Zerodha’s Rise to Retail Stockbroking Supremacy

The day before yesterday, the founder and CEO of India’s largest stock brokerage firm, Zerodha, took to social media to clarify the rumours about his “mis”reported and inflated annual salary figure of ₹100cr ($13.6m).

Let’s say the actual salary figure is lower. There is still no discounting the fact that Zerodha has achieved an enviable position within the startup ecosystem in general and the stockbroking industry in particular over the last decade. Not only did it double its profit in FY21 to ₹1,000cr ($135m), but it has been adding customers at an impressive rate with over 3 million active clients (=20% of active investors on NSE) currently onboard.

The story of Zerodha, in a way, represents the unfolding changes in India’s retail investment sector. It has become one of the vessels driving the ongoing boom in share trading and increasing participation in retail trading, especially from the younger generation.

Another prominence of Zerodha is in the ability of its founders to build and scale a business without venture capital money, making them poster boys for “bootstrapping” (will get to this shortly).

This is how it happened.

When “Zero” met “Rodha”

The company’s name is famously associated with the core of its business, which is to offer “zero obstacles” in trading. It was started on August 15th 2010 by two brothers — Nithin and Nikhil Kamath — who had cultivated an avid interest and practice in trading since a very young age.

Zerodha entered the markets at a time when the world was still reeling from the nightmares of the 2008 financial crisis. Market activity had dropped to a minimum and trading volumes were stunted. As a consequence, the company was rejected for funding by almost all major VCs.

Interestingly, what should have been a disappointment in funding somehow turned into a lasting business model. Till today, Zerodha remains bootstrapped, meaning that it is built entirely from the ground up without any outside cash or support.

The Kamaths have explained this as a more convenient approach to conduct business by taking fast decisions and without having to answer to external investors. This is preferable, they say, since the company is now funding its own growth and expansion.

The company is valued at over $2bn at present. Being a brokerage, the company attracts a “conservative valuation” as per Nithin, who says,

"While our growth is exciting, we know that this isn’t sustainable. A broking business is extremely high beta — highly correlated with the market conditions. Even if there was a mini bear market, our business could drop by 40% in a heartbeat."

Zerodha’s Business Model

Two words : discount broking. The discount trading strategy implies that investors can trade stocks for free, excepting, of course, the registration fees (₹300) and transaction fees (₹20) which are charged on futures, options and intraday trading transactions.

This was a major incentive that had clients flocking to Zerodha. Including the new as well as existing clients who had been paying huge margins to traditional brokerage firms where the commission margins are usually proportional to the size of the trade.

So, this “low-margin-high-volume” model has emerged as the centerpiece of Zerodha’s success. Plus, operational costs for the firm remain low (36% of revenue, lowest in the industry) considering its tech-based online operation and zero (literally zero by the CEO’s account) costs in advertising.

The Kamaths have repeatedly emphasised on making Zerodha’s business technologically sound and rely largely on word-of-mouth marketing to reach customers, something they call adopting the “Google-like” than the “Yahoo-like” approach.

The strength of the company also comes from its location. Based in Bangalore, Zerodha has the city’s brimming pool of technology developers greatly at its disposal. The platform’s design is also tailored for “new investors” who mostly engage in equity delivery trades as opposed to F&O and intraday which are more to the seasoned investors’ liking. No wonder around 75% of Zerodha’s clients are under the age of 35.

Stocks and the City

Zerodha got a headstart in the discount brokerage industry for a while. But new and emerging firms (Upstox, 5Paisa, Angel Broking etc.) are beginning to close in. With an ongoing market swell and lockdowns in effect, more people are prompted to invest in securities and diversify their savings culture. SEBI Chairman Ajay Tyagi said that close to 1 crore demat accounts were opened in the first 10 months of the last fiscal year.

Upstox now commands 11.3% of total active clients on NSE with Zerodha leading at 20%. However, Upstox has reported a net loss in FY20 (despite a 100% increase in revenue). The losses largely stemmed from a rise in Upstox’s operating expenses (employee benefits, discounting charges, after-sales services etc.).

This is where Zerodha’s tightly-run ship gains advantage as its 1,000-member employee base has built the business on the choicest strategy of preventing revenue leakage and expense drain. It has also widened its financial services ambit now as an NBFC that offers short-term and small-value loans to its customers by collateralising the securities in their portfolio.

The 40+ age bracket of investors has been a partial holy grail for Zerodha so far. Older investors are more traditional and hence prefer personal management of broker/wealth services, a total contrast from online platform-based trading.

But we say partial because lately the 40+ investors are facing an increased motivation to move away from the bank-based or traditional brokerages. There has been a decline of credibility in institutions following the debacle of Karvy and other traditional firms.

Plus the traditional ones are still reluctant to switch to discount broking and accepting a Zerodha-like flat fee margin. Perhaps, this explains Zerodha’s foray into the asset management business with the launch of True Beacon, so that it can expand into funds management services for its older and high net-worth clients.

Retail Investment Revolution

Some people credit Zerodha as the “Robinhood of India” for its similarity to the American trading platform Robinhood which has enabled retail traders to become a significant market force recently.

But unlike the US, India has a long way to go. In terms of market penetration, Zerodha’s reach remains highly urban, particularly to Tier I cities. It will be watchful of new players like Paytm Money which are making headways into stock trading and mutual fund distribution now. Paytm has a wide scale presence in the semi-urban and rural areas which means Zerodha may lose out on a potentially large client base if it doesn’t expand aggressively in these regions.

Two months ago, Nitin Kamath himself made a forecast that Zerodha would face a 30% drop in trading volumes and revenue by September 2021. Mostly due to the twin margin rules that SEBI introduced last year.

Twin margins imply the following: 1) mandatory upfront collection of margins from investors, and 2) proceeds for shares sold today cannot be used to buy new shares on the same day (rather clients have to wait for the T+2 settlement cycle).

Plus, by September, traders will be required to offer a 100% margin on intraday positions. This, Mr. Kamath says, is diametrically opposite to the lesser margin framework that Zerodha operates on and will significantly impact trading volumes.

Despite this, Zerodha witnessed an astonishing 100% growth on a month-on-month basis during certain periods last year. With five million orders executed daily, it still maintains leadership in an industry that, although competitive, is on an imminent high. Investment in stocks has long been compared to wagering (note: NOT gambling!), thanks to its mercurial dependence on a number of macroeconomic factors. Thanks to Zerodha, at least now wagering is made easier and so are the returns.

(Originally published June 1st 2021 in transfin.in)