EC-18 Schwab.com 17 May€¦ · Title: Microsoft Word - EC-18 Schwab.com 17 May.doc Author: slorton Created Date: 5/21/2001 1:52:05 PM

GRADUATE SCHOOL OF BUSINESS STANFORD UNIVERSITY

CASE NUMBER: EC-18 MARCH 2001

SCHWAB.COM1

We are a technology company in the brokerage business. —David S. Pottruck, President & Co-Chief Executive Officer, Charles Schwab

On December 28, 1998, the market capitalization of Charles Schwab Corporation topped that of brokerage giant Merrill Lynch, soaring on market enthusiasm about the Internet. The company had come a long way from its early years, when founder Charles R. “Chuck” Schwab “bet the company” on information technology (IT), spending two million dollarsequivalent to the company’s entire net worthto buy an IBM mainframe. Early and large IT investments gave Schwab a technological edge in an industry that thrives on information. Schwab took advantage of its San Francisco location, just a few miles north of Silicon Valley, which was inventing the future of technologyand of management. By the end of 2000, Schwab had captured over half of the discount brokerage market, having amassed 870 billion dollars in customer assets. Over the years, Schwab has repeatedly and successfully leveraged IT to introduce innovations that transformed the brokerage industry. In 1982, Schwab was the first brokerage firm to offer its customers 24 hours a day access to their accounts via telephone, using a nearly paperless office operation. Another major innovation was Schwab’s mutual fund “supermarket” that offered customers access to no-load mutual funds they could buy or sell without paying a transaction fee. Schwab’s TeleBroker automated telephone touchpad order entry system, introduced in 1989 and extended later to four languages, is one of several ways in which order entry has been fully automated. Its Equalizer software product enabled personal computer users to trade stocks online, and its StreetSmart software introduced in 1993 was the first Windows-based software to allow online trading of stocks, bonds and mutual funds. Technology was Schwab’s major advantage, but it could also become its Achilles’ Heel. In the mid-nineties, Schwab was facing the challenge of the Internet, which made trading without the active involvement of a broker easy and inexpensive, threatening to turn trading into a commodity business. Low capital costs and an open network reaching vast numbers of investors lowered barriers to entry, and online brokers like E*Trade and Ameritrade were driving down prices, endangering Schwab’s commission revenues. The common belief was that the Internet would lead to the disintermediation of the entire brokerage industry, allowing investors to bypass financial middlemen and make brokers obsolete. 1 By Sanjeev Dewan, School of Business, University of Washington at Seattle and Haim Mendelson, Graduate School of Business, Stanford University. Copyright 1999-2001 by Sanjeev Dewan and Haim Mendelson. Send comments to Haim Mendelson, [email protected].

Version: (A) 03/01/01

Schwab.com EC-18 p. 2

An Investment Dealers Digest article from June 19962 cites Gary Meshell, director of electronic financial services consulting at Price Waterhouse: “… the brokerage industry is going to get a wake-up call in the next 24 months… As much as the brokerage firms disintermediated the banks, the Internet is just as big a threat to the brokerage industry.” The threat was particularly serious for Schwab, whose customers were well-educated, sophisticated, computer-savvy do-it-yourselfers who could easily switch to the low-cost and convenience of the Internet. Schwab’s Co-CEO David Pottruck described his Company’s concerns: “We were very worried about what [the Internet] represented as a threat to our businessthe cannibalization it representedas the prices for trading continued to drop.” I. INDUSTRY AND COMPANY OVERVIEW The Investment Cycle Figure 1 is a schematic chart of the investment cycle, which consists of four distinct steps: information acquisition, investment decision-making, order execution and account management. Each of these steps, along with the services brokers provide to support them, is described next. Information Acquisition Starting from the top of the figure, the investment process is driven by information, which is primarily of two types: the investor’s financial goals and portfolio positions; and market information including macroeconomic and company news, rumors, price quotes, transaction reports and research that help investors evaluate the market and make investment decisions. Much of the information used by investors comes from their brokers, and increasingly from public sources on the Internet.

Figure 1: The Investment Cycle

Information

Decision

Execution

Account

•Investor FinancialGoals & Portfolio

•Market News,Rumors, Quotes,Research

•Strategy

•Tactics

•Orders

•Order Routing

•Execution inFinancial Market

•Confirmation

•Reporting

•Tax Accounting

•PerformanceTracking

2 “The Cyberspace Threat: Will the Internet do to Wall Street what Wall Street did to the banks?” Investment Dealers Digest, June 3, 1996.


Investment Decision-Making The next step, investment decision-making, involves the formulation of an overall strategy and tactical decisions. The overall investment strategy specifies asset allocation across classes like stocks, bonds and money market funds. Tactical decisions determine when and what securities the investor will buy or sell, and they eventually result in actual orders. Brokers offer tools and services for portfolio design and asset allocation, and they often influence or even make the final trading decisions. Order Execution Once an investor has placed an order, it needs to be executed. Orders captured through one of the broker’s distribution channels (such as the phone) are sent via the broker’s order-routing system to the appropriate financial market. After the order is executed and the trade is confirmed, the investment cycle proceeds to various account management activities. Account Management Brokers provide account management services, such as updating investors’ portfolios, safekeeping securities, bookkeeping services (e.g., transaction confirmation and dividend processing), performance tracking, and other services like periodic statements, risk analysis, and tax accounting. Full-Service vs. Discount Brokers Brokers provide a range of services to support the investment cycle, and in turn charge their customers commissions. Prior to May 1, 1975, most brokerage commissions were fixed by the Exchanges. Brokers earned revenues primarily by charging commission fees to customers who bought or sold securities. As a result, brokers tended to be proactive, offering investment advice to customers, influencing their financial decision-making, and inducing more trading activityand commissions. The main area firms could compete on was advice, which became an essential element of their offering.

On May 1, 1975, the Securities and Exchange Commission deregulated brokerage commissions, spawning the discount brokerage industry. Thereafter, the brokerage industry became partitioned into two distinct industry segments: full-service and discount. Discount brokers charge lower commissions and provide a less comprehensive service support for the investment cycle. Unlike discount brokers, full-service brokers employ a staff of research analysts, who generate proprietary research that is used to advise their own clients. Many of these analysts are quite influential, and their opinions can move the market. Full-service brokers offer investment advice ranging from research reports and buy/sell and market-timing suggestions to actual management of their customers’ assets. In contrast, all investment decisions are made by the investors themselves in the case of the discounters. Although deregulation was the key factor leading to the growth of discount brokerage, an additional impetus was provided by the newly available computing (mainly mainframe) technologies. Advances in technology enabled firms to automate their transaction processing and pass part of the resulting savings to customers in the form of lower fees. Discount brokerage firms reduced commissions to almost one half of the prevailing rates and began stealing trading volume and market share from the larger full-service firms. This was facilitated by the increasing financial savvy on the part of investors, driven in part by wider access to a variety of sources with


financial information, such as newspapers, finance-related cable television programming, and magazines. Also, investors increasingly used self-directed retirement plans, which put them in control and demanded greater sophistication. Discounters tapped into the growing population of sophisticated investors, gradually increasing their presence in the brokerage industry. In 1980, discounters accounted for only 1.3% of total industry commissions, but by 1999, that number exceeded 15% (See Figure 2). It is clear from Figure 2 that full-service brokers still dominate the brokerage industry. Of the total base of ingestible assets held by U.S. households in 2000, about a third was held by full-service firms, another third by banks and bank trust companies, about a sixth by mutual funds, and 7-10% by discounters. Full-service firms typically cater to older customers having significant wealth, who trade less frequently, but with transactions of higher-than-average size. These customers tend to be less comfortable with technology, have limited knowledge of financial markets, or are simply too busy to invest on their own. However, discount brokers have grown significantly over the past two decades and have changed the industry landscape. Leading this transition was Charles Schwab.

