Japanese Online Brokers Are Committing Hara Kiri

They have cut fees so low that only a few will stay afloat

When Japan deregulated stock commissions in October, 1999, as part of its Big Bang financial reform, brokers saw it as a golden opportunity. The brokerage business was run by a sclerotic group of traditional firms and was held hostage to high fixed commissions. Within 13 months, 64 companies--from established Japanese and U.S. firms to rank unknowns--had set up shop online, offering no-frills trade executions and rock-bottom commissions as low as $6.85 a trade.

Yet what was great news for Japanese investors has turned with remarkable speed into a disaster for the brokerages. A vicious price war, the weak market, and the worldwide fall in tech stocks have combined to make the online brokerages spectacularly unprofitable. On Nov. 15, two of Japan's smaller online trading firms, e-Wing and Japan Online Securities, announced plans to merge--the first casualty in what is likely to be a bloody shakeout. No more than 10 online brokers are expected to survive. "With the big decline in commissions, there's just no way for online brokers to make enough to cover their startup costs," says Takeo Omura, a senior researcher at the Japan Securities Dealers Assn.

THE SPOILS. The winnowing-out is likely to favor the biggest players. Six online brokers already handle 70% of the online volume (chart), and each has clear advantages. Matsui Securities Co. has cornered a 20% market share by charging $27.75 a day for unlimited trading, rather than the usual per-trade fee. That has pulled in thousands of day traders. Traditional brokers Daiwa Securities Group and Nomura Securities Co. won second and third place, respectively, by putting their offline customers online.

For the other online wannabes, though, the game is looking grim. Even those with deep-pocketed backers have had trouble making headway. Japan Online Securities--a joint venture of Itochu, Dai-Ichi Kangyo Bank, Fujitsu, and Microsoft--was launched in February, two months before the Internet bubble burst, and has attracted only 27,000 accounts. E-Wing, giant Sanwa Bank Ltd.'s online brokerage, began operations in April, after the tech boom had already peaked, and has also pulled in 27,000 accounts. Japan Online lost $6.7 million in the fiscal year ended Mar. 31; E-wing won't release its numbers.

The two companies are insistently upbeat, predicting that their combined market power will help them garner 200,000 accounts by the end of 2001. Yet analysts are skeptical. "The merger is an alliance of weaklings," says Dean Perry of ING Barings in Tokyo. Neither company has done anything to carve out a niche in the marketplace, he says, or to differentiate itself from the rest of the online pack.

The latest round of commission-cutting was what sparked the merger. Immediately after deregulation, online brokers launched a furious price war that has continued for a year. In August alone, 10 companies slashed commissions. Then, this month, E*Trade Japan, a unit of the U.S. online broker, trumped all the major brokers by dropping fees to $7.50 on trades of less than $4,600.

Profits, of course, become impossible at that level: $7.50 barely covers payments to the stock exchanges and the cost of sending out statements. What's more, Japan's online brokerages have relatively high costs because, on average, half their clients are still so leery of the Internet that they insist on completing trades by phone. As a result, the companies must still staff call centers. E*Trade Japan, for example, employs 150 operators to take phone trades. The company's parent, Softbank Corp., helps generate business for its offspring by giving E*Trade customers a chance to invest in its initial public offerings.

But diversification hasn't been enough to keep the wolf from the door. E*Trade Japan's shares, floated on Sept. 8, are trading at 32% of their offering price. Monex Inc., started by former Goldman, Sachs & Co. trader Oki Matsumoto, is also showing signs of strain. Backed by Sony, J.P. Morgan, and others, the broker lost $4.6 million in the six months ending Sept. 30. Matsumoto, who fired the first salvo in the price war by cutting fees to $9.25 a trade, now calls his rivals' commissions "a hara-kiri campaign."

Indeed, none of the online brokerages will make money until a large number of them die or merge. As in the U.S., the firms still standing when the bloodbath is over are likely to be those, such as Nomura and Daiwa, with the biggest bank accounts--and the highest threshold for pain.