5/6/2020 The $80 Billion Challenge – Replacing Wall Street’s Trading Revenue in a Zero-Fee World.

a Zero-Fee World. - Digital Strategy and Innovation

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ASSIGNMENT

 Blair Kahn 

Assignment: Digital Strategy and Innovation…  Edit

The $80 Billion Challenge – Replacing Wall Street’s Trading

Revenue in a Zero-Fee World.

By Shina Adu
Alumni

POSTED FEB 25, 2020

Next:

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The $80 Billion Challenge – Replacing Wall Street's Trading Revenue in a Zero-Fee
World.

13 BILLION USD – the price Morgan Stanley paid to acquire discount trading platform
E-Trade on Feb 20, 2020. The hefty sum was at a significant premium for the smaller
downstream player with “merely” 360 billion USD in assets under management (AUM)
vs. Morgan Stanley’s $2.7 trillion in AUM. The deal was heralded as one of the largest
financial M&As since the financial crisis when Wells Fargo acquired Wachovia for
$14.8 billion. Why the large spend? In a world where trading revenue has swiftly been
reduced to zero, the old guard financial services firms need to cast a broader net,
embracing a digital-first strategy that democratizes access to investment services for
both very wealthy households (HHs) and investors of smaller means  – creating other
revenue streams to propel growth. E-Trade had developed a robust online trading
platform that will enable Morgan Stanley hold its own against upcoming fintechs
ensuring it does not completely lose the battle for the crowd. They paid to gain strategic
advantage. TD Ameritrade, the first major casualty of the paradigm shift, was acquired
by Schwab for $26 billion in November 20198. See exhibit 1 for the sharp decline in
TD’s projected revenue.

Exhibit 1 – TD Ameritrade Projected Revenue

ELITE CIRCLES. The financial services industry – capital and bond markets – has long
being an elitist group running an archaic systems. Staid market processes and internal
workflow are designed to satisfy a bundle of regulators and for required self-regulation
and monitoring. Due to its social club nature, there was no real impetus for innovation
until computers arrived and Charles Schwab made the first move towards more

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transparent pricing in 19755, effectively kicking off the definitive decline and gradual
death of fat commissions and mark-ups (Exhibit 2)

FROM HBS DIGITAL INITIATIVE

Immersive sports analytics overlays the

virtual world onto real life

Data & Analysis

Harvard business analytics program:

narrowing a gap in the big data age

Learning About Technology

 Exhibit 2 – Steady decline in trading commission @ Charles Schwab

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RETAIL ME NOT. Rather than innovate, the industry reorganized itself much like retail
to segregate clientele according to wealth. On the high-end: family offices, Goldman
Sachs and Morgan Stanley occupied the penthouse – servicing households (HHs) with
several millions in investable assets; and across the divide “discount” brokers were left
to manage the scrap at the bottom – HHs with 200k or less in investment assets. This
protected margins for a while, guaranteeing access to hedge funds, IPOs and more
complex instruments for the ultra-rich. Just as the Bergdorf Goodmans/Neiman
Marcuses of the world have seen cracks in their model while discount outlets like TJ
Maxx, Ross and Burlington Coat Factory have continued to wax stronger, the snobbish
factor + niche value of specialized, white-glove treatment was not enough to stem the
steady rise of “discount” broker-dealers like Charles Schwab and Fidelity. What gives?
Compare Goldman Sach’s revenue stream on the left to Charles Schwab’s on the right.

 
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Exhibit 3 – Revenue model – Goldman Sachs vs. Charles Schwab

ZERO DOLLARS – represents the average cost of buying and selling securities today1.
When index funds (essentially zero-cost mutual funds designed to track the stock
market) showed up, the handwriting was on the wall. How do you replace 80 billion
dollars in trading revenue? Investment advice was touted as the next big differentiator.
Clients were presented with subscription-type models called “wrap-fee” or advisory
accounts where for a flat fee (typically 1-2% of account assets), they received unlimited
trading + investment recommendations and financial planning as a value-add. This
generated a reliable, repeatable source of revenue stream for “wirehouses” (another
name for older style investment firms) vs. transactional business that could not be
accurately forecasted. That model, however, was also not safe from the digital
revolution underway.

