Business Breakdowns
· Arthur Olson
[00:00:00] S1: We could probably spend a whole hour just talking about this. Even Vlad's childhood is fascinating. So his family immigrates from Bulgaria. He's left behind for a year or two when he's in kindergarten. It develops this rock-hard determination and grit that you see pop up at multiple times throughout Robinhood's both founding, then also their trajectory of growth as a public company. I don't think it's really well understood. They've had to do a lot of really hard things. Being a tech company innovating in financial services, which is heavily regulated, is difficult. But if we fast forward to when he and his co-founder Baiju both meet, they're both at Stanford undergrad studying mathematics and physics, both gifted. They have the misfortune of graduating, I believe, in 2009. So the employment market is really bad. Baiju succeeds in getting a job at a high-frequency trading firm. Vlad tries to do the same, basically as an options trader, is not successful, so goes back to Stanford to pursue a PhD in mathematics. Within the first year, he becomes very disillusioned with what he sees in academia. There's this real piece of pure and noble desire to rethink and come up with first principle solutions to problems and a desire to touch a lot of people with those solutions. He talks about looking out to these famous mathematicians, Gauss, and studying their works and being very impressed by the idea of multiple generations working and basically learning from the insights of that one person. He wanted to do something similarly. Punchline is he wasn't getting that fulfillment in academia. So Baiju calls him up and says, "Hey, listen, my fund is doing well, but actually the technology is really old, and I think we could start our own firm, basically mimic what they're doing, use some modern technology, and be successful." They take a risk. They start their own high-frequency trading firm, they move to New York. I think by both guys' admittance, it's pretty much a failure. They very quickly, within the first year, pivot not to trading themselves but to selling the software that they've been building to bigger hedge funds and banks. But both of them ultimately find that somewhat unfulfilling as well. So within a year, they start thinking about Robinhood. They hit it at a very interesting time. So you have three secular trends that are happening.
· Arthur Olson
First of all, you have the rise of electronic trading. You also have the rise of mobile. This is about 2013 is when they're coming up with the product. The iPhone is still new, and it sounds crazy to us today, but the thought of trying to trade stocks, even paying bills on your phone, was crazy at the time. So they were very early to see that mobile would be the next compute iteration and where our lives would be mediated. And I think the third thing that really made the business possible in a way that others had tried commission-free trading in the past and hadn't been successful—part one of that is that they didn't have a really compelling app. But also there was this ripe environment post-GFC where you had Occupy Wall Street. There was a huge erosion in trust in these legacy financial services companies, and that brand equity was kind of at an all-time low, and it created space for these new challenger brands, Robinhood one of them and several others. That was the context. Their specific insight was when they were running the high-frequency trading firm, they saw that we're trading, and firms like us are trading every day, thousands of times a day, millions in aggregate, and we're not paying anything, or effectively we're not being charged, certainly not the $10 per trade commission that the retail investor is being charged. And that doesn't really make a lot of sense that the smallest investor should be charged the highest amount, and that really this is rent-seeking behavior that should be disrupted. The business model that facilitated that is known as payment for order flow. The broker receives a small rebate from a market maker in exchange for the right to execute that trade. Market makers like retail order flow because it's seen as non-toxic, it's uncorrelated, so they pay a small rebate. This is a business model that goes back to the '80s. When Robinhood was coming about, Schwab, for instance, made a significant amount of money on payment for order flow. It was just that they double-dipped. They got the rebate, and then they charged the $10 commission. Robinhood's core conceit was they surveyed the field and saw that traditional brokerages at the time made about 30% of their revenue from commission. And the thinking was, okay, what if we can start with a clean sheet of paper and build a modern brokerage using modern technology?
· Arthur Olson
We run it more efficiently. We don't have a brick-and-mortar network, not old workflows held over from the '80s, smaller headcount, and basically harvest those expense savings in order to offset basically sacrificing this 30% revenue from commissions. We'll make up the difference by volume of new customers that we acquire using that value proposition, but then also using these traditional brokerage revenue lines of net interest income, income on cash balances, margin lending, and also on subscription. The other really important half of this was having a really compelling product experience. So that was one of the big insights as well, is we need to make this product way less complex. Even if you look at the legacy broker apps today, they still very clearly are ports from web-based platforms. It's grid-based, a lot of dropdown menus, very clunky, and you can force your way through it. But if you're a digital native customer that grew up in the era of a smartphone, you're going to naturally gravitate to Robinhood's app.
· Matt Reustle
[00:00:00] S0: As a fellow 2009 grad, I have admiration for anyone from that vintage being a particular moment in time too, to be seeing everything going on in the financial system and to look for ways to maybe improve it or democratize it or whatever we want to call it. But if I were to just play back everything you mentioned, it really does feel like that mobile-first approach stands out. And it's hard to stack rank what was most important for any business because there's so many different things that go into it. Is it fair to say that in and of itself was a major driver of their ability to get customer adoption, and not to downplay by any means anything else, but could you boil it down to the mobile-first approach with everything else being that difference maker?
· Arthur Olson
[00:00:00] S1: I think you're 100% right. Of the two, both are necessary to innovate, and this is a key to understanding why Robinhood won and continues to win. Pretty much on every product, they break down the economic side and then the product experience side, and they say we want to deliver a step change improvement on both sides. Both are necessary. But to your point, the harder of those two is making a killer product that people love. And it's fascinating. Mobile, super important, seeing that early. One of the things they were really lauded for, which is true, is making the investing process less intimidating. And a lot of that is just a clean UI. Even the app today, it leads with big, high-contrast colors, charts, doesn't overwhelm you with a lot of data right off the jump. You can click through to get all the information you need, but it's ultimately very digestible for someone that doesn't live and breathe financial markets. So I think you're absolutely right. Taking down the intimidation factor was really important. One of the things Robinhood has been a master of is building great product but also cultivating a brand identity. A huge, almost existential and insurmountable hurdle for most teams would be the dynamic of when Robinhood was starting. You have to get a FINRA broker-dealer license before you could start marketing and start acquiring customers. To get that license, you need to have capital. You need to show the regulator you've got capital for at least a year. To get that capital, you need VC funding. But what VC in the world is going to put money behind a project that has failed for other startups? And you basically have no customers yet because you haven't been able to market. So super, super hard thing to bust through this chicken-or-egg issue. And it really is a testament to Vlad's will. This is a guy that has just an iron will. They worked through, I think, 75 or 100 no's from different VCs before they finally got three yeses. And they were very innovative. They used a very innovative waitlist technique to build buzz. They had over a million pre-signups before the product even went live. This is a skill set of the company that continues today.
· Arthur Olson, Matt Reustle
Exactly your point: build a great, beautiful product that people love to interact with, but also wrapping a brand around that that generates enthusiasm where customers really identify with the product. Those two things in concert with upending the economics of the industry is exactly what broke the threshold. [00:00:00] S0: Goes without saying, the name Robinhood itself holds a lot of meaning in that regard as well. And so many of those things that you mentioned are commonplace today in terms of waitlists and whatnot. But gotta go back, similarly to mobile, and remember all of this was not well known in the moment. I could speak to my current Fidelity account, which the mobile experience is still a nightmare and still clearly reading off the web. There is still something there, and when you have incumbents competing against startups, you can really take advantage of that and make the most of it. I want to get into the business model, which you've tapped into a little bit there. The question over, well, if they're not making money from commissions, where are they making money? And maybe we just start out with that payment for order flow. Is it possible to just walk through an example? If I were to buy 100 shares of Apple, or you can make up the numbers, but how do the dollars exchange hands in a payment for order flow type situation?