greco-2021-textbook-economics-from-ameritrade-s-joe-ricketts

Studies in Microeconomics 11(2) 195–205, 2023 © The Author(s) 2021 Article reuse guidelines: in.sagepub.com/journals- permissions-india DOI: 10.1177/23210222211051448 journals.sagepub.com/home/mic Policy Analysis and Debate Textbook Economics from Ameritrade’s Joe Ricketts Anthony J. Greco 1 Abstract This article reviews the history of Ameritrade founded and developed by Joe Ricketts into a spectacularly successful discount brokerage enterprise. It, as such, represents another example of a risk-taking innovator who achieves success by filling a need in a free-enterprise market. The main takeaway is that free-enterprise works best from the bottom-up, that is, when individuals or individual companies ‘creatively destruct’ existing markets or generate new markets for goods or services through the implementation of innovative ideas and technology. The article also delineates the workings of the free-enterprise market by pointing out how familiar textbook economic principles are illustrated in the Ameritrade experience. JEL Classifications: A10, D01, E02, G10 Keywords Choice under uncertainty, market equilibrium, microeconomics, producer choice, rational choice, individual decision-making Introduction The founding of Ameritrade by Joe Ricketts and its ultimate spectacular success as a discount brokerage firm is yet another example of what can happen in the free-enterprise system of the U.S. economy when ‘creative destruction’ occurs. Over time, the firm, now TD Ameritrade after its merger with TD Waterhouse in 2004, became the number one online broker as measured by trading volume (Ricketts, 2019, pp. 292–293). 1 Department of Economics and Finance, University of Louisiana-Lafayette, Lafayette, Louisiana, USA Corresponding author: Anthony J. Greco, Department of Economics and Finance, University of Louisiana-Lafayette, Lafayette, Louisiana 70504, USA. E-mail: ajg1979@louisiana.edu

196 Studies in Microeconomics 11(2) Joseph Schumpeter originated the term ‘creative destruction’ essentially to describe the process of moving from the status quo in a market to positive changes that enhance efficiency and progress in that market and, perhaps, in others, as well. While it is undoubtedly a process that involves risk and uncertainty on the part of innovative entrepreneurs, it is a process vital to economic progress (Spiegel, 1971, p. 545). As in earlier and contemporaneous instances of innovative destruction, the Ameritrade experience illustrates basic microeconomic principles at work. After briefly discussing the history of Ameritrade, this paper examines some of the relevant textbook examples of said principles shown in the Ameritrade experience. The Founding and Development of Ameritrade There are essentially three markets involving the trading of stocks. In the ‘first market’, stocks are purchased directly from the issuers of the stock. The ‘second market’ involves the purchase of stock from the traditional stock exchange, such as the New York Stock Exchange (NYSE). The ‘third market’ or ‘over-the- counter’ market is where stocks are traded through a third-party securities trader not bound by the rules or commissions applicable to the stock exchange. This ‘over-the-counter’ market is now referred to as ‘Nasdaq’ which is the National Association of Securities Dealers Automated Quotations (Ricketts, 2019, p. 61). As the reader has deduced, Joe Ricketts recently related the Ameritrade story in an informative and interesting memoir referred to liberally in this study. The company was originally formed by Ricketts and a colleague at Dean Witter along with the two principals at a small brokerage firm in Omaha, Nebraska in early 1975. It was called First Omaha Securities. Stockbroker commissions were non- negotiable, at that time, having been fixed by the predecessor of the NYSE over 180 years before. However, due to antitrust concerns the federal government decided to phase out fixed commissions as of May 1975 beginning with the highest dollar trades (Ricketts, 2019, p. 56). At that time, the trading of stocks ‘over-the-counter’ through third-party securities dealers (‘the third market’ alluded to previously) was in its early stages of development. It was ignored by many brokers who believed that it would be best to maintain their ongoing commissions. Ricketts and his colleague, and his original partner from Dean Witter, however, saw great opportunity in the third market. Ricketts, unlike his partner, had no money to invest, but he found risk- taking exciting. He reasoned that orders in the third market would come from experienced and knowledgeable investors. That being the case, his firm could pay an exchange broker for each evolving trade and offer its customers lower costs through the elimination of the traditional services and functions of brokers. To that end, the firm soon announced that it would provide for third-market trades for a $25.00 fee (Ricketts, 2019, p. 71). Though Ricketts’ firm was actually providing trades at commissions, its competitors attempted to tarnish its image by dubbing it a ‘discount broker’ with the implication that the firm’s services were inferior to those provided by full-service brokers (Ricketts, 2019, p. 72).