The Charles Schwab Corporation Charles R. Schwab founded the company bearing his name in California in 1971 as a brokerage firm helping individual investors trade stocks and bonds. Schwab understood that the bundling of transaction services and advice increased the costs to savvy investors who felt comfortable making their own investment decisions. Following the deregulation of brokerage commissions, Schwab decided that unlike full-service firms, his company would not sell advice to customers on what and when to trade. Instead, Schwab focused on providing investors low-cost execution services, becoming the first broker to discount commissions. Schwab’s primary focus is on serving individual investors, providing them a wide selection of brokerage and investment services at prices that are substantially lower than those of full-service firms. Since the seventies, Schwab’s primary mission has been “to provide investors with the

Figure 2: Brokerage Industry Retail Commissions (in $ Billions), 1980-99

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999E

Full Service Discounters Schwab


most useful and ethical brokerage services in America.”3 Traditionally, Schwab has appealed to “take-charge” investors who are highly educated, technology-literate, comfortable trading securities without advice, and in search of low prices. In 1998, more than 70% of Schwab’s customers owned a personal computer. The firm targeted customers who seek fast, efficient transaction services at fees that were substantially lower than those of full-service brokerage firms. Schwab believed that as financial information became more widely distributed, more individuals would realize that they were better off taking personal control of their investments. The firm’s annual reports until the early 1990’s explicitly state that “Schwab does not recommend specific securities, nor provide primary research...”4 In the mid-90’s, Schwab’s mission started to broaden. First, the firm adopted a global orientation, revising its original mission “to provide customers with the most useful and ethical financial services in the world.”5 By 2000, Schwab operated in Australia, Canada, the U.K., Hong Kong, Japan and Brazil. Second, Schwab realized that a new generation of investors was in need of help in making investment decisions. Whereas in 1987, only 5% of Schwab’s customers did not have prior investment experience, in the 1990’s this figure grew to about 50%. To serve this new market and to improve its services, Schwab started to develop new tools, products and services. This strategy also helped the firm to retain its existing customer base: as investors age and grow wealthier, they demand more attention and service. In 1998, the average age of Schwab’s customer was 47, compared to 57 for full-service firms. This changing vision and emphasis is reflected in the following quote from Schwab’s 1995 annual report:

During our first twenty years, we defined this vision as transactional brokerage and custody services. The changing needs of our customers demand that we continuously strengthen our existing services and broaden and extend our vision. Beyond transaction and custody, we must now also develop relationships offering a more extensive range of help and guidance and an expanding array of financial services.

As of the end of 2000, Schwab had 7.5 million active customer accounts with $872 billion in assets through 384 domestic branch offices, and net income of $718 million on revenues of $5.79 billion (See Exhibits 1-3).

Schwab’s general product positioning strategy is to occupy the “middle” of the market, away from both low-end discounters and full-service brokers. Over the years, Schwab has employed a two-pronged strategy based on brand-name recognition and IT-based innovation. Schwab’s marketing strategy has been based on establishing the Schwab brand name. Using its founder’s congenial, trustworthy face in TV commercials, using radio advertising and athletic event sponsorships,6 the company has built a brand name in financial services on par with American Express and Merrill Lynch. A related marketing tool is Schwab’s extensive branch network. Even though most discount brokers do not have numerous branches, Charles Schwab’s belief that customers want to see something tangible before they entrust their money to the firm was proven by the three-fold increase in business in areas where new branches opened. In 1999, Schwab spent $242 million (6% of revenues) on advertising, compared to only 2% of revenues for the

3 Schwab Annual Report, 1991. 4 Schwab Annual Reports, 1987-1991. 5 Schwab Annual Report, 1995. 6 For example, in recent years Schwab has been the official sponsor of the Professional Golf Association (PGA) Tour.


brokerage industry as a whole. Schwab’s advertising investment seems to have paid off: Over the nineties, its customer base increased by a factor of five. The other distinctive feature of Schwab’s strategy has been the emphasis on IT-based business solutions. Exhibit 4 presents Schwab’s key product innovations; all are enabled by IT. Schwab’s product innovation strategy has proven successful, resulting in attractive products valued by customers and in efficient and effective operations. To wit, Schwab’s compensation and benefit costs as a percentage of revenues has consistently been lower than the rest of the industry (Exhibits 1-2). Much of these cost savings have been passed on to customers in the form of lower commissions. II. SCHWAB’S PRODUCTS AND SERVICES This section provides an overview of Schwab’s brokerage products that were introduced prior to the launch of Web trading; the next section will focus exclusively on the new Web channel. Our discussion will roughly track in chronological order Schwab’s product innovations. We start with the mainstay of Schwab’s business providing reliable transactions services over a variety of distribution channels. Transaction Services In its first years, Schwab focused on transactional brokerage and ancillary services the execution phase of the investment cycle. A Schwab retail customer, through her brokerage account(s) of choice, can buy and sell exchange-listed and NASDAQ securities, options, mutual funds, variable annuities and fixed income investments, including U.S. Treasuries, corporate and municipal bonds and CDs. Customers could choose from a menu of brokerage accounts with different financial goals. The most basic Schwab account requires a minimum $2,500 deposit and offers money market funds for uninvested assets and access to margin loans. The Schwab One account requires a minimum deposit of $10,000 but offers additional services such as personal checks, debit card, and electronic bill payment. In addition, Schwab offers specialized IRA, custodial, trust, and estate accounts. By December 1999, average daily trade volumes reached 243,000 in equity and fixed-income securities and another 50,000 in mutual fund transactions. Distribution Channels Schwab has deployed a variety of distribution channels to deliver its investment services: the Schwab branch offices network, call centers, automated telephone systems, and online channels, as we describe next. Branch Office Network By the end of 2000, Schwab had 384 domestic branch offices in 48 states as well as branches in Puerto Rico, the United Kingdom and the U.S. Virgin Islands. About 70% of the US population lived within 30 miles of a Schwab branch. Customers could use the branches to obtain market information, place orders, open accounts, deliver and receive checks and securities, and obtain customer services in person. Yet, most activities were conducted by phone or by mail. Registered representatives equipped with online computer terminals could access customer account information, obtain securities prices and related information, and enter orders online.


Regional Call Centers In 1990, Schwab established four regional customer telephone service centers located in Indianapolis, Denver, Phoenix and Orlando. Through these call centers, customers can place orders 24 hours a day and 7 days a week (except for major holidays), using Schwab’s toll free numbers. The call centers also handle calls routed from branch offices when representatives are busy or those that are placed outside business hours.7 Schwab has been expanding the service capacity of the call centers, which serve as a partial substitute for branches. The company’s customer service approach is to use teams of registered representatives in the service centers, working closely with branch personnel. Each registered representative has immediate access to the customer account and market-related information necessary to respond to customer inquiries, enter orders and confirm transactions. TeleBroker and VoiceBroker In 1989, Schwab introduced TeleBroker, a fully automated telephone system that allowed customers to retrieve real-time stock quotes and place orders. Virtually all calls are routed to the call centers, which handle customers’ requests 24 hours a day. Schwab offered a 10% discount on transactions executed electronically over the phone. The system offers services in four languages: English, Spanish, Mandarin, and Cantonese. Schwab invested $15 to $20 million in its four regional call centers to service this telephone system. Pooling efficiencies result in improved customer service with nearly all customer calls being answered within three rings and delays of less than one minute. In 1996, Schwab added VoiceBroker to its telephone-based services. Using VoiceBroker, an automated system that utilizes speech recognition technology, investors can get real-time quotes and place orders to trade mutual funds using voice commands. In 2000, over 70% of the 110 million customer calls received by Schwab were handled by TeleBroker or VoiceBroker. Online Channel Schwab introduced a DOS-based software system called Equalizer in 1985, but electronic trading did not catch on until the release of Windows-based StreetSmart in 1992. With these channels, a customer installed Schwab’s software on her PC and dialed up through a modem directly into Schwab’s system. These electronic channels were designed to provide convenience to the customer and minimize Schwab’s costs in processing routine transactions. The software trading system was the preferred channel for Schwab’s most active customers who valued its portfolio management capabilities and overall control and convenience, e.g., the relative ease of retrieving quotes compared to the telephone, and the ability to set up trades overnight. To recognize the cost savings to Schwab, customers using electronic channels were offered significant commission discounts from Schwab’s standard rates. The strategic importance of electronic transactions led Schwab to create a separate electronic brokerage unit in 1995, which launched a special program called e.Schwab. Customers enrolled in e.Schwab agreed to only use the lower-cost electronic channels. When they had problems, these customers were limited to customer service via unlimited email, but only one free phone call a month (additional calls were charged $5 per call). In return, e.Schwab customers received discounts that typically amounted to 20% off standard commission rates. Soon, e.Schwab customers would be able to use yet another access method the Internet. The Internet channel will be discussed in Section IV. 7 Orders placed after the markets have closed are routed to the appropriate markets the following day.


