Transcript E*Trade: Case Analysis

E*Trade: Case Analysis
Executive Summary
E*Trade was a first-mover in the online brokerage market. Because of
this, they achieved early brand name recognition and an adequate
customer base. However, by the late 90s, competition was heating up
and the offline brokerages were waking up. E*Trade needed to change
its strategy to face these challenges. They needed to expand their
customer base to other investors beyond the online world. But to do so,
they faced barriers to entry with their lack of complementary assets in
the offline world. E*Trade overcame the traditional barriers to entry by
spending significant amounts of money on their technological
infrastructure and aggressive advertising. E*Trade Group wants
consumers to use its financial services for E*verything and marketing
the E*Trade name has been a key component of their success.
E*Trade’s strategy focused primarily on customer acquisition and
building a strong brand. Over the last two years, E*Trade spent $640
million on brand recognition and marketing. Schwab, which is eleven
times the size of E*Trade, spent only $520 million in the same time
frame.[1] The E*Trade ‘Monkey riding through a deserted dot.com ghost
town’ advertisement, which aired during Super Bowl XXXIV in 2000 and
reached an audience of 130 million, was named the #4 greatest Super
Bowl advertisement of all time by consumers.
[1] Chen, Huang, Wong, and Wong, ibid.
Executive Summary

The company continues to expand its
services to make up for shortfalls in trading
income resulting from Internet fallout. The
Internet fallout caused their stock to fall and
also online traders to decrease their use of
E*Trade service. This continued slump could
make E*Trade a takeover target for a larger
financial services firm looking to broaden its
online services. (Hoover)
SWOT Analysis and Sustainability
Strength
Weakness
Strong reputation as the first online broker
Quick access
Wide variety of products and services
Introduction of clicks-and-mortar strategy
Not the lowest price
Weak in research and advisory services
Opportunity
Threat
High growth of online trading market
Expand business to International market
Easy entry
Rapidly changing environment

E*Trade has focused on customer acquisition and
building a strong brand since the beginning. This is
critical because in the financial industry, especially
on the Internet, trust and brand-awareness are
crucial for success due to the perception of low
security. It has established a firm position as the first
online broker in the online trading market. While
many brokers have entered and exited this market,
E*Trade has experienced phenomenal growth and is
among the top players in the industry.

Recently, the online brokerage industry has undergone changes and
companies have changed their strategies as a result. During the first
stage, online brokerages could attract customers simply by having
lower commission fees than traditional full-service brokers.
However, by the late 1990's, all kinds of brokers have begun online
trading services, and following the pure-play online brokers, have
provided lower and lower prices. So, the discount strategy is no
longer sustainable. Large, traditional brokers like Merrill Lynch, and
discount brokers like Charles Schwab, can provide new services by
combining their old off-line services with new technology. They have
strong capabilities, huge assets, strong analysis and research skills,
and large staffs. Moreover, new customers to the online market are
not as active as early Internet traders. They trade less often and are
less price sensitive. In addition, in e-business, including online
trading, switching costs are very small so customers can have
multiple accounts with multiple brokers, quit transactions midstream,
or shift to other brokers easily. In these difficult circumstances, pureplay online brokers have pursued other strategies to keep attracting
new customers.

E*Trade began preparing early for a shift in strategy. It
has tried to diversify its business and sources of revenue
beyond transaction fees. They not only offer a variety of
products - including mutual funds, proprietary mutual
funds, bond trading, and access to initial public offerings
- but have also begun to offer services other than
trading. E*Trade started Internet banking services in
1999, and it is the third largest operator of ATMs in the
U.S. The company has also become interested in the
bricks-and-mortar model. E*Trade decided to establish a
branded bricks-and-mortar presence with its E*Trade
Zones, which will serve as a branch office to compete
directly with both discount and full-service brokers. It
also decided to partner with Target to put both E*Trade
Zones and ATM machines in over 20 Target locations.

These new strategies have brought changes in
E*Trade’s revenue structure. While the most important
source of revenue is interest on customers' assets and
investments, mortgages, and fees from banking and
ATM services are increasing. Every e-business company
faces cutthroat competition. Most of the entrants are
kicked out of the market and very few companies can
survive. Moreover, it is more difficult to make a profit.
Even seemingly very successful “dot com” companies,
such as Amazon.com, face difficulties getting out of the
red. In such an environment, E*Trade’s lack of
dependence on transaction fees gives it financial
strength, and greater ability to expand its business.

