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Based on this Case study ( Charles Schwab in 2017)

1. Is Charles Schwab a disruptive innovator? explain why you agree of disagree with Walt Bettinger on this point
2. Can big incumbents be disruptors in the financial services sector?

For the exclusive use of T. ZALAN, 2018. CASE: SM-282 DATE: 11/01/17 CHARLES SCHWAB CORP. IN 2017 The first time that Walt Bettinger met Chuck Schwab, he had no idea that one day he'd take the helm of the wealth management, banking, custody, and brokerage firm that Schwab founded. It was 1995, and Chuck Schwab's company was interested in buying its largest client: Bettinger's Ohio-based, 401(k) plan record-keeping company. Bettinger had flown to California for a meetinghis first opportunity to meet the CEO in person. \"I had never met a multibillionaire before in my life. I was very nervous,\" remembered Bettinger. \"I walked into his office at 101 Montgomery Street, and he had this torn, hideous orange carpet, ratty old chairs, kind of disheveledjust a normal person, just a normal guy.\"1 Chuck Schwab's down-to-earth nature put the Midwesterner at ease. \"It doesn't matter whether you're bringing his lunch to his office or it's a client with $1 billionChuck treats everybody the same way, with honor, with respect,\" said Bettinger. \"His family wasn't particularly affluent, and my dad was a professor. My mom stayed at home with four kids.... We just had a natural connection.\" The deal with Bettinger's company happened, and 13 years later Bettinger was named chief executive of Charles Schwab Corp. (\"Schwab\"). Ever since, he had followed a weekly ritual. \"Virtually every Friday, I write a report for Chuck, and e-mail it to him,\" said Bettinger. \"I write about everything going on that I would want to know if my name was on the door.\" In 2017, nearly a decade after Bettinger took over as CEO, there wasn't much bad news to report. In the fall of 2017, the company's stock was trading near its all-time high and was up four-fold since 2011 (see Exhibit 1). The company was posting unprecedented levels of new client accounts, net new client assets, revenues, and profits and had a record $3.12 trillion in client assets under management (see Exhibits 2 and 3). Charles Schwab Corp. offered a 1 Interview with Walt Bettinger, August 17, 2017. All subsequent quotes are from this interview unless noted. Julie Makinen and Lecturer Robert Siegel prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright 2017 by the Board of Trustees of the Leland Stanford Junior University. Publicly available cases are distributed through Harvard Business Publishing at hbsp.harvard.edu and The Case Centre at thecasecentre.org; please contact them to order copies and request permission to reproduce materials. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means -- electronic, mechanical, photocopying, recording, or otherwise -- without the permission of the Stanford Graduate School of Business. Every effort has been made to respect copyright and to contact copyright holders as appropriate. If you are a copyright holder and have concerns, please contact the Case Writing Office at businesscases@stanford.edu or write to Case Writing Office, Stanford Graduate School of Business, Knight Management Center, 655 Knight Way, Stanford University, Stanford, CA 94305-5015. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 2 multitude of products, including mutual funds, stocks, exchange-traded funds (ETFs), options, futures, closed-end funds, bonds, CDs, money market funds, individual retirement accounts (IRAs), and foreign securities. In addition, Schwab offered savings and checking accounts, home mortgages, home equity lines of credit, credit cards, life insurance, disability insurance, and long-term care insurance. Positioning itself as having lower fees and more objective advisory services, Schwab was taking customers and assets from old-line wire houses like Morgan Stanley, while fending off challenges from young Fintech upstarts by being a fast follower. For example, in 2015, Schwab introduced a \"robo-advisor\" product, Schwab Intelligent Portfolios, to compete with companies like Betterment and Wealthfront. Schwab quickly had become the biggest pure player in that categorywith almost $25 billion in assets by fall 2017. Schwab had been working on its \"Through Clients' Eyes\" strategywhere decision-makers were encouraged to consider each action, large and small, for its impact on customers. Some executives even had hand-lettered signs on their office doors with messages like \"Always Put the Client First, No Matter What.\" That thinking, said Bettinger, motivated Schwab to look for ways to lower fees with technology and other efficiency-oriented moves. Schwab saw itself as a disruptor and had a good run targeting well-known but less-efficient competitors. Attracting more net new assets than any other publicly traded full service investment firm, Schwab had lower operating costs than competitors like Merrill Lynch, Morgan Stanley, E*Trade, and TD Ameritrade (see Exhibit 4). Still, there was no doubt that challenges loomed on the horizon. For example, how could Schwab maintain or improve trust in an era of intense cyber-threats and increasingly sophisticated technology that some consumers found invasive, or even creepy? Were its products elegant and simple enough? In the era of Uber and Amazon, customers' expectations were rising. And what might happen if a big tech company like Google or Amazon started to move onto Schwab's turf? Schwab had upped its technology development budget in 2016 almost 50 percent over 