Discount Brokers

How much lower can they go from here…?

Open any pink paper and the ads of discount brokers are ubiquitous. The model is of fairly recent origin. Unlike the full service brokers who give you research and other services, the discount brokers purely give you a platform for executing trades and invest more in technology and less in people. Hence small brokerage costs are able to defray these fixed costs as long as large volumes can be assured. Today, these discount brokers account for a large chunk of F&O volumes and intraday volumes in India. And the trend is only getting sharper by the day. But there are 3 risks to this model…

A low entry barrier business…

 It is very difficult to differentiate yourself in the discount broking business and it is the first mover and the largest player who seem to have the apparent advantage. But the truth is that the entry barriers in this segment are quite limited. It does not take much for another broker to put up the spread and technology and build a competing model. Historically it has been seen that low entry barriers businesses tend to see winners and losers moving quite fast and that is likely to happen in this industry too.

Client accretion is the key…

The low cost discount broking model tends to survive on the assumption of constant accretion in the number of customers. It operates on the assumption that the loss on an old customer is compensated for by the entry of a new customer. As long as the flow of new customers continues, this model works to perfection. The problems arise when customer acquisition slows or greater competition leads to customers spreading out across brokers. In this business model, the trading platform becomes a commodity and hence the only thing to count on is that new customers are constantly added so that the model gets automatically smoothened out. The day that assumption tends to get questioned in volatile times or languid times, this model can come into question.

Is discount broking covering risks?

Typically, the broker not only worries about the cost of executing trades, cost of managing RMS and the cost of statutory compliance. The broker has to also evaluate if the revenue flows justify the risk entailed in the business. In the absence of that analysis it will be a business with a low Sharpe coefficient. Effectively, the business is not generating returns that are commensurate with the risk that it undertakes. This is the biggest danger in the discount broking model. This model works perfectly as long as customer accretion and low competition tends to underplay the risk in the business. The day that equation fails, the model could be in trouble! ©

You can ask us your stock related questions with #AskReligareOnMarkets via our Twitter channel @religareonline

One response

  1. In that case , why bigger players (including religare) either adopt and replicate the model ( may be offered not to all its customers) but to few new ones , and that can be as competitive as like discount brokers

    Like

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