This week has not been a good one for Robinhood; An SEC fine for misleading customers about how it makes money and a Massachusetts complaint for failing to protect its customers. Add to that a recent slash to annual margin rates by 2.5% and suddenly the eyes of the world are asking – what will this fintech do next?
Kim Muhota is Vice President and Head of Financial Services, North America at global consulting firm, SSA & Company. He is an executive with more than 20 years of experience in the Banking, Fintech, Insurance, Private Equity, Payments, Technology, and Business Services industries. Here, he offers his views on the recent news from Robinhood, including the adverse action from a regulatory body.
In order to understand both Robinhood’s failures as well as its successes, it’s important that we look back. Thirty or so years ago, ETrade, Schwab, TD Ameritrade and other online discount brokerages disrupted the investment industry and forced behemoths like Prudential, Morgan Stanley, and Merrill Lynch to change their business model entirely. ETrade, Schwab and the other disruptors decoupled trading from the full-service investment model, including Advice and Proprietary Research that incumbents offered. In doing so, they were able to zero-in on one aspect of the brokerage business model – self-driven, online trading from your desktop – do it very well, and offer it at a much lower price. The discount online trading business model opened up retail investing to a new segment of the population, who had not previously been active traders, but also made trading simpler, faster for the experienced trader. It increased the size of the pie substantially. Most would agree, that was a positive development for the industry.
Today, the same thing is happening again across the financial services marketplace. Robinhood is disrupting the retail investing space, and that’s a great thing for the industry. Robinhood has removed, effectively, all the friction, making trading seamless – and has done so on a beautifully designed mobile platform. That’s what innovation is about – and should be lauded
There’s a lot of promise in the trends and populations Robinhood has tapped into. Their platform has increased the size of the pie by introducing a whole new segment to investing – that’s a net positive development for the industry as well. First of all, it’s good business for Robinhood. Ultimately, Fintechs like them get rewarded massively by their valuations, when they drive topline growth – and for Robinhood, that’s growing net new customers, and driving active trading activity per account. And by creating another inflection point for the industry, the company can be a good thing not only for itself but by example, can provide a glimpse into how the entire investment brokerage industry can reinvent itself. To start with, the fintech presents an opportunity for incumbents to look at their product and functionality offering, similar to what happened in the 1990s, and hold that against what a more tech-savvy, emerging client base is demanding from their investment platform provider.
A key movement Robinhood is benefiting from is the disaggregation of services. Consumers, especially Gen X and Millennials, have separated out their financial needs and are perfectly happy to work with 5 or 6 financial providers, each of whom do at least one thing really well. They may have their core checking account at Bank of America, credit card with CapitalOne, student loan with SoFi, mortgage with Rocket, transfer money with Venmo and trade with Robinhood. In contrast, their parents may do all those things with Bank of America.
The world has changed.
The fact that Robinhood has opened more than 3 million new accounts in 2020 and averages more than 4.3 million daily retail trades, more than any other publicly traded broker, is testament that something powerful is happening–similar to the 1990s when ETrade and Schwab disrupted the full-service brokerage industry.
The troubles Robinhood is facing are not trivial – they should have disclosed that they work with high-speed trading firms to execute orders. Many fintechs work with banks and other third parties to effect a full transaction.
But I believe the bigger challenge that Robinhood has to manage is how much risk young, inexperienced investors are taking on by trading high-risk instruments with little by way of guardrails via its platform. What Robinhood has done so well, removing all the friction, and barriers, from the trading process is both the reason why it is so successful but also the reason why it could easily fail. In trading, a little friction may in fact be good, particularly when it comes to inexperienced investors.
Aside from their ability to scale rapidly, Fintechs live and die primarily on two things – taking out the friction from an otherwise painful financial transactional process and building sustainable trust with its customers and in the marketplace. The Robinhood case is one of the few instances where having a little bit of friction in a transaction process that they have made frictionless may serve them well in the long term in terms of building trust.
The competitive advantage Robinhood has built over the large publicly traded brokers is compelling. But the advantage around product and functionality superiority is not sustainable in the long term, because it can be easily copied. The advantage around serving an emerging segment of the market, younger Gen X and Millennials, that most other brokers are eager to serve, is what Robinhood can defend in the long term to build a profitable business. In order to grow with the Gen X and Millennial segment as they continue to add to their net worth and trading power, and whether or not the regulators mandate it, Robinhood must therefore focus on risk management and helping their customers better identify and mitigate risky trading opportunities.
We see Robinhood at an inflection point today. If they want to build an enduring business – one that truly disrupts the industry and changes how we think about investing – they cannot afford for customer confidence to erode. And this week is trending in the wrong direction for them. But perhaps the trouble that Robinhood is now dealing with is a good development. Transparency is good; and if management embraces it, then this can help them build credibility with their customers – the action by the SEC and the MA regulator brings “good governance” into focus for the team at Robinhood. And if an IPO is still in the near future, this is an issue that they now have to address. It will also force other players in the fintech ecosystem to focus on transparency, good governance and risk management, which helps the broader ecosystem by building more customer trust.
It’s yet to be seen whether or not Robinhood is around in ten years and becomes a dominant player in the low margin brokerage business like ETrade and Schwab did in the 1990s. And it lies mostly in their own hands. What is clear is that incumbents should now be paying attention to what this emerging, tech-savvy customer is saying and position themselves at the intersection of recognized industry expertise and risk management; and zero-commission, frictionless, beautiful UX mobile trading.