The Business Of

Banking | Charles Schwab | What Are Their Margins?

Morning All!

So, yesterday we dug into how Charles Schwab makes money. And we saw that the reason Charles Schwab can offer zero-commission stock trading is because of payment for order flow. We saw that the asset management division charges a tiny 0.13% annual fee on assets under management. And we saw that more than half of Schwab’s revenue come from them investing their customers’ idle cash. As a result, the company makes more net interest income than Barclays would you believe!

But that’s enough with revenues. Today, let’s turn our attention to margins and look at what costs are involved in Charles Schwab’s business model! Let’s start with a split of Charles Schwab’s cost structure in 2022.

And from looking at the chart, it appears to be a similar story to both Goldman and Barclays. 53% of Schwab’s costs are its people! Which is even more than the 45% (Goldman) and 51% (Barclays) we saw previously.

Now, there isn’t a whole lot to say about Schwab’s costs. Which means we can hopefully keep today’s newsletter short and sweet! Let’s dive in!

Do Brokerages Really Need Many Employees?

Okay, so let’s talk about compensation and benefits (in other words, salaries and bonuses)! And the first question is - how much do Charles Schwab’s employees get paid? Is it more towards the Goldman Sachs range… or more towards the Barclays range?

Well, as we can see from the chart below, it’s much more towards the Barclays range! In 2022, the average salary + bonus for a Charles Schwab employee was ~$168k. The figure for Barclays was £106k. And if we use an exchange rate of £1 = $1.25, the £106k becomes ~$133k.

Okay, so we know how much the average employee takes home. But what do Schwab employees actually do? Goldman’s employees were largely investment bankers and traders. Barclays had a whole mix of functions - high earning investment bankers and lower paid call centre workers. But what about Schwab?

Well, with Schwab, it’s a bit of an odd one. As we saw yesterday, the main operation of Schwab is the brokerage platform. But this brokerage business really doesn’t need a whole lot of employees. Most Schwab users will just go online and click BUY on shares, funds, etc. Then Schwab will have an automated system that transfers the shares/funds to the users’ accounts! So where do the employees come in?

Well, remember the advice part we talked about yesterday? A lot of people with Schwab accounts don’t know where to invest! They won’t just go online and click BUY on shares or funds. They want to speak to Schwab’s financial advisors before they buy. And so Schwab have thousands of employees either in (i) client service roles - helping guide clients over the phone or (ii) branches - helping clients with their financial strategies in person.

Client service roles (left) and Branch roles (right) help clients with their financial decisions

In addition to these financial advisor roles, Schwab will have equity and fixed income analysts in their asset management division. They’ll have individuals working for Charles Schwab Bank - thinking about how to improve net interest incomes. And they’ll also have a few software engineers across the business - who doesn’t these days!

So we can see that Charles Schwab actually does have quite a few employees. In 2022, the company employed ~35 million individuals. Whilst this is less than Goldman’s 49m, Goldman made >2x the revenue of Charles Schwab, so you’d expect Goldman to have more employees. The key thing to note here though, is that despite Charles Schwab having all these individuals, not many of them are in the investment banker salary range. Financial advisors may make $150k post bonus. But not many of them are making $400k post bonus! Alrighty, let’s move on!

We Don’t Want To Do All That Engineering… Can You Help Us?

Okay, so we’ve looked at employee costs. The next cost line we’ll look at is what Charles Schwab call professional services. And I know what you’re thinking - what on earth are professional services?

Well, the screenshot below shows us that when Charles Schwab refers to professional services, one of the things they mean by that is outsourced service providers. Which again, doesn’t exactly provide us much info! So, let’s break it down.

Now, we haven’t actually covered this yet in TBO. But most of the massive organisations we’ve covered, including Charles Schwab, will need a lot of technology to run their businesses. I’m talking about things we probably wouldn’t even think of. Finance software to help them pay their employees on time. Cybersecurity technology to help keep their systems secure. Cloud technology to help them reduce their data costs, etc.