Now E*Trade seeks to enlarge its market
share both in the U.S. and globally. It also
continues to expand its services, loans, and
personal banking. Sustained revenue growth
and good cost management will position the
company for sustained growth.
VIDE Analysis

E*Trade began life as a deep-discount online broker. As
one of the first online brokerages, E*Trade catered to
active, independent, knowledgeable investors who
wanted to execute trades as cheaply as possible and
who did not need expensive advice. For these investors,
even discount brokers were too expensive. They were
early-adopters of new technologies, including those who
were online in the late 1980s and early 1990s, and were
comfortable with the new online environment. E*Trade’s
value proposition was meaningful to a specific market
segment and, as an early mover, allowed E*Trade to
grow.

Since it’s earliest days, E*Trade faced competition from
other deep-discount online brokerages. Though its
market was growing, no-frills trading was a limited
market, so the company sought to broaden its services
to reach other segments rather than compete strictly on
price. This was a significant strategic decision. Since that
time, E*Trade has expanded its services into many other
area. The company offers mortgages, mutual funds, and
referrals. It has built the 3rd largest ATM network in the
U.S. and expanded internationally. It sells ads for all of
its websites.

E*Trade offers banking services, such as deposits,
CDs, and loans – along with all of the bundling and
cross selling opportunities that come with varied
banking and brokerage services. It is now
expanding into the bricks-and-mortar world with its
E*Trade Zones, which are essentially branch offices
which offer research and investment advice through
more personalized service. E*Trade has entered
into an agreement with Target to open E*Trade
Zones and ATMs in Targets stores.


Many of these moves were executed by E*Trade through
acquisitions. E*Trade has made over 15 acquisitions since the
early 1990s. This method is consistent with the company’s desire
to move quickly to attack larger competitors, and pre-empt other
similar competitors.
These moves to diversify by E*Trade have allowed it to attract
more customers and offer more services to its growing customer
base. The wide range of services adds value to E*Trade’s
customers because it allows them to consolidate their banking
and brokerage needs in one place. E*Trade becomes an
intermediary between a customer and their money. By
consolidating their financial services with E*Trade, a customer
builds loyalty because a switch will mean incurring switching
costs.


E*Trade has spent a considerable amount of money building its
portfolio of services, particularly its bricks-and-mortar operations.
The effect of this has been to build somewhat of a defense, and it
has worked. Some other pure-play online brokerages have indicated
that they will not actively pursue the building of similar capabilities.
In the long run, of course, E*Trade’s moves are imitable by
competitors. But in the short-run, it would be very difficult for another
online broker to copy E*Trade’s success as a late mover. E*Trade’s
expanded array of services set it apart from its competitors.
One of the significant benefits of the wider range of products and
services offered by E*Trade is its ability to cross-sell. Many mergers
fail because anticipated synergies fail to materialize. However, the
banking industry has consistently proved to be an excellent example
of synergy in its ability to effectively cross-sell products and
services.

E*Trade can continue to add value by offering additional products
and services and it can cross-sell across these offerings. By
doing so, it differentiates itself by allowing a more complete
financial solution for customers. However, the greatest threat
E*Trade faces is its inability to build effective long-term barriers,
allowing it to exploit the short-term competitive advantages
gained by its innovations. In the long-term, it is easy for other
firms to build branches and ATM networks. Many other firms
already offer research and investment advice. E*Trade is
particularly vulnerable against the larger players. They witnessed
the dramatic growth of Internet usage and online brokerage firms
during the late 1990s. By the late 1990s, they began entering the
online market.

Some predicted the demise of pure-play online brokerages when
the large, established players began to enter the market.
E*Trade, however, has continued to grow. This is despite the fact
that the environment has only deteriorated since the late 1990s
boom in valuations and day-trading activity. In the current market,
customers are more conservative, executing fewer transactions.
E*Trade’s real competitive advantage, its core competence, is its
ability to read the market and innovate, adding value to
customers before its competition. It would seem unlikely that an
upstart pure play deep-discount broker would be able to take on
giants such as Merrill Lynch and Charles Schwab. E*Trade has
not so much as taken them on as it has outran them. And it
continues to do so.
Models of Innovation

Innovation models can be applied to E*Trade
to give us insight into the company’s success
in the face of competition from traditional fullservice and discount brokerage houses.
Teece Model