2015, to a record level.2 Down the hall from Bettinger's office, Tim Heier, the company's chief technology officer and R+D chief, was testing Amazon's new Echo speakers and trying to figure out how to use them to advance Schwab's business. Heier easily could see how to deliver financial information to customers via such voice-activated devices. But what about securely making trades using this new technology, via voice command? The key to staying ahead, Bettinger felt, was maintaining a laser focus on the customer, and being willing to cannibalize Schwab itself to find new growth. Schwab, he thought, had repeatedly proved its willingness to do so over the previous four decades, most recently by introducing the robo-advising product. The move had shifted some customers to a lower-fee product, which generated less revenue for Schwab than some other products, but it also had attracted many new customers, including millennials, and had been a net positive for Schwab. \"Disruption occurs when someone listens more carefully to customers, or better anticipates what customers might want before they even realize it themselves. Most companies are disrupted 2 Ibid. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 3 because they lack the will and courage to disrupt themselves first,\" Bettinger said. Could Schwab stay vigilant and keep up that courage? COMPANY BACKGROUND After finishing his BA in economics at Stanford University in 1959 and his MBA at the Stanford Graduate School of Business in 1961, Chuck Schwab launched an investment newsletter with two partners in 1963. The firm incorporated in the early 1970s and took on the name Charles Schwab & Co. When the Securities and Exchange Commission deregulated brokerage commissions in 1975, Schwab launched itself as a \"discount brokerage\" for the every-person investorone of the first of its kind. The company positioned itself as an impartial broker that offered low-cost trades. Within a decade, the company had 100 branches, 1.2 million customers, $7.6 billion in client assets, and had even begun exploring offering online services.3 Technology was key to its success. In 1979, Schwab became the first discount broker to bring automation in-house. Chuck Schwab risked half a million dollarsan amount equal to all of the company's revenue that yearon a back-office settlement system. He found a Wisconsin software firm that could modify its product to suit the company's needs, then bought a used IBM 360 Model 150 mainframe computer to run it; Chuck Schwab wanted to own the tech.4 The results were transformative: Schwab soon had the first online order entry system in the brokerage business. Suddenly, Schwab brokers could handle everything needed to buy and sell securities on a computer screen. \"Almost overnight, Schwab order-takers could handle twice as much volume, at less cost, with greater accuracy than any broker in the business,\" wrote John Kador in Charles Schwab: How One Company Beat Wall Street and Reinvented the Brokerage Industry.5 \"It was all so heady and so new that the brokerages on Wall Street for the first time took real notice of this upstart.\" And the system generated reams of data about customers and transactions that Schwab could mine to uncover trends and patterns.6 Bank of America purchased the company in 1983 for $55 million, but Chuck Schwab bought the company back in 1987 and took it publicjust before the October market crash. At that time, Charles Schwab Corp. was serving not just solo investors, but also independent investment advisors, providing them with asset custody and back-office operations. It also launched money market mutual funds and started advertising on national TV. By 1994, it had more than $120 billion in client assets. And in 1995, schwab.com went live (see Exhibit 5). Things seemed to be going so well that the company began making plans for Chuck Schwab to hand over the reins as CEO. In 1997, David Pottruck was named co-CEO with the company founder, and trading volume surged. Amid the dot-com boom, the company spent $2.4 billion to acquire U.S. Trust, a financial advisory firm that catered to 7,000 extremely wealthy clients. 3 Charles Schwab Corp., \"Charles Schwab Company History,\" https://www.aboutschwab.com/abou/history (October 10, 2017). 4 John Kador, Charles Schwab: How One Company Beat Wall Street and Reinvented the Brokerage Industry (Hoboken, NJ: John Wiley & Sons, Inc., 2002), p. 54. 5 Ibid. 6 Ibid. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 4 \"Schwab couldn't do anything wrong in the late 1990s,\" recalled Bettinger. \"But when the Internet bubble burst in 2000, Schwab couldn't do anything right, for a period that went through about 2004.\" As the market tanked post-2000, Schwab saw a 50 percent drop-off in trading volume, which struck at the heart of its low-fee, high-volume business model. Schwab's stock sunk, and the company laid off staff, and even stopped matching employees' 401(k) contributionsan embarrassing move, considering Schwab had long championed 401(k)s.7 Turning its back on the small-fry investors who had made the company, Schwab raised fees and transaction charges for clients with lower-value accounts. The company hoped to leverage technology to scale up its services for wealthy clients. But revenue year-over-year dropped 22 percent in 2001, 3 percent in 2002, and another 1 percent in 2003.8 In May 2003, Pottruck was named the sole CEO, with Chuck Schwab retaining the role of chairman, but in mid-2004, the board of directors ousted Pottruck, returning Schwab to the CEO's office.9 The man with his name on the door engineered a turnaround. Within two years, revenue