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November 15, 2006

Price Discrimination at Charles Schwab Corporation and Fidelity

posted by MR WAVETHEORY at 11/15/2006 11:40:00 PM
I have always wondered why it costs more to execute a 5000 share trade than a 500 share trade at an online broker. For me, it is an economic puzzle, because surely, it doesn't cost 10x as much to route a 5000 share order than a 500 share order to the stock exchange. We're talking just a few more bits and bytes. That is why I was even more perplexed when I discovered that The Charles Schwab Corporation (NYSE SCHW) actively price discriminates againsts its regular customers and so does Fidelity Investments. I looked at the commission schedule for Schwab and the commission schedule for Fidelity and found that Fidelity and Schwab sometimes charge their regular customer 10 times more than their active customers when they buy or sell more than 1,000 shares of stock.

Regular Customers Get Ripped Off
Brokers typically price discriminate between their regular customers and their active customers. Regular customers typically pay a base commission plus a per unit fee. At Schwab for instance, regular customers pay $12.95 per trade plus .015 per share over 1,000 shares. At Fidelity, its $19.95 per trade plus .015 per share over 1,000 shares. As you can see, once a regular customer starts trading over 1,000 shares, the fees really start adding up. Let's say you placed a 5,000 share order for a stock.

Fee for 5,000 shares as a regular customer
Schwab: $87.95
Fidelity: $94.95

You can see that the cost of the order is close to $100. That is quite a bit of commission for one trade. Does it look better if you are an active trader?

Active Customers Do Not Pay Per Share Fee
For active customers, the story is different. Schwab charges a flat fee of $9.95 per trade if you trade over 120 times per year, while Fidelity charges a flat fee of $8 per trade. Schwab charges 25% more per trade than Fidelity. There are no per share fees at either broker. So, for the same 5,000 share order, the fees are as follows.

Fee for 5,000 shares as an active trader
Schwab: $9.95
Fidelity: $8.00

You can see that it costs about $10 at either broker. So, what can we conclude from this?

Fidelity and Schwab Charge Regular Customers 10 Times More for the Same Trade
As you can see from the data, Fidelity and Schwab charge their regular customers roughly 10x more than their active customers to execute the same trade. For the same 5000 share trade, active customers pay about $10, while regular customers pay $100.a As far as I understand, the cost of sending a bit or a byte over the wire is the same whether it is a bit or byte for a regular customer or an active customer. There is simply no good economic reason why this kind of price discrimination should exist.

Price discrimination in the brokerage industry is one of those mysteries I don't understand. I don't think any broker can claim that it costs 10x more to serve a regular customer than an active trader - especially since almost all transactions all completed online. In fact, it may be more expensive to service an active trader. For all you brokerage industry veterans out there, I'm curious what you have to say to this.

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