Amazon (NASDAQ:AMZN) has become a behemoth in the retail world.
Sure, the company's most recent earnings report may have left a bit to be desired, but there is no denying how far Amazon has come in a few short years. The company easily dominates the consumer world, and it has left a variety of big box retailers in its wake in the process.
While we can point to a number of reasons for Amazon's ascent, a key to their rise is clearly Amazon Prime. This subscription service-which costs $99/year-gives users free two day shipping, video content, music, and a number of other features as well. The deal is so good that some estimate close to half of the country's households have a Prime account , with plenty of new subscribers now being added in foreign nations too.
What is the point of this? Well, Prime members (at least in the U.S.) spend roughly twice as much as non-Prime users on Amazon, while the service has an insane renewal rate in the United States, over 90% according to the Consumer Intelligence Research Partners, so people are clearly seeing the value.
But with so many services and offerings in the Prime package, how does Amazon make any money? Well, the idea is clearly to suck people in to the Amazon ecosystem via Prime, and then keep them there for years. And with such a high renewal rate and spending that is double non-Prime users, it is clearly paying off. One only needs to look at the demise of other retailers in a number of areas to understand just how much Amazon is dominating the consumer world these days.
So, the strategy is to give people an offer that is too good to refuse in order to get them in the door and looking at higher margin products later on. As Jeff Bezos said , Prime is 'such a good value, you'd be irresponsible not to be a member'.
The Amazon of Investing?
We can see how Amazon has changed the world of retail and the consumer market, but is anyone doing the same thing for investing?
I'd argue that Charles Schwab (NYSE:SCHW) is adopting this 'Amazon model' in the world of investing, and this is especially evident after their recent move. Their latest announcement brought fees down to $6.95/trade from their previous spot at $8.95/trade, while Schwab also announced a fee cut on some of its broad market mutual funds, and that mutual fund costs would match their ETF counterparts too.
The company will now charge 0.03% for its Schwab S&P 500 Index Fund (MUTF:SWPPX), while the Schwab Small-Cap Index Fund (MUTF:SWSSX) will cost 0.06% per year. Additionally, the company also reduced fees for its Schwab U.S. Aggregate Bond Index Fund down to 0.04% (which comes out later in February) to become an ultra-cheap choice in that market too. They also discussed the idea of reducing fees for the Schwab U.S. TIPS ETF (NYSEARCA:SCHP) and their fundamental index ETFs, but those changes will take place on March first.
These cuts put Schwab's fees down to levels below its major competitors, Fidelity, E*Trade (NASDAQ:ETFC) and TD Ameritrade (NASDAQ:AMTD), and it sent shockwaves throughout the industry. Share prices of ETFC and AMTD were down nearly 10% immediately following the announcement, while SCHW took a hit as well.
I understand why the group was hit in the markets following the press release, as it definitely kicks off worries over a price war. And as for Charles Schwab, charging such rock bottom levels all but guarantees that Charles Schwab will lose money on its fund business, and it will probably see less revenues from its commissions in the process too.
So Why Is This Like Amazon?
To me, this is very reminiscent of the Amazon Prime service. You give people a ton of low cost options that are bound to please a wide range of people. So, instead of two day shipping and free video content, if you are in the investing world, you offer up fees that are less than major peers and nearly-free ETFs and mutual funds.
The move gets plenty of people in the door, and it keeps them inside the ecosystem. Once you switch to Schwab for the low fees and start putting money in their ETFs and mutual funds, it becomes difficult to justify switching back. This is exactly like how you get used to the two-day shipping, music, Pantry, and other features from Amazon, keeping you stuck in the system. Charles Schwab, much like Amazon, realizes that winning over new customers is a vital part of this business, and that providing them low cost products is essential to keeping customers happy and away from the competition over the long-term.
And once you have enough customers that you sucked in through the low price options, you now have the ability to earn money off them in different ways. Amazon does this with a variety of their media products and retail options in general (such as Pantry), though there are obviously some key differences between the retail and investing worlds.
Schwab can do something similar to Amazon's approach nonetheless though. Bring people in for low cost index products and cheap trades, and then make the real profits off high margin activities that Amazon can only dream of. These include, investment management, servicing fees, and most importantly, investing the float.
This last item will prove to be key for Schwab and other brokers, and especially if rates rise as most are expecting. For 2016, interest income accounted for roughly 44% of Schwab's net revenues, and that was in a year with mostly low-rates. Considering that trading revenue makes up about 11% of the total revenue (looking at 2016), and it is pretty reasonable to think that Schwab will be alright in the long term with a modest fee cut.
I think that Schwab sees the same thing with the writing on the wall for a low rate environment. They are willing to sacrifice a bit in trading revenue now in order to get new users on the platform and get access to their potential asset base and the investable float that comes along with it. And if rates rise as most are expecting, this could prove to pay off, and especially considering that interest makes up a plurality of revenue already, and that is with rates at ultra-low levels.
So, while Schwab might be down on this news now, it is a brilliant strategy in order to get more clients and capital in the door over the long haul. It is this type of forward thinking that has propelled Amazon to greatness in the consumer market, and it is about time someone tried this in the investing world as well.
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