How are brokers and technology vendors responding to commoditization in capital markets?

Key Takeaways

• Brokers face the challenge of delivering a differentiated offering
• The rise of commission-free trading is squeezing margins
• Technology can help meet the challenges of a commoditized market

Commoditization, the process by which specialized and bespoke products and services become increasingly indistinguishable from one another, affects almost all sectors of the modern economy, and the capital markets are no exception. Equities brokers around the world face the challenge of delivering a differentiated offering in a crowded and competitive marketplace. Firms are responding in various ways, and technology plays a crucial role in supporting many of these strategies.

What is commoditization?

As a particular market matures, products and services tend to become increasingly standardized and interchangeable. Several factors drive this process – for example, successful innovations tend to be quickly replicated by all providers to stay competitive. The desire to appeal to as wide a market as possible also leads providers to simplify and standardize their offerings, making it easier to attract customers from competitors.

As products and services become standardized, they tend to become cheaper to produce and market. In addition, reducing costs becomes one of the few ways that providers can differentiate themselves, and this competitive pressure also drives down prices. New and immature markets are characterized by bespoke, experimental products, targeted at expert, well-resourced early adopters. In contrast, the products and services available in mature markets tend to be cheaper and interchangeable, just like commodities. This process has been observed in numerous consumer markets, from cars to smartphones, and financial services are not immune either.

How are brokers affected by commoditization and how are they responding?

In the equities markets both global and regional brokers are facing increasing cost pressures. The rise of commission-free trading, driven by new entrants to the market, is driving down margins across the board. Market access is an increasingly commoditized product, provided at a low cost through user-friendly smartphone apps. Such developments have opened global markets to a far wider range of consumers but have thrown legacy business models into question. Brokers are faced with the question of how to respond to these competitive pressures, and all potential solutions come with challenges.

One option is to focus on value-add, delivering a more bespoke and comprehensive service for a more targeted segment of customers. Brokers can offer customized trading strategies, personal support, and advisory services. By positioning themselves as a premium choice, brokers can protect their margins and sidestep the threat of low-cost competitors. However, such services can be difficult and expensive to deliver, and firms targeting this segment face a constant challenge to justify their status.

Another potential approach is to accept lower margins per-order and look to maintain revenues by servicing more customers. Technology is key to supporting such an approach. By deploying automated solutions, brokers can manage more customer flow by streamlining the whole order lifecycle. Automated order management and algorithmic trading can make it easier to deliver better execution outcomes, even while managing greater order throughput. While this approach offers brokers a route to thrive in a commoditized market, it is also dependent on appropriate technology solutions being available. Such solutions, moreover, are themselves increasingly commoditized, making it hard for brokers to differentiate their services and leaving them vulnerable to low-cost competitors.

How can technology vendors support brokers in an increasingly commoditized space?

Broadly, there are two ways technology vendors can support their broker customers to meet the challenges of a commoditized equities market:

• Automation: Sophisticated automated solutions allow brokers to maintain a high-quality service while controlling their overheads. Processes across the order lifecycle can be automated, from inbound order handling and trading venue selection to post-trade processes. Automation not only delivers efficiencies, it may also improve execution outcomes – for example, through benchmark algorithms.
• Customisation: Trading platforms are themselves an increasingly commoditized service, so the ability to add customisations quickly and easily is crucial to adding value and delivering competitive advantage. There are various ways that software can empower brokers to differentiate their services, including APIs, third-party integrations, or agile development frameworks. Customizable tools offer a pathway to delivering a bespoke service, without the associated costs.

Both brokers and technology vendors face the pressures associated with a commoditized marketplace. Both need to consider whether their business models and strategic goals are fit for the competitive environment in which they operate. But by working together to understand requirements and deliver responsive technology solutions, both can continue to thrive and serve the growing pool of buy-side investors around the world.