Robinhood announced recently that it would be raising a new funding round of $350M led by DST Global on a $5.6B valuation. They also announced that Josh Elman, a general partner from Greylock, would be joining as VP Product.
The Wall Street Journal casually describes Robinhood as “Maker of App That Offers Free Stock Trades,” but these are very unusual events, even for the best of Silicon Valley startups.
Why is a general partner from one of the top Silicon Valley VCs joining a startup? And why is this startup all of a sudden worth so much?
Robinhood is reshaping financial services into a winner-take-all opportunity
There is a small group of companies that include Google, Facebook, Uber, Airbnb and Netflix that exhibit exceptional, winner-take-all dynamics. Ben Thompson of Stratechery calls them aggregators.
Never before Robinhood has a financial services company had all three characteristics of an aggregator:
A direct relationship with users
Robinhood offers what is arguably the easiest way for anybody to sign up for an online trading account. The entire process can be completed in the Robinhood mobile app in minutes, including a simple way to connect to your bank to fund your account (there’s no minimum requirement).
Zero marginal costs for serving users
Robinhood doesn’t incur any of the marginal costs Ben Thompson points out that traditional companies incur when serving customers directly:
- The goods “sold” by an aggregator are digital and thus have zero marginal costs (they may, of course, have significant fixed costs)
- These digital goods are delivered via the Internet, which results in zero distribution costs
- Transactions are handled automatically through automatic account management, credit cards payments, etc.
Buying and selling of investments is already end-to-end digital. Robinhood already provides online-only account management, account funding and customer service–and with the appropriate scale, Robinhood can also do all the necessary clearing and settling required.
With no gatekeeper to block them, at scale Robinhood checks the box for zero marginal costs for serving users.
But don’t other large brokerage firms like Fidelity and Schwab also have a direct relationship with users and zero marginal costs for serving them too?
Yes. It’s the next characteristic where Robinhood starts to really stand apart.
Demand-driven multi-sided networks with decreasing acquisition costs
Today’s brokerage market is fragmented, uninspired and has seen little or no innovation in years. The biggest player is Fidelity Investments with 26 million accounts, followed by TD Ameritrade with 11.1 million accounts and Charles Schwab with 10.7 million accounts. There are 25 broker dealers with more than $12 billion in assets under management and there are more than 3,700 total broker dealers registered with FINRA (Financial Industry Regulatory Authority).
But the real problem with today’s brokerages is their business model: fee for trading.
This creates an agency problem–a conflict of interest between the principal (individual investor) and the agent (broker). The broker makes money when an investor trades, so the broker is incentivized to encourage as much trading as possible. But trading more frequently is usually not in the best interest of the investor.
Robinhood has approached the market differently. They have tried to eliminate any obstacles to investing (including fees) and made the entire experience as easy and approachable as possible.
Robinhood uses a freemium business model where basic trading is completely free, but where more advanced features like margin trading, after hours trading and instant access to funds require a monthly premium subscription.
Given that at scale there is zero marginal cost for serving users, eliminating fees better aligns incentives between Robinhood and its users and allows Robinhood to obsess about customer experience in a way today’s business model conflicted companies cannot.
The results are impressive.
Early investors say they have “never seen a finance company that’s managed to grow like an Internet company.” Also important: Robinhood is the first brokerage account for most of their users and their median age is 28. This means many of Robinhood’s customers are net new investors that might never get an account anywhere else.
In October of 2016, Robinhood had 1 million user accounts. By April of 2017, Robinhood had 2 million user accounts. And by March of 2018, Robinhood had 4 million user accounts–which is more than E*Trade, who has been at this since 1982.
If Robinhood maintains their Internet-style growth, suppliers of all types of asset classes will have to come on to Robinhood’s platform on Robinhood’s terms or be left out, effectively commoditizing themselves in the process.
This is the dilemma content providers have faced with Netflix. Netflix is too large and there is too much money on the table for content providers to opt out of Netflix. But being on Netflix helps Netflix further cement their dominant aggregator position in the video entertainment market.
Those additional suppliers then make the aggregator more attractive to more users, which in turn draws more suppliers, in a virtuous cycle.
This means that for aggregators, customer acquisition costs decrease over time; marginal customers are attracted to the platform by virtue of the increasing number of suppliers. This further means that aggregators enjoy winner-take-all effects: since the value of an aggregator to end users is continually increasing it is exceedingly difficult for competitors to take away users or win new ones.
