With the invention of the internet and the ongoing digital transformations, many everyday practices changed. I believe that one many of us can relate to, is stock trading for individual investors and the business models of the brokers we use.
In the traditional setting, we notice that a lot of communication is needed for buying or selling stocks. The brokers must actively seek to acquire a client base and then do research about the financial market to generate stock ideas. They will then communicate buy/sell recommendations to clients over the telephone and finally the brokers would then use their systems to order the stocks with their people on the trading floor. With this much communication and systems needed, cost for placing orders were high. This means that stocks had to rise (or fall) a lot before a profit was made. (Beattie, 2015)
Because more and more people started connecting through the internet a new type of stock brokers emerged: Online Traders. The first company to offer this online trading was K. Aufhauser & Company in 1994 (!). On its website “WealthWEB” individuals were now able to order stocks directly and therefore minimizing the role of the agent they had to contact in the past.
With this development there was also a big change in the business models of brokers. In the traditional setting, brokers generated revenues from mostly payments for orders and trading commissions. They generated a lot of revenue on relatively few people.
The quality of traditional brokers varied dramatically across individuals, making it hard for investors to choose the best among them. Also, it is difficult for investors to discern whether or not the brokers have made a well-informed recommendation after only having had a brief telephone conversation. (Wu et al, 1999)
According to Wu, the online trading model however, is much more dynamic. Because of the huge amount of data available the investor got a much more active role in his own portfolio. With the Internet serving as an information gateway, the investor can do everything that the retail brokers used to do. With online trading, they can make their own decisions, and trades are executed instantaneously, at essentially the same price.
The business model for online brokers today is about delivering service and value. Convenience, control, accessibility and low commissions make online investing very attractive to individual investors. They generate revenues mostly from trading commissions, net interests from margin accounts, and (sometimes) payments for orders. Their goal is to generate highest possible traffic through an effective system with quality service. So in contrary to traditional brokers, they try to make profit through volume. (Investopedia, 2015)
To conclude, through digitalization and a change business models we can now trade stocks faster, cheaper and more convenient than ever before.
Author: Sven Sabel
Beattie, A. (2015) ‘The birth of stock exchanges’, http://www.investopedia.com/articles/07/stock-exchange-history.asp, last visited: 9-9-2015.
Wu J., Siegel M., Manion J. (1999). ‘Online trading: An internet revolution’, Sloan School of Management Institute of Technology (MIT) Cambridge.
Investopedia Staff (2015) ‘Brokers and online trading: Full service or discount’, http://www.investopedia.com/university/broker/broker2.asp, last visited: 9-9-2015