198 Studies in Microeconomics 11(2) Other discount brokerages recognized this as well. Ricketts pondered the creation of his own market maker to counter Schwab and, hence, eliminated the cost involved in dealing with a middleman. However, a regulatory minimum investment of $20 million was required to do so. Ricketts worked this out by collaborating with other discount brokerage firms wherein the firms still competed with one another for clients, but they shared their new high-tech market to service their clients (Ricketts, 2019, pp. 229–230). From its inception, Ameritrade had relied exclusively on advertising to generate new accounts. However, the firm discovered in the 1990s that it could be more efficient in this endeavour by acquiring smaller competitors. Eventually, it considered the acquisition of a relatively large competitor. At that time, Ameritrade and other industry leaders, such as Schwab, had touch-tone and computer dial-up trading systems. However, the banks of telephone modems supporting these systems were generally considered to be unreliable. The firm that Ameritrade was considering to acquire, however, inaugurated trading stock over the Internet by discount brokers in August 1994 through a proprietary email system. Though lacking an expertise relative to the Internet, Ricketts foresaw its potential use by the public in trading from their personal computers (Ricketts, 2019, pp. 236–237). The company issued its initial public offering in March 1997 with shares priced at $15.00 and finishing the day at $19.50. The company raised over $22 million and experienced large stock price increase. In July 1997, Ricketts announced a lowering of the per trade price to $8.00. Ricketts also pushed for $20 million in advertising and a like amount on technology to support his trades (Ricketts, 2019, p. 260). After the implementation and continuance of the ad campaign, the numbers of daily accounts opened by the company soared. It was maintained that each account opened had a net present value of almost $1,300. For the next nine months the company opened 181,000 accounts. At a net present value of $1,300.00 for each of these accounts, the firm would have netted $235,300,000 over those nine months. Ameritrade’s share of the total online brokerage market was then doubled from September 1997 to June 1998 (from 3% to 6.4%). The company continued to grow. It survived a downturn in the early 2000s and was eventually acquired by TD Waterhouse in 2004 (Ricketts, 2019, pp. 263–264). Recent Developments In September 2017, TD Ameritrade acquired Scottrade, based in St. Louis, Missouri. Then, in November 2019, Charles Schwab announced plans to acquire the online brokerage of TD Ameritrade for approximately $26 billion in stock. The sale was to close by the end of 2020, with the full integration of the companies anticipated within 18–36 months. TD Ameritrade will remain a full-service broker providing a wide variety of services, inclusive of investment research and advising, retirement planning, and more, as well as online, discount trading

