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Thanks to Alpha Ideas carrying our previous article, it has now crossed 500 reads; 🤯! I’m super grateful to them, and to each of you for the attention and encouragement.😊
Onto today’s piece.
Zerodha is one of India’s most loved companies. From traders and investors, to students and enthusiasts — the capital markets’ community has warmly embraced their discount broking pricing model, clean product interface, educational initiatives, and everything in between.
This article unpacks the business of Zerodha, layer by layer, to articulate their strategic positioning and the factors contributing to their moat.
Let’s get started.
Zerodha was founded in 2010 by Bangalore-based siblings, Nithin and Nikhil Kamath. Aged just 31 and 24 at the time, both had capital markets experience — from being traders themselves, and later, sub-brokers of Reliance Money.
They realised, no one in the industry tailored their offerings for traders. High brokerage and suboptimal customer experience were quite common.
They started Zerodha to offer low-cost, digital-first broking to traders in India. The name Zerodha, comes from Zero plus Rodha (Sanskrit for barrier), meaning zero barriers… to trading.
Next, we'll look at how Zerodha entered this industry.
Definition of Sub-broker ⬇️
First, who’s a stockbroker? Those with a licence to access a stock exchange (think NSE) are called stockbrokers. When regular people need to access a stock exchanges, they do so through such stockbrokers, while paying them brokerage on the purchase / sale transaction.
Sub-brokers are downstream partners / agents of such stockbrokers, who find their own clients, serve them through the principal stockbroker, and take a part of the commission earned.
There are few things as complex as the emergence and eventual success of a new business model.
Newcomers can thrive in an established industry only when armed with one (or both) of the following:
- Exclusive rights to a Cornered Resource: Like an innovative product with a patent, or a superior skill-set.
- Counter Positioning: A superior business model, which incumbents do not or cannot mimic; fearing immediate damage to their existing business.
Zerodha, to my eyes, perfectly counter-positioned themselves. And that coupled with first-mover-advantage played a massive role in their initial success. I experienced this first hand; my family part-owns a stock brokering company.
Traditional stockbrokers had two income streams — one, brokerage, and two, bank interest on client money. Beyond a certain scale, bank interest on the total money lying in thousands of client accounts, generates far more revenue than the ever-declining brokerage. Consciously, clients only know about brokerage, and negotiate for lower percentages. This ranged from 0.01% to 0.3% of transaction value. Zerodha however, killed this negotiation by charging a fixed ₹20 per trade in the derivatives segment. Like I said, they primarily served traders; and traders focus on derivatives, and not on equities.
Next, they welcomed retail investors by offering equity transactions at zero brokerage. Why would they charge ₹0 for a service? … Bank interest!
Traditional brokerages didn’t or couldn’t mimic this model. Just imagine this conversation at a traditional broker’s office. X says, “The industry is moving towards discount broking, should we follow suit?”, Y answers, “Are you crazy!? We would lose 60% of our revenue!!!”
You see, "financially", it didn’t make sense for incumbents to sabotage their top-line. Only later, once new client acquisitions waned, and existing clients started switching, did they realise, that not only were they losing brokerage, but also, their coveted interest income. Pivoting then was already too late; Zerodha was miles ahead.🎯
Such incumbent debilitation makes counter-positioning a compelling strategic move. The only way to fight a better business model is to adopt it, while wrecking your exisiting model. When a better alternative arrives, you either transform yourself, or someone else will render you insignificant.
Some popular examples of successful counter-positioning are — Netflix (video streaming) over Blockbuster (DVD rental); Vanguard (index funds) over Fidelity (Managed Mutual Funds); and Apple (Touchscreen phones) over Blackberry (Clickable keyboard phones).
This win put Zerodha ahead of their competition. But, a good start was all it was. They had to get much more right, to get where they are.
Doing The Right Thing
Zerodha’s focus, right from the beginning, was on building a superior, digital-first experience. When most brokers purchased standard trading software from vendors, Zerodha created its own. While older ones were usually black, and not new-user-friendly, they made theirs white, and intuitive to use. The color just gave them a distinctness. Remember how Apple always shipped white earphones, when everyone else did black? Subtle psychology!
Then, most brokers had employees calling clients with trading tips. This has an inherent flaw. With brokerage being income, a broker's earning increases when more trading happens. So, best-case scenario for a broker’s P&L is that, everybody trades all the time. This, however, doesn’t always benefit the client.
Zerodha steared clear of tip-giving; they invested heavily in meaningfully informing their client. Through Varsity, they’ve created an extensive, free for all, financial education repository.