ARTIFICIAL INTELLIGENCE (AI) powered algorithms had been developed by fintech

startups to effectively manage investment portfolios for a fraction (15-20%) of the cost
of traditional asset managers. So called “robo-advisors” offered by agile startups such
as Betterment and Wealthfront, could literally monitor portfolios 24/7, and could be
deployed 100% online – from account opening through KYC (know your customer)
verification to asset allocation and goal setting. This digital approach represented an
enormous opportunity for exact replication, infinite times over at zero marginal cost.
The platforms were accessible through smartphone apps with user-friendly interfaces.
The human vs. machine debate followed as the old guard balked at jumping in because
“the human touch was irreplaceable”. Leveraging healthy margins from its cash
balances, Charles Schwab caught the wave and launched “Intelligent Portfolios” in
20152 offering automated investing to the masses.

The delay by traditional investment houses, allowed for further disruption – enter
Robinhood3 – an app that enabled zero-cost trading. What followed was a race to zero-
cost trading which in turn led to M&A activity as firms team up to be more competitive
in the new landscape. With the advent of this digital shift, how about we innovate?

STRATEGY 1

Embrace Artificial – Intelligence (AI) to drive growth and profitability in a digital first
environment. Firms need to build data/analytics teams to drive decisions with smarter
insight. And utilize client provided data to generate better value for clients.

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AI Portfolio Management: With efficient market frontiers increasing difficult to

breach, firms need to utilize AI for investment decisions and other routine
management tasks such as rebalancing and tax loss harvesting. By working with
more data points than traditional KYC questionnaires can provide, the portfolios can
be tailored to serve best interest (Reg BI) and fiduciary duty + regulatory
compliance.
Digital Operations: Paper heavy operations should be digitized to free up employees
to do more meaningful tasks. Historically, part of the justification for fat margins
was the “call-my-broker” aura, as clients would call to do everything from account
journals to wires. However, it led to operational bloat and multilayered monitoring
and controls. Enhanced efficiency driven by tech enabled platforms will drive
balances and improve KPIs such as gross production per advisor, net new assets
(NNA), gross production per support. Full online capability obviate the need to call
in for account operations.
Robo – Supervision: Repetitive vetting of trading/account activity for suitability and
regulatory compliance must be delegated to AI. Real-time control, not reactive
measures will lead the way into the future with Instant Compliance. The “robo-
supervisor” can process more complex analysis for thousands of accounts without
fail, going beyond “random sampling” as a control mechanism. Fewer complaints,
fines, litigation in tandem with higher client satisfaction rates will propel the
businesses and minimize violations.
AI-Planning: Lifestyle Planning in AI – virtual assistant companionship format rather
than retirement based financial planning. Predictive Analytics in financial planning
with more accurate forecasting. Questions should shift from “will I have enough to
retire?” to managing smaller projects today – “Alexa, can we redo the nursery this
month?” Value Tip: More accurate forecasting/tracking of financial wellbeing
providing greater confidence for monthly/periodical financial decisions.

STRATEGY 2

Tap Other Revenue Streams via Analytics and Data

Firms must augment existing model with additional revenue streams from analytics
driven, lifestyle planning.

 Orderflow Revenue: Apps generate revenue from order flow, a practice where market
makers pay extremely slim commissions per trade for activity directed their way.
With large volumes, the numbers add up quickly6. Fractional share trading – when
you can purchase less than one share of larger-dollar-amount stock positions – is
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fueling broader retail investment engagement among next-gen investors9. Value Tip:
Zero platform costs for trading will accelerate retail investing.
 Intelligent Margin/Lending: Interest rates on margin loans are proving to be a huge
value creation engine and ready value capture opportunity. Margin facilitates trading
and enables financing to purchases additional shares using your current portfolio as
collateral. Digital portfolios could make this mainstream within reason and
responsibility. See exhibit 4. Value Tip: Lower cost financing with neither portfolio
liquidation nor taxable events as deemed suitable