To believe this is true for Robinhood requires believing that the supply of financial assets operates similar to vacation rental listings (Airbnb), movie/TV catalogs (Netflix), or web pages (Google, which has an entire industry devoted to optimizing web pages to rank in Google).
It certainly is the case that there is an abundance of supply of financial products, with a wide range of quality and complexity. It also is the case that, for a variety of reasons, ownership in many financial assets is not available to most people.
Perhaps if Robinhood’s platform can introduce the right transparency, reporting and reputation mechanisms for financial services (the way Airbnb has reviews, Google has rankings, and Uber has ratings, etc) we might see the creation of completely new financial products. More on this in product opportunities below.
Robinhood’s business model
The most difficult and disruptive competitor in any market is one that is able to enter and give away what existing players charge for–which is exactly what Robinhood has done.
Robinhood’s premium subscription business model is a good start, but I don’t think it is a good long term play as it currently stands. Margin trading is cyclical, and after-hours trading and instant access to funds are niche features for sophisticated active traders–not something for people attracted by the tagline currently on the Robinhood web site: “Investing. Now for the rest of us.”
I would suggest Robinhood consider an annual premium membership fee similar to Amazon Prime, where users receive a basket of incremental benefits for being a member.
At the core of this offering should be at least one surprising and valuable benefit to Robinhood users broadly–similar to Amazon Prime’s free shipping. Around the core, Robinhood should then layer more and more benefits in the same way Amazon Prime has added Prime Video, Prime Music, Prime Reading, and countless others.
What might some benefits be? Here are a few ideas:
- Access to asset classes not normally available (hedge funds, venture funds, foreign assets, real estate)
- Free wire transfers or free ACH payments to US bank accounts
- Access to exclusive financial podcasts, articles and videos
- Quality online courses on investing and financial literacy (makes membership gift-able?)
- 1:1 financial advice with a licensed financial advisor
It’s also worth noting that having a strong premium subscription business model does not preclude Robinhood from exploring a Google-style self-service advertising model. Robinhood could charge an advertising fee for sponsored listings displayed alongside personalized portfolio recommendations or investment ideas when an investor is entering keywords in discovery mode.
Robinhood’s product opportunities
Robinhood’s mission to democratize access to financial markets is inspiring. They have done a great job stimulating the demand side with product and user experience innovations.
There are many additional tools and services that could further improve the investor experience, including:
- Normalized rankings, ratings and reviews for financial assets
- Personalized portfolio recommendations
- Simple and automated portfolio re-balancing
- Automated dividend reinvestment
It’s the supply-side though where things start to get really interesting. What new offerings fit Robinhood’s mission and would be so remarkable that people couldn’t resist talking about them?
Democratizing access to traditional assets
What if I as an average citizen would like to invest $100 per month in Google stock? Not possible. Google trades at over $1000 per share. So does Amazon. Tesla and Netflix trade at over $300 per share. Berkshire Hathaway A trades at over $300,000 per share. The pricing of many quality stocks prevent many people from owning it.
What if I have a child in high school or middle school who I’d like to be able to invest $10 per week in any stock he or she liked to learn about investing? Even with free trading, you can’t do this today.
What if there were funds that trade only in a single stock and required no minimum investment?
Robinhood could create these funds themselves to seed the market. Or in more typical aggregator fashion, they could perhaps just facilitate connecting the fund provider (supplier) with the fund investor (demand) while maintaining the quality standards of the funds listed, providing reviews and ratings of the fund, and requiring the fund to operate subject to investor-friendly transparency and reporting requirements.
Democratizing access to specialized assets
What if Robinhood could facilitate investment in assets that are normally difficult to access, like hedge funds, venture funds, angel funds, real estate or foreign assets?
Company stock option/incentive plans
Setting up and managing a stock option and stock incentive plan is something virtually all companies would like to do if it’s easy. Though it might be a distraction right now, what if in the future Robinhood provided incentive plans as a service? What if Robinhood could do for equity incentive plans what Gusto has done for payroll? Just a few benefits to Robinhood could be:
- Significantly accelerating the creation of accounts
- Digitizing and unlocking private company stock at scale, increasing supply
- Opening a secondary market for sale of private company stock
- Businesses would gladly pay for this, opening new revenue opportunities
The future of financial services
There is a lot of change taking place right now in the wealth management industry and financial services in general. As assets pass from Baby Boomers to Millenials, it’s hard to see how Robinhood won’t be an important part of the future. Just how important depends on how well they can scale their demand-driven multi-sided network and whether their acquisition costs truly are decreasing over time.
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