moved back toward all-time highs, and Schwab began to shed non-core acquisitions, including U.S. Trust.10 In an effort to woo back middle-class customers who had jumped to newer low-cost online brokerages like E*Trade and TD Waterhouse, Schwab cut trading fees on average by over half from 2004 to 2005, even though this would cut into revenue. Schwab began to rely less and less on fees from trading: In 2000, half of Schwab's revenue came from trading activity, and 27 percent from asset-based fees, such as those generated by keeping custody of mutual fund balances. But by 2005, Schwab was making 79 percent of its revenue from asset-based products and services, and interest; just 17 percent came from trading. That let the company further reduce its trading commissions.11 The growth of Schwab Bank, which had been launched in 2003, would further change that revenue mix later on (see Exhibit 6). In 2007, Chuck Schwab promoted Bettinger to the position of president and chief operating officer from his prior role leading Schwab's core retail business. In 2008, just as the global financial crisis was coming into full view, Bettinger was named CEO, succeeding the company's founder and namesake. It was a tough time to take the helm. Like many financial services firms, Schwab took a hit during the Great Recession. But unlike some other firms, it did not accept government bailout funds. As profits and profit margins dropped from 2008 through 2010, the company downsized by 1,000 employees from 2008 to 2009.12 But earnings began to recover in 2011 as the benefits from strong client asset growth 7 For further information, see \"Charles Schwab & Co. Inc. (B) in 2003,\" GSB No. SM-35B. For further information, \"The Charles Schwab Corp. in 2007: Fixing and Redefining the Core Business,\" GSB No. SM-35C, p. 16. 9 Ibid., p. 1. 10 Ibid., p. 2. 11 Ibid, p. 6. 12 Charles Schwab Corp., \"2010 Annual Report,\" March 12, 2011. https://www.aboutschwab.com/images/uploads/inline/ar2010_complete.pdf (Oct. 12, 2017) 8 This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 5 kicked in and the economy began to pick up (see Exhibit 2). Schwab's headcount increased from 12,400 in 200913 to about 16,200 in 2016.14 Active brokerage accounts grew from 7 million in 2007 to 8 million by 2011, and 10.1 million in 201615and its market share rose. With each passing year, Schwab relied more and more on asset management and interest fees and less on trading revenue, which represented just 11 percent of net revenue in 2016 (see Exhibit 7). By many measures, in 2017, Schwab was one of the largest investment services firms in the United States. HOW SCHWAB SAW ITSELF IN A COMPETITIVE LANDSCAPE At the end of 2016, Schwab executives estimated that \"investable wealth\" in the United States exceeded $30 trillion. That meant the company's $3 trillion in client assets represented a market share of no more than 10 percent, which meant there was significant opportunity for growth. Bettinger and his team told shareholders: \"The company's strategy is based on the principle that developing trusted relationships will translate into more assets from both new and existing clients, ultimately driving more revenue and, along with expense discipline, generating earnings growth and building long-term stockholder value.\"16 The company referred to this strategy as the \"virtuous cycle\" (see Exhibit 8.) \"Where we continue to take our market share from is the big wire houses and banks,\" said Mike Hecht, senior vice president for corporate development, planning and strategy. \"That drove our growth over the last 40 years, and we think it's going to drive our growth over the next 10-plus years, if not more, because six out of every seven dollars in the U.S. is still with the wire houses.\"17 The competitive landscape for Schwab, though, extended far beyond the \"big four\" wire houses, or broker-dealers (Morgan Stanley, Wells Fargo, Bank of America Merrill Lynch, and UBS). Schwab also had to compete with Fidelity in the online brokerage space, and both Fidelity and Vanguard in the retirement fund management sector. Online financial advisors including Betterment, Wealthfront, and SoFi were accumulating billions of dollars of assets under management, although these newcomers were still far behind Schwab. And Schwab faced a variety of small and agile upstarts offering services such as crowdfunding, mobile payments, money transfers, and more. In part due to accounting and regulatory hurdles, Schwab opted not to set up a corporate venture capital arm, and was circumspect about most acquisitions. In Hecht's seven years with the company, Schwab had bought only four companies, and none of the deals exceeded $1 billion. Schwab's leaders believed the company's reluctance to chase fads had generally served it well. Said Peter Crawford, Schwab's chief financial officer: 13 Ibid. Charles Schwab Corp., \"2016 Annual Report,\" March 2, 2017, https://aboutschwab.com/images/uploads/inline/CharlesSchwab_2016AR.pdf (October 12, 2017). 15 Charles Schwab Corp. Annual Reports (2011, 2016). 16 Charles Schwab Corp., \"2016 Annual Report,\" op. cit. 17 Interview with Mike Hecht, August 17, 2017. All subsequent quotations are from this interview. 