Exhibit 4 – Margin trends at US Banks

Cash Deposits: Zero interest rate policy (ZIRP) from the Federal Reserve crippled
cash reserve revenues for over a decade. However, as demonstrated by Schwab Bank
and Goldman’s Marcus, brokerages can leverage cash balances to generate income
on deposits. Morgan Stanley intends to leverage E-Trade’s cash of $56 billion in
deposits. Value Tip: Value for clients is a service akin to zero-fee checking which
traditional retail banks have shunned.
Direct Listing vs. IPOs: IPO and capital markets – direct listing using real time
analytics to gauge broader interest rather than underwriters attempting to fix offering
prices. This will help to avoid oversubscription, lowering barrier of entry as against
an era when a handful of Wall Street elites received allocations. Retail investing
must be the core approach. This will potentially make it easier to raise capital,
leading to greater engagement and spawning more unicorn growth. Investment
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banking revenue will eventually be disrupted as shown by the recent public debut of
Slack7, with disintermediation in full display. Broker dealers reap enormous rewards
when large companies go public10. The shift is inevitable.
Platform Building – Network effects can magnify retail investing by utilizing the vast
network of clients and accounts to drive value and collective bargaining on relevant
services. One-sided benefit does not drive value. With platform investing, we can
extend the reach across boundaries. Identity investing coupled with transparent
revenue models, can drive steady growth. Ironically, brokers sought out lists of
wealthy clients to attract to their firms. In this age, investors will be propelled to
firms for benefits other than just “investment” services. Robinhood recently created
“profiles” (exhibit 5) inching closer to its social goal of crowdsourced ideas and
sharing of portfolio/investments within authorized groups.

Exhibit 5 – Robinhood Profiles

As successfully demonstrated on more social friendly platforms such as Venmo, perhaps

the future of financial service is AI-Enabled Robo-Services on Social Investing
Networks+.

References –

1 – https://www.wsj.com/articles/charles-schwab-ending-online-trading-commissions-on-
u-s-listed-products-11569935983

2 – https://pressroom.aboutschwab.com/press-release/corporate-and-financial-
news/charles-schwab-launches-schwab-intelligent-portfolios
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3 – https://www.cnbc.com/2019/10/04/battle-for-zero-trading-fees-pressures-
robinhoods-next-leg-of-growth.html

4 – https://dealbook.nytimes.com/2013/01/25/making-sense-of-wall-streets-trading-
revenue/

5 – https://www.aboutschwab.com/history

6 – https://www.investopedia.com/articles/active-trading/020515/how-robinhood-makes-
money.asp

7 – https://qz.com/1642378/slacks-direct-listing-may-render-the-ipo-obsolete/

8 – https://www.businessinsider.com/charles-schwab-acquires-td-ameritrade-to-create-
brokerage-mammoth-2019-11

9 – https://www.cnbc.com/2019/12/12/robinhood-joins-a-wave-of-fractional-stock-
trading-offers.html

10 – https://www.vanityfair.com/news/2019/07/wall-street-ipo-business-is-being-
disrupted

Analytics, asset management, Finance, fintech

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24 thoughts on “The $80 Billion Challenge – Replacing Wall Street’s

Trading Revenue in a Zero-Fee World.”

FEBRUARY 27, 2020

Teaching Fellow Qinyi Ding says:

Great job Shina. A well structured case study with clear paths forward. Both strategies
don’t feel to be mutually exclusive, so it is a possibility to take advantage of both.

Reply

MARCH 1, 2020

Shina Adu says:

Thanks Qinyi. I did not intend to present the strategies as mutually exclusive, I
believe both avenues can lead to transformation and can be employed in tandem.
If our industry could embrace the changes, there will be significant growth as
engagement rises.

Reply

FEBRUARY 29, 2020

Meenakshi Mukherjee says:

Excellent case Shina. Robinhood is great for small investors as they can benefit from
lower fees as compared to other platforms like Think & Swim Ameritrade. You have
mentioned rightly that zero platform fees will create network effects and Robinhood is
one of the best examples as of today. “ With platform investing, we can extend the
reach across boundaries. Identity investing coupled with transparent revenue models,
can drive steady growth. This will help us to understand investor patterns, driving new
solutions.

Reply

MARCH 1, 2020

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Shina Adu says:

Thanks Meena, Robinhood was recently valued @ $7B+ in another round of

funding. The next chapter will require the big players to move into similar
territory, it will be interesting to see how the network effects grow – and how
regulators respond to prevent “pump-and-dump” schemes. Ameritrade was
acquired by Schwab to better compete.