Teece argued that two factors were instrumental in reaping profits from
an innovation. The appropriability regime, which is the extent to which
the technology can be protected from imitation, and complementary
assets, other non-technological capabilities the firm needs to exploit the
technology.[1]
E*Trade’s technology was easy to imitate as evidenced by the large
number of competitors who have entered the online brokerage market.
Initially, they were able to use their run strategy to stay ahead of the
competition, but this did not prevent imitation by others. Complementary
assets became one of E*Trade’s distinguishing features, but this was
not the case at the outset. It took heavy marketing, advertising
campaigns, acquisitions, and alliances to develop a now enviable set of
tightly held complementary assets.
[1] Afuah, Allan. “Innovation Management,” Oxford University Press,
1998.
Utterback-Abernathy Dynamic Model


The Utterback and Abernathy model details the dynamic changes
from a fluid phase to a transitional phase to a specific pattern.
Technological and market uncertainties comprise the fluid phase
and is a key time for entry by entrepreneurial firms. E*Trade entered
the market during this fluid phase when the changing technology
and acceptance of the world wide web provided them with an
opportunity to build a pure-play Internet trading platform.
Companies enter the transitional phase when they begin introducing
more and varied products. The market uncertainty is reduced and
research and development investment increases are justified. This
phase also requires major process changes due to rising volumes.
By this time, E*Trade had entrenched itself in the online trading
market and established a strong brand name. E*Trade changed its
focus to expanding services and technologically accommodating a
large, changing customer base. The addition of E*Trade’s wide
range of services including online banking, financial advice,
mortgages, insurance, college savings plans, etc. signified their
entrance into this phase.
Utterback-Abernathy Dynamic
Model

The transitional phase eventually leads to a specific
pattern whereby cost reduction becomes the focus.
This phase is also characterized by a more formal
corporate culture with a greater number of levels of
authority. E*Trade has not moved fully into this
phase as it continues to diversify and reinvent
itself.[1]

