The No-Service Broker Ameritrade's recipe for success? Plain-Jane online stock trading and the lowest costs among some pretty tough rivals.
By Kevin Kelleher

(Business 2.0) – Russell Fine used to be a serial broker-hopper. He opened and closed an account at E-Trade, and started another at Harrisdirect. He studied the pros and cons of other online brokers before he heard Ameritrade's boast of the fastest order executions. For four years now, Fine, an Internet entrepreneur who lives in Los Angeles, has stayed put. Ameritrade's $10.99 commissions aren't the industry's lowest, and its research offerings are paltry. But Fine sticks with Ameritrade for what it lacks--surprises. "I look at it as the McDonald's of investing," he says. "It's cheap, easy to use, and consistent. You know what you're getting, and you get it every single time."

If investors like Fine have remained faithful to Ameritrade through good times and bad, it's because, more than any other major online broker, it has kept faith with the little guy. The typical Ameritrade user is middle-age, makes less than six figures, and has built up about $250,000 in assets. Ameritrade won't advise on which stocks to buy, knowing that the do-it-yourselfers who flock to the site spend an average of eight hours researching a single stock.

Charles Schwab had built its business on that kind of customer. E-Trade had wooed them as well. But in the bear market that began in 2000, clients' portfolios shriveled, trading volume plunged, and a parade of sordid scandals left individual investors uncertain about returning to a market that seemed rigged. Brokerages had to find new sources of revenue. For E-Trade the answer was selling bank accounts and mortgages. Schwab moved into investment advice.

The same strategies were urged on Joe Moglia by analysts and institutional investors when he took the helm as Ameritrade's CEO in March 2001. At first the Merrill Lynch veteran was inclined to agree. But in the end, Moglia figured that if he stayed focused on the online brokerage business, he'd spend less, face less regulation, and hold fewer financial liabilities. "We are an Internet transaction processing company," Moglia says. "That's all we do."

The financial results confirmed the wisdom of his strategy. As soon as investors returned to the stock market last year, revenue grew twice as fast at Ameritrade as at its two main rivals. The company's operating profit margins rose to 63 percent of revenue in the latest quarter, from 29 percent a year before. By contrast, E-Trade's margins have only risen to 39 percent. "Ameritrade stuck to its knitting," says Matt Snowling, a senior analyst at Friedman Billings Ramsey, "and it's sitting pretty now."

Forget the Frills

How did Moglia do it? by keeping costs down. To see how frill-free Ameritrade is, look no further than Moglia's own office. Unlike his former corner suite at Merrill, which afforded a view of the Statue of Liberty, his Ameritrade office is a spartan 10- by 15-foot space overlooking the parking lot of an Omaha, Neb., industrial park. Ameritrade's customer service center operates out of an abandoned Younker's department store in a suburban mall. The rent is a steal, even in Omaha. Low costs let Ameritrade make money on accounts that others don't want. Schwab's extensive brick-and-mortar service centers and its army of advisers make inactive, low-asset accounts unprofitable to maintain. Schwab recently slashed commissions for its wealthy customers, but still imposes fees on accounts with less than $50,000; Ameritrade's fees kick in only for accounts below $2,000.

Pump Up the Volume

Nonetheless, Moglia's cost cutting was more nuanced than the usual "I survived the downturn" business story. Moglia took a contrarian, and seemingly contradictory, strategy: He cut and grew at the same time. While he axed 2,100 jobs--more than half the staff--in three years, he also bought four smaller online brokers and one giant, Datek. Paying $1.3 billion for the latter made Ameritrade the market leader in online trades. "With the Datek acquisition," says board member Glenn Hutchins, a managing director at investment firm Silver Lake Partners, "Ameritrade doubled down on its strategy rather than diversifying."

Within nine months of the merger, Moglia had worked out 95 percent of the integration questions--who stays, who leaves, and what technology standards prevail. He made a point of letting employees know where layoffs might occur and what their severance and benefits package would be, as well as their share in a bonus tied to the success of the integration. "We told those people, 'We'll let you know as soon as we know,'" Moglia says. "Most people don't do that, and it's one of the biggest mistakes they make, because they are not treating their people with respect."

The payoff was heady. Ameritrade brings in an average of $19.74 per trade--the $10.99 commission, plus fees, interest income, and rebates from market makers. But at current volume levels, executing each trade costs only $7.32. The company won't lose money unless its volume declines to 29,000 trades per day. (It bottomed out at 100,000 in February 2003 and rose to 212,000 a year later.) If its trading volume rises above 350,000, whether through more acquisitions or a bull market, its costs would fall to $3 per trade and its margins would rise to 85 percent.

Branch Out ... Carefully

Ameritrade is also boosting trading volumes through technology. It has created an automated portfolio-building service that warns investors when their asset allocation moves away from preset levels. The company is also adding new functions that mimic the program trading of big institutional investors. Ameritrade's site will now let investors set stop-loss orders that rise along with a stock's price: If an investor wants to sell a stock when it drops from $20 to $18, that two-point spread will stay put if the stock rises to $22, $24, or above, an innovation in online trading.

The danger, of course, is that no matter how Ameritrade tries to maintain basic service, more of its best customers will demand red-carpet treatment. History shows that when customers' assets grow large enough--$500,000 or more--they start to want higher levels of service. Even now customers entrust an average of only 25 percent of their assets to Ameritrade. To gain a bigger chunk of its most profitable clients' money, the company must step--carefully--into limited forms of investment advice while somehow avoiding a Schwab-like cost structure. When Russell Fine, who now has more than $1 million with Ameritrade, started asking questions that went over the heads of the company's customer reps, Ameritrade assigned him a single representative to help set up advanced maneuvers like out-of-the-money puts and calendar spreads. It's a perk the company will soon offer to all high-net-worth investors. "Now they know what my issues are, so I can close my eyes and not worry about it," Fine says. But while Fine may be content for now, Moglia is going to have to keep his eyes wide open.