Alfred R. Berkeley III was chatting one day with Meg Whitman, CEO of eBay, the online auction site. “I said, ’You know, our businesses have some common characteristics,” commented Berkeley, vice chairman of NASDAQ, who spoke on campus two weeks ago. “We both work with secondary markets. I sell old used stock certificates and eBay sells old used ashtrays.”
All kidding aside, it’s no secret that the exchange is at a crucial point. The NASDAQ index has fallen about 75% from its high-water mark at the end of the 1990s bull market. More importantly, many of its stocks have fallen to levels where they have had to be de-listed. The result has been a crisis of confidence.
Berkeley, a Wharton graduate, has seen both ends of the tech boom that made NASDAQ – once a haven for young tech companies – into a high-flying phenomenon. He spent much of his career with Alex, Brown & Sons, eventually becoming the firm’s head of information services. He subsequently led Alex, Brown’s technology practice and, by the time he left for NASDAQ in 1996, was managing director of the corporate finance department, primarily financing software and e-commerce companies. Now, with NASDAQ no longer such a hothouse, Berkeley is charged with keeping it ahead of other exchanges and marketplaces as a place for companies to park and trade. He explained these issues at a lecuture organized by the Executive Masters in Technology Management program, which is run by Wharton and the Penn Engineering school.
It’s a challenging job at best. Market forces are already chipping away at NASDAQ’s three major revenue streams, admitted Berkeley, pointing out that before the crash, NASDAQ was an $800 million business. About $200 million came from initial listing fees and some recurring fees for companies that were accepted by NASDAQ. Another $200 million came from the sale of stock quotes from the exchange. The final $400 million came from transaction charges.
The threats to each of those streams are real and each is enhanced by the increasing power of technology in the world markets, which is where NASDAQ has to shine. Its biggest challenge is to use those same technologies to enhance its own image and business. For now, at least, NASDAQ-listed companies are not fleeing the exchange, Berkeley said.
“Companies are looking for a place to trade where it is efficient and inexpensive,” he added, noting that they are satisfied with the support and efficiency of NASDAQ, although there is always the chance of another exchange coming along that could offer adequate support and security – and charge a lower price for listing. “That is why we always have to be aware of the competition and make sure our costs are as low as reasonably possible.”
More important is the sale of quotes, which has typically been a good revenue stream. Right now, NASDAQ owns the rights to transaction quotes for 15 minutes before they become public domain. If a customer wants the quotes faster than that, he pays a premium.
“But intellectual property rights are always on shaky ground,” Berkeley said, pointing to a case decided in New Jersey which allows reporters at National Basketball Association games to own the intellectual property rights to any score or action at a game – on an equal basis with the NBA – so long as he or she is there to see it happen. Thus, the reporter doesn’t have to pay the NBA for the information. “So how far is that from saying Merrill Lynch is sitting at our game, looking at our action. Technology may soon allow a company to do that. We will have to be vigilant to keep our business there.”
Finally, the price customers pay for transaction charges has come way down due to advancing technology and competition. In 1996, Berkeley said, each NASDAQ transaction cost $5. Now that figure is 20 cents. The upside is that in 1996, NASDAQ had an average of 325 million shares traded daily and by 2000, it was up to 2.325 million a day. “We made it attractive, convenient and cheap to trade. But you can only go so low. We may be there now. It is still important for customers to come to NASDAQ and we have to be able to find ways to keep it that way.”
The big question before the trading public, though, is whether markets are needed at all. In Germany, for instance, more than 9000 companies are traded without listings like NASDAQ. [Indeed, the Neuer Markt, Germany’s equivalent of the NASDAQ, is being shut down after losing nearly 95% of its value since the peak of the dot.com boom.] “Companies are required to be listed in the United States, but who says they won’t just list with the cheapest place?” asked Berkeley. “Maybe 10 years from now, technology will be such that NASDAQ will lose [out]. We can’t let that happen.”
With each stock scandal or price slide, even if it doesn’t have anything to do with NASDAQ’s own inner workings, the reputation of the market is as stake. NASDAQ closed the NASDAQ Japan market this summer because it attracted fewer than 100 companies to the exchange in its two years of operation. When NASDAQ Japan opened near the end of the tech boom in 2000, it expected to have 200 companies listed by now and as many as 2000 in 2005. The hope was to have a virtual 24-hour trading system, with big markets in Europe, Japan and the U.S. Now, however, NASDAQ is concentrating on keeping its markets current where they are operating.
Berkeley said that several years ago, he asked NASDAQ’s advisors from McKinsey who they thought the real customers of the exchange were. Surprisingly, he said, they told him it wasn’t the listed companies, but the investors who were trading. “If the investors weren’t happy with the market, the advisors suggested, then the companies would surely not be happy with their listings,” Berkeley said, adding that it wasn’t the retail investors he was talking about, but the institutional investors who make up 80-85% of the trades on NASDAQ.
Even then, he said, the investors were divided into three categories: strategists, speculators and gamblers. Berkeley likened the strategists to a typical Warren Buffett trade. “He buys GEICO in 1968 and likes the way management does things and holds it forever,” said Berkeley. “Because of the time horizon of that investment, I can’t make much money on it.”
Then, he said, there are the speculators, “who think they are better athletes than anyone else. ’I will outguess the movement of the crowd,’ they say. They care about the supply and demand of buyers and create random movement of prices.” Their time horizon is weeks and, in some cases, a few months. The gamblers are the day-traders, whose turnaround time for a trade is minutes or, in some cases, hours.
Berkeley discovered that the great bulk of NASDAQ investors were in the speculator category. The gambling day-traders tended to be lone wolves, often spread around the country and not demanding much besides the availability of speed. Big institutions didn’t day trade and certainly wanted speedy trades, but they valued other things more.
“They wanted liquidity – the knowledge they could find someone to buy and sell to at the moving price,” he said. “They wanted transparency – to have as much information as they could. And they wanted as much anonymity as possible. They didn’t want to show their hand.”
Regulations didn’t allow NASDAQ to do everything – such as offer total anonymity in trading – but Berkeley tried to find the technology to do almost everything else. The new system, which is going through regulatory approval, is called SuperMontage. The software will eventually offer electronic order matching in many cases, allowing prospective traders – with like amounts of a stock to buy and sell – to do so without revealing themselves on the open market. It will also allow some form of auction market for stocks (currently not available at NASDAQ), where investors will be able to throw large blocks of stock out and see what they can get, picking the buyer rather than just taking the first offer.
While it is fortunate that NASDAQ itself hasn’t been tainted by the scandals of some of its constituent-listed companies, the downturn in stock prices has clearly not been a pleasant experience. Whatever exuberance and momentum there was for NASDAQ as its index hit 5000 has been lost. NASDAQ may not be just another run-of-the-mill exchange, but Berkeley said it is imperative now to keep attracting listings and investors with as many services as possible.
“Do I have enough acorns squirreled away? Will I be able to make companies and customers feel they are well-served?” asked Berkeley. “Technology has improved so much that anyone can move fast. We’re not the only provider in our business. But we have to use that technology to be the best one.”