[1] Abernathy and Utterback, “Patterns of Industrial
Innovation,” Technology Review, June/July 1978.
Exhibit 1: Stock Price History
Source: Yahoo!, www.yahoo.com
Exhibit 2: Value Chain
Retail Securities Industry Value Chain (Simplified)
Exchange/ Trade Executer
Stage I
Investor/
Decision
Maker
Broker/
Intermediary
Stage II
Stage III
Internet:
Full Service:
Discount:
Branch infrastructure
Financial Consultants
Low Transaction Fees
Fast trades
Lower Transaction Fees
Faster trades
24/7 availability
Access anywhere
Retail Brokerage Evolution
Exhibit 3: Balance Sheet for E*Trade
Balance Sheet for Fiscal Years 1994-2000
($ in thousands)
ASSETS
Cash
Marketable Securities
Receivables
Other Current Assets
TOTAL CURRENT ASSETS
9/2000
9/1999
9/1998
9/1997
9/1996
9/1995
9/1994
175,443
4,314,415
10,715,262
0
15,205,120
157,705
1,548,465
5,136,585
0
6,842,755
52,776
502,534
1,365,247
24,287
1,944,844
38,235
191,958
724,365
6,970
961,528
50,141
35,003
193,228
2,203
280,575
9,624
0
1,936
470
12,030
692
0
535
623
1,850
Prop. Plant & Equip.
Net Prop & Equip
Invest & Adv to Subs
Other Non-cur Assets
Intangibles
Deposits & Oth Asset
TOTAL ASSETS
334,262
334,262
985,218
0
484,166
308,671
17,317,437
181,675
181,675
828,829
0
18,554
160,361
8,032,174
50,555
50,555
59,276
3,719
0
7,892
2,066,286
19,995
19,995
5,519
3,259
0
5,121
995,422
9,228
9,228
2,860
0
0
2,218
294,881
1,458
1,458
676
0
0
0
14,164
313
313
0
0
0
0
2,163
LIABILITIES AND EQUITY
Notes Payable
Accounts Payable
Cur Long Term Debt
Cur Port Cap Leases
Accrued Expenses
Income Taxes
Other Current Liab
TOTAL CURRENT LIAB
3,531,000
10,777,331
0
0
470,742
0
0
14,779,073
1,267,474
5,074,360
0
0
207,961
0
0
6,549,795
0
1,244,513
0
0
83,659
0
0
1,328,172
9,400
681,106
0
0
21,542
0
0
712,048
0
225,555
0
0
0
0
0
225,555
0
2,369
0
0
0
602
0
2,971
0
430
1,314
23
0
9
415
2,191
Mortgages
Deferred Charges/Inc
Convertible Debt
Long Term Debt
Non-cur Cap Leases
Other Long Term Liab
TOTAL LIABILITIES
0
0
650,000
0
0
0
15,429,073
0
0
0
0
0
0
6,549,795
0
704
0
0
0
0
1,328,876
0
0
0
0
0
0
712,048
0
0
0
0
22
0
225,577
0
0
0
45
0
0
3,016
0
0
0
64
0
0
2,255
Minority Int (Liab)
0
0
Preferred Stock
31,531
30,584
Common Stock Net
3,101
2,838
Capital Surplus
1,814,581
1,320,338
Retained Earnings
-6,908
-26,060
Treasury Stock
0
0
Other Equities
46,059
154,679
SHAREHOLDER EQUITY
1,888,364
1,482,379
TOTAL LIAB & NET WORTH 17,317,437
8,032,174
Source: Disclosure, Inc., www.disclosure.com
0
3,000
2,313
685,553
33,786
0
12,758
737,410
2,066,286
0
0
399
266,953
16,022
0
0
283,374
995,422
0
0
295
68,738
271
0
0
69,304
294,881
0
1
149
9,899
1,099
0
0
11,148
14,164
0
0
150
1,241
-1,482
0
0
-91
2,163
Exhibit 5: E*Trade Market Share
Online Brokerage Market Share by Total Assets*
Charles Schwab
38%
Fidelity
30%
TD Waterhouse
10%
E*Trade
5%
Ameritrade
4%
CSFB Direct
2%
Datek
1%
NDB
1%
Scottrade
1%
Dreyfuss
1%
Quick & Reilly
1%
Other
6%
*Data as of 6/30/2000
Source: Brokerages Need Banking to Keep Customers, Web Finances, 5 (7): April 5, 2001, Securities Data Publishing.
Exhibit 4: Income Statement for E*Trade
Income Statement for Fiscal Years 1994-2000
($ in thousands)
Net Sales
9/2000
9/1999
9/1998
9/1997
9/1996
9/1995
9/1994
2,157, 958
955,470
335,756
234,128
48,991
23,340
10,905
126%
185%
43%
378%
110%
114%
267%
Cost of Goods
1,116, 433
517,794
138,942
95,933
38,027
12,819
6,796
Gross Profit
1,041, 525
437,676
196,814
138,195
10,964
10,521
4,109
R&D Expenditures
142,914
79,935
33,699
13,547
4,699
943
335
Sell Gen & Admin Exp
734,971
431,058
159,035
94,379
19,182
5,269
3,530
Inc Bef Dep & Amort
163,640
-73,317
4,080
30,269
-12,917
4,309
244
Depreciation & Amort
22,764
2,915
-36,427
-7,174
Non-operating Inc
Interest Expense
Income Before Tax
NA
NA
NA
NA
-1,929
NA
NA
-946
NA
13,529
NA
NA
NA
NA
NA
NA
NA
104,449
-83,406
2,151
29,323
612
4,309
244
Prov for Inc Tax
85,478
-31,288
224
10,130
-555
1,728
-541
Minority Int (Inc)
-181
2,197
NA
NA
NA
NA
NA
-2,454
NA
NA
NA
NA
NA
Ex Items & Disc Ops
NA
Net Income
19,152
Source: Disclosure, Inc., www.disclosure.com
-56,769
1,927
19,193
1,167
2,581
785
Exhibit 6: Broker Comparison Table
Online Broker Comparison 2000
Company
Fidelity
Schwab
E*Trade
TD Waterhouse
Ameritrade
DLJ Direct
Datek
NDB
Average
Average Online
Transactions per
Transactions per
Account per
Day
Quarter
Number of
Online Accounts
YOY Account
Growth
4,757,000
4,200,000
3,027,362
2,272,000
1,233,000
476,571
623,624
55%
40%
95%
96%
120%
58%
115%
100,771
203,500
150,000
151,900
105,540
24,949
97,638
1.4
3.1
3.3
2.7
5.6
3.5
10.6
268,900
69%
10,600
2.6
Source: Investext ™ by The Investext Group: Putnam, Lovell, & Thornton, December 1, 2000.
Exhibit 7: Online Brokerage Trading
Costs
Commission Fee Changes over Time
Feb. 1996
E*Trade
$14.95/trade
May
Ebroker
$12
July
Datek
$9.99
Sep.
Scot deal
$9
Oct. 1997
Ameritrade
$8
Nov.
Suretrade
$7.95
March 1998
Brown and Company
$5
Source: Piper Jaffrey, February 2, 2000.