Charles Schwab, back from the brink
The discount brokerage pioneer got his namesake company back to the top by returning it to its roots.
(Business 2.0) - When you think of innovators in the world of personal finance, Charles Schwab is the first name that comes to mind. The man who famously brought Wall Street back to Main Street by undercutting the big brokerage houses in the late 1970s was also one of the first to bring investing online (on CompuServe, well before the '90s Internet trading frenzy).
A stumbling giant
By the late 1990s, Schwab's eponymous company was the largest discount brokerage in the world and Schwab had handpicked his successor (David Pottruck, co-CEO from 1998 to 2003 and sole CEO afterward). He could certainly be forgiven for indulging in a few fantasies about spending more time on the golf course.
But it was not to be. During the recent boom and bust, Schwab's company began to founder. Schwab was still chairman of the board, but he says he attributed the company's problems to the state of the markets and didn't realize how bad things were getting. By 2004 it was clear that a change was needed.
The board stepped in and asked the founder to take back the reins. Schwab's most impressive performance -- turning around his own company after stepping away -- was about to begin. Eighteen months into the effort, we caught up with Schwab just after the company reported record quarterly and annual earnings and announced that it had surpassed $1.2 trillion in client assets.
Congratulations on that quarter. You must be very pleased.
I'm pleased, actually, with the whole of the year. 2005 was a very special year for me. The quarter was certainly terrific, but all four quarters put together added up to a record in terms of profitability. We hit the highest profits we've ever hit in 30 years, so that was pretty neat.
In 2004 you seemed on your way to a permanent tee time. All of a sudden, you're running the company again. How did that feel?
At that moment it was an overwhelming cascade -- like standing under Niagara Falls and you can't get out.
Can you tell me the story of how you came to be running the company again?
Well, it wasn't my decision. It was the board's decision. They had lost confidence in the CEO at the time, and they felt there should be a change. They asked me if I would return as CEO. And you know, I thought about it for a few minutes and I said yes. I didn't quite know what I was saying yes to, but I said yes.
What did you learn, once you started digging into the business, that surprised you?
I don't want to cast too many stones. Of course I was here, there's no question about it. I was chairman of the board, and I was witnessing a lot of negative things -- much of which I rationalized as being due to the markets. My hope was that management would pull this thing out.
I saw a variety of things. We lost the emotional connection with our client. We did a long series of things that antagonized our client relationship -- raising fees and rates in a bunch of areas, impersonal marketing. We lost one of the great sources of our growth in the past, our happy customers referring new customers to us. And as our pricing got disconnected from the marketplace, we lost all momentum with new customers who came from marketing and advertising. So the franchise was being seriously weakened. The morale in the company was about as low as I could have imagined. And our cost structure was totally bloated. We were sort of immobilized. Not a good place to be.
David Pottruck was your partner for a long time. Did that make taking over from him tough?
I don't want to make this a personal thing about David. But you know, what I found is probably indisputable. Certainly the markets had turned south, and we were victims of that. David has moved on to some other things. We've spent a year and a half restructuring the whole place, and we're real happy where we're at now. Completely different than a few years ago.
Part of your new message is that this investing thing is hard, and we're here to help. Why the change in focus?
When I started in this business, I was totally focused on the people who were self-directed, which is not more than 15 percent of the investing population. The other 85 percent really do need help, want help, and take help. The company grew from its origins of helping self-directed investors and do-it-yourselfers to where we now do business with 3 million households. We had to change.
What did the bust teach you?
I've seen a couple of manias in my work history -- emotional markets that got completely disconnected from reality. Certainly the markets in '99 and early 2000 were in that category. It was a pretty extensive mania. And there's nothing you can do about it, unfortunately. We had to ride through it because we were in that business. People sort of went crazy. You can coach people to diversify more, which certainly would have been one way for most people to get through that period better.
What do you make of the second coming of technology today? Is this time different in some way?
Oh, it's completely different. You know, the first one was just the first generation of the Internet and all the expansionist thinking, and it didn't make any difference what business you were in. If you were in an Internet business, you would be valued at 10 or 20 times sales, if you had any. Maybe 20 times eyeballs.
But now it's the second phase. The real thing is happening, a real revolution, and real income is occurring. And those firms that show that income -- there are a limited number of them, so that's why they're becoming more precious.
You have a lot of competitors trying to use the Internet as the channel to the customer. By contrast, Pottruck is credited with inventing the term "clicks and mortar" to describe Schwab's strategy of maintaining branches as well as a Web presence. What do you make of the online-only brokerages?
If you're going to be a major player in the financial-services industry, you've got to have the capability of face-to-face. It's been reaffirmed to me I don't know how many times. We have about 300 branches throughout the country.
Why do people still want branches in this day and age?
If we're going to be your bank, if we're going to be your financial-services person in a significant way, you get some comfort in the fact that we are nearby, we're not up in Omaha. You don't have to get in your car and drive to Omaha.
You've been slashing commissions recently, yet you're more profitable than ever. How does Schwab make money today?
If you hold some of our mutual funds, we make money there in management fees. If you have money in our money market funds, we make 0.4 to 0.7 percent of that a year. We also have a bank, so if you get a mortgage through us, we make some money on the interest spreads there.
Do you think 2006 is going to be a good year for the markets? What are you doing with your own money?
Well, I think you can build a portfolio, and I certainly think I have done so, a portfolio essentially for all markets. It's appropriate asset allocation and diversification. So that's something that you can do and have it perform quite nicely over long periods of time, through thick and thin. That's what I do.
Are there any short-term threats to the markets?
Well, there are two answers to that. Business is great. The American business scene is in pretty fantastic shape. Profits are up, and there's certainly optimism and confidence. Yet, in free enterprise worlds, there are cyclical movements, ups and downs, interest rates going up, interest rates going down.
As to the market, it's an emotional animal. It's the collective amount of fear and greed at any particular moment. You look at it by the hour, you get dizzy watching it. So my own view is you have to have a longer-term plan.
What are your thoughts about your own future with regards to the company? Are you thinking about succession plans? Well, sure. That's very natural for me to be doing that. And so that is always front and center as I've reorganized the company, making sure that there are some very viable candidates in our company now. That's my preference. I've got a little bit more to do before I'm totally comfortable taking that step.
I'd like to have every client of Schwab have the sense that they have a relationship with Schwab, which includes that they have somebody that they can trust, they can talk to, and that goes from the largest clients we have to even some of the smallest.
John Battelle is program chair of the Web 2.0 conference and author of "The Search" (Portfolio, 2005).
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From the March 1, 2006 issue