14 This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 6 I don't know that we're trying to predict what's going to be popular five years from now.... We feel like we can follow pretty quickly, as we did with Schwab Intelligent Portfolios when we saw robo advice was resonating with clients. What we don't want to do is chase fads. In the mid-2000s it was sub-prime lending. And four years ago, it was peer-to-peer lending. Everyone was talking about peer-to-peer lending, encouraging us to get into peer-to-peer, to go buy someone. And then, it actually wasn't that big a deal. I'm really glad we didn't get into peer-to-peer lending, or sub-prime before it.18 Schwab's executive team believed the company had much going for it, including: Scale and size: Schwab could spread operating costs and amortize new investments over a large base of clients and had the resources to develop new capabilities to satisfy clients. Operating efficiency: Schwab's sharing of infrastructure across different businesses let it competitively price products and services while profitably serving many client channels. Brand/corporate reputation: In an industry where trust was paramount, Schwab believed its reputation helped to attract clients and workers and introduce new products with success. Service culture: Schwab believed delivering a great client experience would earn the trust and loyalty of clients and increase the likelihood that those clients would refer others. Willingness to disrupt itself: The company espoused a commitment to challenge the status quo, to benefit clients, and foster innovation and continuous improvement.19 Bettinger rose before dawn each weekday to make sure that he was keeping his finger close on the pulse of Schwab's business, competitive threats, and the industry as a whole. Up at 3:30 a.m., he was usually in the office by 5 a.m. Every morning, he made sure to look at three key metrics: number of new accounts, net new assets, and net transfer of assets. He explained: What new accounts tells us is the level of engagement by the general population in investing. Net new assets tells us how healthy the business is overallare people bringing more and more money to us? And net transfer of assets is the measure of where we stand from a competitive standpoint; our market share.... A transfer of asset would be if you had an account at Morgan Stanley and you decided to close it and move that money to Schwab. If you get a bonus at work and you deposit it at Schwab, that's a net new asset. In the previous five years, Schwab had logged more than $100 billion each year in net new assets. And in August 2017, things were looking even better. \"We did over $80 billion in the first six months of this year,\" noted Bettinger. Still, there were many unknowns on the horizon, both for the industry and for Schwab in particular. Besides general macroeconomic and regulatory changes, Schwab's managers outlined a number of threats including: 18 19 Interview with Peter Crawford, August 17, 2017. All subsequent quotations are from this interview. Charles Schwab Corp., \"2016 Annual Report,\" op. cit. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 7 Security breaches by organized crime, activists, hackers and foreign state actors Technology and operational failures or errors Threats to outsourced service providers who perform key functions Competition in hiring and retaining qualified employees20 To be sure, many of Schwab's big-league competitors would claim many of the same advantages, and be on guard against similar risks. The trillion-dollar question was whether a disruptive force was lurking around the corner, unseen. \"We have a lot of discussion internally\" about where disruption might come from, acknowledged Heier, Schwab's chief technology officer. \"I actually fuss over this a lot.\" He added: When I think of disruption, and what's going on with Fintech and the tech giants, I think it may belong on two planes. First, a lot of the Fintech companies are doing rapid experimentation. They're looking at incumbents like Schwab and unbundling us, saying, \"I can do free trades. I can do automatic asset allocation. Investing robos.\" They're not trying to replicate the whole elephant, but they're biting us off one part at a time. Some of them deliver better, faster, cheaper solutions and ... if we did nothing, and I think the other incumbents did nothing, that would probably amount to what I think of as low-end disruption. It wouldn't tank an incumbent, but it does chip away at their business.21 But as Schwab had shown with its move to build its own robo-advising product, the company had the chops to defend against such \"low-end\" challenges, Heier thought. \"It's not perfect, but along the way, we think we will trade punches,\" he said. \"We'll do some things that are hard for those small, single-purpose unbundling companies to keep up with.\" More worrisome, said Heier, was \"disruption with a capital D.\" He elaborated: Somebody goes into a new market, offers a new service, something that's pretty dramatically different: You know it when you see itlike Google did with search. ... Those are harder to see coming, because it's usually a culmination of forces. I don't have the crystal ball, but I try to look at the little pieces to see what's coming together that has the potential to add up to that. Would a number of Fintech companies that somehow came together, either through acquisition or some kind of arrangement over time, equal a bigger disruption, a new market disruption? Would a tech giant come into the industry? No surprise, but we often think about an Amazon or a Google, that has extreme technology prowess and scale.... That would probably be harder to defend against. It would be a company that, by definition, would have money for investment. And if they're deciding to do this, they're going to make a real go of it. That's something for us to worry about. 20 21 Ibid. Interview with Tim Heier, August 23, 2017. All subsequent quotes are from this interview. