Mixed Messages Trip Up Schwab

It takes money to make money.

Yet discount brokerage firm Charles Schwab Corp. can’t seem to turn a decent profit despite holding $1 trillion of clients’ assets.

The problem is so vexing that it cost David S. Pottruck his job as chief executive of the San Francisco-based company last week. He was replaced by the name on the door: Charles R. Schwab himself, the firm’s 66-year-old founder and chairman.

Schwab, the company, is becoming one of the great paradoxes of the revolution that has swept consumer financial services over the last two decades.

The name is synonymous with the empowerment of the individual investor and the opening to the masses of a wide array of investment choices, and at low cost. For years, Schwab’s success was its customers’ success.

But as the company has tried to do more than just offer cheap commissions on stock trades -- it now sells portfolio-building advice, stock research, services for the very wealthy and for institutional investors, for example -- critics say it has become confused about its mission, and how to deliver profit growth significant enough to sustain that mission.

More troubling for a firm that has long prided itself on being the small investor’s champion, that isn’t how many of Schwab’s customers see the company.

A survey last year by Forrester Research Inc. of Cambridge, Mass., asked 6,000 consumers to rate their primary financial service providers based on whether the companies did “what’s best for me and my household.”

Of 38 financial firms in the survey, Schwab ranked 27th, with less than half, or 40%, of its customers giving it high marks for being their advocate.

The company ranked below competitors including brokerage Edward Jones, which scored 61%; Morgan Stanley, at 54%; and Merrill Lynch, at 43%.

Whether something is seriously wrong with Schwab, however, remains an open question. This still is a franchise with 7.5 million accounts and the aforementioned $1 trillion in client assets.

It’s possible that Schwab, which in the past has been ahead of the curve in its financial service innovations, is ahead once again -- just too much so.

The company believes that many Americans in the years to come will need and want more hand-holding when it comes to their money. Given the aging baby boom generation, and the wealth being accumulated by them, that’s probably a good bet.

If those people are going to turn somewhere for advice and for more financial services than simple stock trades, many might well be willing to look to Schwab.

For the moment, however, the company’s marketing message is badly muddled, some critics say.

Pottruck, who had been founder Charles Schwab’s chief deputy for most of the last 20 years, acknowledged at a Forrester conference last month that consumers’ perceptions of the company had become troubling.

“People struggle with where we fit,” Pottruck said at the conference. “I hear this: ‘You guys are not discount brokers anymore, but you’re not really a traditional firm either. You’re this hybrid firm.’ ”

That image doesn’t bring new business in the door, Pottruck said. “What we stand for and the psychological position we hold in consumers’ minds need to be crisper,” he said.

Schwab’s board decided last week that Pottruck, 55, couldn’t fix what was wrong. He was ousted Monday, as the firm prepared to report that its second-quarter earnings fell 10% from a year earlier, to $113 million, or 8 cents a share, from $126 million, or 9 cents, a year earlier.

The company’s performance was particularly dismal when compared with that of its rivals. At the full-service end of the brokerage spectrum, Merrill Lynch reported second-quarter earnings up 10% from a year earlier. Among discount brokers, Ameritrade Holding Corp. said its profit jumped 25%.

Pottruck declined to be interviewed for this story. Charles Schwab also declined an interview request.

The brokerage’s woes stem in part from the massive overhead of branches, staff and back-office facilities it built up during the long bull market of the 1990s, as its assets and accounts boomed.

As many investors have pulled away from the market since 2000, Schwab has been slashing staff and facilities and says it will cut further. Its head count now is 16,700, down from 26,000 in 2000.

“It’s still a very large company with a lot of overhead,” said Tim Carpenter, an online brokerage industry analyst at research firm Watchfire GomezPro in Waltham, Mass. That means high embedded costs.

Meanwhile, as Schwab has geared up in recent years to serve an expected wave of advice-seeking investors, the bread-and-butter part of the business -- discount brokerage -- has suffered as cut-rate rivals have gone on the attack, luring customers away.

Schwab responded in May by cutting its own commissions, at least for active online traders, to as low as $9.95 a trade, from $29.99.

In a conference call with analysts last week, Schwab’s chief financial officer, Christopher Dodds, said the company’s struggle to attract new accounts had been “very disappointing to all of us.” The message of the commission cuts, he said, was that “we are not going to just surrender a large portion” of the potential client market.

Yet some analysts say that’s exactly what Schwab may have to do to succeed in the long run.

On Wall Street, a common impression of Schwab’s veteran customer base is that many are, as one analyst put it, “cheapos.”

Encouraged for years by Schwab’s own advertising, which encouraged a buy-and-sell approach to the market, many clients resent being told that they now could qualify for lower commissions if they would simply trade more, said Mike Ford-Taggart, who follows the brokerage industry for Morningstar Inc. in Chicago.

What’s more, as Schwab has raised fees for various services in recent years, trying to bolster revenue amid the stock market’s slump, the moves haven’t sat well with some of Schwab’s longtime customers who probably came to the firm, in the first place, because they were frugal.

Schwab’s fee structure also got surprisingly low marks for clarity in the Forrester study last year: Fifty-five percent of Schwab’s customers said they found its fees to be “crystal clear.” By contrast, 64% of Edward Jones’ clients thought that firm’s fees were clear; Merrill Lynch’s number also was 64%.

The appearance that Schwab is conflicted, in terms of its mission, has been deepened by its purchase in 2000 of U.S. Trust, some analysts say.

U.S. Trust caters to the affluent, and Schwab representatives are supposed to refer those kinds of customers to that division -- but only if they’re rich enough. That can encourage the feeling that the company no longer is most interested in the average investor, some critics say. Ford-Taggart’s view is that Schwab went “too far upmarket” in buying U.S. Trust.

If Schwab wants to provide advice and more services to the so-called mass affluent -- people with investable assets of $100,000 to $1 million -- the company’s shareholders naturally will want that business to be profitable.

That means clients will have to be willing to pay a fair price for what they get. Schwab’s challenge is to demonstrate to its customers that the services are worth the cost. If it can’t, it may have to be willing to cut more of those clients loose, analysts say.

Schwab’s “Personal Choice” program of investor advisory services, which allows customers to pick and choose what they want and how much they want to pay, could work well in the long run, said Carpenter of Watchfire GomezPro.

“There is substance there,” he said. “The challenge is to get that message out to the public.”

The question now is whether founder Charles Schwab, back in the CEO seat, is the man for the job. Wall Street didn’t appear to be terribly impressed with the boardroom coup last week. Many of the company’s institutional investors noted that Schwab had been co-CEO with Pottruck from 1998 through May 2003. So the founder has to share the blame for the company’s decline, they said.

Schwab stock rose 55 cents to $8.85 on Tuesday, when Pottruck’s exit was announced. But it ended the week at $8.57 on the New York Stock Exchange. It’s down 28% this year, compared with a 15% drop for the average brokerage stock in the Standard & Poor’s 500 index.

Mark L. Constant, a brokerage industry analyst at Lehman Bros., showed what Schwab is up against in the battle to revitalize its business and its image.

“We still see the company as relatively poorly positioned, with inferior growth prospects and material strategic inconsistencies,” he told clients in a note on Tuesday.

Tom Petruno can be reached at tom.petruno@latimes.com.