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Analysis of the E-brokerage Industry

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Executive Summary

The financial brokerage industry has undergone dramatic changes worldwide in the last decade, due to the rise of the Internet. E-brokerage brought huge opportunity to the industry as it introduces enormous amount of on-line traders but at the same time posted serious threat as it open up the market to new competitors. In this thesis, we investigate past and current challenges the brokerage industry faced. From our literature review, we studied the impact of online trading to the brokerage industry and the online traders, and proposed solutions pinpointed to the facts we found. We studied the challenge the brokerage industry faced from the perspectives of strategy, marketing and technology and carried out strategic analysis using value chain and framework of five forces by Michael E. Porter. A small scale survey was conducted to collect local people attitude towards online/mobile trading and we used the data collected to justify the information we found during our literature review. Finally, we proposed a basket of suggestions for the brokerage industry in various aspects including product enhancement, customer education, partnership, differentiation, customer segmentation and more. An in-depth interview with a local broker firm was organized to value our suggestions, their feedback are positive.


The tough challenge among e-brokerage industry is still going on and in fact, it is getting even more furious. The situation was more rigorous during bearish market after the burst of IT foams, SAR outbreak and the recent financial tsunami. The strategy the brokerage firms adopted to handle the challenges they faced determine who will survive the competition and stay in the market. Losers will soon be squeezed out of the market. This is especially true for small to median size local brokerage firms who are now facing new competitors like direct banks and oversea online trade provider like E-Trade. Confronted with growing competition, old-guard brokers are being forced to restructure and re-focus their market offerings. Various strategies were adopted, some brokerage firms seek to maintain their lead in value-added services through a focus on knowledge/advise - more financial planning and investment advice - rather than transactions -processing trades. Other firms attempted to comprehend how to offer on-line services without alienating their brokers, to minimize channel conflict.

The purpose of this article is to analysis the current e-brokerage practices and device new service directions and enhancement to existing products to increase competence of our local brokerage industry. We will first present the evolution of security trading in Hong Kong and characteristic of different types of brokerage firms and customers. From our literature review, we found that online trading exerted great impact on both brokerage industry and online traders. For brokerage firms, they faced vigorous competition due to new competitors, reduced customer loyalty and market fragmentation due to low entry barrier. While illusion of knowledge and control, lack of personal advice and overwhelmed by information were the hurdle online traders faced. We have presented the strategic challenge faced by the brokerage industry and analysis their strategy using value chain and framework of five forces algorithm. We have devised a basket of suggestions and discussed with a brokerage firm the feasibility to comprehend our research.

Financial Broker Industry In Hong Kong

Evolution of security trading in Hong Kong

The ultimate goal of a well-functioning stock market is to bring together all possible buyers and sellers, so that the market price reflects the combined preferences of all participants. The history of securities trading in Hong Kong can be traced back to 1866. The present Sock Exchange of Hong Kong (HKEx) was established as a result of the unification of four exchanges during the big market boom in 1986, while the first stock exchange began its operation in 1891.

Exchange System Architecture

Computerized trading system was first introduced on 2 April 1986 and in 1993 the exchange launched the "Automatic Order Matching and Execution System" (AMS), which was replaced by the third generation system (AMS/3) in October 2000. AMS/3 is the core system used to serve securities trading which has significant enhancements in central market functions, open connectivity and system capacity as compared with AMS/2. AMS/3 supports multiple trading facilities for market access. Most of the participants developed their own Broker Supplied System (BSS) which interfacing with AMS/3 via the Open Gateway (OG) facility for greater control to the front-end solutions instead of the Multi-workstation System (MWS) by HKEx. The open connectivity of OG has made possible the large-scale automation of Participants' operations, enabling Participants to offer new investor services and experience efficiency gains. In 2002, a new generation of the system, CCASS/3, was launched for clearing and settlement. MDS (Market Data Feed System) is the key system used for delivery of securities price data to about 60 local and international information vendors. HKATS (Hong Kong Futures Automated Trading System) is the electronic order matching system operated for the derivatives market.

Advancement in information technology, especially the Internet, is revolutionizing traditional commerce. Obviously the securities industry, and in particular the on-line brokerage, is at the forefront of this revolution. Here in Hong Kong, retail online trading as a proportion of total retail investor trading continued to grow in 2008/09, reaching 43 per cent from 39 per cent in 2007/08. Its contribution to total market turnover was 10 per cent, up from 7 per cent in 2007/08. For stock options, retail online trading contributed 23 per cent of total retail investor trading (up significantly from 15 per cent in 2007/08) and 2 per cent of product turnover (1 per cent in 2007/08). For other derivatives, retail online trading contributed 49 per cent of total retail investor trading and 18 per cent of total product turnover (up from 44 per cent and 15 per cent respectively in 2007/08).

Types of Brokerage Firm

The basic function of a brokerage firm is to execute buy and sell orders for clients. Traditionally these firms have offered the investigation of the quality and the possibilities of investing in a variety of investment products. It is still accustomed for brokerage firms to offer information about possible investments free of charge. This activity of bringing free of charge stock investment reports is one of the main tools that are utilized by brokerage houses to compete against other firms. To investors, it continues to be an important service. However, with the bloom of communication technology, especially the Internet, more and more investors rated that investment reports as less important service. Instead, those investors preferred other types of services that charged less commission and service fee, by forfeiting those investment reports. In order to capture this vast diverse clientele, the brokerage industry segmented itself. After the restrictions in commissions were eliminated, several brokerages began to open up their doors as discount brokerage firms. At that time, brokerage firms were classified into two types: full service brokers and discount brokers. Full service brokerage firms continued to offer informative stock reports and a level of service much higher than other brokerage houses. They looked for purchasing and selling opportunities for clients and offering more customer and portfolio advisory service than was available from discount brokers. Discount brokerage houses, on the other hand, only dedicated themselves to execute orders for clients with minimal services. These differences in services and philosophies led to great differences in commission costs. It was evident that these differences were an important factor in the return of an investment.