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 8 Still, it was difficult to see exactly how that would develop, Crawford said. Regulation remained a high barrier to entering Schwab's industry; like other Fintech companies, Schwab was so highly monitored that government officials actually occupied office space in its headquarters to make sure the company complied with a multitude of rules and laws. Such regulation even made it hard for Schwab to partner with smaller upstarts and outsource some business functions. It was possible, Crawford allowed, that Amazon might one day offer customers something like a money-market type fund, as Alibaba had done in China. \"That could to a certain extent disintermediate the banks,\" he said. \"What I have a harder time seeing is how Facebook would allow people to invest in the stock market. They could create a portal to someone's brokerdealer or robo advice offering, but it would be much more difficult for them to replicate the broad range of products and services we offeradvice, tools, different products, and access to people when needed.\" FACING THE CHALLENGES Tech and Innovation Technology had been in Schwab's DNA since the 1970s. \"Depending on what hat he was wearing at the moment, Chuck would say he's either in the direct response business or the technology business,\" Kador wrote in his book on Schwab.22 But fast-forward to 2017, and no one within Schwab was under the illusion that the company was still a \"technology company\" technology had simply become too ubiquitous and democratized. The question was how to keep upor even stay aheadin a rapidly evolving world. \"There was an era where we built everything,\" said Joe Martinetto, Schwab's senior executive vice president, who joined the company in 1997 and served as CFO from 2007 to 2017. \"I think we have gotten a lot more rigorous in our thoughts around what's really a competitive advantage and what's a commodity. We buy commodities. We only build things that we think are differentiated.\"23 While in the 21st century Schwab had many more options to purchase technology or partner with tech firms, deciding what to do and how to do it was a major challenge. Schwab faced some complex legacy issues from owning so much tech early on. In 2017, for example, Martinetto's group was in the midst of a 10-year project to modernize the company's core computer systems and move to more up-to-date hosting capabilities. His team had to decide what it could outsource to third parties, both in terms of code and hosting, and still meet regulatory requirements and security concerns. \"We licensed a core broker dealer platform 40 years ago and brought it in-house, and went off of their upgrade path and have been doing our own enhancements and our own customization, and our own maintenance for 40 years,\" he said. \"The core books and records system is still that system. That system has been through countless permutations of where it runs in data centers, 22 23 Kador, op. cit., p. 54. Interview with Joe Martinetto, August 17, 2017. All subsequent quotes are from this interview. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 9 what types of platforms it's running on, and you can only imagine the complexity that has built up.\" The process was like unwinding a huge ball of twine. \"The mainframe code base was around 39 million lines of code,\" said Martinetto. \"We've probably pulled about a third of those off.\" Martinetto and Heier, the CTO, believed that the messy unwinding process would help position Schwab for the next wave of innovation. \"We're having to figure out how to deliver to people what they want, or what's convenient to them, which is actually inconvenient to us, because we have to re-architect and re-build core systems, our core transaction processing systems,\" said Heier. Every Tuesday, Heier hosted a video conference call with the eight members of his R+D team, which consisted of four computer science specialists in California and another four in Austin, Texas. Lately, the squad had been studying voice assistants such as Apple's Siri and Amazon's Alexa. \"I think about: What does the world look like in 10 years.... How do people interact with their devices, and what expectations will they overlay on a company like Schwab?\" Heier said. He added: The web came out; we came out with a website. Mobile was out long before we had a mobile app; then we [eventually] responded with a mobile app for convenience and accessibility. Expectations keep changing, which puts pressure on our software development teams. You have to think about the verbal agent and how people will interact with us with voicenot necessarily about picking up the phone and going through a call center or call tree. They can use a virtual assistant. That's a different kind of software. Do we write it? Do we buy it? Whether we own it in the future, whether we partner with another company; who are the companies to partner with? Is it too early to partner? Should we wait a couple years? If we wait too long, are we behind? I go through that decision thought process to figure out: Does something pop out the other end where we, I, the team should do something? The team was small and had to choose carefully how and when it moved. \"It's expensive to be first on everything,\" said Heier, \"so I think we've honed our skill and our process of watching, learning, innovating.\" Trust How to winand retaincustomers' trust was something that Schwab's CEO thought about constantly. Bettinger believed it was the No. 1 issue for Schwab. Thanks to unscrupulous and sloppy practices and conflicts of interest, the financial services industry as a whole, he said, had lowered trust across the board \"to maybe just one or two levels below used car sales.