Ameritrade Case

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Louis-Henri Jardins is considering opening a European onlineokerage. He is evaluating the economic factors of such a business using Ameritrade as a model.

Analysis of Economic Model

The short-term economic model for an onlineokerage relies on heavy upfront advertising, earned interest, and the management of revenues and costs per trade. Advertising is used to buildand awareness and toing customers to the website. Theokerages value proposition of "convenience, cost, choice", or other services is expected to convince the customer to open an account. The firm then earns money from interest on that balance and from customer trades. In the long-run, theokerage hopes to create enough switching costs and loyalty so that the customer deposits more money and continues to trade.SENSITIVITY ANALYSIS

The following sensitivity analysis is based on Henris Ameritrade analysis. The account profit and customer lifetime value calculations can be found at the end of this document (Exhibits A and B).

Transactions per Account

Account profits are not very sensitive to trading volume. If Ameritrade customers were to average 4 trades a year (a 0% increase) profits for customer would only decrease by about 1%. This does raise the point that Ameritrades customer profits have a negative relationship with the number of trades. Currently, Ameritrades transactions are a bigger driver of costs than they are a driver of revenues. Based on Henris analysis, the average transactionings in $1.7 in revenue while costing $1.76.

Fee Revenues per Account

Account profits are sensitive to commissions earned on trades. Holding all other factors constant, if those commissions were raised from $1.7 per trade to $15 per trade, profits would increase by more than 0%. If commissions per trade dropped to $7, the lifetime value of each customer would be negative. Ameritrades low price strategy makes it difficult to capture more value in this area.

Marginal Cost per Transaction

Account profits are sensitive to marginal cost per transaction. If total fees per transaction dropped by a dollar (from $1.76 to $1.76) then account profits would increase by over 1%.

Interest Margin on Margin Loans

Ameritrades current model relies heavily on net interest earned from account balances. Assuming Henris estimates are accurate, Ameritrade currently pulls $156 per account per year. If the average balance of each account dropped from $,000 to $1,500 (a 5% decrease), account profits would also drop by about 5%. If this balance drops to $500 per account, then the customer lifetime value becomes negative. Note, these also assume that Ameritrades enviable 7.8% earned interest is also accurate. If each account maintained its $,000 balance but the earned interest dropped to 5% then account profits would decrease by 5%.

Customer Lifetime Value

The NPV per customer account can be defined as the Customer Lifetime Value (LTV). Based on Henris analysis the 5-year NPV for acquiring a customer at the cost of $148 is $5.8. This gives us an extremely high Internal Rate of Return (IRR) of 6%. The 10-year NPV is slightly higher at $55. with an IRR of 8.%. This value is largely driven by the loyalty rate. According to Henri, Ameritrade is expected to experience a 10% attrition rate giving them a 0% loyalty rate. If Ameritrade managed to maintain a 5% loyalty rate, then the 5-year and 10-year NPVs would increase by about 1% and 1%, respectively.

Note that Henris model assumes no sales growth. If Ameritrade managed a sales growth of 10% per year, then the 5-year and 10-year LTVs of each customer would increase 5% and 41%, respectively.

The discount rate is also a key driver of the NPV per customer. If the current discount rate of 0% were reduced to 15%, then the 5-year LTV would increase by almost 18% and the 10-year LTV would increase by %. On the other hand, it would take a discount rate of more than 0% to give the current model a negative NPV so this is not of great importance to Henri.

Recommendations

Invest in Advertising. Given that Henri is late to the game, it will be necessary for him to invest heavily in upfront advertising andand creation. Assuming Henrisokerage was to achieve similar numbers to Ameritrade, even a $400 acquisition cost could result in a positive NPV per customer. Henris firm should also launch campaigns to buildand loyalty.

Avoid Low Price Provider Strategy. Due to Ameritrades low price offering, interest earned per account has become the main revenue generator. While Ameritrade has stated that trading volume is not its strategy, higher commissions on trades could make it far more profitable. Henris firm could differentiate itself by offering online research or educational resources in order to justify a higher premium. In addition, if the site offers customization, portfolio management tools, and some level of personalization it could create more switching costs. Henris goal should be to build stronger loyalty to achieve high customer lifetime value.

Require a Minimum Balance. Given Ameritrades reliance on net interest margins, Henris firm should require a minimum balance of at least $1,000. This number assumes Henris firm achieves similar numbers to Ameritrade. Given that transaction fees are difficult to control and the volatile relationship between the number of trades per customer and economic conditions, this will reduce risks. Henris firm will depend less on trading volume and strong economic times to find success.

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