|
|
Charles Schwab Corporation
Case Study
by
Bruce Egsieker
This case study is about the first discount broker, their I.T. (information technology) and pricing decisions.
Charles Schwab Founder/Chairman/C.E.O.
David Pottruck Co-C.E.O.
This case study focuses on Schwab's late 1997 decision to offer a significantly discounted Internet trading price to its entire customer base of $29.95 per trade. E-Trade and Ameritrade, had burst onto the scene in 1995 with commissions now as low as $8.00 per trade. Schwab has always been able to grow its business by differentiating itself on the basis of innovative products and superior customer service. The firm risked enormous cannibalization of its offline business, as customers migrated to the lower priced Internet channel. In fact, internal analysis suggested that projected cannibalization would cost the firm $125 million in revenue the first year of the proposed commission decrease to $29.95 per trade. Here again they are moving away from the old legacy commission structure.
Company Background
Based in San Francisco, Charles Schwab in 1975 formed the company and seized the opportunity to start the world first discount brokerage firm after the S.E.C. (Securities and Exchange Commission) abolished fixed rate commissions brokerage trades. Schwab's strategy was to empower the individual investor by offering products and services at discounted prices. To avoid churing (many buys and sales of stocks to generate commissions), Schwab paid its brokers a salary plus bonus as opposed to commissions on trades...a great move. The bonus was determined by performance against a number of team-based measures including business development, client satisfaction, and productivity. While Schwab initially attracted customers who felt they had been "burned" by traditional full-service brokers, by 1982 they had grown to $54.0 million dollars in revenues.
In 1983 BankAmerica bought Schwab for $57.0 million. However, they did not own them long due to Schwab's go-go entrepreneurial culture which clashed with BankAmerica culture.. Schwab lead a $280 million dollar management buyout of the firm from BankAmerica in 1987. Then in 1988 Schwab went public. (they sold common stock to the public) in the years 1987 and 1988 Schwab grew from $18 billion in customer assets to $354 billion and revenues from $267 million to $2.3 billion. They now had a branch system of 272 offices in 47 states. They were on a roll.
Now get this! To provide live customer support, Schwab operated four 24-hour a day, seven day a week regional customer service centers. Indianapolis, Denver, Phoenix, and Orlando, handling 150,000 calls per week related to trading, quotes, and general inquiries. Customer Service representatives were fully equipped with online computer terminals that enabled account information and placing of orders online. Schwab is beginning to build his information technology infrastructure. Schwab's role as a product and service innovator is well known in business. One Wall Street industry analyst said, "we view Schwab as perpetually having next years model."
Schwab decided to augment its mutual fund offerings in 1992. The company introduced its Onesource Product...the industry's first no transaction fee mutual fund "supermarket." Instead of charging customers a transaction fee for mutual fund purchases, Schwab earned a 35 basis point (.35 of 1.0%) fee on assets under management from the participating mutual fund companies whose products they were selling, marketing, and distributing. In March of 1992 Schwab dropped its $22.00 annual fee on I.R.A (individual retirement accounts) accounts with balances of over $10,000. By December of 1994 Schwab's I.R.A. assets had doubled to $33.0 billion. Also, in August 1994 Schwab announced it would reinvest dividends in any stock owned by one of its customers for free as opposed to a fee for this as competitors did.
Being headquartered in San Francisco, Schwab very early on took advantage of its proximity to silicon valley to embrace technology. At its core, Schwab is really a technology company that happens to be in the financial services business. Technology is not a channel, its the air we breathe. We think about one business as a human-technology partnership. Schwab's use of technology helped the company develop state of the art products and customer service. Schwab always takes a high tech high touch approach to the brokerage business and because of this is still maintaining 20% profit margins.
In 1979, Schwab made his first major investment in technology by bringing its entire trading clearing system in-house...not subbed out to others. As a result Charles Schwab made a "bet the company" decision to spend $500,000 to bring Schwab's back office software in-house at a time when the company had a net worth of just $500,000. In 1985, Schwab made its first foray into the electronic brokerage channel with the introduction of its Equalizer Product. The Equalizer product gave individual investors the same timely information and trading capabilities as the wall street pros. Equalizer was a DOS-based proprietary software package that customers loaded onto their computer using diskettes. Customers would then use dial-up lines to access the Schwab system to get up-to-the minute research information...news, stock quotes, company narrative summaries, review your account information, download trade confirmations and transaction details and make trades.
So this was the a first for the individual investor. They started to get control of valuable market information. The equalizer software sold to customers for $99.00 dollars.
