The equities broker model has been slammed by two waves of change:
- End of fixed commissions. This happened decades ago and simply opened the market up to competition.
- Internet. This is what enabled the human broker to be replaced by servers and led to e-brokerage firms such as eTrade, Charles Schwab and many others.
Which brings us to RobinHood
RobinHood offers zero cost equities brokerage and plans to upsell to premium services later – a classic Freemium strategy. They recently raised a $13m Series A and claim traction among Millenials (who have less to invest and therefore scrutinize the current fee of about $10 per trade more carefully).
For a service that is close to zero cost on a per unit basis and falling further every day thanks to Moore’s Law, a Freemium strategy makes sense.
The question is about the upsell. If RobinHood creates their own value added premium services they will end up competing directly with the bigger e-brokerage firms. However, if they simply offer an API to anybody who creates value added services they will create an ecosystem that is far more powerful than what any single firm can create. These kinds of Low Cost Active Alpha services are complex, so it is smarter to let other entrepreneurs create them. These entrepreneurs will be quite happy paying RobinHood for customer access. This could be a classic network effects game that unbundles services and creates a stack. It is the same dynamic we are seeing in the lending marketplace business.
Today, RobinHood appeals to Millenials with less to invest. When we get another Bear Market, wealthier older investors will also scrutinize the per trade cost. At first a Bear Market will reduce trading costs as we get the usual “death of equities” stories. That will hurt the traditional e-brokerage firms but RobinHood can afford to sit it out. Trading volume will eventually return. There is always money to be made by active traders. All they need is volatility, the actual direction matters less. Active traders care about the per trade costs. RobinHood could be one of those businesses that take off in a Bear Market.