Reply

MARCH 1, 2020

Jon Buccola says:

Shina, Thank you for the great insight. Your second solution resonated with me, in an
environment of seamless lifestyle planning. Finding new sources of revenue in a rapidly
changing environment seems daunting. The network effect seems uniquely suited here.
jon

Reply

MARCH 1, 2020

Shina Adu says:

Jon, that is exactly what I was thinking.Thanks for commenting. You are able to
make a purchase and your Lifestyle planner hints that with next pay day @ X and
your account balance @ Y you may fall short for “bill Z” coming due.

Personal finances used to be secretive like all other personal information, I view
general society as comfortable enough with public/social privacy that a fintech
social network is now viable. Might be great to really know how the “Joneses” are
doing…

Reply

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MARCH 1, 2020

nick.moen@mail.analytics.hbs.edu says:

Nicely composed. As the Millennials older tiers are getting a little more aware of their
pending retirement (only 27 yrs away) and the reality of what their parents are now
experiencing first hand with their 401K, I believe you’re right that these brokerage fund
leaders will have to adapt or follow the path of the traditional steel mills.

Thank you for the insight and the tips.

Nick Moen

Reply

MARCH 1, 2020

Shina Adu says:

Nick, spot on. The demographic tide is another major reason why the industry will
experience a shift. The new generational is not as dependent on and/or trustful of
financial advisors. They ask more questions and demand more value. There is a
projected $68 Trillion wealth transfer ensuing within the next 2-3 decades as
baby boomers pass on, their children will do business differently. thanks for
reading!

Reply

MARCH 1, 2020

William Fine says:

Shina, your case study is something I have tremendous interest in, yet am
embarrassingly infantile in my familiarity with the industry. From reading your case, I
need to do something to fix all of that! Also curious about the Platform building part of
the industry and finding out more how it relates to what we’ve studied. Great job and
can’t wait to talk at Immersion! -bill

Reply

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MARCH 2, 2020

Shina Adu says:

Look forward to that Bill!! Most of us are not exposed to the inner workings of the
brokerages – it is a rather closed. It doesn’t have much bearing on daily life. Can
we merge both industries for GUI + investing game platforms??

Reply

MARCH 2, 2020

Jeremy Langer says:

Shina,
I really enjoyed reading your case study. Your summary really helped me understand
how to apply what we’re learning into a real case scenario for myself. My best friend
used to trade coffee futures on the NYSE and I was lucky enough to get a guest pass
onto the floor during an era when I was clearly classified in the “Burlington Coat
Factory” category. In the last couple of years, I’ve been buying and selling a handful of
stocks with which I’m familiar in my IRA. It’s high risk, high reward (until last week),
but it ultimately feels safe to someone like me who can’t wrap his head around puts,
calls, index funds, mutual funds, bonds, etc. Understanding how the brokerage firms
are operating or need to operate going forward will make a difference for someone like
me who wants to trust the brokerage firms and not feel threatened by endless streams
of fees.
Jeremy

Reply

MARCH 2, 2020

Shina Adu says:

LOL @ “Burlington Coat Factory” .. thanks for the feedback. I have not been on
the NYSE floor just yet, high frequency trading might one day rival those market
makers. Complex trading and derivative products are already being handle by
quants with powerful algorithms, I think discount folk will not have access to that
kind of computing power for a while. The business model is changing,
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consolidation will increase and hopefully we will get a better deal in the new
world. @ Last week, par for the course but that was real pain!!

Reply

MARCH 2, 2020

Oksana Hansen says:

Great case. As I was reading about this I couldn’t help but wonder how the government
is going to treat FINRA regulated personnel like my husband and I. I also wonder what
this looks like for individuals who hold their money at several different brokers and have
a diversification strategy. Great Read. I think that one thing that is great about the
human touch is when you have lots of businesses, assets, and other things that you are
managing across multiple generations, etc. This may not be the right way to go.

Reply

MARCH 2, 2020

Shina Adu says:

Thanks Oksana, very true!! I am also FINRA regulated myself and constantly
wonder the best approach to certify robo-solutions. The robo-advisor piece was
allowed as long as certified 9/10 or series 24 principal could be held responsible
for the process. A 407b will be relatively easy to monitor, as algorithms can
monitor trade across several brokerages.