\" \"Without trust, everything else you do to a certain extent becomes irrelevant. Because this is not like buying shoes, or cars, or neckties, or a cup of coffee,\" said Bettinger. \"This is your future, this is your family's future, this is what you work for, and so trust is at the core of everything you do. After that it comes down to, in many ways, scale and efficiency.\" This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 10 Technology, thought Bettinger, offered the possibility for Schwab to know its customers better, give them more relevant guidance, and build up trust. But technology also held the potential to offend and alienate them. In 2017, Schwab had the ability to analyze every single one of the 40,000 calls that came into its call center daily. It could track every word a customer clicked on its website. \"If you're on schwab.com and you click on the 'life events, divorce' section, we might know something before your spouse does,\" said Bettinger. \"I mean, there's a lot of things that we can know, that we just have to be really, really careful about.\" There were still questions that data could not answer for Schwab. \"It is very difficult to understand the motivations of clients, behind every dollar of money movement,\" Bettinger said. How, he wondered, could Schwab leverage technology to better understand those motivations, without invading clients' privacy? Another constant concern was cyber-threats and hackers. \"Information security is a huge thing that we all have to deal with all the time, and we are in the business of trust. Trust is so foundational to our relationship with clients,\" said Neesha Hathi, executive vice president for investor services experience and platforms. \"There's a real risk if we have some issue on that side, or our industry has some issue on that side, that really results in a big disruptive force.\"24 Martinetto wondered what types of new authentication protocols Schwab could adopt to increase security and improve the customer experience. \"You can spend an infinite amount of money, and if anybody tells you that they can give you 100 percent guarantee that their systems are impermeable, they're lying to you,\" he said. But threats were increasingly moving to the client side, as thieves found new ways to spear-phish consumers or steal their login information.25 Martinetto believed passwords would soon go away, but he wondered: Should Schwab move aggressively on voice authentication? Facial recognition? Retina scanning? Thumb-print technology? Other biometrics? \"In the old days, there were things that were just too expensive. But there's very little that's not affordable in technology anymore,\" said Martinetto. \"I would love to have some of this better authentication stuff in place, because one, I think it's great for the client on the front end and two, because once we know it's really you ... it just makes it a whole lot easier for us to deliver better, faster experiences to you.\" Engagement Besides trust, Bettinger was wondering how to get the general public more interested in investing. More engagement would mean more business. What, he thought, would it take to get 24 Interview with Neesha Hathi, August 17, 2017. Spear-phishing, an email-spoofing attack that appears to come from a trusted source, targets an organization or individual by seeking unauthorized access to financial information or other sensitive data. 25 This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 11 the next generation of customers in the door? Because once a customer came to Schwab, it was highly unlikely that they would leave; the company's attrition rate was about seven percent. \"It's rather remarkable, the low levels of engagement among people with their money, and with investing,\" he said. Complexity was one reason, he believed. \"It's not a topic that people are proud to say, 'I really don't understand this at all.'\" In 2017, 17 percent of Schwab's retail clients were under 40, up from 15 percent in 2012. Its average customer was in his or her mid-50s, consistent with the age where most investors have substantial levels of investible assets and are focused on investing. Schwab's senior executives believed that attracting new customers involved many factors financial literacy, the right product mix, pricing, branding, and life stage. They worried whether the challenges of younger people in the 21st centurylarge student debts, high housing costs might make them less likely to engage with Schwab, or any investment firm for that matter. \"When I think about convincing a 20- or 30-something to start investing, someone who has a tremendous amount of debt and no interest [in investing], that's a big challenge, and we don't spend a huge amount of time trying to solve that,\" said Jonathan Craig, Schwab's chief marketing officer. \"What we're trying to do is address their need when they realize that need is real. What we continue to see is people reach certain life stages. They get married, they have a child, they couple, they have a partner, whatever they do, they reach a point where they say, 'I can no longer put this off.'