Shares of Motley Fool Stock Advisor selection Charles Schwab (NYSE: SCH) are off a couple of percentage points since the discount broker announced yesterday morning that it would once again reduce its trading fees to improve its competitive position.
The price reductions are intended to make Schwab more competitive in what has become an intensely competitive field that includes companies such as Ameritrade (Nasdaq: AMTD), E*Trade (NYSE: ET), Toronto-Dominion's (NYSE: TD) TD Waterhouse, and Fidelity Investments. However, the price cuts will also be accompanied by at least a short-term reduction in revenue.
After the price cuts are implemented on November 1, Schwab expects a 2% reduction in revenues from current levels over the following 12 months. However, CEO Charles Schwab noted that the company's cost-reduction initiative "has already identified more than $200 million in annualized expense savings for 2005."
Earlier this year, Schwab had announced an initial price reduction (see Schwabbing the Decks and Reinventing Schwab) for clients with more than $1 million in assets with the firm, as well as active traders. This time, the company will extend price cuts across its entire customer base, lowering its base online trade rate from $29.95 to $19.95 per trade for the first 1,000 shares plus $0.15 per additional share. Clients with $1 million in household assets at Schwab will still pay $9.95 per online trade, and active traders who make 30 or more stock trades per quarter -- or 120 trades over the prior 12 months -- also will see their rate reduced to $9.95 per trade.
Schwab also reduced the rate on broker-assisted trades and trades made through the company's automated phone service, and eliminated quarterly service fees associated with its Schwab Independent Investing Signature service.
Schwab's actions serve to highlight the value of competitive advantage and the nature of the service. For example, online auctioneer eBay (Nasdaq: EBAY) has long been able to raise auction fees due to its strong brand and lack of competition. Similarly, coffee retailer Starbucks (Nasdaq: SBUX) recently announced its own price hike. And as fellow Fool Nathan Slaughter astutely pointed out early in the summer, "Some investors will always be willing to pay for hand-holding and advice," where Schwab offers some form of competitive advantage.
However, Nathan's relevant point here is that "others will always seek out low-cost trade executions." Competition is growing for a service in which Schwab isn't appreciably any better or worse than its key competitors. What's more, further diminishing Schwab's advantage, I think that investor resources are also improving considerably through the ease of obtaining information on websites such as Yahoo! (Nasdaq: YHOO) Finance and The Motley Fool (shameless plug).
Add that together, and it is competition that determines Schwab's lack of pricing power. And as the latest price reductions show, that lack of pricing power comes at a cost of overall profitability.
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Fool contributor Jeff Hwang owns shares of eBay and Starbucks.
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