Type of customers in brokerage industry

In Hong Kong customers of brokerage firm can be divided into three typical categories:

l Prestige Group: These are customers with large amount of capital put in to the brokerage firm for investment. They have granted total authority to the brokerage firm to execute trading decision on behalf of them. Although they are minority in terms of the customer base of brokerage firm, they contribute a great portion of revenue to the brokerage firm.

l Middle Group: Customer of this group usually trade through account agent of the brokerage firm. They utilities financial information, report and analyzing tools provided by the brokerage firm to make trading decision. Account agent will also actively contact these customers whenever they see an investment opportunity fit for them.

l Basic Group: Customer mostly uses service of brokerage firm to maintain account balance and execute trading order on the own. Although multiple channels are supplied to them, they mostly adopt on-line trading as their first choice of trading media.

Although the first two groups of customers contribute quite a large portion of the revenue of brokerage firm, we will concentrate our research on the third group for two reasons. First, there is a clear trend that this group of customer is increasing in a fast pace. Second, by investing and improving the on-line system, the other group will also be benefited.

Literature Review


Simply put, “On-line brokerage” can be defined as selling of securities which encompasses equity like stocks and warrants and derivatives like bonds, mutual funds etc, on the Internet. Although traditional banks and brokers also provided online trading after year 2000, new entrants like direct banks and new brokers offered a genuine e-commerce business model. Direct banks are internet-only banks or "virtual banks". These banks were designed without a traditional banking infrastructure with physical branches. This cost-saving advantage enabled many of them to offer savings accounts with higher interest rates, loans with lower interest rates and minimal management fee and commissions than most traditional banks. More and more customer joined in as online trade and a peak was hit on year 2000. At the same time, new competitors like traditional brokers and virtual banks joined in proactively by acquiring existing brokerage firm or using their own business model. At that time, then customer base and knowledge of the traditional institutions was still advantages for online trading enhancement.

The strategy online brokers adopted was customers segmentation and directed their offer to the most preferred customer group, the active private investors, which allowed them to swiftly catch up the market. Compared with banks, absence of physical branches thus low overhead costs gave these internet brokers an advantageous in cost structure. They competed with each other rigorously to achieve the biggest market share in the shortest time frame to reach the break even point. The strategy to conquer and develop loyalty of new customers was invested massively in marketing. They also adopted a cut-throat commission rate to attract private individuals who were more sensitive to this cost of investment. The position of banks and traditional brokers in the brokerage business was deeply undermined by the pressure caused by these new entrants.

Bloom of on-line trading

For the first time ever, investors could, from the comfort of their own homes, accessed a wealth of financial information including breaking news developments and market data on the same terms as market professionals did. In addition, on-line brokerage provided investors with tools to analyze this information, such as research reports, calculators, and portfolio analyzers. Finally, on-line brokerage enables investors to act quickly on this information. The technological and regulatory barriers that gave traditional brokerage and securities companies' edges were rapidly becoming extinct. First, new provider quickly gained access to the market by leveraged on the use of Internet technology. Without expensive branch networks and labor-intensive advisory services, new competitor like direct banks and new online brokerage firms were able to process retail clients' orders in relatively low cost. Second, the bull markets in year 2000 attracted large number of new online customers. For example, lot of local residents became online investors and started to hold security when frequent and gigantic scale IPO activity were taking place during 2006. These new customers welcomed the new internet investment style that encompassed vast amount of free of charge real time information, enhanced market transparency, convenience and low commission. Together with the rising share prices in bull market atmosphere, these new customer, in particular, heavy traders quickly got accustomed to doing online trade.

The Internet also made other comparisons easier. For example, it increased price competition for products for which price comparison was previously more difficult. New information applications enabled investors to compare the quality of trade execution provided by different brokerages and thus extend the trading costs that investors consider beyond commissions.

Companies scrambled to create viable strategies that balance many priorities. Typical considerations included:

  • Should they defend their existing customer base or enter into new customer segments?
  • Grow their existing business or expand into new products?
  • Acquire, partner or go alone?

Basically, companies were competing not only to offer different and better products and services, but to design robust, lucrative business models that took advantage of emerging forms of electronic commerce. Electronic commerce - the facilitation of exchange of value over computer networks - fundamentally changed the brokerage business in part by increasing the velocity of financial services [1].
Impact of on-line brokerage

Hurdle on brokerage firm

Rigorous competition

With the advancing Internet technology, investors had became less reliant on stockbrokers for trade execution or obtaining research information as such services were readily available on the Internet. In addition, the Internet was a convenient and efficient channel for doing stock trade transactions and for providing information support to investors. Indeed, the trend of self-investing led to the proliferation of Internet brokerages around 2000, offering trading services on the Internet at very low commission rates compared to using traditional brokerages.

Reduced customer loyalty

Lower transaction costs online led many investors to e-brokerages and away from traditional brokers to place their trades Another concern was that since investors feel that they can distinguish between the good and bad advice that they find on the Internet, they therefore were not be willing to continue to pay a financial planner solely for their expert opinion. This was in part due to the information illusion discussed in next section: illusion of knowledge and control, where investors feel that since they have access to so much information that they had no need to pay for such service and can do it better on their own.