Mutual Fund Marketplace Schwab’s innovations in the mutual fund area have transformed the way mutual funds are sold by discount brokers and mutual fund companies alike. The first product was the development of a mutual fund “marketplace” in 1984 that offered customers one-stop-shopping access to a broad menu of mutual funds from Schwab and non-Schwab fund families. Customers were also attracted by the simplified paperwork, consolidated statements, easier tax reporting and the convenience of switching investments from one fund to another. However, customers were required to pay a transaction fee when buying or selling shares. Perhaps Schwab’s most clever innovation in the mutual fund area, and one that reshaped the mutual fund industry, was the introduction of the Mutual Fund OneSource program in 1992, whereby customers could purchase Schwab and non-Schwab no-load mutual funds without paying transaction fees. Prior to OneSource, buying mutual fund shares was a complicated and time-consuming process. As Charles Schwab explained:

To buy a fund, you had to write or call [the fund distributor]. On Day Six you’d get a prospectus. On Day Seven or Eight you call up, and they say you’ve got to put in the money. If you’re lucky, by Day Ten you've bought it. It was even more cumbersome when you redeemed. You had to send a notarized redemption form.8

With OneSource, customers were able to purchase mutual funds from their own brokerage account using any of Schwab’s trading interfaces. Schwab also provided customers with a consolidated periodic statement reflecting portfolio changes and balances from all funds purchased through OneSource and a year-end tax statement. The development of OneSource presented many technical challenges. Major sources of complexity included the aggregation of customer orders for, and interfacing with, many different fund companies, clearing the transactions, calculating redemption fees and customer discounts all of which had to comply with the complex rules of a highly regulated industry.

OneSource reflects Schwab’s open approach, based on offering a broad selection of “best of breed” products. Charles Schwab himself criticized the full-service brokers, who offer only their own products, as follows:9

It's the same game, the same flaw as in Apple [Computer]. They were a closed architecture. They contained things. They got a higher price on their PCs, a higher price on their software. That is a flawed long-term business strategy. If we can figure out how to offer our customers [investment] choices, we can help them sort it out, and we will have a great business. It may not be for everybody, but an intelligent, self-reliant person doesn’t want to be in a closed architecture. They’re too smart for that.

OneSource established Schwab as the intermediary between the mutual fund and the customer. Schwab charged fund providers a 25 to 35 basis point fee (0.25% to 0.35% of customer assets per annum) for listing the fund in OneSource and providing shareholder services. Fund providers, especially the smaller ones with limited marketing capabilities, found a convenient distribution channel in OneSource. They were also able to transfer all record keeping and transactional duties to Schwab’s computers. However, participating in OneSource was like “dancing with the devil”

8 Forbes, April 22, 1996. 9 Forbes, April 22, 1996.


for fund providers since Schwab controlled the information on each customer and provided only aggregate data to the fund. Because it was easy for customers to purchase and redeem shares, customer loyalty to any fund family was low, and frequent switching among fund families was commonplace.10 When investors redeemed their mutual fund shares, nearly 99% of the money remained in a Schwab brokerage account, primarily because Schwab offered the only money market funds in the OneSource program, and therefore, captured idle investor funds following redemption. The OneSource program took a long time to break even, in part because of zero customer transaction fees, but in time has proven to be a highly profitable business for Schwab (see Exhibit 1). By 2000, Schwab’s OneSource service gave customers access to 1,280 mutual funds from about 200 fund families without incurring transaction fees. Customer assets in Schwab’s own funds reached $140 billion by the end of 2000. Mutual fund giant Fidelity followed suit, introducing its own mutual fund “supermarket,” FundsNetwork, a year after Schwab. Fidelity’s FundsNetwork lagged behind OneSource, since Fidelity naturally emphasized the sale of its own products.11 By 2000, however, Fidelity accelerated its FundsNetwork momentum, broadening its product offering to 3,400 funds12, aggressively marketing FundsNetwork and shrinking the asset gap with Schwab’s “supermarket.” While the distribution of third-party funds was less profitable than selling its own, Fidelity’s president James Curvey explained: “We’d rather have thin margins than no business. Wouldn't you?”13 About 30 other brokers started their own fund “supermarkets,” but the vast majority of “supermarket” assets were held by Schwab and Fidelity. Fee-based Financial Advisors Historically, Schwab was not directly involved in giving advice or managing customers’ assets. Nonetheless, Schwab’s customers could obtain advice and asset management indirectly through fee-based financial advisors. These advisors charged an annual fee based on customer assets and helped individuals set up and manage their investment portfolios. In contrast to commissioned advisors, whose incentives might not necessarily align with the customer’s, fee-based advisors are more objective and less committed to pushing proprietary products at the expense of clients’ real needs, thereby providing more “ethical” investment advice. One of the features that attracted financial advisors to Schwab is the SchwabLink service introduced in 1991. With SchwabLink, financial advisors were able to use Schwab’s computers to trade and manage customer accounts using software provided by Schwab. Each advisor was assigned to a registered Schwab representative. Without SchwabLink, an advisor would have to keep track of numerous statements from every investment for each customer, making recordkeeping very tedious. With SchwabLink, an advisor could outsource all transaction, record keeping and statement preparation duties to Schwab’s computerized system for a fee based on the number of transactions and the size of customer assets. This service was so successful that of all assets generated through fee-based advisors, 82% were managed using SchwabLink.

10 In 1995, Schwab instituted a fee on customers engaged in frequent short term redemptions (holding periods of less than 90 days) . 11 Between 1993 and 1998, the assets gathered in Fidelity’s FundsNetwork were generally less than half of the assets in OneSource. 12 Including Fidelity’s own funds. Of those, 900 were no-load funds. 13 “Fidelity's Rivals Help It Draw Shoppers to Its 'Supermarket',” The Wall Street Journal, May 26, 1999.


Schwab’s relationship with independent fee-based advisors allowed it to reach more customers and to provide themalbeit indirectlywith investment advice. These advisors have become a virtual sales force for Schwab. As Arthur Urciuoli, senior vice president for retail marketing for Merrill Lynch explained, “We don’t compete with the discounters. We do compete with Schwab. They have essentially built a Merrill Lynch by proxy.”14 By the end of 2000, Schwab attracted 5,700 fee-based advisors who had brought in $234 billion in assets (about 27% of total customer assets), up from zero in 1987. III. SCHWAB’S IT CAPABILITY Schwab’s track record of technology-based product innovations, and more recently, its rapid ascendance in Internet trading, make it clear that IT is a big part of Schwab’s success. In the words of David Pottruck:

Schwab is a technology company that happens to be in the brokerage business. This is a very good defining statement. We say this all the time inside the company: it’s the mantra in the company to our own employees. I think it makes the technology people feel good. I think it makes the rest of our employees understand where our bread is buttered and what the separating element of the company is: it is our ability to leverage technology, to apply technology… So we think in terms of ‘how do we leverage technology for competitive advantage?’ We have 2,000 full-time technologist at Schwab, and we have [a total of] 13,000 employees: 2,000 are full-time technologists, and the other 11,000 are expected to be part-time technologists. Every single employee in the company is expected to understand how to use technology. And every manager in the company is expected to understand how to leverage technology and look for opportunities to leverage technology to reduce cost and improve service.15