Greco 199 (commission-free trading) in stocks and other securities. Because of its value and service quality, it is viewed as one of the best US brokerage firms. It boasts of having over $1 trillion in customer assets and over 11 million client accounts (Folger, 2021). The last quarter century has witnessed a marked increase of discount brokerage firms affording individuals the opportunity to invest in stocks inexpensively or with no commission fee without the use of stockbrokers (Lemke, 2019). Prominent among recent entrants are Robinhood and Webull. Robinhood, founded in 2013, aided the revolution of online brokerage in 2014 by application of the simple fee structure of commission-free trades on a mobile application for stocks and often investments. It has thus attracted many new trades and investors. The company quickly acquired over 6 million users. In addition to stock trading, Robinhood has introduced other trading, such as cryptocurrency trading (Dave, 2020). Webull was established in 2018 in direct competition with Robinhood. Webull purports to having surpassed Robinhood in a fast two-year period by amassing over 9 million users. Robinhood and Webull have expanded so rapidly because they both offer new customers free stocks when they open accounts. In addition, their popularity has grown because their apps have abetted the simplification of investing for novices (Dave, 2020). Both Robinhood and Webull are commission-free brokerages requiring no account minimums. One can trade stocks and options, and cryptocurrencies as well as Exchange Traded Funds. Whereas Robinhood presently deals with individual brokerage accounts, Webull offers these, as well as, traditional and Roth IRA’s (Dave, 2020). While E*Trade, a full-service brokerage house was listed as Nerd Wallet’s Best Investment Broker of April 2021, TD Ameritrade was ranked 2nd; Robinhood, 3rd; and Webulll, 6th of the top 11 ranked by this source (Davis, 2021). Table 1 lists the fees for various services offered by TD Ameritrade, Robinhood and Webull. Table 1. Trading Fees for Services Offered by Ameritrade, Robinhood and Webull (20 March 2020). Feature Ameritrade Webull Robinhood Minimum deposit $0.00 $0.00 $0.00 Stock trade fee (per trade) $0.00 $0.00 $0.00 ETF trade fee $0.00 $0.00 $0.00 Mutual fund trade fee $49.99 N/A N/A Options base fee $0.00 $0.00 $0.00 Options per contract fee $0.65 $0.00 $0.00 Futures (per contract) $2.25 N/A N/A Broker assisted trade fee $4.99 N/A N/A Source: Dave (2020) and Mirani (2021).

Greco 201 suggest a high advertising elasticity, with the percentage change in the gaining of new accounts exceeding the percentage increase in advertising expenditures. As indicated above, Ameritrade relied on advertising and technology from its inception to generate new accounts and that in the 1990s it sought to achieve this same objective by combining these with the acquisition of small competitors. The phasing out of fixed commissions on stock trades initiated by the federal government in 1995, as mentioned previously, provided an opportunity for Ameritrade to enter and prosper in the discount-trading market and spurred its use of advertising. Prior to this rule change, the large natural brokerages, as Ricketts notes, had bought out small local firms and enjoyed financial and other economies of scale which served as barriers to entry to smaller firms (Ricketts, 2019, p. 58). Herein was a classic example of the dominant firm in an oligopolistic industry surrounded by a large number of small firms benefiting from these barriers to entry. This ‘disruptive’ rule change, hence, lessened the impact of a regulatory barrier to entry. Ameritrade seized upon this opportunity and made a significant entry into discount trading by using and advertising negotiable commissions in their trades. The firm sought to achieve economies of scale by expanding trading through advertising. Advertising does not necessarily lead to economies of scale. Consider Figure 1. Some advertising may be described as ‘defensive advertising’, undertaken in order to maintain a firm’s sales in response to the advertising of a firm’s competitors. In Figure 1, the lower curve, AC 1 , indicates that the firm is not advertising. Hence its average cost curve ( AC 1 ) includes only the cost of production. If the firm advertises, its average cost curve shifts up to AC 2 , inclusive of production and the advertising costs. If the firm is only able to maintain its Figure 1. Possible Effects of Advertising. Source: The author.

202 Studies in Microeconomics 11(2) sales at Q 1 and no more, the firm’s costs rise from point ‘a’ to point ‘b’ reflecting higher costs at the firm’s scale of plant and, hence no economies of scale are achieved. If the firm’s sales soar from A 1 to AC 2 its costs would rise from point ‘a’ to point ‘d’, clearly placing the firm in the diseconomies of scale region. If sales, however, increase from A 1 to A 3 , the firm’s costs move from point ‘a’ to point ‘c’. Here the firm is experiencing economies of scale at a large scale of plant. In regard to Ameritrade’s advertising, the defensive advertising outcome of moving from point ‘a’ to point ‘b’ is actually not relevant, for its competitive brokerage houses were essentially not participating in discount trading. Ameritrade was breaking new ground by offering trades in this third market at reduced commissions. Therefore, Ameritrade’s accounts and number of trades would be expected to increase, moving the firm from point ‘a’ to point ‘c’ due to its advertising efforts. Seeing this expansion, Ameritrade’s competition, especially the large ones, would respond by entering this market through their own advertising efforts, as well as, by the acquisition of small brokers. Figure 2 illustrates what occurs when economies of scale are actually achieved through advertising. Initially, it is assumed that the monopolistically competitive long-run equilibrium position of normal profit is attained at point ‘a’ where price equals P 1 and quantity per unit of time equals Q 1 . The firm depicted above is not initially engaging in advertising. Stock trading was, at this time, a monopolistically competitive industry with many firms, mostly small, selling or providing a similar, but not identical service. It eventually became the oligopolistic industry alluded to above with an oligopolistic core of the large, full-service firm’s surrounded by a ‘competitive’ fringe of small firms. It gravitated to this condition after the acquisition of smaller firms by the large firms, such as Dean Witter and subsequently by the growing Ameritrade firm. Figure 2. Relationships of Advertising to Prices. Source: Industrial Organization, Clarkson and Miller, p.217.

