Retail FX brokerage: The expensive reality, the facts and the figures. FinanceFeeds research
Last week, FinanceFeeds produced detailed research which provided a statistical insight into the costs associated with operating a retail brokerage based on a global average deposit size and the amount of resources required to gain such a deposit and maintain customers, at a time in which competition is at an all time high and margins […]
Last week, FinanceFeeds produced detailed research which provided a statistical insight into the costs associated with operating a retail brokerage based on a global average deposit size and the amount of resources required to gain such a deposit and maintain customers, at a time in which competition is at an all time high and margins are very narrow.
One particular metric that has been on the minds of every executive in the retail sector over recent times is the cost of two important metrics, those being client acquisition and client retention.
There is an intrinsic difficulty when viewing two sets of statistics that have such a short term purpose, and by far a wider set of figures and circumstances need to be borne in mind because something of a stalemate has begun to occur due to a few contributing factors:
- Many brokerages rely on digital marketing and media buying, therefore look at cost of acquisition and retention as the only two metrics to consider.
- Client lifetime value is between 3 and 6 months for small-deposit retail FX accounts.
- Many marketing departments and sales floors are still structured as they were 10 years ago with media buyers generating leads and sales/retention staff calling leads to convert them.
Back in 2011, when the cost of bringing on board a new client was less than half of where it stands today, this was a tried and tested model that had worked in other online businesses including the telecoms and online gaming sectors, the ability to make a lot more revenue was evident.
Five years ago, E*TRADE spent $431 to obtain a new client. Today, the cost of acquisition ranges between $1,000 and $1,300, apart from Plus 500 which has managed to get it down to approximately $850, approximately double that of E*TRADE’s CPA just five years ago.
Meanwhile, back in 2011, many retail brokers still charged fixed spreads, however the increase in costs has come as a double-edged sword these days as spead is down to less than 0.3 pips on EURUSD in most cases, and partner remuneration is high.
Sales floors the white elephant of an online industry?
This leads on to one of the largest costs: maintaining a sales floor. This is without even looking at the regulatory capital requirements.
At first glance, the prospect of being a salesperson at a retail brokerage may appear to be an opportunity encased in gold, because turnover of clients is so high these days, however there is much more to consider.
The rental cost of office space is at an all time high in regions with a large and developed electronic trading industry, details of which can be viewed on the FinanceFeeds report on this which was published last week.
Why is a large office space needed? This is a moot point, largely because the majority of space which equates to several square meters having to be leased at between $50 and $70 per square meter, is necessary to accommodate large sales and retention desks.
When analyzing the cost of operating a sales-led brokerage model, the cost does not stop at the office space itself. Far more expensive is the continual need to recruit sales people and pay their commissions, and then find that they leave the company after a few months.
In order to dissect this cost, the remuneration packages being offered are usually around £25,000 in the form of a basic salary, plus a bonus which is based on either profit and loss, or more increasingly these days acquisition, trading volume and retention deposits.
Bonuses paid to salespeople and account managers in telephone sales positions within London these days, according to major general employment agency Reed, can take the average salary of a sales person to between £35,000 to £60,000 depending on experience and targets provided in the contract of employment.
When bearing in mind that the turnover of sales and retention staff in brokerages in the retail sector is very high, the cost does not stop here.
British company Hunt4staff states that the cost of recruitment is indeed not cheap. As the salary increases, so does the percentage which is charged for recruitment. For roles up to £15,000 annual salary, companies will typically pay 13 to 15%. For salaries of up to £20,000, the fee is around the 17 to 18% mark, and in excess of £20,000, companies are likely to be charged 20% to 25% i.e. £4,000 upwards to recruit an employee, who may then leave and need replacing just a matter of month later.
Large companies such as FXCM have recently taken steps to mitigate this, one of which was the removal of the use of affiliates, and in many cases introducing brokers – so long the darling of the retail industry.
The company has positioned its service at direct retail customers which respond to online advertisements and become customers on a self-deposit basis.
It makes a lot of sense to go down this route because it removes the cost of not only paying commission to affiliates and introducers, but it reduces the cost of continual recruitment.
Plus500 became a company with a $1 billion market capitalization very quickly after becoming listed on London Stock Exchange’s Alternative Investment Market (AIM) because it was so efficient and lean in its operations. No sales team exists at all, and the low-touch model means lots of small deposits, no risk of massive withdrawals and also no need for expensive and palatial premises.
This model is contrary to companies with a large global footprint such as IronFX which opened several offices in many countries within just one year, and applied a very sales-led approach, culminating in difficulties in paying introducers and partners, and the subsequent closure of certain operations and ensuing redundancies.
In very much a nutshell, this is the cost:
Average client deposit across entire retail FX industry – $6600 (including United States)
Average monthly salary for a sales person: £3,300 per month
Let’s take the data from one of the most efficient companies in the retail industry and look closely at this.
In 2015, Plus500 set the industry record for the number of active clients being serviced by a retail brokerage in the spread betting and CFD sector, at 137,000 active trading for the full year.
The average revenue per client within that year was $2019 for Plus500, far lower than the average globally, however the company had recorded an increase in the cost of acquiring customers.
Taking this as an equation, the company acquired 85,000 new customers in 2015 but this, at a cost of approximately $850 per new customer ich is vast when considering that the company’s entire revenues were $275.6 million for the year, and the company is one of the leanest in the business when it comes to operational costs.
Now take these figures, add another $200 to $500 per client acquisition, in order to estimate the cost for acquiring clients via a traditional sales team and media buying method (representing the cost of up to $1300 per client that it costs most brokers), and add the cost of recruitment, attrition, office space, employee pension contributions, insurance, training, management and the remuneration of IBs brought on board by sales and retention staff (commission for the sales people and for the IB and sub-IB is now applicable) and the cost then rises to over half of the revenues of a brokerage with a good and healthy active client base.