We discuss below three aspects of Schwab’s IT capability: the structure of the IT organization (called the Schwab IT Enterprise, or SITE), the partnership between SITE and Schwab’s business units, and the company’s IT infrastructure. SITE Organization Structure Schwab’s IT Enterprise (SITE) mirrors the company’s overall enterprise structure, with a one-to-one mapping between units of SITE called Enterprise Technology Solutions (ETS) and the business enterprises they support.16 Each ETS has a direct reporting line to the IT organization with dotted-line reporting to the corresponding business enterprise. CIO Dawn G. Lepore is on the Schwab Management Committee and reports directly to Co-CEO David Pottruck, reflecting the importance of IT in the company. The organization of SITE combines the advantages of a centralized structure with the user focus that comes from the partnership with the business enterprises. IT decision-making is centralized, leading to unified companywide standards on computing and communication platforms and application development tools. An additional advantage is integration which, along with economies of scale, implies a significant cost advantage. On the other hand, the close relationship

14 Institutional Investor, April 1996. 15 Presentation at the Kellogg Graduate School of Management, 10/14/98. 16 Since the beginning of 1995, Schwab is organized into several independent enterprises, mostly along product lines. The enterprises included Retail, Electronic Brokerage, Mutual Funds, Institutional, Capital Markets and International, along with the Schwab IT Enterprise (SITE). In addition to the ETS groups, SITE has an infrastructure group called the SITE Technology Services (STS) which is responsible for both building and operating the hardware and software infrastructure.


between each ETS and the corresponding business enterprise guarantees that IT has a business orientation: effective business-IT relationships are key to Schwab’s IT capability. Business-IT Partnership SITE works hand-in-hand with the business enterprises to develop new products and distribution channels. Schwab’s practice of developing mission-critical applications through a technology-business partnership is a key element of Schwab’s technology strategy, as explained by Pottruck:

[The] partnership between technology and business… did not start with [CIO] Dawn [Lepore] and myself. This is a great legacy at Schwab, going back to the beginning of the company. One of Chuck [Schwab]’s first big decisions was to go in-house with technology at a time when we were much too small to have made that decision. We really had no right to go that route when we were so small. But he recognized that for a company to grow and to achieve the kind of vision we had for the future, going in-house and building our own proprietary technology was going to be critical. He made that decision back in the seventies and we have never looked back. Dawn and I have worked together for 15 years. We have a great relationship because we are both trying to solve the problems of the business and we both understand that technology is our big tool but it’s only one of the tools.17

This partnership affects both Schwab’s product development process and the company’s evolutionary approach to technology innovations. Evolutionary Development Approach Schwab follows an evolutionary development approach, stressing the importance of user feedback. Vince Phillips, Vice President, Web Systems at SITE-Electronic Brokerage, explains:

To me, it’s very simple. It’s almost trite. The classic engineering model is a waterfall one: you nail down your first step, nice and clear, then you get to the next one and so on… You built exactly what you wanted. Nothing more, nothing less. That’s where the $1,000 toilet seat comes from. We just do not use that over here. When projects try to use that, they fail.

Schwab’s development approach is best illustrated by example. Consider an Electronic Brokerage (EB) project involving the development of a new feature on Schwab’s Web site. After the project gets approved, the first step is an agreement between EB and the EB ETS of SITE on resources required and on the people from EB and SITE who will form the development team. Next, the project manager (typically from EB) would prepare, working hand-in-hand with team members from SITE, a concept statement that describes the overall objectives of the project.

The next step is feasibility study, first on paper, then through prototyping. In parallel, a creative strategy is sent to a design firm for user interface design. Subsequent to the feasibility study, business and functional requirements are specified together with the technical team, which is responsible for coding. Reliability and availability are key development priorities. In addition, the product undergoes usability testing in Schwab's EB usability lab. Alpha testing of the new feature is done with employees, followed by beta testing by customers who are likely users of the new feature. Following successful Beta testing, the feature is finally incorporated in the production Web site. The development process engages IT and business people right from the concept stage. Further, both sides maintain a strong level of participation and coordination throughout the duration of the

17 Presentation at the Kellogg Graduate School of Management, 10/14/98.


project.18 Randy Goldman, Vice President in the Electronic Brokerage Enterprise and Vince Phillips, VP in the SITE-EB unit, often work together on new Web projects. Randy Goldman describes their working relationship as follows:

Anyone who works for me has a team meeting weekly. As we get closer to launch, we have bug meetings daily. Vince and I meet once a week on all the projects in our area… We actually have a great track record of working together... that kind of [business-IT] partnership has been really key to our success.”

Evolutionary Technology Strategy At Schwab, the adoption of new technologies follows an evolutionary approach. Schwab’s philosophy is to be an early entrant, but not on technology’s “bleeding edge.” The development of Schwab’s PC software channel illustrates this approach. Fidelity was actually the first to come out with Fox, a DOS-based trading product. In 1985, Schwab countered with its own DOS product, Equalizer, using direct dial-up that allowed investors to connect through a modem with Schwab’s computers to trade, check account balances and retrieve real-time quotes. Schwab also provided transaction capabilities to on-line customers of GEnie, an on-line service similar to CompuServe. Neither of the DOS products really took off. When Microsoft Windows came out, Schwab went through a “crash” course, developing a Windows-based trading software product called StreetSmart that was introduced in 1992. The initial “quick-and-dirty” version was refined later a strategy Schwab has successfully followed in other cases as well, including Web-based trading. Fidelity fell behind and mistakenly decided to take their time and come out with a product significantly superior to Schwab’s. Software development being what it is, the more complex software requirements translated into a substantially longer development time for Fidelity’s product, Fox Plus, and the project floundered for 2½ years. Meanwhile, Schwab introduced an improved StreetSmart in 1994, including access to the Reuters Money Network and Schwab’s Mutual Fund Performance Guides as research tools. By the end of 1995, more than 15% of Schwab’s 15 million transactions originated from personal computers. However, software was a difficult channel for Schwab. In the words of Randy Goldman, “each new software version was one big cycle, and you’d better get it right. And we never got it right… The Internet freed us up.”19 IT Infrastructure A firm’s IT infrastructure encompasses the computing platforms and development tools which enable the development of IT applications and determine the firm’s overall IT capability. The importance of the IT infrastructure at Schwab is explained by CIO Dawn Lepore as follows:

Technology has played such an important role from the very beginning of the company. Chuck Schwab who founded it had an early sense of the role technology could play in the evolution of the company. We have this view that we will have an infrastructure that will continually evolve. That any... specific technology strategy is not sustainable. What is sustainable is a constant evolution of your technology and people who are very good and creative at applying technology to business problems. So we really focus

18 Development initiatives – typically several hundred at the start of every planning year – are prioritized and approved by a governance committee, comprised of senior management of the EB enterprise. The list of features to be developed is locked in for half a year at a time. The environment is so dynamic that some 30% of spending is on projects not originally planned at the start of the year. 19 Personal interview on December 3, 1998.


on keeping our infrastructure constantly evolving. We have rules like no more than two generations of technology at any one time. We want to get rid of the old and in with the new. And we also really focus on hiring the right people who have the creativity to keep our technology moving forward. And the combination of our vision, customer focus and our technology has shown very good results.20

