When the Product is Free, You’re the Product

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This isn’t a note about Facebook. It’s a note about online brokerage fees.

And it’s a note about Facebook.

Schwab Cuts Fees on Online Stock Trades to Zero, Rattling Rivals   [Wall Street Journal]

Charles Schwab Corp. said it would eliminate commissions on online stock trades, one of the most dramatic moves yet in a broad-based price war that is crimping profitability across the financial sector.

“There are certain parts of finance that have become commoditized,” said Devin Ryan, an analyst at JMP Securities LLC. “Trading is one of them.”

The end of commissions for trading is near as TD Ameritrade cuts to zero, matching Schwab   [CNBC]

TD Ameritrade said late Tuesday that the company will eliminate all commission fees for online U.S. stock, exchange-traded fund and option trades .

“We expect Fidelity and E*TRADE to react next and announce cuts to their own commission rates over the short-term, with both likely matching SCHW’s/AMTD’s zero rate,” said Credit Suisse research analyst Craig Siegenthaler in a note to clients titled “Finishing the Race to Zero.”

The match by TD Ameritrade failed to shore up its crashing stock. Shares of TD fell 2.5% on Wednesday following a 25% plunge on Tuesday, its worst day in 20 years. Analysts cited a higher reliance on commission revenue as a reason for its outsized decline.

Six months ago, I wrote the following about TD Ameritrade in a note called Pricing Power Part III: Government Collaboration. Here’s the money quote:

The most amazing thing to me about Vanguard’s advertising strategy is that sometimes I don’t think there is a strategy. Does Vanguard even have a TV ad budget? My best guess on Vanguard’s annual advertising budget is $100 million, twice what they’ve said they spent a few years back. And yet the AUM just comes rolling in, billion after billion after billion … trillion after trillion after trillion.

THIS is the power of a business model that fits the Zeitgeist of capital markets transformed into political utility.

You don’t have to convince people to give you money. You don’t have to construct a winning brand or marketing alpha. The secret of Vanguard is not only that they’re not wasting resources on unrewarded active investment management (in 2017, 45 employees managed $2 trillion in AUM in Vanguard’s equity indexing group … that’s $44 billion per employee!), but also that their cost of customer and asset acquisition is so low.

I can’t emphasize this point strongly enough. Financial services companies live and die on distribution. Clients come and clients go. But if you can keep your customer acquisition costs low, you will ALWAYS live to fight another day. No matter what happens to performance.

On the other side of that spectrum, you’ve got TD Ameritrade and their incessant advertising campaign for all active management, all of the time. My god, but I weary of the smarmy dude with the beard, telling me that trading options is “just like playing pool”. And yeah, go ring that 24/5 bell, Lionel. All night long. Haha. How droll.

In 2018, TD Ameritrade spent $293 million in direct advertising expenses, three times my estimate of Vanguard’s spend for one-twelfth the net asset increase. Forget about all the employee comp associated with sales and marketing, I’m just talking about direct advertising costs. For this money, the company gained 510,000 net new accounts in the year, meaning that each net new account cost $586 in direct expenses. Now is there churn on accounts, so that gross new accounts are more than 510k and customer acquisition costs are proportionally less? Yes. But I can’t see any way it costs less than $500 for TD Ameritrade to get a new client, before you even start considering employee comp. And these costs are going up. TD Ameritrade is guiding to $320 million in advertising expenses this year. Lionel doesn’t ring that bell for free, you know.

I’m not trying to make a direct comparison between TD Ameritrade and Vanguard. They play in different ballparks. I’m also not trying to say that one is a better managed company than the other. What I AM saying is that Vanguard has taken an easy business path and a robust business path, and TD Ameritrade has not.

Vanguard fits the financial services Zeitgeist perfectly, and TD Ameritrade fits not at all.

Not. At. All.

So I’m not going to belabor this point, because you can read the original notes for the full scoop.

But if you want to skip all that Monty Python exposition and get straight to the Meaning of Life, here are my two takeaways from this latest news.

As a consumer … don’t cry for Argentina, and don’t cry for the online brokerages who are taking their commission fees down to zero.

As the old saying goes (apparently it goes back to a 1973 exhibit by the artist Richard Serra) … when the product is free, YOU are the product.

It’s the same with these guys, who have the requisite scale to make a pretty penny from selling YOU (in this case your order flow) to the execution shops who are in the sausage-making business of grinding buyers and sellers together. Plus, and I know this is hard to imagine, but the execution of your trades is about to get even crappier than it was before. Still, free is a pretty hard thing to pass up. Works for me.

As an investor in or an employee of ANY financial services company, on the other hand … maybe it’s time for a good cry and a hard look at your future prospects.

As the Epsilon Theory saying goes … capital markets are being transformed into political utilities.

If you don’t see that every facet of the financial services world is being transformed into a collection of two or three massively scaled and massively regulated behemoth corporations – into ACTUAL utilities – then you’re just not paying attention. The common denominator of each of these winning behemoths is that they have a Narrative that fits the modern Zeitgeist – a profoundly status quo spirit of the age, dominated by the Nudging State and the Nudging Oligarchy.

“Yay, free!”

Except it’s not really free.

And it’s no place I’d want to work.

(See, I told you this was also a note about Facebook.)