204 Studies in Microeconomics 11(2) in stock trading by using touch-tone trading and continually improved technology (computerized online trading). Ameritrade’s experience also illustrates that such innovations can result in an increase in demand for an existing product or the creation of demand for a new product or service. Recall how the number of the firm’s accounts surged as it inaugurated discount trading and, still further, as it introduced online trading. Another accompanying innovation by Ameritrade was its exploration into negotiated commissions in place of the traditional fixed commissions. This facilitated into implementation of discount trading. This, indeed, was a novel and risky approach, one that other existing brokers would not broach. This low-price strategy illustrates the basic microeconomic concept of price elasticity of demand. That is, the firm’s amount (quantity) of accounts increased significantly when the price (commission) offered was reduced, that is, quantity demanded increased as price was lowered. The high advertising elasticity of demand was also revealed in Ameritrade’s large expansion of advertising expenditures which greatly expanded its business. This expansion powered the firm’s attainment of significant economies of scale. The firm’s expanded commitment to technology, noted alone, together with its eventual acquisitions of smaller competitors also contributed to the firm’s gaining of economies of scale. Yet another contributing factor to Ameritrade’s expansion and attainment of economies of scale was its vertical integration into the wholesale aspect of market clearing which allowed it to diversify into the provision of retail banking services to smaller brokerage firms. Hence, Ameritrade’s story is fraught with examples of textbook economics. It is an optimistic and positive story which can surely give encouragement to prospective entrepreneurs today. It says that they can still achieve great success when ‘thinking outside the box’ in developing new niches and then having the vision to implement their brainchild. Hence, the main takeaway from Joe Ricketts’ Ameritrade experience is that free-enterprise markets can be expanded and made more efficient and that new markets can be generated through the use of innovative ideas and technology. Ricketts energized trading markets by introducing such innovations as discount trades, online trades, negotiated trades, etc. Further, the effectiveness of his lower- price policy, as well as his increased advertising, vividly illustrate both the relatively high price elasticity of demand and high advertising elasticity of demand for stock trades. Finally, Ameritrade’s vertical integration into market clearing displayed the possibility of attaining further economies of scale. Declaration of Conflicting Interests The author declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article. Funding The author received no financial support for the research, authorship and/or publication of this article.

Greco 205 ORCID iD Anthony J. Greco https://orcid.org/0000-0003-0828-1508 References Clarkson, K. W., & Miller, R. L. (1982). Industrial organization: Theory, evidence, and public policy . McGraw and Hill Book Company. Dave. (2020, March 20). Webull vs Robinhood: Which free broker is better? Day Trade . Davis, C. (2021, March 22). 11 Best discount brokers of April 2021. Nerd Wallet . Folger, J. (2021, January 29). Robinhood vs TD Ameritrade. Investopedia. Lemke, T. (2019, October 4). What are the largest discount brokerage firms? The Balance . Mirani, S. (2021, April 20). Webull Vs. TD Ameritrade: Compare Trading and Account Fees of the Two Trading Platforms . RepublicWorld.com Muris, T., & McChesney, F. S. (1979). Advertising and the price and quantity of legal services: The case for legal clinics. American Bar Foundation Research Journal , 4 (1), 179–207. Ricketts, J. (2019). The harder you work, the luckier you get: An entrepreneur’s memoir . Simon and Schuster. Spiegel, H. W. (1971). The growth of economic thought . Prentice-Hall.