We discuss two elements of Schwab’s IT infrastructure: the IT architecture and Schwab’s development environment. IT Architecture Schwab has a hybrid IT architecture, that is continuously evolving to balance the continuity and stability of legacy mainframe applications with the flexibility of newer client-server systems. Thus, Schwab deployed a client-server architecture for its order-routing network, general ledger system and customer service support applications. However, about three-quarters of back-end brokerage applications still run on mainframe systems. The Schwab Architecture and Migration Strategy (SAMS) project, launched in 1990, was directed toward replacing the mainframes with a client/server architecture. Various reasons, including the falling prices of mainframes, slow maturing of client-server tools and internal management hitches, forced Schwab to rethink its migration strategy. As a result, the scope of the SAMS project was scaled back and Schwab decided to stay with a mainframe-centric architecture. As Dawn Lepore puts it, “we have many big mainframes... [and] they are absolutely part of our architecture going forward”. One of the biggest problems with modern-day servers, Lepore adds is that “they have neither the performance nor the throughput to handle big time transaction loads.”21 Development Environment Schwab has a sophisticated development environment with state-of-the-art tools. Most applications are developed in-house. The basic philosophy is “buy tools, build applications.” Exceptions are made if the requirements are not unique to Schwab or the required skills are not immediately available internally. For example, a key factor driving the choice of Microsoft NT on Schwab’s workstations was the ability to buy off-the-shelf software. Schwab chose to purchase a sales automation tool because it felt it would not derive a competitive advantage from building one. According to Lepore, “there’s nothing that unique about Schwab that I think we have to reinvent the wheel and go write our own [sales automation application].” While Schwab will at least consider buying third-party software, Lepore says that one thing the firm will not do is outsource its technology functions or transaction processing applications: “we’re in a cyclical business, and we want to take advantage of changes in the marketplace. You give up flexibility, I believe, if you outsource. And we are not willing to give up either control or flexibility.” This is not to say that Schwab never outsources development activitieseven key ones. When Schwab partners with others on systems development, it makes sure it acquires the knowledge of key technologies, so it can maintain the application on its own. This is exemplified by the development of Schwab’s Web trading site. The company initially outsourced the development of the site, because it did not have the requisite skills internally. Around the time Schwab was in final negotiations with a vendor to design its site, Charles Schwab grew impatient and wanted the site delivered sooner than planned. Accordingly, the development was brought back in-house under the leadership of Gideon Sasson, who had gained Web experience at MCI and IBM before joining Schwab in December 1995. Schwab partnered with IBM to connect the Web system back

20 Presentation at the Kellogg Graduate School of Management, 10/14/98. 21 “Making Sweet Music with Charles Schwab,” Wall Street & Technology, October 1996.


to its mainframe applications, where transactions actually take place. The team of IBM consultants, with mainframe expertise, worked hand-in-hand with Schwab’s internal development team of 5-6 developers, to bring the system up and running on the Web in about three months. This was accomplished in half the time and half the budget that was estimated by the outside vendor. Further development and enhancement of the Web site have been done by SITE in partnership with Schwab’s Electronic Brokerage Enterprise, now headed by Sasson. In Summary Schwab’s IT capability is well-recognized in the industry. In 1997, the Tower Group surveyed securities industry professionals to find out which broker was the “most respected technologist.” More than half of survey participants chose Schwab, followed by Merrill Lynch (19%) and Morgan Stanley (3%). In 2000, CIO Magazine named Schwab a winner of its annual Enterprise Value Award for effectively combining business leadership and technology innovation to create value for the enterprise. IV. SCHWAB AND THE INTERNET The Threat In 1995, the Internet caught everyone by surprise with its potential to rapidly transform the brokerage industry. As reported in Investment Dealers’ Digest in 1996, “… the Internet has grown from an idle curiosity to the Street’s number one obsession.”22 Internet technology was based on open standards and scaleable computing power, offering lower costs compared to the legacy systems that dominated the brokerage industry. The Internet decreased both the fixed and variable costs of the brokerage business, and barriers to entry were substantially lowered. Electronic brokers such as Lombard (later acquired by Dean Witter) and E*Trade were springing up everywhere, offering prices as low as $12 per trade (less than one tenth the price of full-service brokerage commissions), and threatening a price war. In only three months, Web-based trading grew from zero to 20% of E*Trade’s total volume. The Internet promised to change the relationship between the broker and the customer. Customers could easily get market information, online advice, and direct access to transactions using a Web browser. Thus, the Internet represented an attractive alternative to a human broker.

The Internet had a particularly significant impact on discount brokers like Schwab, which historically used technology to lower costs and offer superior service at lower prices to investors who did not want to pay for investment advice. While the Internet was another channel that Schwab could use to reach these customers, pure transactional services were becoming a commodity business, and lower costs coupled with the entry of competitors were driving prices down. Indeed, the online brokerage industry has been the scene of vicious price wars, especially in its early stages. Since the industry had primarily targeted the discount brokers’ base of customers interested in fast and cheap trades, price-cutting was commonplace. For example, E*Trade reduced its prices seven times between 1993 and 1996, before settling down at $14.95. These price wars extended into 1997, with average commissions dropping by 50% in the second half of 1997. From the beginning of 1996 through the end of 1997, average commissions decreased by almost two thirds

22 Investment Dealers’ Digest, June 3, 1996.


from about $53 to $18.5 per trade. Subsequently, average commissions stayed almost flat (see Figure 3).

Figure 3: Weighted Average of Commissions Charged by Online Trading Firms

The typical Internet investor was similar to the typical Schwab customer. For example, the median age of E*Trade’s customers was 40, with 75% having two or more university degrees, and they were active traders, using the Web to buy or sell three times a week. To a large degree, Web-based brokerage firms were attractive to Schwab’s most profitable customers: those who traded often, usually through electronic channels. Thus, Internet discount brokers presented a threat to Schwab’s commission revenues. Initial Response In 1995, full-service brokers dismissed the Internet, warning investors of potential security issues. Schwab initially held back, concerned with the inevitable cannibalization of its commission revenues. In the words of Randy Goldman, VP of Electronic Brokerage, “we always knew it [the Internet] was going to happenwe just wanted to slow it down.” These factors, along with the lack of suitable technology to seamlessly integrate the Web interface to Schwab’s mainframe-based back-end, led Schwab to adopt a wait-and-see approach to Web-based trading. The waiting was over in late 1995, when Dawn Lepore, Schwab’s CIO, invited Charles Schwab to a technology demonstration. The demo showed a Schwab server accepting an order from a Web browser running on a PC, routing it through the complex back-end mainframe systems, executing it and sending a confirmation back to the PC. The alternative would be to have orders printed out and manually entered into another system, which is far more expensive than fully-automated tradingand unaaceptably slow. Lepore and Schwab quickly recognized the implications of this quick-and-dirty demo. In a matter of days, an independent project team was charged with the responsibility to get Web trading up and running. This resulted in the creation


of a separate Electronic Brokerage (“EB”) Enterprise reporting directly to Schwab’s co-CEO, David Pottruck. Schwab launched its Web-trading service on March 31, 1996. New customers had to open an account with a physical check or wire transfer, but after that they could trade by logging onto the Schwab Web site. Instead of the usual sliding scale of commissions, these customers paid a flat $39.95 commission for up to 1,000 shares, and 3 cents a share beyond that. Customer response to the new distribution channel was enthusiastic. Schwab’s goal was to have 25,000 Web-based accounts by the end of 1996. That goal was achieved in two weeks, even though Schwab did not advertise the new channel, and customers learned about it by word-of-mouth. Due to the huge surge in Web-trading, Schwab’s systems failed to meet demand when volumes skyrocketed in the first week of May 1996. Schwab solved the problem quickly by adding servers and increasing the system’s capacity. Schwab leveraged its brand name, marketing muscle and wider range of product offerings to quickly overtake its rivals on the Web. While E*Trade and Lombard were offering only stocks and options, Schwab introduced in close succession, trading in Treasury securities, mutual funds and, shortly thereafter, corporate bonds. Both the number of active online accounts and the associated assets doubled from December 1996 to December 1997. Going All the Way Initially, Web-trading was offered as a defensive move to protect Schwab’s market share from low-priced on-line competitors. The Web-trading price was set at $39.95, about half the commission on an average trade using other channels, and it soon dropped to $29.95. To get this price, users were required to trade through the Web, but request customer service by e-mail, similar to e.Schwab. Users who wanted the option of speaking to a human, could keep their regular Schwab account and still trade online, but they got only a 20% discount off the regular Schwab commission schedule. “We were trying to offer a technical product that didn’t have all the rest of the services that Schwab had to offer but could offer a lower price,” recalls Pottruck. This strategy reflected Schwab’s view of the Internet as a threat, and was an attempt to prevent the cannibalization of the entire customer base. However, the dual pricing structure confused and irritated Schwab’s customers, who were forced to choose between service and price. Schwab realized that it had to alter its Internet strategy. As co-CEO David Pottruck explains:

[Initially] we made our customers choose - if you wanted Internet service at the Internet price you go over there. If you want the full array of services Schwab has to offer, you can't have that kind of pricing. That was a mistake… The key to our success is how we melded the Internet into the middle of who we are and what we try to do for our customers.

