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Back to the Future?

Charles Schwab’s decision to replace David Pottruck as its CEO is, at its heart, an ironic statement on the firm’s commitment to his business philosophy.

Charles Schwab’s decision to replace David Pottruck as its CEO is, at its heart, an ironic statement on the firm’s commitment to his business philosophy.

Pottruck, who spent nearly 20 years with the firm, is legendary for his impassioned preaching about the need for reinvention, the importance of shaking things up. He aimed to turn the company from a discount broker into an operation that could serve all kinds of customers, ranging from do-it-yourselfers with limited budgets to wealthy families requiring complicated estate planning and constant hand-holding. Under his guidance, Schwab also moved into other non-core business such as trading and buying SoundView Technology Group, the small stock-research firm.

But the Schwab board apparently ran out of patience with this project, dismissing Pottruck on a day when the discount broker reported an earnings decline for the second quarter. In essence, it chose radical change over staying the course. SoundView and U.S. Trust are now more likely to be sold, observers say.

Some advisors questioned the wisdom of Pottruck’s approach, complaining that it saddled them with rising fees and cost them choice customers. But few would contend he lacked the courage and flair needed to put bold innovations into practice.

Courage has never been in short supply at Schwab. The company was founded in the 1970s by Charles R. Schwab, who set out to take advantage of the deregulation of brokerage commissions. Cutting fees, Schwab helped jump-start the discount-brokerage industry. In the 1990s, Schwab changed how investors buy mutual funds, introducing the first large-scale fund supermarket. With the rise of the Internet, Schwab became a pioneer in online trading. The company’s stock soared above $40, as daytraders raced to earn quick fortunes. But when markets collapsed in 2000, Schwab’s stock also dropped, and it recently traded below $9.

Pottruck was in large part the architect of the 1990s rise and fall. In 1998, he was promoted to co-chief executive, serving as Chuck Schwab’s partner. With trading volume slumping badly in recent years, Pottruck and Schwab scrambled to change the firm’s business model. Do-it-yourselfers were becoming an endangered species, the pair concluded. Burned by falling technology stocks, amateur traders lost their taste for the markets. Baby boomers, who once felt competent to manage their own money, now wanted more advice.

To reach the wealthy, Schwab purchased U.S. Trust, an old-line money manager. More recently, the broker introduced a stock-rating system and a private client business where customers could pay to meet face-to-face with an advisor. The company stepped up efforts to refer clients to a list of advisors.

As Pottruck pushed the firm to offer more service, he also took aim at the rock-bottom discounters, announcing that Schwab’s best customers could get trades at $9.95, down from $29.95. In effect, Pottruck was waging war on all fronts, targeting Ameritrade with low commissions and Merrill Lynch with advice and stock ratings.

The chief executive would surely have kept his job if the broad-ranging effort brought stellar profits. But so far the results have been lackluster. Earnings dropped 10 percent in the second quarter. And while shares of some discount brokers climbed along with the markets last year, Schwab’s stock stagnated. Assets of clients rose 18 percent during the 12 months ending in June—an uninspiring showing in a period when the S&P 500 climbed 18.9 percent.

If anyone can get the company fired up again, it is Charles Schwab, who stepped in to replace Pottruck. But the task of reinvention is not a simple one. To compete with the deep discounters, Schwab must offer bare-bones services. To match the full-service brokers, Schwab will have to provide the kind of advice that will attract picky clients. All those services can be expensive, and traditionally, Schwab has kept its cost structure low, paying moderate salaries and running lean operations.

If Charles Schwab cannot soon deliver on its goal of reaching all kinds of customers, then perhaps the board will insist on another change, this time demanding that the company goes back to its model of the 1990s. Then Schwab was clearly a discount broker. While never promoting the cheapest commissions, Schwab sought to provide moderate prices with better service than the cheapest discounters offered. The formula proved a winner, and perhaps something like it can work for Schwab again.

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