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Taking Stock

Failure after failure could not stop Charles Schwab from achieving huge success.
November 1, 1996
URL: http://www.entrepreneur.com/article/13478

If there are three themes running through Charles Schwab's life, they are: hard work, persistence and vision--in that order. Pursuing these ideals helped him to make San Francisco-based Charles Schwab & Co. Inc., the world's largest and most innovative discount brokerage house. Fortune magazine dubbed Schwab, 59, "the king of discounting." With 235 branch offices worldwide employing nearly 10,000 employees, the company chalked up 1995 revenues of $1.42 billion, a 33 percent gain over 1994. That's not bad for someone who, as a child, could barely read a simple sentence.

The keys to Schwab's extraordinary success can be traced to his childhood in California's San Joaquin Valley. From the moment he entered school, Schwab had great difficulty learning. He didn't understand the reason for his academic struggles until the mid-1970s, when his son Michael, then 10 years old, was diagnosed as having dyslexia, a learning disability that makes reading painfully difficult. Only at that time did Schwab discover that he, too, was dyslexic.

Rather than seeing things sequentially, the way most of us do, Schwab's world was more like a huge, three-dimensional crossword puzzle. He could easily absorb visual symbols, such as illustrations, drawings or cartoons, but deciphering straight text threw him. "If it weren't for the Classics Illustrated comics series, I don't know how I would have gotten through school," he chuckles.

Schwab laughs about the problem now, but for him, learning has been a lifelong struggle. "I remember spending a lot of time at the blackboard running through the multiplication tables," he says. "The teachers were hard on me. They drilled me until I got it."

His teachers assumed he was slow. So did Schwab. "I didn't know I had a learning impediment," he says. "All I knew was that I had to work harder than everyone else."

Schwab's disability turned out to be a blessing in disguise, because it allowed him to see the world differently. "There were people who were a lot brighter than I was, or at least seemed to be, because they got much higher marks," he explains. "But I could see the bigger picture, whereas they could only see what was right in front of them."

A Meager Beginning

Combine the need to work harder with the Puritan work ethic instilled in him by his father, a Sacramento, California, district attorney, and you have the makings of a relentless, hard-driving entrepreneur. Schwab's father, having grown up during the Depression, constantly drove home the importance of prudent spending and of socking away money for a rainy day. "The Depression had a major impact on my parents and people my age," he says. "Those discussions about the difficulty of the Depression were burned in my mind. I was cautioned about not wasting money and the importance of stretching a dollar as far as it could go. There was a real incentive to work hard and earn money so I wouldn't wind up without any financial resources."

Pressure to contribute to the family funds fired up Schwab's entrepreneurial instincts. When he was 11, he made money selling the eggs of his father's chickens, as well as the droppings for use as fertilizer. When it was time for the hens to "retire," he negotiated a good price for them as fryers. As a teenager, he sold ice cream in the summer and sacked walnuts in the fall.

"I learned a lot when I was kid," says Schwab. "I didn't know what my potential was, but instinctively I knew there were lots of ways to make money. No matter how I earned it, my goal was always to make and save money. The next step in my life was learning how to invest it."

By his late teens, Schwab already knew he wanted to make his mark in the investment world. He insists his learning disability had something to do with his fascination with numbers. However, plunking down $100 of his hard-earned savings to buy 100 shares of a low-priced, speculative stock and then seeing a hefty return on his money might have played a part in his decision, too.

Entering Stanford University, Schwab set his sights on becoming a securities analyst. He managed to earn a bachelor's degree in economics and a master's degree in business administration, though not without difficulty. "My reading speed was about half that of the average Stanford student," he says. Once again, he found a second resource: Thanks to Cliff's Notes, Schwab passed with flying colors.

After graduation, in 1961, Schwab and two friends from Stanford cranked out a monthly newsletter called "Investment Indicators," selling one-year subscriptions for $84. Two years later, the under-funded newsletter almost went belly-up. "The newsletter needed a marketing push," says Schwab, "so I developed a direct-mail marketing program that boosted circulation."

Disaster Strikes

As the newsletter took off late in 1963, Schwab launched the Investment Indicators mutual fund in San Francisco. By 1967 the fund had grown to $20 million, but then, in 1969, Schwab hit a snag while expanding his operations to other states. Texas ordered Schwab to stop selling shares to its citizens because he wasn't registered to do business there. Schwab fought the decision, but lost. To make matters worse, things soured when the market tumbled, and Schwab was forced into financial ruin when he had to reimburse each Texas investor. By the time it was all over, Schwab was more than $100,000 in debt and forced to start over.

The early 1970s brought more financial disasters for Schwab: a drive-thru animal park that never opened, and Music Expo, a three-day extravaganza that took place at San Francisco's Cow Palace. Both ventures failed miserably.

But Schwab became more determined than ever, chalking these defeats up as priceless learning experiences. "I learned that for every big success a person has, there must be at least one huge failure," he says. "I think that's the basic law of the universe."

