The traditional brokerage business died last week. Merrill Lynch certainly didn't put it so morosely in announcing its shake-up last Tuesday, but industry experts say that's the inevitable outcome.
What got most of the media attention was Merrill's plan to launch its own Internet brokerage operation, with commissions of as little as $29.95 a trade -- allowing Merrill to compete with online discounters such as E*Trade and Charles Schwab.
Lost in the hubbub was what may prove the more important part of Merrill's announcement -- that it's changing the rules for its full-service brokerage business. The nation's largest securities firm announced that for an annual fee of $1,500 and up, depending on how much money is in the account, customers can get unlimited trading -- plus investing advice and other services from Merrill's thousands of professionals.
Merrill, in effect, is proposing to transform its core business into a giant asset-management firm. Instead of giving away its advice for free, in return for fat commissions, it now will sell that advice directly. Its brokers will be rewarded for how much they increase their customers' assets, rather than the number of trades they do.
"This is going to change the face of the securities industry," said SEC Chairman Arthur Levitt in an interview Friday. He believes the industry's move to a fee-based structure will reduce many of the bad-broker practices the SEC has been battling for decades.
Merrill's announcement, in part, is another example of how the Internet is transforming American business. Just a year ago, the head of Merrill's brokerage operations, John "Launny" Steffens, was warning that reckless online investing could pose "a serious threat to Americans' financial lives." But in the end, Merrill couldn't resist the desire of many of its customers for low-cost Internet services.
That same whirlwind of change will blow through other industries over the next few years, no matter how tenaciously the players try to resist. Two obvious examples are the sale of automobiles and real estate. Those business will have to adapt to the "frictionless" selling of the Internet just as the brokerage business has.
In the short run, taking the Internet plunge will hurt Merrill's profits. That's because online retailing -- of stocks or any other commodity -- is inevitably a cut-price, low-margin business. Investors sometimes forget that fact when it comes to glamour Internet stocks, such as amazon.com, but they didn't with Merrill. The stock plummeted from $84 a share at the close of trading Monday to just more than $72 Friday. Stocks of other brokerage firms, which will have to match Merrill's discount tactics, also were hit last week.
Merrill is betting that, over the longer run, the demand for its full-service operations will increase. The do-it-yourself crowd will use the stripped-down online service, and Merrill will compete for that business. But Merrill's strategists believe that as people accumulate wealth, they'll want the advice of a professional -- rather than simply the wham-bam cheap trading offered by online brokers. That yearning for help often arises when investors have made $250,000 or so -- and decide they have some serious money at risk, according to Merrill Senior Vice President Paul Critchlow.
The transition won't be easy for Merrill. The firm has a costly network of 14,000 brokers in 700 offices -- and not all of the brokers will have the skills to survive in the new world. To ease the adjustment, the company is guaranteeing brokers they won't lose income during the next two years. And Merrill projects it actually will need more "financial consultants" (the new, up-market term for brokers) -- with their number growing to 20,000 by 2002 -- as customers decide they like the new fee-based, asset-management approach.
For anyone who has ever been badgered by a commission-crazed broker into buying or selling a stock, Merrill's announcement is good news. As the company's CEO, David Komansky, told the New York Times last week, Merrill's move is "the beginning of the death knell" for commissions -- and for the inherent conflicts they created between the brokers' interests and those of their clients.
"Under the new structure, the broker will get compensated the same for saying, `No, don't do that,' as for executing a trade," Komansky said.
That marks a revolution from current practice -- where, as the SEC's Levitt noted, "broker compensation has been based on quantitative rather than qualitative factors." Too often, brokers simply churned customers' accounts -- moving them in and out of stocks and making nice commissions on each trade, regardless of whether the customer benefited in the long term.
Merrill's new look marks the death of the salesmen for an industry that has existed for generations on a smile and a shoeshine. The portfolio-churning broker is going the way of the hustling, let's-make-a-deal car salesman.
We're entering a more orderly, no-haggle world, where we'll do many routine transactions cheaply, online -- but pay knowledgeable people a reasonable fee to help us make more complicated financial decisions. Despite the recent mania for Internet retailing, the real profits are likely to be on the value-added, human-interaction side of the ledger.
At some point, we can get nostalgic over the passing of the old slap-on-the-back broker. But not for a while, thanks.