WFC), which will offer online trading as just one of dozens of financial services. "Isolated online trading firms won't exist," Burnham said.
To ensure their survival, online brokers will have to greatly expand their services. One example offered by Franco: Offering investment advice, either through robust automated tools or by partnering with financial advisors.
No matter how the future ends up looking, most observers agree individual investors will be the ultimate winners. They'll have more access to information and more control over their money than they've ever had. And it won't necessarily come from Wall Street.
Written By Darren Chervitz