More complex portfolios will likely follow a hybrid format.. part AI part human. In
that space there will be real value for human experience. Hard to imagine AI that
is a CFP or CFA

Reply

MARCH 2, 2020

alan.rodriguez@mail.analytics.hbs.edu says:
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Great case. Does it provide access to derivative contracts?

Reply

APRIL 6, 2020

Shina Adu says:

Hi Alan, not to the best of my knowledge. Derivative contracts present elevated

risk levels and are instruments geared towards sophisticated/institutional
investors and are thus, highly regulated for suitability. One day perhaps!

Reply

MARCH 2, 2020

JINGRU LI says:

Thank you so much Shina! It is a great case and I learn a lot from it.
I am a layman of the finance industry, but I am very interested in what you mentioned
stock investment revolution with data technology and ecosystem platform. I would like
to try the AI advisor app.:)

Reply

APRIL 6, 2020

Shina Adu says:

Thank you Li, we are all right up there with you! Most people need an advisor who
understands investments/instruments and financial planning. AI powered apps
are designed to enable further democratization of investing, no experience
required.

Reply

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MARCH 4, 2020

Michael Higgins says:

Excellent case & discussion Shina. It will be interesting to see who is held responsible
for the recent technology issues they’ve faced just these past few weeks. Do you think
that could help clarify some of the oversight issues?

Reply

APRIL 6, 2020

User deleted this comment on April 6, 2020

APRIL 6, 2020

Shina Adu says:

Thanks Michael, I assume you are referring to the Robinhood app crashing?
Certainly, that has revealed flaws within the system, especially when confronted
with elevated volumes!! Trading losses will result in litigation. @ Responsibility,
therein lies the conundrum of adopting AI in investing, I believe the management
of the companies will be held accountable by regulators. I would highly doubt
programmers/developers will be on the hook, except perhaps internally.

Reply

MARCH 8, 2020

Vlad Muste says:

Great case and summary of all the moving parts in the financial ecosystem. What
regulatory obstacles have you observed that have been lifted over the last decade to
allow for further digitization of the financial consultant and what barriers do you foresee
as being removed in the near future?

Reply
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APRIL 6, 2020

Shina Adu says:

Comments much appreciated Vlad. The DOL fiduciary rule which was vacated by
the courts was a major barrier to innovation in this area – the burden of
documentation posed a significant hurdle. Recently, I noticed FINRA hiring
software developers and engineers. I see regulators providing guidance which
includes algorithms as a channel of service/advice delivery. The suitability bar
might also be lowered for algos, so the future is fascinating.

Reply

MARCH 9, 2020

Klaus Seiler says:

Thank you for sharing your very interesting and structured case! I should have listened
more to you during the platform simulation since you very clearly do have a much better
financial understanding than I.

For me, access to IPOs under “Strategy 2” is so interesting because there are so many
promising startups and getting access to invest early in those offers a margin that is
unseen in commercial financial products. I work for a startup myself self and while I am
lucky to receive equity, investing in the company is limited to an “exclusive” club just
by default alone since it only possible for my company to manage a few large investors
and not many small ones.

Under “Strategy 1” you mentioned another interesting aspect to use A.I. for financial
planning and supervision. Now, my novice understanding of the financial market is that
there is always some dynamic where someone’s loss is another one’s gain. Fast forward
to a time where everyone has access to the latest and greatest financial A.I tools so that
everyone makes similar good financial decisions, how might this affect the financial
market globally?

Reply

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APRIL 6, 2020

Shina Adu says:

LOL! You driving was perfect for the team! We crushed them twice

Totally on the money with IPOs, historically it remained a huge differentiator

between the rich and the not-so-wealthy. I believe it’s a game changer if it
catches on. Especially because established wirehouses/underwriters want a slice
of that pie.
For you as a stakeholder, a successful IPO increases value and benefits the VCs
as well. It will be interesting to watch how well the next few IPOs are priced.

In the world of A.I. directed investing, the zero sum game effect will be reduced.
Investing is equally a factor of time, resources (networth) and risk appetite. A.I.
will be near ruthless with suitability determinations and perhaps will not permit
less sophisticated folk into certain riskier investment products. The markets will
still go through boom-bust cycles, I reckon peaks and troughs will be diminished
as returns become linear. I see a battle for more advanced+sophisticated AI to
provide an edge to countries, large money managers and uber rich investors!

Reply

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