Starting January 15, 1998, Schwab offered Web-trading for everyone at $29.95 for up to 1,000 shares.

Most discount brokers charge commissions lower than Schwab, while full-commission brokerages have started offering discounted commissions to selected retail customers. In 1998, Schwab’s commissions were 60% cheaper than those of full-commission brokers, but they were higher than those of most discounters. Full-service firms justified their higher commissions by


offering services like investment research and a personal relationship with a broker in addition to order execution. On the other hand, the primary service offered by low-end discounters, trade execution, was similar to check-processing in banking a necessary function that adds little value to the product. Schwab justified its commissions by offering additional information and account services as well as high-quality executions. The rapid growth in customer demand presented operational challenges. On October 27, 1997the day of a stock market mini-crashtraffic on Schwab’s Web site doubled to 10 million transactions, corresponding to 130% of capacity. Thirty percent of Schwab’s customers along with hundreds of thousands of other online investors got the Internet’s version of the busy signal and could not connect to their brokerage firms. Schwab responded by significantly increasing Web-trading capacity and introducing its “Total Customer Access Promise,” which guarantees customers access through an alternate channel in case of any difficulty due to a problem on Schwab’s Web site. Schwab kept increasing its capacity, and Web servers were sometimes added on a daily basis. By the end of 1999, the capacity of Schwab’s Web site was increased sixteen-fold over two years earlier. At that point, Schwab had 3.3 million active online accounts holding assets of $349 billion, and 73% of Schwab’s trades were conducted through online channels. Products and Services on the Internet The Internet allowed Schwab to vastly broaden its product and service offerings. Customers can place orders to trade stocks, options, U.S. Treasuries and corporate bonds and choose from about 1,100 no-load OneSource mutual funds with a few clicks of the mouse on Schwab’s Web site. Once an order is placed, customers are prompted to verify it before it goes through, and an online acknowledgment is sent to the customer upon execution. Using the Internet, customers can obtain real-time quotes, construct watch lists, draw performance charts and compare securities. Schwab also partnered with insurance companies to provide life insurance quotes and enable customers to apply for life insurance policies through the Website and with E-Loan to give clients access to mortgage products from over 70 lenders. In 2000, Schwab Formed a partnership with America Online to become the premier financial services company across its personal finance channels. Customers can also view account information, order status, account history, market news, quotes and charts on MySchwab, a customized customer site. A variety of services are available in Schwab’s Customer Center. Those are summarized briefly below; the best way to review them is to browse http://www.schwab.com and try out the Customer Center Demo.

• MoneyLink enables Schwab customers to electronically transfer funds between their Schwab account and other financial institutions. • BillPay enables customers to use the Web to make payments electronically instead of writing checks. • The Analyst Center provides tools to research industries and individual stocks using fundamental and technical data, stock screening, charting and earnings estimates. Data include company and industry reports from Standard & Poor’s; earnings forecasts from First Call; market summaries and interviews from Briefing.com; insiders’ trading data from Vickers; price and volume charts by BigCharts; and news from Dow Jones. • Industry CloseUp provides industry analysts’ reports including company rankings, recommendations, and trends.


• MarketBuzz provides a broad collection of information including market highlights, emerging financial news and links to finance-related Web sites and publications. • Research Reports from Credit Suisse First Boston and Hambrecht & Quist, covering more than 1,000 companies, were provided free for a limited time ($29.95 thereafter). The fee is waived for Schwab’s most active customers. • Investor tax and retirement centers provide online retirement and tax planning tools and information including retirement planning tools, a capital gains estimator, tax strategies, and tax forecasting. • IRA Analyzer educates investors about their retirement planning choices and estimates retirement income under each IRA option. • Mutual Fund Performance profile allows investors to analyze the performance of their entire mutual fund portfolio. • Asset Allocation Toolkit allows investors to view their asset allocations and compare alternative investment strategies. • The Portfolio Performance tool allows investors to easily track the performance of their portfolio and its components against relevant benchmarks. Customers can even track investments that are held at other brokerages. • SchwabAlerts is a collection of services that alert customers when certain events take place. Market Alerts offer market updates, news and highlights throughout the day. In addition, the automated system monitors clients’ portfolios and sends them an e-mail message when a triggering event (e.g., market events or pre-specified price movements) occurs. Alerts are sent via email, phone, pager and wireless, and may also be viewed on the Schwab Website. • eConfirms is a service that delivers trade confirmations directly to customers by e-mail, eliminating paper delivery and shortening turnaround times. With eConfirms, customers can trade in a completely electronic environment from log-on to trade execution and trade confirmation. • Stock Screener enables investors to sort through and select from 9,000 US-traded stocks by a variety of criteria. • Mutual Fund OneSource Online has automated selection tools that help an investor choose a fund and then click and buy it. Customers have access to fund prospectuses online, and they can query Schwab’s mutual fund database to search funds by different criteria, e.g., performance over one, three or five years in a particular sector. • SMART Investor is an interactive online resource that provides investor education, and SchwabWelcome.com is a destination on the Schwab Website to help prospects learn about Schwab products and services and to help them to open an account online.

Embrace and Extend Schwab is not relying solely on the Internet channel; rather, it is seeking to take advantage of synergies between the Internet and its traditional channels. “Schwab.com is only one way we provide access to Schwab for our customers. It complements our other two channels, the branches and phone service. The ability for customers to select their channel, whether they are placing a trading or seeking information, is core to Schwab’s value proposition,” says Randy Goldman. Schwab held thousands of online investing seminars over the year 2000 in its branches for those not comfortable with Internet technology.


Schwab revamped its branch network, replacing the teller-like counters by desks and private conference areas for meetings with customers. Telephone calls to the branches are directed to the national call centers, where business like trades and account inquiries are conducted either by an automated service or a rep. In this way, branch reps can spend their time helping investors on topics like financial planning and mutual fund selection. Reps are encouraged to develop a field of expertise, such as retirement planning or insurance. In January 2000, Schwab acquired U.S. Trust, a New York-based money management firm that caters to the wealthiest Americans. Schwab described the acquisition: “We’ve long held a goal of building an organization that can serve investors completelyfrom those taking their first steps towards becoming lifelong investors, to those looking to manage their accumulated wealth for themselves and their families. We believe U.S. Trust brings the most respected wealth management expertise in the nation, and our combined strengths create an organization that can serve clients at every stage of wealth accumulation. The combination also adds new strengths to the services that Schwab’s affiliated investment advisors provide. U.S. Trust represents for us a piece of the puzzle that had been missing in our offering to affluent investors.” Schwab also expanded the services available to select customers. For example, it created the Signature Services program, which offers tiered services for investors who have more than $100,000 in assets or trade more than 12 times a year. Four levels of service are available: “plain vanilla” Signature Services, “gold,” “platinum” and “pinnacle,” depending on the client’s assets or trades. Signature Services clients receive access to an exclusive Web site, have access to discussions with CEOs and money managers, can get referrals to pre-screened fee-based advisors and have free access to online research. In addition, Schwab partnered with Bloomberg, L.P. to develop an exclusive analysis magazine published quarterly for Signature Services clients. Clients do not get personal brokers, but each is assigned to a small team in one of the call centers. These teams help clients develop an investment strategy and they get special treatment, such as a “red-hot call” when the market is very volatile. Schwab also started participating in the distribution of Initial Public Offerings (IPOs), whose shares were historically offered primarily to large institutions. In 1997, Schwab partnered with Credit Suisse First Boston, J.P. Morgan and Hambrecht & Quist to distribute shares of stocks they underwrite to Schwab customers. Since 1998, Schwab sold shares to select customers who were invited to participate in specific offerings. More recently, Schwab has become co-manager in a number of IPOs. Partnering with TD Waterhouse, Ameritrade and leading venture capital firms, Schwab is forming a new online investment bank, Epoch Capital Partners, to underwrite IPOs that will be distributed to online retail customers. Convergence Schwab’s Web site has come a long way since late 1995, when it was static and had little functionality and pizzazz. Over time, Schwab increasingly partnered with outside firmswith IBM for help with Web technology; with information providers First Call and Quote.com for information and research content; and with Web-design firm Razorfish to bring design savvy to its Web site. “Given the pace of the Internet, we have learned to be flexible, to learn as we go and to incorporate new technology, ideas and vendors,” says Randy Goldman.