Reduced customer-broker cohesiveness

Before on-line trading is prevalent, a single stock trade typically involves multiple telephone conversations between a customer and a broker. The broker may take the opportunity to reinforce the personal relationship with the customer by discussing pros and cons of the trade or offer tailor-made investment package. On the contrary, on-line traders are more on their own. Together with the convenience to switch broker, the loyalty of the customer to the brokerage firm is largely weakened. Although transactions are the bread and butter of brokerage companies, brokerage firms were also strived to developing client relationships in order to provide total solution to their customers. The income by providing strategic planning, advisory services, financial advices, margin loan and other client services are also vital to brokerage companies..

Market fragmentation

Market fragmentation occurs when too many competitive suppliers enter an active or new market. It happened starting from 1998 and peaked around 2001, when online trading started to take off and attracted many different competitors. They all aimed attract on-line investors and to achieve the largest possible market shares by all means, for example, by giving them some extra bonuses. However, the sudden downturn of the market quickly turned a lot of these new investors to passive customers, if not entirely retired, due to lack of knowledge and experience. This phenomenon was even more obvious after market started to plunge beginning at 2001.

As a matter of fact, it is too risky for e-brokers' to over-rely on commission as the main source of revenue. After all, the demand for brokerage services highly depends on investment atmosphere of stock market. The number of on-line executed orders during bullish and bearish market varies significantly. These large variation experts high risk for those who base their income on commission. In order to safeguard possession of active traders during both bullish and bearish market, it is very important to educate them and foster a correct investment culture.

Lower entry barrier

The Internet changed how information is delivered to investors and the ways in which investors can act on that information. On-line brokerage provide a effective and convenient access media between customers and the brokerage firm, the unit cost of operations is much reduced. It had lowered both the fixed and marginal costs of producing financial services, thus enabling newer, smaller companies to challenge established providers of these services. On-line brokerage firms, such as E*Trade, are among the most vivid and successful financial service firms to provide on-line financial advice, research tools, and financial information that emerged in the last decade. These e-commerce firms transformed the way traditional services were delivered and offered a vast assortment of new services.

Hurdle on customer

Investors in general and on-line investors in particular now make decisions in a very different environment than investors in the past. They have access to far more data. They often act without personal intermediaries. They can conduct extensive searches and comparisons on a wide variety of criteria. Although the quantity they can produce may be large, it is the quality that matter. As a consequence, they trade more actively, more speculatively but less profitably than before. On-line trader stress heavily on commission and management cost when choosing broker firm to use. However, there are other unobservable costs that are unaware by them: information-processing costs, information illusion, illusion of control, frequent trading behavior, and the lack of personal advice.

Information-processing costs

Information-processing costs are the costs that online investors sustain before they actually make a transaction and it is defined by the time and energy that the investor expands trying to reach an investment decision. Because of the huge volume of information found on the Internet that it can take investors a lot of extra time to find, sort, and analyze all of the relevant information. This in turn can out-weigh the benefits of online trading for some investors because they might not be able to afford the opportunity. In fact, the overwhelmingly huge amount of information available on the Internet scales many investors away, let alone their validity or intentional hoax.

Illusion of knowledge

The proposition that more information leads to better decision-making is intuitively appealing. But the truth of the proposition depends on the relevance of the information to the decision and on how well-equipped the decision maker is to use the information .The vast amount of on-line investment data available will enable investors to confirm their prior beliefs and may lead them to become overconfident in their ability to pick stocks and other securities. Faster feedback may focus investor's attention on recent performance. Psychology shows that when people who initially disagree on a topic are given arguments on either side of the issue, they become further polarized in their beliefs. They are impressed by the arguments with which they already agree and they discount opposing views. Not only are people more impressed by arguments they favor, but they actively seek out confirming evidence. For this reason, investors are more likely to visit chatrooms or forum of like-minded investors. If controversies ensue, they are likely to be convinced by those with whom they already agree. Investors who believe that additional information makes them better investors are unlikely to seek out or attend to evidence that indicates otherwise. Thus, on-line investors are likely to become overconfident. They may believe that they have more ability to perform tasks such as stock-picking than they actually do. In theoretical models, overconfident individual investors trade more actively and more speculatively than they otherwise would, hold under diversified portfolios, have lower expected utilities, and contribute to increased market volatility. In an empirical study of investors at a large discount brokerage who switched from phone-based to personal computer-based trading by Barber and Odean, they find that after going on-line, investors tend to trade both more actively and more speculatively.

Illusion of control

This illusion results when investors think that because they have access to so much information via the Internet that they have an advantage over the entire market and this can lead them to make bad investment decisions. These investors then have an exaggerated sense of control over the outcomes of their investments. Frequent trading is another cost associated with online investing. Low transaction costs can encourage frequent trading and day-trade strategy according to Konana, Menon and Balasubramanian. As an example, in Singapore, 71.1 per cent of online investors say that they trade more frequently than they did prior to online trading (Teo, Tan, & Peck, 2004). Researches show that most of the on-line traders adopt short term trading strategy: a risky strategy rather than the believed "buy and hold" strategy. The Internet also seems likely to change what information investors focus on, because it reduces the cost of some kinds of information more than others. For instance, the Internet especially facilitates comparisons of real time data, and thus has changed investors' focus by emphasizing the importance of speed and immediacy. While the serious individual investor of a decade ago may have checked stock positions once a day in the morning paper, casual investors now may check theirs several times an hour. Many more investors pay attention to short term-even intraday- return trends than ever before. Worse still, many firms advertise their ability to deliver real time data or to execute investors' orders rapidly, making the situation even worse.

Lack of personal advice

The downside of investing online is the lack of personal advice from those in the financial field (Vakil & Lu, 2005). According to Phelan (2001), the Web will never be able to substitute for the judgment and expertise of financial planners, nor will it be able to protect investors from all of the scams that are abundant on the Internet. In reality, the news and new information people found on the internet might not be as new as they think. Moreover, many online traders only focus on the here and now and do not look at the whole picture or at the future as financial advisors are trained to do, thus jeopardizing their investment.