Further, they removed various layers of friction from the customer experience. Since their app / trading software is user-friendly, there is little reason for a user to actually require "customer care". Users don’t need to make phone-calls to place orders, request account statements and holding summaries; users prefer to use the app.
They’re continuing on the same path of doing the right thing, while staying low-cost, digital-first, and customer-focussed through:
- Console: A Zerodha user’s central dashboard.
- Tickertape: A screener for stocks, Mutual Funds, and ETFs.
- Coin: To offer Direct Mutual Funds.
- GoldenPi: To offer Bonds.
- Streak: Allows users to automate their trading. Example, buy if share price goes above 50-day-moving-average.
- Smallcase: For a fee, investors can access a basket of stocks curated by certain analysts. This empowers advisors to sell their strategies to a large investor community, without all heavy compliance. And for investors, it opens up a wealth of options to choose from. A whole article can be written on Smallcase, but for now only a few sentences :)
- TradingQnA: A forum where traders and investors interact.
- Pulse: Business, finance, and market news
All these are good products in themselves, but collectively, they make Zerodha even stronger. How?
Building The Moat
Once a business hits critical mass, there are five ways to strengthen its moat. Let's see each of them from Zerodha's persepctive:
- Scale Economies: The quality of declining costs with increased business size. When Zerodha introduces a new feature, say the cost of building it is ₹10 Lakhs, with their 70 Lakh+ users, their per user cost is marginal, compared to a competitor with lesser scale.
- Network Effects: The benefit each user gets, from a new user joining the network, which attracts more users, and induces massive growth. Think Instagram. From my vantage point, Zerodha doesn’t enjoy network effects on the customer (demand) side, but it does so on the startups (supply) side. Zerodha invests in, and incubates startups which it later adds to its basket of offerings. Finshots and Smallcase are two examples. For any startup targeting investors, Zerodha is the best partner, since they have the largest audience.
- Switching Costs: The loss experienced by a user when they switch to an alternative competitor. This, for me, is Zerodha’s strongest power. By relentlessly building out the entire stack of investor needs, Zerodha has made it extremely difficult for any user to switch to a competitor. Switching means additional cost, the hassle of relearning, and of having part historical data at Zerodha, and part elsewhere. This is the reason Apple users stay with Apple, and Android users stick to Android. Switching is too damn stressful.
- Branding: The quality that invokes positive emotions in a customer, leading to paying for, and endorsing a product. This usually comes in the long term when users have repeated good experiences with a brand. From my interactions with Zerodha users, I can say that they don’t just use Zerodha, they love Zerodha.
- Process Power: Embedded company habits that enable low costs and superior products. This can be matched only by extended commitment by the competition. The fact that Zerodha continues to improve their offerings is proof of their process power.
From the above, the first three come right after a business hits critical mass, and the last two come after maturity.
My sense is that Zerodha is doing really well on all the above fronts. Until a different technology or a regulatory change (where, say, a new broker can pay clients to trade on their platform) knocks them off their perch, it would be hard for a newcomer to do so.
Leadership is an underrated trait, and Nithin Kamath seems to be an excellent leader. He never fails to publicly praise his younger brother Nikhil, his CTO Kailash Nath, the head of education Karthik Rangappa, among others.
Here are a few instances where he said or acted admirably, or led Zerodha to do the right thing:
- Added a nudge feature to inform clients about online nomination, right entitlements, and bonus issues & share splits.
- Killed work chats post 6 PM.
- Started a get fit challenge at the company during the lockdown.
- Moved 30% of staff to permanent work-from-home.
- Adopted the strategy of no advertising; instead, made the product so good that users evangelise it.
- Refrains from hyperbole in public discourse.
- Didn't raised capital, though they easily could have, in today's frenzied environment; chooze to stay nimble.
- And what really caught my eye, his answer to the question “Is trading gambling?” ⇒ “Yes, you can gamble when trading, just like you can gamble with everything else in life.” I’ve been defending trading for years now, that it’s not gambling, but Nithin’s answer was wise and refreshingly honest.
If you pick up super-successful businesses like Amazon, Netflix, Google, etc, you’ll find that they exhibit many of the aforementioned seven business strategies. And finding them in effect at Zerodha was no surprise.
Young entrepreneurs would do well to understand such strategic business layers. A lot has to go right for business success, but, being prepared is a prerequisite.
My understanding of the 7 business strategies mentioned above, comes directly from Hamilton Helmer’s phenomenal book, 7 Powers; which I highly recommend.
If you’ve gotten here, thanks so much for your time! Do share this piece with others. :)
Stay safe, and see you soon!
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