In 1989, Schwab developed Telebroker...it automated brokerage phone service. Customers using this would obtain a 10% commission discount. By 1997, Telebroker service averaged 5.7 million calls per month and accounted for approximately 13% of Schwab's trading volume. It wasn't until the fall of 1993 that Schwab introduced its next online trading program Streetsmart. Streetsmart took advantage of the user interface advantages offered by windows, including icons, floating menu bars, and pull-down menus to make it easier for customers to trade stocks, bonds, and mutual funds. The customer charge for the software was $59.00.
By 1995 they start to see the growing importance of the on-line channel; the response to Streetsmart was strong, especially as online services such as America On Line were growing rapidly. Schwab was facing new competition from new discount brokers. By the spring of 1995 Schwab's management team decided to make a greater commitment to its emerging online channel, forming a separate project team to work on it.
The dilemma was the online business competing with the traditional retail branches. The net present value of the traditional branches would always be higher do to higher commissions. The online business was to be set up as a separate more nimble organization. They called it E-Schwab (March of 1996) with a 1-800 number. A flat rate fee per trade of $39.95 up to 1,000 shares was offered to customers. Within two weeks of its launch 25,000 customers signed up which was the the entire years forecast. (actualy the first to offer online trading was Aufhauser & Co. 1994) Schwab now offered Internet trading to all of Schwab's full service retail customers for a 10.0% discount off all standard retail commissions. Then the huge decision.
The Schwab management team knew that dropping the commission per trade from $39.95 to $29.95 would cost the company between $100 and $125 million dollars the first year. But in August 1996 they did it. But when they did it the Schwab online accounts grew by 25% and the online trading now accounted for 23% of total revenues. In the year 2000 it was tracking at over 50.0% of its total revenues.
I.T. Architecture
Schwab's modular I.T. architecture was based on the premise that all front-end customer channels should access consistent backend systems. Schwab's back-end architecture consisted of three tiers: mainframes, middleware servers, and web servers. The company chose to co-locate the data centers in Phoenix (away from earthquake zone in San Francisco) in order to facilitate linking the two centers with high-speed fiber optics lines. In the event that one of the data centers went down, the high speed fiber lines allowed transactions to be quickly re-routed to the other data center, thereby maintaining consistent customer service. And get this! To avoid the threat of both data centers going down simultaneously, Schwab designed them to be in separate power grids in Phoenix in case the power on one grid went out. So, the two data center buildings are 20 miles apart. Of Schwab's mainframes, three mainframes are dedicated to transactions processing and back office operations. One runs on a legacy datacom database and the other two run run on I.B.M.'s cutting edge DB2 database. The DB2 database leveraged I.B.M.'s "clustering" technology which allowed multiple mainframes to "look" like the same mainframe. This was especially important in situations where one of the mainframes went down; the DB2 data system allowed the workload to continue processing seamlessly on a different mainframe. Schwab's systems did not go down...in fact they were up 99.2% o the time, unlike many other firms.
The company also had eight middleware servers, which served as the conduit between all front-end applications and the corporate databases residing on the mainframe. One of the primary roles of the middle servers was to validate a users identity before granting access to the mainframe system. The final component of the back-end system was a series of 48 web servers, which served two primary functions: processing communication with customers over the web and conducting value-added processing on data obtained from the middleware servers and mainframes.
In Conclusion
By the end of 1997, as more and more investors gained Internet access and the longest running bull market in history continued, interest in Internet trading soared. As one analyst stated, "in biological terms the industry morphed from infancy through childhood in 1997." Today Schwab is on top as the finest Internet Broker. They have no intention of entering a price war with an $8.00 per trade broker. Schwab generates 80.0% of its revenue from 20.0% of its customers and they are a very good technology company. Please note that in late 1997 the Schwab management team became convinced that the business models of both the e-Schwab (in space) and Charles Schwab (in place) were not the business models for the long term. So correctly, they had correctly formed a separate e-business to pursue their new Internet strategy. But when its growth is at a pace that it will make it as big as your traditional business...you put them back together again!!
THE WORLD WANTS THE WEB
In 1999-2000 Schwab was obtaining 75 million hits per day and was processing over 4,000 transactions per second. Schwab's web site is regarded as the most active, encrypted, and secure site in the world. Schwab's success is based on the fact that they embraced technology as the core of their business.
Case Study Questions to be answered and returned to Mr. E.
1) Explain how Schwab reinvented customer service in the financial services industry?
2) Explain your view of: a) Schwab's pricing decision and b) Schwab's technology mapping.