Our research examines the pressures for change over the past decade that was overcoming the inertia in the brokerage industry. We viewed the challenge from the perspectives of traditional brokerage firm and electronic brokerage firm.

Traditional brokerage firm

To provide online trading, traditional brokerage firms were forced to decide on which of the two approaches to go, either establishes new subsidiary with a new brand name or provide under its own name. For the first case, brokerage firm suffer from overlapped company structure and considerable marketing expenditure to build the new name, which prolonged the period to reach break even point. The later case, though easier to setup, brokerage firm is putting their reputation at stake when the service do not meet customers' expectation.

The strategy adopted was to have differentiated brands serve the younger, more tech-savvy investors that gravitated to on-line trading without nibbling full-commission business. With the advent of the World Wide Web, discount brokerage firms face a comparable disintermediation dilemma. Commissions were suddenly under pressure, customers wanted to trade directly, and competition is coming from non-traditional sources like direct banks. To address the competitive threat, some entrenched firms adopted the supermarket approach by providing other supplementary services like providing financial information and news. However, such approach was in fact a typical re-intermediation path that directly competed with full service brokerage firm which offered a wider portfolio of products and services. Nevertheless, creating a financial services supermarket was a misguided strategic choice for three reasons:

- First, many successful 1990's businesses have rediscovered the virtues of adhering to their core competencies and the power of strategic outsourcing in order to gain agility. Most of the conglomerates which attempted to enter the financial services arena - learned the hard way that adding unfamiliar lines of business can dilute their ability to compete, weaken shareholder and customer loyalty and multiply management complexity. The reason for failure was economic. Risk and cost sharing in the production or delivery process can enable better time to market and make providing a product/service bundle more efficient than integrating everything in-house.

- Second, offering additional products to an existing customer base does not prevent customers from leaving. Also, the decision to add new products to an existing portfolio is complicated by an uncertain environment such as the Internet. In an uncertain techno-marketplace, a firm is often making an informed guess about what it thinks is best for a customer without fully knowing what that customer's preferences and goals are.

- Third, technology-enabled firms like ETrade were taking the “re- intermediation” path in a new way by providing customers with interactive and personalized services at little or no cost. This branding and trust-building approach enables the service providers to learn directly and accurately from each customer what's actually important to him or her. Armed with this intimate customer knowledge, these companies are better positioned to build loyalty and increase profits for the long term. Clearly, re-intermediation was a difficult strategy as sustainable competitive advantage was becoming rare in the on-line environment. High performers today look for a series of short-term advantages over a long period of time instead of attempting to plot a far-sighted course in an environment with too many unpredictable variables. Innovative Internet-based intermediaries were the real threat to the entrenched players. These firms were adopting dramatically more effective means of forging interactive relationships with customers added value, which was essentially the incremental benefit that the new "in the middle" firm brings to the customer. They were looking to exploit synergism across different product lines. They innovated more frequently and organized to seize opportunities much faster than their competitors. The reason was: concentrated focus on traditional sources of competitive advantage - such as cost, technology, and differentiation - was inadequate because competitors were quick to replicate advantages. They seek to identify and rapidly responded to subtle changes to the finest ingredient: the individual customer. To sustain competitive advantage, it was important to embrace business practices that encourage deep customer insight and thinking about how to materially improved the customer's value proposition.

Electronic brokerage firm

Online brokers rushed to pour money to increase their capacity to absorb the fast growing demand during dot.com boom in 2000. The only way considered effective to increase market share at that time was advantageous offers and promotions, combined with enormous marketing expenses exposing them to a very high costs. The development of the online brokerage market was highly dominated by such marketing approach. Absence of physical branches and thus reduced operation cost entitle internet brokers the advantageous cost structure. Instead, they allocated this saving and invested on massive marketing campaign in order to achieve the biggest market share as soon as possible. By attracting and developing the loyalty of new customers, these brokerage firms were expecting soon to reach the break-even point.

The bull market during the dot.com boom had dusted the eye of these online brokers. They failed to anticipated adverse situation when significant downturn in capital investments occurred and stroke their over investment. The stock markets had proved its volatility in a year time, when the dot.com boom burst in 2001. The serious regression caused by global slump of economy and the later SAR outbreak during 2003 had made the situation even steeper for the industry. The depression lasted for a couple of years before reaching a rising track started on 2007. Stock market transaction was drastically dropped from hundreds of billion down to tens of billions and last for years. Investors were either scared away or suffered from great lost by the sudden market plunge and prolonged recession. The once admirable capacity had turned into the biggest burden for brokerage firm. Naturally, all of them suffered from great investment lost, if not bankrupted altogether.

All the internet brokerage firms had paid a huge price for this costly experience. The lesson they learnt made them re-evaluated the challenges ahead and the goals to attain. They have learnt that low commission rates or excessive marketing expenses would not give them competitive advantages and made the break-even point harder to reach. Instead, they had to revise the services they offered and discover alternative source of revenue. Suffered from the great impact of market volatility, they were looking for a flexible enough business models that is able to cope with the huge capacity demand during a bull market while enable them to safely transit bearish market. We can classify the challenges facing online brokerage firms into three categories: strategy, marketing and technology.

Strategic challenge

The characteristic of online brokerage had fundamentally changed the brokerage industry. New competitors like insurance companies, banks and financial portal had entered the arena. With the competitive advantage in possessing technology, a large customer bases and knowledge of their customers, they posted great threat to traditional brokerage player who want to participant in online brokerage. The large customer bases not only significantly reduced marketing cost but also helped to minimize development and operation cost due to economy of scale. Coupled with the open standard characteristics, traditional brokerage players had an up hill battle to fight.

