Business Breakdowns
· 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?
· Arthur Olson, Matt Reustle
[00:00:00] S1: The way it works is I buy $100 of Apple. That order gets executed, and it gets routed either to a market maker or to an exchange. The market maker—let's use a name like Citadel that people know. I mean, it is crazy. By the way, I just saw this stat the other day. I think Citadel trades is responsible for over 20% of total US market trading on a daily basis. So they are just massive in scale. But the concept is that the market maker values retail order flow. Their business model is buying and then reselling and turning over their book very, very rapidly. And their goal is to make an infinitesimally small profit. We're talking tenths of cents per share. But when you magnify that and multiply that across so many trades, obviously in aggregate, that is very meaningful. [00:00:00] S0: 20% of the volume. That's a big number.
· Arthur Olson
[00:00:00] S1: Exactly. It's massive. So it's this dynamic where retail is getting filled at a good price, and yet the market makers are able to make a significant profit. This was a point of a lot of contention and controversy about three years ago. Gary Gensler made it very much a mission to go after payment for order flow. I've looked into it. I think the reality of the matter is, you look at a lot of the studies in academic literature, and it's kind of a push. Half would say it can very, very slightly impact negatively execution quality. Half would say it has no impact. What's interesting and what is really unequivocal is that it is a way better deal for Robinhood-specific customers. So payment for order flow is much more efficient for small-dollar trades. If you think about the old model, you were paying, let's call it roughly $10 commission to buy and then $10 to sell. Robinhood's average account today is $10,000. Back in 2021 even, it was like $5,000. So these were very small accounts. If you're making a $100 trade and you're paying $20 in transaction fees, you've got to earn a 20% return just to be even. And then if you take that a step higher, let's say $1,000 trade, okay, now it's a 2% hurdle. So 200 basis points of your return is chewed up in transaction fees. When you look at payment for order flow, generally speaking, I think the academic research would show that the effect on liquid names is about 1 to 2 basis points. So in that $1,000 trade example, you're talking about 200 basis points of transaction cost lowered to 1 to 2 basis points for payment for order flow. And if you think about the coin of equivalency—it's more a rule of thumb, it's actually different for every stock. Even the volatility that day, there's a lot of different moving parts—like around $50 or $100,000 trade is the point of equivalency where, over that, so trades that are larger than that, actually are more expensive using payment for order flow for the customer, and then trades under that are going to be cheaper. And obviously Robinhood is overwhelmingly under that.
· Matt Reustle
[00:00:00] S0: It makes a lot of sense, particularly with that piece of the market. And there's this discussion of increasing TAM of any type of market. And theoretically, anyone with a logical brain might see that $20 commission that they're going to have to pay on a $100 trade and know this is a bad situation, whereas that payment for order flow model with zero commissions is going to be net better, and that might bring in new customers on top of everything else that they're offering. I'm curious, is there still the double dipping in terms of payment for order flow with the commission trades? I know pretty much everybody has free commissions now, so maybe it's not as relevant. But how dominant is that across the brokerage market?