Charles Schwab recently announced that it would be slashing trading commissions on U.S. stocks, ETFs (exchange traded funds), and options to zero. This represents the next phase in the evolution of the online brokerage industry. Trading revenues have been declining for quite some time thanks to increasing competition among online brokers. This activity shouldn’t come as much of a surprise given the trend towards no cost trading. How is it possible that the online brokers can remain profitable when they no longer charge for an important product? Let’s examined their rationale.
The decline in commission revenue across the brokerage space combined with the fact that more Americans are opting for low cost ETFs has created near perfect conditions for massive industry disruption and more importantly, a pricing war. As other major online brokers drop their commissions, Schwab had little choice but to drop their commissions as well. According to Schwab’s 2018 10-K, trading revenue was around seven percent of the company’s overall net revenue. While the drop to zero fee commissions may stoke fears of a substantial decline in revenue, it’s important to note that the company still generates most its revenue from interest on accounts. If interest rates rise and more individuals are drawn to Schwab’s zero commission platform, revenues may actually increase over time. At least that is what senior management was probably thinking.
Pricing wars are great for the consumer but can prove stressful for corporate managers and investors alike. While the future of online brokers may seem murky at best, it’s important to remember that many of these firms have undergone major transformations over the last several decades. Trading and investing are not likely to disappear. Companies that offer platforms to facilitate this activity will likely develop new ways to grow revenues and profits.
Reuben Advani is the author of The Wall Street MBA 3rd Edition (McGraw-Hill).