A key challenge of the Internet era is that information shifts control to the customer. As Gideon Sasson, President of Schwab’s Electronic Brokerage Enterprise, explains:23

Before the Internet, the world was the realm of the few. Few people had access to real-time quotes, to analyst reports, to real-time news, research, other people’s opinions.... What the Internet did was basically democratize it [information]...

The challenge is: How do you make money when well-informed customers can switch to the competition at the click of the mouse? How do you prevent your product from becoming a commodity? Whereas most major brokers shunned the Internet, at Schwab, the Internet is catalyzing a new business mission. David Pottruck, Schwab’s co-CEO, says: “… The Internet is the most profound change the company has ever gone through… The Net is totally embedded in the center of our business.”24 Indeed, the Internet channel is grabbing the lion’s share of Schwab’s business: By the end of 2000, Schwab had 4.3 million online accounts with $365 billion in assets, and 81% of daily trades were made online. As Randy Goldman put it: “Everything is converging on the Web.”

23 San Jose Mercury News, October 4, 1998. 24 Fortune, December 7, 1998.

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ludi

ng in

tere

st

C

ompe

nsat

ion

and

bene

fits

$17,

715

$20,

824

$24,

162

$28,

968

$27,

340

$30,

309

$36,

768

$41,

666

$47,

344

$60,

098

C

omm

unic

atio

ns

$2,2

22

$2,1

19

$2,2

82

$2,4

81

$2,7

13

$2,8

22

$3,0

89

$3,4

50

$4,1

77

$4,5

92

O

ccup

ancy

and

equ

ipm

ent

$3,0

92

$2,9

50

$3,0

09

$3,1

36

$3,1

70

$3,4

01

$3,6

32

$3,9

34

$4,7

36

$5,3

23

M

arke

ting

and

adve

rtisi

ng

$878

$9

30

$1,0

94

$1,2

79

$1,2

96

$1,2

45

$1,5

53

$1,8

42

$2,1

17

$2,4

08

C

omm

issi

ons,

cle

aran

ce a

nd fl

oor b

roke

rage

$1

,731

$1

,760

$1

,867

$2

,306

$2

,620

$2

,728

$3

,103

$3

,673

$4

,345

$4

,896

Oth

er

$5,8

41

$7,4

14

$8,2

57

$9,4

17

$9,3

57

$10,

219

$11,

637

$14,

617

$15,

294

$19,

435

Tota

l Exp

ense

s (e

xclu

ding

inte

rest

exp

ense

) $3

1,47

9 $3

5,99

7 $4

0,67

1 $4

7,58

7 $4

6,49

6 $5

0,72

4 $5

9,78

2 $6

9,18

2 $7

8,01

3 $9

6,75

3 In

tere

st e

xpen

se

$22,

717

$18,

871

$15,

983

$16,

995

$23,

731

$38,

175

$49,

196

$63,

614

$83,

002

$70,

345

Tota

l Exp

ense

s (e

xclu

ding

inte

rest

exp

ense

) $5

4,19

6 $5

4,86

8 $5

6,65

4 $6

4,58

2 $7

0,22

7 $8

8,89

9 $1

08,9

78

$132

,796

$1

61,0

15

$161

,015

O

pera

ting

inco

me

($16

2)$5

,850

$6

,186

$8

,600

$1

,128

$7

,404

$1

1,27

1 $1

2,20

8 $9

,790

$1

6,27

0

Ope

ratin

g R

atio

s

To

tal R

even

ues

(net

of i

nter

est e

xpen

se)

100%

10

0%

100%

10

0%

100%

10

0%

100%

10

0%

100%

10

0%

Expe

nses

exc

ludi

ng in

tere

st

C

ompe

nsat

ion

and

bene

fits

57%

50

%

52%

52

%

57%

52

%

52%

51

%

54%

53

%

C

omm

unic

atio

ns

7%

5%

5%

4%

6%

5%

4%

4%

5%

4%

O

ccup

ancy

and

equ

ipm

ent

10%

7%

6%

6%

7%

6%

5%

5%

5%

5%

Mar

ketin

g an

d ad

verti

sing

3%

2%

2%

2%

3%

2%

2%

2%

2%

2%

Com

mis

sion

s, c

lear

ance

and

floo

r bro

kera

ge

6%

4%

4%

4%

6%

5%

4%

5%

5%

4%

O

ther

19

%

18%

18

%

17%

20

%

18%

16

%

18%

17

%

17%

To

tal E

xpen

ses

(exc

ludi

ng in

tere

st e

xpen

se)

101%

86

%

87%

85

%

98%

87

%

84%

85

%

89%

86

%

Ope

ratin

g in

com

e -1

%

14%

13

%

15%

2%

13

%

16%

15

%

11%

14

%

Sour

ce: 1

999

Secu

ritie

s In

dust

ry F

actb

ook;

SIA

Schw

ab.c

om E

C-18

p.

23

Exh

ibit

3: S

chw

ab M

etri

cs a

nd O

pera

ting

Res

ults

CAG

R

19

9019

91

1992

19

93

1994

19

95

1996

1997

19

9819

99

2000

1990

-95

19

95-

00

Cus

tom

er A

sset

s ($

B)

$31.

0 $4

8.0

$66.

0 $9

6.0

$123

.0

$182

.0

$253

.0

$354

.0

$491

.0$7

25.0

$8

71.7

42%

37%

Activ

e C

usto

mer

Acc

ount

s (M

) 1.

4 1.

6 2.

0 2.

5 3.

0 3.

4 4.

0 4.

8

5.6

6

.6

7

.5

19

%

17

%

C

usto

mer

acc

ount

s th

at tr

aded

dur

ing

the

year

(M)

0.68

0.83

1.

05

1.23

1.

35

1.54

2.

042.

38

2.78

3.35

3.

79

18

%

20

%

Av

erag

e nu

mbe

r of t

rade

s pe

r acc

ount

that

trad

ed4.

95.

5 5.

6 5.

7 5.

4 6.

3 6.

77.

6 8.

812

.3

16.1

5%

21

%

Av

erag

e co

mm

issi

on p

er re

venu

e tra

de

$74.

3$7

5.9

$75.

7 $7

2.9

$71.

9 $7

5.9

$69.

1$6

4.3

$53.

4$4

5.6

$37.

4

0%

-13%

N

ew S

chw

ab c

usto

mer

acc

ount

s (K

) 30

038

4 51

3 64

4 68

8 69

8 98

51,

164

1,38

01,

481

1,48

2

18%

16%

Full-

time

equi

vale

nt e

mpl

oyee

s (K

) 3.

0 3.

9 4.

6 6.

5 6.

5 9.

2 10

.4

12.7

13

.318

.1

26.3

25%

23%

Activ

e in

depe

nden

t inv

estm

ent m

anag

ers

(K)

2.0

2.3

3.2

4.3

4.8

5.6

4.8

5.3

5

.4

5.8

5.7

23%

0%

In

depe

nden

t inv

estm

ent m

anag

er c

lient

ass

ets

($B)

$4

.2

$8.3

$1

3.3

$22.