All of this without considering the 20% corporation tax payable on profitable business in Britain and the development and maintenance costs of operating proprietary platforms, or leasing MetaTrader 4 servers.
When looking at these figures, it is now possible to work out the real monthly cost of operating a traditional sales-led brokerage.
The automation of retention and acquisition is now a very real alternative, yet is in its infancy.
There are a few companies in the retail market that have made a massive impact on the Chinese market by having very small offices, and in some cases no physical offices at all, and have expended their efforts in developing large IB networks across China with companies that resemble brokerages with up to 100 staff, manage accounts for traders and conduct around 90,000 lots per month and are located in China’s prized tier 2 development towns. This on the face of it would appear to be a way of reducing costs and maximizing revenues.
These IBs operate in every way just as a brokerage does, and have payment processing, back office, a trading desk, their own marketing team, portfolio managers and customer facing sales and support staff, and simply operate an omnibus account with a Western broker which just does the processing of orders (usually on a b-book basis).
Although this at first may appear to be a very lean and efficient model as the entire business is effectively outsourced to the IB network, however remunerating IBs of this magnitude which need to capitalize their entire operations, and to keep the face-to-face aspect of working within China, is very very expensive in itself.
It is clear that this is a labor intensive model, and companies which have succeeded with this modus operandi can get toward a market capitalization of approximately $20 million under today’s volume and remuneration conditions.
The next step for this model is to partner with local exchanges in China, and offer prime brokerage services from a central point to actual brokerages.
Using Plus500’s model as an example, the low-touch ethos being completely the opposite of the high-touch approach required by those developing IB networks in China, the market capitalization of Plus500 is infinately higher despite its Western client base and small deposits, and its operating costs on a pro-rata basis, lower.
Cost of platforms
Important metric: There are 1,231 active MetaTrader 4 brokerages worldwide, and 4 million retail traders across every brokerage including those with proprietary platforms. This indicates loyalty to proprietary platforms.
In Japan, which is home to 35% of all global retail FX order flow, loyalty to brokerages is huge – in fact MONEX Group stopped offering third party platforms altogether.
It is not just a Japanese dynamic either. IG Group, Saxo Bank and FXCM all represent brokerages with very large and diverse client bases, all of which are using proprietary platforms.
With regard to considering the human resource cost compared to average deposit size and spread, that is just one aspect, which now is looking set for an overhaul.
Platform choice has increased, and the method by which prime brokerage services are capitalized, usually on a cost per million basis.
This can be looked at from a different perspective because the cost of operating a platform which provides a good user experience, or using a prime brokerage service or liquidity provider that provides reliable and high quality execution are areas of investment that clients notice, whereas the cost of running an operations with sales staff and all of the cost that goes with it, is not noticed by customers.
Therefore, investment by companies in the user experience is now paramount, and automated means of engaging with clients is a cost that firms are more than happy to look at.
Today, FinanceFeeds spoke to Itai Damti, CEO, Asia Pacific at Leverate about this matter, to gain perspective from a professional who operates within Asia, one of the most avantgarde regions in the world as far as new media, engagement via automated and social applications and online communities is concerned.
“For any trading platform, being able to offer a unique and engaging user experience across multiple channels is the key to retention. We shouldn’t look further than Facebook or Quora to understand the future of engagement in FX trading platforms” said Mr. Damti.
“Brokers can learn to use the power of network effects (think social trading), mobile experience, push notifications (think updates on market and account events) and data based recommendation engines (think recommended instruments and investors).”
“In a market dominated by MT4, brokers struggle to take these concepts to the edge because they don’t control the front-end, but those who invest in proprietary technology (from Saxo Bank to Plus500) or adopt cutting edge retention engines (Sirix Active) can do this in a compelling way and keep traders for much longer periods” – Itai Damti, CEO Asia Pacific, Leverate
“Brokers should understand some subtle differences between territories worldwide when thinking about long term engagement. For example, in Asia and especially China, mobile user experience and transparency are obviously important. But more important than them are the “hidden influencers” who can make or break your business in Asia: IB’s. IB reporting systems, money management tools and protection mechanisms for IB’s (such as private social communities) are all must for any broker that wants to engage its customer base in Asia for the long term” concluded Mr. Damti.
Tradency CEO Lior Nabat explained a similar issue that affects social trading in an interview with FinanceFeeds recently.
Mr. Nabat considers the largest problem that affects social trading to be quantity and liquidity. In this case, quantity is referred to as the combination of quality and liquidity.
“The biggest problem is quantity. If there are more followers which are following one expert, the performance starts to deteriorate. This is partly because there is not enough liquidity that will be served at the same price and the same time to all the followers” – Lior Nabat, CEO, Tradency.
“If the system buys shares, or currency pairs such as EURUSD, with 20,000 people in one go making the same trades at the same times, then the venue or broker has to supply the same asset at the same time to all of the people concerned. This affects the price and can cause adverse effects such as slippage. The account then doesn’t really work, the account eats itself, and people become disappointed” said Mr. Nabat.
At this point, the critical mass has been reached, and there is not enough ‘meat’ to give the same quality that is required” he said.
As a result, the company developed a new system called Robo-X which uses data collected over the last 10 years in order do automatically switch between strategies and ensure traders continue to be engaged.
When viewing the entire retail brokerage as a quid pro quo on the side of the brokerage and the ever demanding retail client, most certainly a new automated direction is on the horizon, the question is at which point will the retail business go from being sales-led to platform and user-experience led?