\" But what kind of services did this new generation of customers want? Should Schwab offer more services, perhaps around budgeting, insurance, or health care? How much interaction would the next generation of clients want with real-life representatives, and how much would they just want to use technology? What was the right balance between automation and the human touch? \"I don't think it's going to be more of the same.... There will be a lot more that clients are going to want to do digitally. But they're still going to want to talk to people at some point, when things get really complicated,\" said Rich Fowler, senior vice president of investor relations. \"It's a bifurcated approach. Making sure that all the stuff that they don't want to talk to somebody for, we can make it as easy as possible to do business with us, and then this other stuff, enable our people to have really good conversations there.\"26 Recruiting/Talent Another unknown for Schwab heading into the future was whether it would be able to attract the type of technical talent necessary to innovate. Schwab executives believed the company's culture was unique in the financial services industry, and they liked to talk about \"Schwoomerangs\"employees who left Schwab, only to return when they found life outside wasn't as attractive as they had hoped. 26 Interview with Rich Fowler, August 17, 2017. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 12 Still, Schwab these days wasn't just competing against other financial services firms. Heier had recently lost one of his R+D team members to Facebook. And that wasn't all. \"Over the last year, we've lost an engineer to Facebook, one to Google, and one went to a startup,\" he said. \"But we hired somebody from Google about two years ago. People don't think of Schwab competing in that arena, but we're after the same talent. ... If we can get to them and tell them what we're up to, they get pretty interested.\" CONCLUSION Schwab, Walt Bettinger thought, must never lose the will to disrupt itself. He had seen this force on display in 2004, when Chuck Schwab returned to the helm of the company and the two of them decided to cut fees, even though it would mean reducing the company's revenue in the short term. When Schwab put the idea to board members, Bettinger recalled, their response was predictable. \"They said, 'We've just seen our revenue go down 40 percent post-Internet bubble; now you're saying we should take it down another 20 or 25 percent. On what basis is it going to be replaced?'\" He recalled how he and Chuck Schwab convinced them: We gave the same answer, which was: \"We will return to being the Schwab of old, which did the right thing by every customer. And in return, clients will choose to bring business to us.\" And the board said, \"You're right. Go do that.\" That would not happen in every public company, and I do think that Chuck's presence and his significant ownership contributes to the willingness of the board. You know, if the guy who at that time owned 18 percent of the company says, \"We should take that hit,\" it's easier [for the board] to say yes. In 2017, Chuck Schwab turned 80. Bettinger himself was about to turn 57. Perhaps in 10 years, neither one of them would be involved in running Charles Schwab Corp. Bettinger thought about what this might mean: I think when Chuck is gone someday, what he has built culturally will remain. The risk will be, when big decisions have to be made that demand bigtime courage, will they be able to get done? If the company got in trouble 15 years from now, could someone walk into the board of directors and say, \"We need to give up 20 to 25 percent of our revenue to fix this, and trust that in doing so consumers will reward us by bringing more money.\" Fifteen years from now, if it's a different CEO, if [Chuck Schwab's] ownership has been diluted, if a trust takes his holdings and has sold them to donate the money to charities... that's a possible scenario. And if the person walking in there is the CEO, who owns a fraction of a percent, and nobody owns more than 1 or 2 percent of the company, it may be a tougher decision. What, Bettinger wondered, could he do now, in 2017, to bake in that courage to Schwab so that it could endure for a long, long time to come? This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. p. 13 Charles Schwab Corp. in 2017 SM-282 Exhibit 1 Charles Schwab Corp. Stock Close Price* 60 50 40 30 20 10 9/22/17 9/22/16 9/22/15 9/22/14 9/22/13 9/22/12 9/22/11 9/22/10 9/22/09 9/22/08 9/22/07 9/22/06 9/22/05 9/22/04 9/22/03 9/22/02 9/22/01 9/22/00 9/22/99 9/22/98 9/22/97 9/22/96 9/22/95 9/22/94 9/22/93 9/22/92 9/22/91 9/22/90 9/22/89 9/22/88 9/22/87 0 *Schwab stock split 2-for-1 in July 1999; prices adjusted to reflect split. Source: Compiled from Yahoo Finance. Exhibit 2 Charles Schwab Corp. Financial Results 2006-2016 (dollar figures in millions) $8,000 45% $7,000 40% $6,000 35% 30% $5,000 25% $4,000 20% $3,000 15% $2,000 10% $1,000 5% $0 0% 2006 2007 2008 2009 Revenue 2010 2011 Net Income 2012 2013 2014 Pretax Profit Margin Source: Compiled from Charles Schwab Corp. Annual Reports 2006-2016. This document is authorized for use only by TATIANA ZALAN in 2018. 2015 2016 For the exclusive use of T. ZALAN, 2018. p. 14 Charles Schwab Corp. in 2017 SM-282 Exhibit 3 Total Client Assets (in billions) $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017* *As of August 31, 2017 Source: Compiled from Charles Schwab Corp. website, \"About Us\" and \"Letter from the CEO, March 2, 2017,\" https://www.aboutschwab.com/investor-relations/annual-report/letter-from-the-ceo and https://www.aboutschwab.com/about (October 12, 2017). This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. p. 15 Charles Schwab Corp. in 2017 SM-282 Exhibit 4 Expense\tto\tAverage\tClient\tAssets\tQ12017\t(bps) 70 60 58 53 50 43 40 27 30 18 20 10 0 Cost Morgan Stanley $2.187B Bank\tof\tAmerica $2.585B E*Trade $336B TD Ameritrade $847B Charles Schwab $2,923B Expenses and average client assets among publicly traded investment services firms. \"Morgan Stanley\" refers to Morgan Stanley Wealth Management and \"Bank of America\" refers to Bank of America Global Wealth Management. Source: Charles Schwab Corp. