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Online brokers could move into free trades

Online brokerages are working harder than ever to lure new customers, leading some to speculate that the industry will soon turn to a free-for-all.

Competition in the online brokerage industry is heating up to the point that some are speculating the era of the free trade could be around the corner.

"There is a war with the online brokerages right now. All of them are increasing their advertising spending," said Richard Repetto, an analyst with Lehman Brothers. "If they can't get customers with their advertising and marketing, they have to attract them with prices. This should play itself out this year and we should see a consolidation next year."

DLJdirect said this week that it spent $18.1 million on advertising in the third quarter, or an average of $724 to acquire each of its 25,000 new accounts. That figure was up dramatically from $389 per customer the previous quarter.

While brokerages are spending more to lure new customers, many also are lowering prices to attract and retain customers. The $10-per trade threshold was crossed long ago and commission-free trades could be next.

American Express, for example, announced last week it will enter the online brokerage business and offer commission-free trades to clients who maintain a certain balance in their accounts.

Over the past five years, online trading has boomed. The industry initially began with Internet brokerages such as E*Trade, which touted their discount commission prices that beat the brick-and-mortar houses such as Merrill Lynch.

Discount firms, such as Charles Schwab, then jumped into the action. And in the past two years the full-service firms have also added online trading to their mix--Merrill Lynch being the latest entrant.

The industry has also undergone a morphing of sorts. Online brokerages have added more full-service features like research reports, while full-service firms have included real-time quotes to their sites.

To stand out from the crowd, a number of companies have discussed the free-trade strategy for more than a year, analysts said. It's also a concept that E*Trade dabbled with last March, when the Dow Jones Industrial Average closed above 10,000 for the first time. E*Trade's one-day promotion allowed customers to buy and sell the index's 30 stocks without paying a commission.

Greg Smith, an analyst with Hambrecht & Quist, and other analysts note that although free trades have emerged as a means to snare customers in what has become an increasingly crowded industry, the concept probably won't become an industry standard.

"Free trades are a marketing gimmick to acquire more customer accounts," Smith said.

Free trading programs likely will be offered only to customers with large accounts. Like a bank, brokerages dip into these funds to lend money to other investors who are willing to pay interest to buy stocks on margin. This may allow brokerages to earn more money on interest than they lose by eliminating commissions.

But a number of online brokers don't have customers with $100,000 accounts, limiting the likelihood they would engage in offering free trades, analysts said.

"The average guy does not have balances that high at online brokerages," said Repetto of Lehman Brothers. "That means more creative pricing programs will be used."

Price segmentation is one area that will be increasingly used, Smith said. That method calls for offering price discounts based on the volume of trades conducted.

One fallout from the pricing pressure will be an industry consolidation, analysts said.