  1. Ben, it’s hard to get a read on you…

    To steal some terminology from Demonetized’s piece last week it would seem to me you’re leaning towards the “zombification of everything” as our permanent regime. And yet at other times some combination of the Great Reset or Jihad. I’m not asking you to pick sides as the whole point of the narrative machine is to observe and not predict. IMHO though you seem more naturally drawn to zombification than you do the others.

    I however cannot help myself and think (hope) the last decade plus maybe a bit longer was our Zombification of everything tour and then we’re on to a new regime. I’m an FA though so the belief we’re headed toward an outcome where the “value” of my advice is more than ABB is quite appealing. I know what my confirmation biases are; I wonder, what are yours?

    Thanks for all the work you do, it’s a joy reading your notes

  2. Avatar for Wraith Wraith says:

    Yep, love the note. Now that AMTD and ETFC (hey notice that…they are a financial corp, the ticker even says so!), have gone the same direction, everything you wrote regarding utility transformation has warged from a heavy, powerful yet plodding B-52 formation into multiple F-15 wings accelerating toward something at full 'burner. There are two things to ponder here (well there are more, but brevity and such):

    1. What are the implications to the overall ecosystem of Retail Orders -> Order Dark/Lit pool aggregation -> Data/flow Sale to Citadel and Virtu etc. -> the price delta of ‘flow’. How are HFT-type strategies doing? AUM? Performance? I don’t know enough about Citadel, but Virtu is SUCKING wind. Industry data ain’t great on OTC market making. Or derivative market making, industry wide. The Virtu/ITG deal was pure desperation (and also disintermediating execution from order gathering - and I am being kind here). My gut tells me HFT based strategies are leaking gallons of oil.

    2. As Ben discussed, the business models of Schwab, Vanguard and Ameritrade are different. Their client base is different, as is the asset gathering MO. Now they are all playing #metoo on this race to -ve transaction costs. What are the consequences? Vanguard is a finely tuned machine, but what about the others? Yesterday was NASTY for AMTD (even before they announced the #metoo today), but keep in mind two things. First off, TD Bank is the major sponsor/shareholder of AMTD. I was surprised at how fast they followed suit, particularly surprising given TD C-lounge culture. (I am a Canadian PM and know this shit well). It was going to happen, but wow that was fast. This will end terribly at some point, but like I said, Vanguard will (maybe) be fine, but some of the others (like AMTD) I feel are playing piranha footsie. And probably this is a wolf trap for the non Death Stars set by the Death Stars.


    I have no idea when the flow selling/asset gathering ‘panacea’ (lol) ends, but I have to go back to supply/demand. The guys with the non DeathStar Inc. business models (Schwab, Ameritrade), are now price takers on flow. Like buyers of output from utilities (your grandma’s nat gas bill), they typically get the floating rate end of the contract. Their brands will get piss-diluted, beards and all. Because no one likes the cable company. Don’t even get me started about why Rogers owns the Blue Jays. (hint: everyone hates cable oligopolies. It’s public goodwill, which only works when the team is good. We HATE Rogers in Toronto, as well the Jays P&L does not move the needle of this public oligarch run behemoth utility). On the other hand, from the handful of HFT and market making type firms I look at, business is hot garbage. More importantly it’s declining at an increasing rate. Despite the typical (mostly BS) ways of looking at shops like BGCP and ITG and VIRTU from the sell side as “revenues positively correlated to equity vol and retail flows”, I have a suspicion that this breaks. I’ve run some quick regressions lately that shows that it has. There is finite demand right now for cheaper order flow. This could get much worse if we are looking at a real correction.

    You should always abide by determining if you’re the sucker at the table. If you figure out who it is, you DON’T kill the golden goose. You buy him drinks. I am not sure how many drinks the sucker has left in him. And the golden goose needs a drunk sucker.

    Badass note as always Ben. Cheers.


  3. A few years back I had a discussion with my father, who was an FA and also my partner at the time. He kept pushing me to take what appeared to be the easy road in the advice business. That road was as follows: sub it out to a good SMA, be the client’s friend and confidant, and have a low stress career. It’s important to note that he never did this. In fact he was a classic broker from the old days, where he traded for clients who wanted the action and he executed simple buy-and-hold for those who wanted a less active approach to their lives. His clients did very well over his 33 years and when he retired they lamented the loss of an honest guy who worked hard for them. But he didn’t want me to take that path. Because that path is hard. And it’s miserable. He looked around at the higher producers and saw that they had a lethal combination of knowing nothing about the market and being great schmoozers. THAT was the path to a career with bigger money and fewer headaches. But I rebuffed this advance, repeatedly. My argument then, as it is now, was simple: if all I do is slide people to a faceless SMA why do they need ME? What does the client need me for? To be their friend? To be their bartender who will listen to their problems? That’s not me. That’s not why I spend so much of my free time reading and observing. And yet those guys are lapping me every single quarter. But their days are numbered. The world in which you can charge someone 150bps to allocate their money to an SMA and have four one hour conversations a year are coming to an end. Advice isn’t free (yet), but it’s cheaper than that. At some point we’ll hit a fork in the road and the FA model will evolve into whatever is next. For the younger (ish) crowd like me that evolution is not too scary. For those who have lived high off of the old model and still need it to last another 15 years…that’s got to keep them up at night. In their McMansions.

Continue the discussion at the Epsilon Theory Forum


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