The value chain of the brokerage was invaded by these new competitors, forcing traditional players to re-evaluate their strategy. The value chain can be broken down into five links:

  • Provide data service including quotation, market information, charts and analysis tool to customers
  • Advise investment opportunity to customers
  • Collecting orders and submit to HKEx to execute the order on behalf of the customer
  • Manage account balance
  • Manage security balance

New competitors were mostly affecting traditional brokerage players at link 1 and 3. For example, financial portal provide delayed or simplified stock market information to their customer and provide hyperlink to redirect them to their associated trading platform. As a result, traditional brokerage firms were confronted with two strategic choices: specialize in one of the link of the value chain or spread out resources and provide total solution for the whole value chain. They had to carefully weighted the pros and cons of each strategy from their own perspective..

Marketing challenge

Electronic online brokerage had fundamentally changed the way they provided services and products for their customers. They believed the most effective approach was to focus on service complexity. The business model enabled them take control of the whole value chain, thus eliminate the need of intermediaries. As a result, they had bundled lots of gadgets to the customers. They provided complementary information including economic information, financial news, investment reports, stock commentaries and much more. Tools for investment training, analysis and portfolio management were also put in the disposal of their customers.

However, during the last several years, more and more institutions entered the online brokerage industry and led to market fragmentation. They imitated others features into their online service to make it richest content-wise. It was this vicious cycle making it difficult to for brokerage firm to differentiate their services offered to customers. These homogenous services leaved customer no choice but to take cost as the decisive factor when choosing brokerage firms to trade. This is obviously an unhealthy situation for the brokerage industry.

Technological challenge

Compare to traditional brokerage firm, the need to provide channels for contacts and trading, both quantitatively and qualitatively is even bigger for online brokerage firm. The versatility of Internet has provide such channel in various forms including web sites, email, Internet phone, web applications and even set top box for HDTV. In addition, with the advancement in GPRS and 3G network, the afore-mentioned applications are readily available to the mobile network users thus giving them advantages in mobility and interactivity. Although it gives little competitive advantage, telephone is still regarded as the most available channel for communications between brokerage firm and customers. Therefore, brokerage firm should put in resource to ensure its high availability through telephone, both in terms of number of phone lines and staff answering the call. It is vital for brokerage firm to maximize between high availability and cost and come up with an optimized combination of channels for their customers.

Technology, especially Internet technologies is ever evolving and replacing the old one. It is no surprising there is chance for incompatibility between new technoloy and legacy system. Investing in new technology entail thorough exploration of compatibility issue beforehand. It is vital for every company to ensure those new technologies can be efficiently and effectively integrated into the existing legacy information system. In some cases, they may have to consider applying the new technologies in parallel with existing system or even abandon the legacy system altogether. Either case, it is very important to a backup / roll back plan before any such transition or integration is made. Failed to observe this importance will undermine the capabilities of the whole system, if not bring down the whole system and interrupt the service.

There is three system solutions to consider when establishing online brokerage service to their customers:

  • Have the new information system running with legacy system in parallel, the approach adopted by most of the traditional banks.
  • Revamp existing information system using latest technologies. This is the most risky and challenging approach but offer saving in cost and time for dealing with legacy system.
  • Provide online brokerage service by establish a new subsidiary. This approach leverage existing systems and reduce the risk of undermining company's reputation if failure occurs. However, this approach introduces overlapped operation cost and thus reduces profit.

The strategic positioning of the brokerage firm will be influenced by the choice of approach. After all, adopting which approach will largely depends on the nature of the brokerage firm, including company scale, technological expertise, established fame and attitude to risk management.

Brokerage firm should also optimize operation of their back office. Internet investors, especially active and day traders are very demanding on the availability and speed of the trading system. Brokerage firms must strategically allocate resource in building the infrastructure. Over investment increases expenditure and reduces their profitability, especially when market slumps and makes capability in excess. On the other hand, under investment lower customers' satisfaction and undermines company's reputation. And finally, the arguably most important issues concerning online trading: transaction security and privacy, must be addressed comprehensively. Even a single failure will exert tremendous impact on the company and expel customer away, making it extremely difficult to build up market share.
Strategic Analysis of the e-brokerage market

We performed a strategic analysis of the online brokerage market, based on Michael E. Porter framework of five forces, to illustrate the situation the e-brokerage firms are facing:

The intensity of competitive rivalry

There are around 30 brokerage firms in Hong Kong, all providing e-brokerage services. Together with banks and other financial institutions, there is no doubt that the level of competition among online brokerage provider is very high for such a small market. Although e-brokers are trying their best to choose a different set of services and financial products, their efforts are in vein. In fact, technological restraints and active imitation of service/product among brokerage firms makes differentiation extremely difficult. Their offers are very similar in nature thus making such approach not very productive. As a result, forcing brokerage firms resort to destructive price competition.

The threat of substitute products or services

Threat of substitute products and services can be reduced by enriching their trading portals. Additional services may include insurance, property market information, tax and accounting services. However, there is new competitor whose core business is not impossible for brokerage industry to provide. For example, an interactive TV provider that provides stock trading capability is obviously something that brokerage industry is incapable to provide. They must resort to partnership in this case.

The threat of the entry of new competitors

The feature of being open standard is attributable to the swift development of the Internet. The common standards and high interoperability by hardware and software modules enable indispensable applications and system solutions to be build. This is known as network effect or network externality, a phenomenon whereby a service's value increases as more and more people use it which in turn attract more people to join in. Although this is in favor to the new competitors, it posts a threat to existing online brokerage firms. The interoperability also discourages proprietary applications and thus making product differentiation even harder. With a cost saving structure of absence of physical branches, the entry barrier for new or future competitors is further lowered. However, in 2000, Morgan Stanley published the result of their study on investors' preference and showed that consumers preferred recognizable financial brands with physical branch rather than to the purely online brokerage company link direct banks in the purchase of financial products. Furthermore, without a highly recognizable brand name, new competitors have to put in enormous resource in marketing campaign, thus giving advantages to existing brokerage firms.