In 1971, Schwab, now ready to make his mark as an innovator, borrowed $100,000 from his uncle and launched First Commander Corp. as a traditional brokerage house. By 1973, there were rumblings that a major change would rock the investment world: the then 181-year-old fixed-commission structure would be abolished by the Securities and Exchange Commission in favor of variable commissions. "It meant brokerage houses could lower the rates they charged for transactions," says Schwab. "It signaled the dawn of a new age, and I intended to be part of it."

That day came on May 1, 1975, which marked the legal elimination of the fixed-rate structure. As soon as it was announced that brokerage houses had free reign on their commissions, many small companies made plans to operate as discount houses. Anticipating the change, Schwab was ready to do business as a discount broker. "In 1974, we had already changed our name to Charles Schwab & Co.," he says, "to create a new identity as a discount broker."

Rolling with the Punches

Schwab saw the change in rate structure as a chance to execute the savings and investment philosophies that had been instilled in him as a child. "It was an opportunity to develop new and creative investment and savings vehicles," he says.

Schwab never intended to be just another discount broker offering bargain-counter trading for small investors who didn't want to deal with the big guys. From the outset, he established himself as an innovator--and an ethical one at that. "As soon as I established an identity as a discount broker, I wanted to create a reputation as an honest broker who sincerely cared about his customers," says Schwab.

Schwab discovered he had his work cut out for him. His first priority was toppling the image that discount brokers were slick operators offering third-rate, inferior brokerage services; rumors had circulated that discounters could not offer clients the best executions or market analysis and that they lacked sufficient capital to weather sudden market downturns.

Schwab separated his company from the huge Wall Street brokerage firms that depend on commissioned salespeople by paying his brokers salaries and awarding bonuses based on customer satisfaction. "That fundamental change altered the traditional paradigm of the brokerage industry," says Schwab. "It changed the entire relationship between customer and broker. Even today, if you get to the core of why we are different than traditional commission firms, it is that one single factor that makes us stand out. By paying our brokers salaries, we removed the concept of interest from the relationship."

Through innovative marketing, he began to offer a selection of low-cost and imaginative investment programs, such as no-fee mutual funds, computerized stock trading and specialized banking services. Without resorting to the high-pressure tactics common among many of the larger, traditional brokerage firms, he left it up to the customers to stop in at one of the branches and talk to a Schwab broker.

It was simply smart marketing that promtped Schwab to make himself the spokesperson for his company. In commercials, potential customers didn't see some slick actor pretending to be a Schwab broker; instead, they saw clean-cut, All-American Chuck Schwab himself, dressed conservatively and presenting a hard-to-resist, down-to-earth manner that clearly identified him as a no-nonsense, straight-talking professional ready to meet his customers' investment needs.

The plan worked. Schwab finished his first year racking up sales of $30,000 a month. In 1976, that figure doubled to $60,000 a month and continued to grow. "Revenues increased by about 40 percent a year," he says, "and moved very fast."

Technological Advantages

Schwab also knew the industry was changing rapidly, and that today's innovators would be tomorrow's leaders. He intended to be one of them. "I didn't want to fall into a rut and stay in one place," he says. "The key was to continually offer better service. And one of the most efficient ways to do that is through technological innovation."

In 1979, he shocked his competitors by spending $2 million to buy a used IBM System/360 mainframe computer and software. "At the time, it was a lot of money to invest in technology, but I knew it would pay off," says Schwab. He was right. Two years later, financial reporters heralded Schwab as an innovator, one who offered better technology than the average Wall Street firm.

Even though the business was growing rapidly, Schwab needed large amounts of capital to fuel plans for expansion. "I was at a point where I needed talented people," he says. "But I couldn't afford them. Without a lot of reserve capital, it was hard recruiting people away from big companies. They had no reason to leave a secure job and take a gamble on a fledgling company."

In an attempt to raise money quickly, Schwab sold his company in 1983 to BankAmerica Corp. for $55 million in the bank's stock. In 1987, Schwab began to regret the move, as the giant bank was sinking in loan losses. "After coming that far, I was not about to lose everything I had worked for," says a determined Schwab. He bought his company back for $175 million in cash and $105 million in bonds. Six months later, (just one month before the October, 1987 stock market debacle), he took his company public, with a price tag of $100 million more than he had paid BankAmerica for his company.

Once again firmly positioned in the fast lane, Schwab intended to stay there by continually upgrading his technology. In 1989, he introduced TeleBroker, an automated 800-number touch-tone telephone system that handled more than 14 million client calls and more than 640,000 trades in its first year. He also spent an additional $20 million to upgrade software. Today, 25 percent of Schwab's trades are made through the TeleBroker service.

Judging by his sales, credibility and market penetration, you'd think Schwab would feel untouchable. Yet, he still worries about his competitors. "We have competitors at every level of the business," he says. "That's the way the American system works. Maybe it's a good thing, because it keeps us fresh and on our toes."

Schwab adds that a crowded marketplace keeps him humble. "Early on, I learned the importance of keeping in touch with the core of my business. Once you lose sight of that, you're not doing your job. No matter how big my business gets, I still ask myself how I can do better."