Net gains for individual investors

A BUOYANT US economy and vibrant stock market have led to individual investors bypassing traditional brokerage services and trading directly on the Internet.

On Tuesday, October 28th, 1997, when investors saw a post-crash buying opportunity and created record trading volumes of 1.2 billion shares in a day, the online trading industry in the US generated more than 200,000 trades. The biggest online trading firms generated volumes on a par with many of the major full-service brokerage firms.

However, almost all of the leading online trading firms were incapable of meeting the massive rise in demand that occurred that Tuesday morning. Charles Schwab & Co, Fidelity Investments, E*Trade Group, DLJ Direct and Discover Direct all admitted their customers had varying degrees of difficulty accessing their Web sites. As a result of these difficulties, the industry received some negative publicity.

To counter this and to increase capacity, the online trading companies are adding network Internet connections and examining their Internet provider relationships as part of an effort to avert transaction traffic jams. The top five firms have said they will add capacity to the Web servers that distribute data and process electronic buy and sell orders.

E*Trade, the all-electronic brokerage based in Palo Alto, California, plans to spend more than $70 million (£47 million) over the next year to increase simultaneous user capacity and to address the network access issue. Fidelity Investments is upgrading its servers to double its online trading capacity.

Most of the firms discovered that during the buying spree, the geographic location of cyberinvestors affected the speed with which they could access the Web sites. For example, Internet users in Detroit, New York, and Washington DC, experienced longer delays than those located in Kansas City or Boston.

But upgrading will surely pay off. There are now more than 30 firms offering online trading over the Internet and their volumes have grown 44 per cent in the last six months, Mr Bill Burnham, senior research analyst of electronic commerce at Minneapolis-based Piper Jaffray Inc predicts in his latest report.

Figures in his "Online Trading Update" show that the top five firms control 74 per cent of the market. E*Trade has moved past Fidelity Investments into second position with a 15 per cent share behind Charles Schwab with a 33 per cent market share. During 1997, E*Trade's account base has doubled to 225,000 accounts and its daily trades have grown by 124 per cent to 24,096 (including telephone trades).

A newcomer, privately-held Datek Securities, has jumped into fourth place with 10,000 trades a day in the third quarter and DLJ Direct is in fifth claiming 370,000 accounts.

And still others are entering this growing lucrative business. Quick & Reilly Group's new offshoot, SureTrade, could make an impact now that it is offering $7.95 trades, the cheapest on the market. The previous low was $8 charged by Ameritrade, a deep discounter based in Omaha, Nebraska. Quick & Reilly is apparently going to spend upwards of $30 million advertising the new service. In general, online trading firms plan to spend more than $250 million on advertising in the next 12 months.

"In the short-term, advertising expenditure is increasing faster than the market, effectively making it costly to acquire new customers," said Mr Burnham. "The real focus in the industry is not on pricing issues but on a shift towards customer acquisition costs. Firms need to control their customer acquisition costs and hold on to the customers they have," he stated.

Conducting research over the last two months, Mr Burnham reports that since the beginning of the year the average commission charged by the top 10 firms dropped by half to $17.24. Fidelity was perhaps the single most aggressive price cutter, reducing its standard commission rates twice. In mid-August, Fidelity established a flat rate of $28.95 for all trades done through its Internet site. In early October it reduced again to $19.95, believing that Schwab was likely to cut its rates.

However, Schwab continues to charge the highest rate of $29.95 per trade, but then it has the advantage of being the largest discount broker in the US with 4.6 million accounts at the end of September and it generated an average of 46,100 trades a day during the third quarter.

The average daily trades in the industry increased to 137,978 in the third quarter, representing a 44 per cent rise in daily trading volumes in the last six months.

And even with more than 30 firms already fiercely competing, by the end of 1998 Mr Burnham estimates that six of the top 10 US banks and several of the top insurers will offer some form of online trading. "There are a number of banks and insurers planning launches of their own and the potential for acquisitions is a real possibility," he said.

Recent bank acquisitions of brokerages include Fleet Financial Group and Quick & Reilly; Mellon Bank Corp and Pacific Brokerage; Toronto Dominion's Waterhouse Securities Inc and Kennedy Cabot & Co.

"Acquisitions become more attractive as the costs to acquire customers increase," said Mr Burnham. "Anyone who is independent is a potential takeover target."