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. Charles Schwab Corp. in 2017 SM-282 p. 16 Exhibit 5 Key Dates in History of Charles Schwab Corp. 1963 Chuck Schwab and two partners launch Investment Indicator, an investment advisory newsletter. At its height, the newsletter reaches 3,000 subscribers paying $84 a year to subscribe. 1971 Firm is incorporated in California as a conventional broker-dealer securities business. 1975 The SEC deregulates brokerage commissions. The company, now called Charles Schwab & Co., creates a discount brokerage; opens first branch in Sacramento, Calif. 1977 Schwab opens office in Seattle and begins offering seminars for customers. 1978 Schwab extends customer service and quotes from 5:30 a.m. to 9 p.m., an industry first. 1979 Schwab invests in expensive BETA mainframe system, an automated transaction and record-keeping system. Company deduces that technology can be a key growth driver. 1980 Schwab establishes the industry's first 24-hour quotation service. 1981 Schwab becomes a member of the NYSE. 1982 Schwab is the first to offer 24-hour, 7-day-a-week order entry and quote service. The company's first international office opens in Hong Kong. The IRA account is introduced. 1983 Bank of America acquires the firm for $55 million. 1987 Management leads buyback from Bank of America for $280 million; completes its initial public offering. In October, market crashes; Dow Jones Industrial Average loses 500 points. 1989 Schwab introduces an automated technology for telephone brokerage service. 1990 Schwab introduces money market mutual funds; opens first Asia Pacific center. 1991 The company introduces the Schwab 1000 Fund, an equity index fund that reaches $191 million in client assets by year-end. Company debuts its first network TV advertising campaign. 1992 Charles Schwab Trust Co. is created. The company introduces no-annual-fee IRA and one-stop-shopping for mutual funds from multiple fund families. 1994 Spanish-language TeleBroker service introduced. Total client assets top $122.6 billion. 1995 Schwab activates its first website. Company acquires 401(k) plan record-keeper, Hampton Co., founded by Walter W. Bettinger II. 1996 Web trading goes live. 1997 Charles Schwab Corp. is added to S&P 500 Index. David Pottruck is named co-CEO. 2000 Schwab and U.S. Trust merge. In March, NASDAQ peaks; falls 78% in next 30 months. 2001 September 11 attacks; NYSE drops 7 percent on the first day trading resumes. 2002 DJIA drops to a four-year low on September 24; NASDAQ reaches six-year low. 2003 Charles Schwab Bank launches. 2004 Pottruck resigns as CEO; Chuck Schwab reinstated as CEO. Bettinger moved from leading the Corporate Institutional Services unit to Retail unit. 2005 Company launches a new ad campaign: \"Talk To Chuck.\" 2006 Company sells U.S. Trust, its wealth management subsidiary, to Bank of America. 2007 Bettinger named president and chief operating officer. Bear market starts; financial crisis. 2008 Bettinger appointed CEO. 2009 Schwab offers first exchange-traded funds (ETFs) that trade commission-free online. 2010 Schwab launches mobile apps for smartphone users. 2012 Total client assets exceed $2 trillion. 2015 Schwab Intelligent Portfolios (robo-advisor) launched. 2016 Schwab launches Schwab Intelligent Advisory, a hybrid service that combines live credentialed professionals and algorithm-driven technology Source: Charles Schwab Company History, https://aboutschwab.com/about/history (October 12, 2017). This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. p. 17 Charles Schwab Corp. in 2017 SM-282 Exhibit 6 Schwab's Changing Revenue Mix Source: Charles Schwab Corp. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. p. 18 Charles Schwab Corp. in 2017 SM-282 Exhibit 7 Charles Schwab Corp. Net Revenues by Source 2012-2016 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2012 2013 Asset management and administration fees 2014 2015 Net interest revenue 2016 Trading Revenue Definitions: Net interest revenue is the difference between interest generated on interest-earning assets and interest paid on funding sources, the majority of which is derived from client cash balances held by the company as part of the clients' overall relationship with Schwab. Asset management and administration fees come through Schwab's proprietary and third-party mutual fund and ETF offerings, as well as fee-based advisory solutions; a portion of these fees comes from client cash balances placed in Schwab's money market mutual funds. Trading revenue is generated through commissions earned for executing trades for clients in individual equities, options, fixed income securities, and certain third-party mutual funds and ETFs, as well as principal transaction revenue earned primarily from actions to support client trading in fixed-income securities. Schwab's services include: Brokerage accounts Mutual funds Exchange-traded funds Advice solutions Banking: checking and savings accounts, certificates of deposit, mortgage loans, home equity loans and lines of credit, and pledged asset lines Trust: trust custody services, personal trust reporting services, and administrative trustee services. Source: Charles Schwab Corp. 2016 Annual Report. This document is authorized for use only by TATIANA ZALAN in 2018. For the exclusive use of T. ZALAN, 2018. p. 19 Charles Schwab Corp. in 2017 SM-282 Exhibit 8 Source: Charles Schwab Corp. This document is authorized for use only by TATIANA ZALAN in 2018