Although the real-money Rule Maker Portfolio counts itself as a customer of AmEx brokerage, we're really more concerned about this situation from our perspective as shareholders of the company. American Express is our third-largest position, making up 9.1% of the portfolio. As shareholders, we care deeply about how and why management makes decisions, and we used this interview as an opportunity to assess how well AmEx is running its online brokerage, one of the company's more significant expanding opportunities.
All in all, we found the interview to be very insightful. To AmEx's credit, in making this price switch, they owned up to the fact that they entered the online brokerage market last year with a flawed pricing plan. Their liberal offer of free trades was a case of "the bait you use determines the fish you catch." AmEx caught some fish that it didn't want to keep. As a result, the company made the tough decision to bite the bullet and change its value proposition -- at the risk of losing customer trust. It's unclear as of yet whether AmEx will lose more in customer mistrust from this move than it stands to gain from the improved economics of its new value proposition.
What follows are some excerpts from Barry Murphy's comments that offer an inside look at the AmEx brokerage business model.
The thinking behind AmEx's new pricing structure.
"We did extensive client research on the people we attracted [as clients of AmEx Brokerage] in the May/June period using a professional research firm to see who we have, what they want, and what our future in this business is. The findings were quite clear and very dramatic.
"Of about 16 attributes that our clients want, the top three outpaced all the others by far. Number one, they want a website that's stable, useable, and intuitive. Number two, when they call us, they want service that's quickly available from intelligent people who are well-informed about their business and are open 24 hours a day, 7 days a week. Number three, they want advice. For some people, advice means advice on the website that can be printed out. For others, it'll be advice on the phone from people who are licensed and competent. Or, advice face-to-face with people whom they would have a longer-term relationship.
"Those three things -- the website, service, and advice -- that's what we're going to do because that's what our clients told us they want from us. And it was an unbelievably heavy vote in that regard.
"Price on the list of those attributes was number nine or 10 out of 16. [According to our research] clients liked our price and that was very attractive to them, but it wasn't the prime motivator.... So, when we restructured our pricing, the notion was, we're at $14.95, which is at the very lower-end when we do charge people; we thought we could move that up to $19.95. And there's been virtually no reaction to that."
The nonprofit zone at AmEx Brokerage
"We have several clients who were trading two or three or four hundred times per month -- who are trading in one or two shares at a time. And that, frankly, was business that we didn't anticipate. We didn't know there were that many people who would trade that often for one share. That was a segment we did not know existed. And frankly, we reinvestigated that because it is not a segment we're interested in -- at any price. That was not what we were trying to attract....
"Let me talk about the Tier II group, which are the clients with $25K-$100K in assets. Consumer behavior in this group was to execute a huge numbers of buys, in small share increments [accumulated into one large block of a single stock], followed by one sell [of all those accumulated shares]. So, if you want 100 shares of a stock -- that's 20 buys and one sell. And that behavior was happening quite a lot."
Little negative reaction from customers -- so far
"We track the number of people who are contacting us every day, and those numbers of contacts are so much fewer than we had estimated that we are ecstatic. We track it every day -- by e-mail, by phone, and by the nature of the protest.... Our contacts have been in the hundreds, not thousands. Of course, people can vote with their feet, so I can't tell you that we know what the attrition will be over the next few months. But from a telephone and e-mail basis, the contact we have received is substantially lower than we anticipated."
The need for charge to limit orders
"The limit order being free allowed people to place four or five or six orders, all around a price target.... We incur the cost of the data processing while holding a trade pending to see if the price is ever met, and it might execute at one of those prices. There will be one limit order executed for six or seven orders placed. And then we didn't earn any money on the limit order that ultimately executed. So for the six or seven orders you placed, we traded one, and you didn't pay us for that one [if your assets were more than $25K], but we incurred the cost for all seven.... The economics of that became very poor."
The AmEx Brokerage advantage: no advertising.
"One of the reasons the economics of [the free-trade pricing structure] were possible for us is that we virtually don't advertise. We spend a total of less than $10 million on advertising. That is opposed to Ameritrade (Nasdaq: AMTD) and E*Trade (Nasdaq: EGRP) who are in the $200 million-per-year range, and Schwab (NYSE: SCH) and Fidelity at $300 million per year. We have decided to put that money into the offer -- into the technology, into the service -- because we think longer-term, if we can create loyal clients with a value proposition around the website, service, and advice, that's enduring and endurable and better for the customer. It's the lack of advertising that allows this thing to fly."
The big-picture view of AmEx's brokerage business.
"We make money through [interest spreads on] cash and margin. We're particularly attracted to clients who would value a relationship with an American Express advisor at some point during their tenure with us. We do offer clients the ability to speak to an advisor if they'd like, and 50% of the clients who've received that offer have accepted it. The economics of that longer-term relationship with an advisor are very attractive.
"Obviously, some clients are totally do-it-yourselfers, some people are completely advisor-dependent, and most people are in between. Our shtick here is to attract both ends of the spectrum -- very advisor-focused, very do-it-yourself -- and bet that most people during their lifetime are going to want advisors for different events of their lifetime, and we want to be the company that will accommodate you during your do-it-yourself stage, accommodate you in your advisor-dependent stage, and accommodate you when you want to pick and choose along that continuum....
"So, we think we can straddle that full-service brokerage model and the direct model, and have an integrated model that gives customers unparalleled flexibility to choose how they want to deal with us. That's our long-term bet in this market. And that's quite a different business model from our competitors."
So there you have it, AmEx's say on the rationale behind their fee restructuring. We want to thank Barry Murphy for taking the time to speak with us.
Does this change your assessment of the acceptability of AmEx's new price structure? If you're thinking only as a customer, it may not. Perhaps try to considering it from a shareholder's point of view. Let's put it to a poll.
Note to reader: As of last night, we've rolled out our new Comparable S&P 500 benchmark (this replaces what we had been calling S&P 500 DCA) in the Rule Maker index tables (just scroll down and you'll see it). This tracking tool gives readers an apples-to-apples comparison between the overall return of the Rule Maker, which invests $500 in fresh capital every month, and the S&P 500, which has been adjusted as though $500 were added every month there as well. This metric has an added benefit: The comparison is based on the date we deposit money into our Rule Maker account, not the date we make a trade. It makes for a tougher comparison, but we think it's the most conservative way to track our returns and one that gives readers the most accurate representation of our results. For more information on this thorny topic, and the importance of tracking the portfolio's internal rate of return, check out Matt's story last Tuesday.
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