The bargaining power of customers (buyers)

Their clients are gaining more and more power, which stems from relatively good access to information and their ability to build virtual and informal organizations like virtual communities(like blog, forum, newsgroup, etc.) that constitute a strong business partner, which must be taken into account. Whenever the individuals who belong to that kind of organization are not content with the quality of the service they can easily and very quickly make the information available to rest of the group and thus can provoke a real "storm" among customers. The Internet also makes comparison of services provided by different brokers easier. With low switching costs the consequences for e-brokers are obviously high volatility.

The bargaining power of suppliers

The main suppliers of e-broker are technology suppliers, the sole trading supplier HKEx and quotation service suppliers. HKEx do not compete with the brokerage industry for customer, except for EIPO service. Although public can apply IPO directly through EIPO free of charge, they have to transfer to bank or brokerage firm before they can sell it. However, the fact that HKEx monopolized stock trading makes brokerage industry have virtually no power when negotiating fee issue. For the other two suppliers, brokerage firm is still having an upper hand and greater bargaining power. However, a low entry barrier of brokerage industry means that the rising group of financial intermediaries who do not offer end-to-end service builds a stronger supplier position, which results from simple law of demand and supply.


To create a sustainable strategy in the long-run, firms will have to place an emphasis on understanding and responding to customers' real preferences in four different aspects:

  • What content the customer is really interested in?
  • What is the demand for new technologies? For example, security and personalization.
  • How sensitive is the customer towards service fee?
  • What service attributes do the on-line customers see important?

If the four dimensions are in sync with one another, customer will find the product or service have high level of “ease of use”, which will be a key selling feature of new technologies and products. If the dimensions are out of sync, then a feeling of discomfort will develop leading to potential defections.

Value Chain

The brokerage value chain consists of four main parts:

  • Supplies stock quotation service to customers
  • Collects orders
  • Executes orders (submit order to HKEx)
  • Manage security balance, include collecting dividend shares.
  • Fund transfer between third party like bank.

The emergence of new competitors has entailed the destruction of the value chain of the brokerage and forced traditional players (brokers and banks) to rethink their strategy. New rivals are attacking traditional brokerage players at the stage of client contact (function 1 and 2 of the brokerage value chain). For instant, mobile operator's financial web portal redirect their user to associated online broker for doing trading. Thus brokerage firms are confronted with a strategic choice. They have to decide whether to adopt a niche strategy on one element of the value chain, or to choose a volume strategy on the whole of the value chain, where integration will be driven more by the offer so as to reduce production costs and increase value created for the customers in every stage of the value chain.

The first case means banks have to recognize the superiority of new competitors in the management of the customer relationship on the Internet. Since the latter do not suffer from any structure inherited from the past, they have adopted a dominant strategy based on cost. This repositioning of retail banks is translated by the separation of the activities of production and distribution, and a greater specialization of banking institutions according to their comparative advantages in one of two activities.

These two strategies present numerous risks for retail banks. By specialising in the activity of production that is by supplying infrastructures or products to other banks, they agree to compete with their own distribution network. It is notably the case of the Banques Populaires group, which through its subsidiary, Xeod Bourse, processes the orders of the on-line broker Consors. This service has allowed this company to establish itself in France, and to compete with the brokers on the Parisian market place, and, in particular, with the stock exchange department of Banques Populaires (Line Bourse).

However, if this bank had not brought out this service, this broker would have found another supplier and it would have lost the volume of transactions, which it generates. Now, the customers of this type of on-line broker are much more active than those of large traditional banks.

In the United States there are five times more on-line brokers than in France but this is due to the scale of the American market. However, comparing the ratio number of brokers/population, it can be stated that they are equal, even if there are 100 American brokers versus only 20 French entities. But not only should the number of e-brokers de considered but also, the quality and technological advancement of their services.

American brokers enrich their value chain by aggregating new services. The traffic generated by their sites allows them to negotiate agreements of cross selling or to take participation with other financial suppliers in creating new services. One of the first agreements, which released mechanisms of this movement, was the partnership between E-trade and E-loan (the on-line loans activity) in March 1998. So, E-trade offered mortgages to their customers and conversely E-loan sent them back to E-trade's site for their stock-exchange deals. However, both of them finally got divorced and found other partners: E-loan operates with Charles Schwab and E-trade co-operates with LoansDirect. E-trade also has shares in the capital of Telebank (retail banking activity). The objective of these brokers was to become a kind of one-stop-shop where their customers would have made all their financial operations. In fact American brokers' offer is much more diverse and innovative when taking communication tools and services into consideration.

It is based on their way of evolving which can be described as follows: first they just offer a pure broker services; then they became a financial portal where one could find many additional information and supporting services. But the last stage of the evolution is an idea of a financial supermarket or financial one-stop-shop which can satisfy any financial need of the customers. It covers everything from simple stock exchange orders through the different insurance and real estate businesses to on-line payments.

We can quote the example of Bank of America and its "build your own bank" concept, which repositions the customer as the "consumer entrepreneur". In this case, the customer builds and personalises his relation with his banker. In return, the banker develops an autonomous and specific relation with his customer as well as an important database for commercial and marketing purposes. This step is innovative [MIC 98] and inverts the plan of the classic relation (banker/customer). Indeed, the customer takes the initiative to deliver the information to the bank; in return the latter offers him high added value services so as to make him a loyal client.

