Online trading volume continued to grow in the third quarter, but the rate of growth slowed compared to previous quarters, according to a new report to be fully released next week by Credit Suisse First Boston.
The report said that online trading grew 14 percent in the third quarter, but was less than the 16 percent increase in the second quarter and the 25 percent increase in the first quarter. The drop in the growth rate is attributed to the growing volatility of the market during the past quarter.
The report points out that online firms, such as E*Trade, Ameritrade, and Datek, saw their market shares decline or remain flat. But more established discounters, such as Waterhouse Securities, Charles Schwab, and Fidelity, saw their market shares increase.
"What happened was that as markets became more volatile, the new, online-only firms found it tougher to grow than the existing firms," said Bill Burnham, vice president and senior research analyst for electronic commerce at Credit Suisse First Boston Technology Group. "The existing firms benefited from the fact that they have a huge reservoir of customers that they have yet to convert to online trading.
"What we saw this past quarter was the acceleration in the conversion of existing customers to online trading at Schwab, Fidelity, and Waterhouse," he added.
The report named Waterhouse as the big winner this quarter because it increased its market share to 10.5 percent. With this growth, Waterhouse leapfrogged Fidelity into the No. 3 spot, and was within just a few tenths of a percentage point of upsetting long-time No. 2 E*Trade, according to the study.
Looking forward, the most significant development in the industry will be intensifying competition, which may force smaller firms to become part of larger financial institutes, Burnham said.
"Unless you have a blank check for a $100 million for advertising, online trading is pretty much a closed industry to you," said Burnham. "We saw that the door to new entrants in the industry was essentially shut tight, essentially by E*Trades' $100 advertising campaign, and also because of the huge technology expenditure now required to stay in the leading edge."
The companies not in the top ten are likely targets for takeovers by large financial institutes, Burnham speculated.
"I think in the short-term we could see some mergers in the second-tier firms," said Burnham. He said the only way the smaller firms will survive is by merging amongst themselves as well as "selling a piece to a very large financial institute that could provide them with some capital."
Burnham said there has been some discussion about mergers and acquisition, but declined to comment or name any specific companies.
Burnham, however, noted that companies in the top ten, like E*Trade, Ameritrade, and DLJ Direct, may manage to stay independent.
"You hear rumbling now and then about merger discussions," said Burnham. "But each of those could survive on their own and they are not under any pressure to merge with anybody, although it's always an opportunity."
As online trading has boomed along with the Internet economy, it has been accompanied by a rise in consumer complaints about unreliable access during critical moments, when individual investors have the most money on the line. With online trading surging, Web brokerages have tried to keep adding capacity to their systems.
Still, as recently as September 10, equipment failures at Ameritrade and Waterhouse stymied online traders for a short time on a day that the market dropped more than 3 percent.
The report also highlights that the average commission charged by the top ten online trading firms remained flat in the quarter as the companies continued to focus on differentiating themselves through their enhanced products and services rather than their prices. The average commission remained flat at $15.75 per trade. The study said it did not anticipate any major price movement in the coming quarter.