And to help them with these technology decisions, who do Charles Schwab call on? Technology consulting firms – companies like Accenture, Deloitte, Capgemini, Infosys and Wipro to name a few! Now, unfortunately I couldn’t find any public examples of Charles Schwab working with tech consultants. But let’s briefly look at an example of how another big company has worked with a tech consultant – Vodafone and Accenture.

So, as we can see, Vodafone wanted to move to the Cloud. And the cloud system that Vodafone moved onto was AWS – Amazon Web Services. Now, some of you may be thinking – okay, Vodafone moved onto AWS. But what on Earth does Accenture do in all of this? Well, Accenture will basically have loads of software engineers (who are experts on AWS) who will help move all of Vodafone’s systems onto AWS.

And this is not a quick process by the way! This article of the Vodafone/Accenture case study tells us that it took a whopping 5 years for Vodafone to complete their cloud transformation. And during this time, Vodafone will be paying Accenture a fee for their services! Now, don’t worry if this is a bit confusing. We’ll be diving into The Business Of Consulting early in the New Year and things like the cloud will hopefully start to make much more sense!

But the important takeaway here is that when massive companies like Charles Schwab talk about ‘professional services’, a big part of what they’re referring to is outsourcing work to consultants. Instead of hiring LOADS (they still hire some) of their own software engineers to implement things like AWS Cloud or SAP’s ERP systems, companies like Schwab will outsource these projects and pay a fee.

Hargreaves Have 0 Branches… Why Does Schwab Have So Many?

Okay, so the final cost line we’ll look at today is what Charles Schwab calls occupancy and equipment. And one of the main costs involved here is rent. Now, Charles Schwab currently has ~400 physical branches in the US and for the majority of these branches, the company will be paying rent.

But here’s a question – why do Charles Schwab have 400 branches? I mean, Hargreaves Lansdown and Robinhood have 0 branches! And so, 400 seems fairly unnecessary!

Well, the reason is because – as we saw earlier – financial advice is a significant part of Charles Schwab’s business. When super wealthy individuals go to Charles Schwab looking for advice, do they want to be doing it over Zoom or phone call? Or do they want to be having that meeting in person? Well, it seems like the in-person option is most desired! And hence, why Charles Schwab have so many branches.

Now, as time goes on, and Charles Schwab’s clients become more comfortable with receiving their advice online, the company may decide to save some costs and reduce their branch count. Which is in fact what Schwab has started to do with their own corporate offices. Earlier this year, pressure from investors resulted in Schwab shutting down 5 of their offices in a bid to save costs. Maybe branches will be next!

Charles Schwab, You Boring Beauty!

Alright, so to wrap up, let’s look at what Charles Schwab’s EBT margin looks like after we take into account those costs we just saw. And from the chart below, we can see something pretty special.

Charles Schwab’s EBT margin was a staggering 45% in 2022! And the company’s margin has only fallen below 25% just once since 2006!

Now, I’m sure some of us are wondering - how on Earth is Schwab’s margin that high? Because yes, the other financial companies we’ve looked at on TBO have had high margins - Ninety One (32%), Goldman (33%) and Barclays (28%). But none of them have had 45% margins!

Well, I think one of the main answers comes from what we’ve looked at today. Charles Schwab’s costs are very boring! They don’t have the kind of litigation costs we saw at Goldman and Barclays. They don’t have all the credit losses to worry about from handing out mortgages and loans. Even with their employees, they’re not paid the fancy amounts that we see at some financial institutions. So Schwab’s costs are incredibly well-controlled.

But the other main factor here is scale. What do I mean? Well, we’ve seen that for all these financial companies we’ve looked at, employee costs are ~50% of their total costs. But as we can see from the chart below, there’s actually quite a bit of difference in how much these employee costs are as a % of revenue!

Charles Schwab only pay out 29% of their revenue in employee compensation. Whilst Ninety One pays out 44% of their revenue in this cost line. And that 15% difference pretty much covers the EBT margin difference between the two that we saw above!

On Friday, we’ll dive into this scale phenomenon more and see how it applies across other industries too!

22nd Nov 2023

Nigel Jacob CFA