As the Internet took off, online discount brokerages like E*Trade and others realized that it would change the fundamental forces in the market, and that successful players would need to take a completely different approach. The key was to identify and scale the right features by desegregating the existing value chain. The logic goes as follows: If E*Trade can desegregate, and drive costs down, it can lead the way to new business models while establishing a well-branded position that is hard to assail . Functionally, every on-line brokerage value chain is comprised of three main categories: Distribution, Customer context and Tools and Content.

Distribution - Electronic distribution - Internet Service Providers, providers of home and on-line banking services and traditional banks - that must be in place to distribute the product, such as on-line advice and trading. D istribution infrastructure also helps in new account acquisition and development.
Customer Context - Context makes discrete content bundles more interactive, entertaining, easy to navigate and understand. Increasingly, industry leaders are less concerned with the piece parts, and more concerned with unifying them into an experience for the do-it-yourself investor. This act of framing the customer context has become a key element of on-line strategy. The proper mix of content, context and community is emerging as a new frontier.

Tools/Content - The valuable information that is being delivered, such as real time quotes of stocks, options and futures contracts, investment newsletters, up-to date information on stock upgrades and downgrades, and charting and analysis programs. Content also includes high-end advisory services which are crucial for retaining customers. Traditionally, tools and content components were always necessary to do analysis on content. The emergence of electronic commerce has shattered the unified or vertically integrated model and has enabled the tools and content components to be de-coupled and largely outsourced. Unbundling the value proposition requires functional decomposition.

Functional decomposition, often initiated by the new market entrant, is the basic building block of any strategic design process. To illustrate how the functional decomposition of the brokerage industry consider how the old bundle of functions is fracturing into discrete services. Table 1 illustrates the portfolio of services offered in the brokerage industry. The objective of functional decomposition is to either eliminate non-core functions or creatively integrate functions dispersed among several different players to reduce cost, improve system coordination and responsiveness. 17

Advisory Services
Charting/Analysis Programs
Mutual Funds
Real-time Stock Quotes
Online Wealth Management
Historical Data
Tax Accounting & Reporting
Internet Service
Regulatory Organizations
Order Execution Services
Search Engines

Unbundling the Value Proposition - E*Trade and Microsoft Investor Neo-intermediaries like E*Trade and Microsoft Investor have disassembled and reassembled distribution channels and content into integrated collections18 of functions. They are essentially controllers of customer context. Take for instance, E*Trade.

1) Channel Infrastructure - E*Trade leases the required network infrastructure from third parties such as America On-line, AT&T and Microsoft Network. At the back-end, E*Trade provides clearing and execution services to its own retail brokerage operations, as well as to independent broker-dealers, depository institutions, registered investment advisors and financial planners.

2) Context - E*Trade's objective is to provide a wealth of information in a highly personalized, interactive context, which creates an entertaining environment that attracts active traders to its websites, fosters brand awareness and encourages more frequent trading. One of the new techniques for providing context in the on-line environment is to build end-user communities around specific types of stocks. By organizing its websites by stock types, E*Trade is able to aggregate targeted demographic user groups, thereby offering advertisers and sponsors access to highly defined audiences. 3) Tools/Content - E*Trade provides content and tools from sources like Quote.Com, InvestTools and other sources through 'content alliances'. Theobjective is to provide individual investors with access to multiple sources of independent investing advice, research and interactive services that help them make profitable investment decisions. By outsourcing content, E*Trade benefits from access to new and fresh content, turnkey market hardened commerce systems, low costs, and a share of the revenue. The partners gain by getting access to an efficient distribution channel and a strong brand.
Reallocation roles and responsibilities as the customer determines what they will do and what they will pay for in the market

Creation of strategic alliances with complementors - firms whose products complement yours - in order to generate traffic and build brand awareness;
Repackaging and emergence of both commodity and differentiated service providers that serve the needs of the “new” customer; and
Emergence of patterns of loyal and disloyal behaviors in buyers, sellers, and intermediaries which causes the whole process to recycle again.

The ability to rapidly re-aggregate value is a core competency which offers significant competitive advantage. As customers demand novel products to meet their evolving needs and as innovative firms discover ways to combine products to lower total cost or improve some aspect of their financial service, neo-intermediation is emerging as a competitive strategy. The first step in devising an effective neo-intermediation strategy is to consider the nature of the demand for the products. Many aspects are important - for example, customer segments, demand patterns, content partners, demand predictability, product variety, and market standards for service.
Transactional versus Knowledge-Based Products

Brokerage products can be classified on the basis of their demand patterns in two categories: transactional or knowledge/advisory.

Transactional products include real-time stock, futures and options quotes, charts, and execution of trades. Because such products satisfy basic needs, which don't change much over time, they have stable, predictable demand and long life cycles. But their stability invites competition, which often leads to price competition and low profit margins. To avoid low margins, many companies introduce innovations in terms of bundles to give customers an additional reason to buy their offerings.

Knowledge/advisory products include pre-purchase information such as analyst reports, advisories, newsletters and recommendations. These products range from commodity information to sophisticated advisory services. Knowledge products keep the investor informed and help them make better decisions. Although knowledge can act as a transaction stimulus and enable a company to achieve higher profit margins, the very novelty of knowledge and advisory products makes demand for them unpredictable. In addition, their life cycle is short because as imitators erode the competitive advantage that innovative products enjoy, companies are forced to introduce a steady stream of innovations. The short life cycles of these products further increase unpredictability. It may seem strange to lump technology and knowledge together, but both types of innovation depend for their success on customers changing some aspect of their trading patterns or value proposition. 27

Strategic failure is often caused by a mismatch between the type of product, a specific target segment, with distinct requirements and needs and the type of intermediation structure. The choice is dictated by whether a firm elects to compete on low cost, operating excellence (e.g., by emphasizing reliability), customer context creation (e.g., by emphasizing customization), or superior choice.