9 $3

2.6

$50.

6 $7

2.9

$105

.8

$146

.4$2

13.1

$2

34.1

65%

36%

Inde

pend

ent i

nves

tmen

t man

ager

clie

nt a

ccou

nts

(K)

57.5

87

.1

133.

3 21

6.4

301.

1 39

0.6

442.

2 54

7.2

689.

984

8.3

1,00

9.7

47

%

21

%

Num

ber o

f dom

estic

bra

nche

s (S

chw

ab)

129

158

175

198

208

226

235

272

291

340

384

12

%

11

%

N

umbe

r of U

S Tr

ust o

ffice

s

21

28

Onl

ine

cust

omer

acc

ount

s (M

)

0.

34

0.62

1.20

2.

203.

30

4.30

66

%

O

nlin

e cu

stom

er a

sset

s ($

B)

$23.

0 $4

1.7

$80.

3 $1

74.0

$348

.7

$364

.9

74%

Asse

ts in

Mut

ual F

und

One

Sour

ce ($

B)

$

-

$

-

$1.8

$8

.3

$12.

5 $2

3.9

$39.

2 $5

6.6

$69.

9 $1

02.3

$9

8.3

33%

Asse

ts in

Mut

ual F

und

Mar

ketp

lace

(inc

l. O

neSo

urce

; $B)

$2

.6

$6.1

$1

1.5

$24.

9 $3

1.0

$50.

0 $7

4.6

$104

.6

$129

.1

$176

.6

$190

.8

81

%

31

%

As

set i

n Sc

hwab

Fund

s M

oney

Mar

ket (

$B)

$6.9

$8

.2

$10.

7 $1

4.5

$22.

1 $2

9.7

$39.

4 $4

8.3

$67.

3 $8

5.2

$109

.4

34

%

30

%

Av

erag

e as

sets

per

acc

ount

($K)

$2

2.1

$30.

0 $3

3.0

$38.

4 $4

1.0

$53.

5 $6

3.3

$73.

8 $8

7.7

$109

.8

$116

.2

19

%

17

%

Av

erag

e cu

stom

er a

sset

s pe

r em

ploy

ee ($

M)

$10.

3$1

2.3

$14.

3 $1

4.8

$18.

9 $1

9.8

$24.

3$2

7.9

$36.

9$4

0.1

$33.

1

14%

11%

Inde

pend

ent m

anag

er a

sset

s pe

r acc

ount

($K)

$2

0.0

$25.

0 $3

4.0

$105

.8

$108

.3

$129

.5

$164

.9$1

93.3

$2

12.2

$251

.2

$231

.9

45

%

12

%

In

stitu

tiona

l ass

ets

as s

hare

of t

otal

14

%17

%

20%

24

%

27%

28

%

29%

30%

30

%29

%

27%

15%

-1%

K=Th

ousa

nds,

M =

Milli

ons,

B=B

illion

s

Sour

ces:

Sch

wab

Ann

ual R

epor

ts, 1

992-

2000

; Sch

wab

Web

site

; Aut

hors

' est

imat

es

Schw

ab.c

om E

C-18

p.

24

Exh

ibit

4: S

chw

ab In

nova

tions

Tim

e In

nova

tion

Des

crip

tion

1980

24

-hou

r quo

tes

24-h

our q

uota

tion

serv

ice

esta

blis

hed.

1982

24

hr-s

even

-day

ord

er e

ntry

and

quo

te

Cus

tom

ers u

sing

toll

free

num

bers

to p

lace

ord

ers.

Firs

t bro

kera

ge to

offe

r thi

s ser

vice

.

1984

M

utua

l Fun

d M

arke

tpla

ce

Um

brel

la fu

nd p

rogr

am p

rovi

ding

cus

tom

ers w

ith a

n ar

ray

of n

o-lo

ad a

nd lo

ad m

utua

l fun

ds.

1985

Eq

ualiz

er/o

nlin

e tra

ding

D

OS-

base

d so

ftwar

e en

ablin

g el

ectro

nic

tradi

ng.

1989

Te

leB

roke

r Fu

lly a

utom

ated

tele

phon

e sy

stem

for o

rder

ent

ry a

nd q

uote

.

1990

Te

leph

one

serv

ice

cent

ers

Four

regi

onal

cal

l cen

ters

est

ablis

hed

in In

dian

apol

is, D

enve

r, Ph

oeni

x, O

rland

o.

1991

Sc

hwab

Link

Pr

oprie

tary

ele

ctro

nic

inte

rface

that

ena

bles

fee-

base

d in

vest

men

t man

ager

s to

trans

act w

ith S

chw

ab.

1992

M

utua

l Fun

d O

neSo

urce

En

ablin

g pu

rcha

se o

f no-

load

mut

ual f

unds

with

out p

ayin

g tra

nsac

tion

fees

.

1993

St

reet

Smar

t for

Win

dow

s W

indo

ws-

base

d el

ectro

nic

tradi

ng so

ftwar

e.

1994

e.

Schw

ab

Spec

ial p

rogr

am fo

r cus

tom

ers u

sing

onl

y el

ectro

nic

chan

nels

.

1995

C

anto

nese

and

Man

darin

Tel

eBro

ker

Firs

t bro

ker t

o of

fer s

ervi

ce in

Chi

nese

.

1996

Sc

hwab

NO

W W

eb tr

adin

g In

tern

et-b

ased

onl

ine

tradi

ng se

rvic

e.

1996

Sc

hwab

Adv

isor

Sou

rce

Net

wor

k of

inde

pend

ent,

fee-

base

d in

vest

men

t man

ager

s (re

ferr

al se

rvic

e).

1996

V

oice

Bro

ker

Firs

t spe

ech

reco

gniti

on sy

stem

to o

ffer q

uote

s and

ord

er e

ntry

to c

usto

mer

s.

1997

M

utua

l Fun

d O

neSo

urce

Onl

ine

Aut

omat

ed m

utua

l fun

d se

lect

ion

tool

via

the

Web

site

.

1997

M

arke

tBuz

z In

form

atio

n to

ol o

fferin

g up

-to-th

e-m

inut

e m

arke

t hig

hlig

hts,

finan

cial

new

s, lin

ks to

fina

nce-

rela

ted

web

site

s.

1997

A

sset

Allo

catio

n To

olki

t In

vest

ors v

iew

the

allo

catio

n of

thei

r ass

ets,

com

pare

it w

ith o

ther

stra

tegi

es. W

eb-b

ased

tool

.

1997

Sc

hwab

Link

Web

W

eb v

ersi

on o

f Sch

wab

Link

.

1998

A

naly

st C

ente

r C

olle

ctio

n of

Web

-bas

ed re

sear

ch to

ols u

sing

fund

amen

tal a

nd te

chni

cal d

ata

on st

ocks

and

indu

strie

s,

stoc

k sc

reen

ing,

cha

rting

, ear

ning

s est

imat

es.

1998

IR

A A

naly

zer

Web

-bas

ed to

ol a

imed

at e

duca

ting

inve

stor

s abo

ut re

tirem

ent p

lann

ing.

1998

Po

sitio

ns M

onito

r W

eb-b

ased

tool

allo

ws i

nves

tors

to tr

ack

the

perf

orm

ance

of t

heir

portf

olio

and

com

pare

it a

gain

st b

ench

mar

ks.

1999

Sc

hwab

Ale

rts

Del

iver

y of

inve

stm

ent a

nd m

arke

t act

ivity

new

s via

e-m

ail o

r wire

less

1999

M

ySch

wab

C

usto

mer

-cen

tere

d po

rtal

1999

eC

onfir

ms

Elec

troni

c de

liver

y of

trad

e co

nfirm

atio

ns

Documents

EC-18 Schwab.com 17 May€¦ · Title: Microsoft Word - EC-18 Schwab.com 17 May.doc Author: slorton Created Date: 5/21/2001 1:52:05 PM