- Low Cost Trading.

The customer's value proposition is simple: low or lowest price and hassle-free service. The predictable nature of transaction products makes market mediation easy because a match between supply and demand can be achieved. Companies that make such products are thus free to focus almost exclusively on minimizing transaction costs, given the price sensitivity of most trading products. In this instance, the important flow of information is the one that occurs within the chain as suppliers, resellers, and delivery channels coordinate their activities in order to meet demand at the lowest cost.

- Level 2: Integrated Trading.

The value proposition is to offer products that push performance boundaries. Reading early customer reaction or other market signals and reacting quickly, during the new product's short life cycle is critical in Integrated Trading models. In this instance, the flow of information occurs not only within the service chain but also from the marketplace to the service chain. The strategic decisions to be made are not about minimizing capacity costs but about creating barriers to competitive response. To do so, the firm may have to lock itself into an efficient internal process or into ties with partners.

- Level 3: Integrated Account Management.

Most important in this environment is providing the customer with an integrated set of products and delivery channels. For instance, Schwab provides Web access, direct dial-up access, and access through on-line service providers such as America On-line and Microsoft Investor. Also, on-line customers have access to Schwab representatives in branch offices nationwide. On the product side, Schwab provides integrated access to hundreds of mutual funds through Mutual Fund OneSource service. In this service, customers find the portfolio manager's commentary, fund philosophy and fund prospectus information. In order to hedge against uncertain demand, suppliers should be chosen for their speed and flexibility, not for their low cost.

- Level 4: Trading Community.

Most important in this environment is customer choice (see Table 2). This involves having a full range of services available to serve customers upon demand - this may involve running a 'see-through company', in which a variety of goods or services are available quickly through contract arrangements. The resulting networks or value-adding partnerships are like confederations of specialists. They are flexible and specialized, and they emphasize inter-firm relationships, with a pooling of complementary skills and resources to achieve shared goals. The uncertain market reaction to context innovation increases the need for flexibility and adapting to changing demand. Short product life cycles increase the risk of obsolescence. Market mediation costs are higher for Trading Community products.

Co-Branding and Traffic Growth

One of the challenges of e-brokerage is to manage soaring branding and marketing expenses with plummeting commission rates. E*Trade has shown the brokerage industry that a firm with a great brand image can win customers and service their financial needs via products from third parties. The importance of establishing market share for new products increases the importance of effective branding. Any activity that is not central to the context creation strategy can be performed better by another organization. Along with rationalizing their activities, firms are exploring new marketing relationships and alliances with customers, suppliers, and intermediaries. The resulting openness to partnering is producing new collaborations for the sharing of activities such as co-branding and traffic growth. Wouldn't it be nice to have other sites that refer interested customers or even sell your products? This is what Amazon.com did to become the "world's largest bookstore" with their digital associates program. On-line brokerage firms are using similar tactics to build a franchise. Once a firm finds complementor sites based on customer segments that it seeks to serve, it becomes possible to: create mutual hyperlinks and banners, exchange or place ads, promote and sell each others products. The logic behind co-branding alliances is simple: an individual electronic commerce website can maximize its awareness and traffic through the use of strategic alliances with other websites having high user traffic. Through the use of embedded hyperlinks, higher traffic websites can refer potential customers to electronic commerce websites for potential purchases of goods or services. These agreements generally involve economic arrangements including up front payments or commissions on the dollar volume of goods sold. These payments are analogous to rent paid by traditional "brick and mortar" retail locations, and can be critical to an electronic commerce website's ability to expand. The new linkages require relationship management skills and careful negotiations. Both participants must realize durable mutual benefits in financial terms (through increased revenues or lower costs) or hard-to-quantify benefits due to risk sharing or the pooling of expertise and market knowledge. Such mutual benefits are increasingly feasible because of advances in information technology that have sharply reduced the costs of coordinating and administering transactions between partners. How can a firm choose a strategic arrangement when confronted with multiple possibilities? It should rely on strategic design principles, subject to the constraints of prior commitments, resource availability, and rigidities. The design choice must meet the requirements of:

1. Risk Management - Risk management is a key element of strategic design. Firms in high-velocity environments, where relationships are uncertain, are creating portfolio of options for coping with inevitable uncertainty of demand. These options enable a firm to explore context design by trial and error.

2. Customer Migration - design questions must be asked in the context of two different customer bases: existing customers and new customers. For a firm with an established customer base, the key question is: How do they reach out to the technically proficient investors without losing their margins or alienating their existing customer base. At the same time, how do they migrate their existing customer base quickly?


Our survey examines the demographic characteristics of online and non-online investors as well as their stock trading frequency and preferred stock trading method. We also studied their attitudes towards Internet stock trading in terms of security, cost. In addition, we tried to look for factors that affect them when choosing brokerage service, their willingness to pay for financial services and their attitude towards new trading channel: the mobile internet. Implications of the results are analyzed and discussed in details in this section.

As the research is descriptive and exploratory in nature, we did not put forth formal hypotheses as there is a general dearth of empirical research that examines Internet stock trading. Instead, we had carried out an on-site survey near a local brokerage firm to collect statistical data. To broaden the scope of participant, we had also posted a hyperlink to our web site to local investment forum, newsgroup and blog invite the public to take part in our survey through the internet. We had put in quite a few logic to verify against the data participant filled in while they were entering their choice. This ensured the correctness and completeness of the web forms submitted. A total of 183 questionnaires were successfully completed. The data was consolidated and presented in the following paragraph.

Our survey is intended to capture the following information:

  • Demographic characteri

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