DISCOVER SURPRISES ONLINE INDUSTRY WITH MORGAN STANLEY REPORT FREEBIES: BLURS LINES BETWEEN DISCOUNT, FULL SERVICE

Business models are constantly evolving, as IBM learned in the 1980s when it resisted abandoning mainframes and was too late in embracing PCs.

Full-service brokerage firms aren’t insulated from change, either. And right now they’re having to address the increasing numbers of investors who’ve flocked to the Internet to do their trading. According to the investment services firm Piper Jaffray in Minneapolis, a full 22% of U.S. retail trades thus far this year have been conducted online.

Morgan Stanley Dean Witter’s reaction has been the most dramatic: In the last couple of weeks, it has begun offering same-day Internet access to its stock analysts’ research through its wholly owned online discount subsidiary, Discover Brokerage Direct. The reasoning, says company spokesman Jim Fusco, was simple: “We’ve done research that shows the people using full-service firms and those trading online are very distinct market segments. Web traders tend to be younger, with smaller estates. And we’re hoping to expand total market share by introducing those traders to our services.”

Discover doesn’t give traders access to full reports, but for between $19.95 and $34.95 per month (based on the number of companies followed), it does give them nearly immediate access to execution reports and portfolio updates, including changes in stock recommendations.

Credit Suisse First Boston analyst Bill Burnham says the decision was difficult for Morgan Stanley — for one central reason: “Institutional-quality research has long been one of the biggest perks available to customers of full-service brokers; it’s something brokers use to strengthen relationships with their customers.” By making its research available online, he says, Morgan Stanley stands a good chance of drawing some online clients, “but it’s also running the risk of alienating its human brokers.”

Heather Ashton, an analyst at Hurwitz Group in Framingham, Mass., says: “The company will actually be able to attract a different type of customer, one who is interested in doing business over the Web and doesn’t necessarily need the hand-holding that some of its high-net-worth, full-service customers require.”

Indeed, says Ms. Ashton, “the imperative right now for Morgan Stanley is to model its online business on what some of the other online brokerages have done.”

Actually, Morgan Stanley is following rather closely in the footsteps of E*Trade, the enormously successful online discount brokerage that provides immediate research information to customers by way of BancAmerica Robertson Stephens analysts. San Francisco-based E*Trade serves about 11% of all online traders, according to Piper Jaffray.

‘human’ Brokers may balk

Of course, the tricky part for Morgan Stanley in mimicking an online discount brokerage is that it has full-service brokers who will squeal when its online arm undersells them by thousands of dollars. Discover Brokerage Direct charges just $14.95 per trade — far less than its “human” brokers demand. In contrast, most big brokerages, like Merrill Lynch and Salomon Smith Barney, offer online trading exclusively as full-service firms.

Mr. Fusco insists that Morgan Stanley sees no danger in expanding its offerings because its full-service customers are relying heavily on a combination of analyst advice and research. He also calls the online research “modified.” Mr. Burnham calls it “watered-down.” Still, for now the company appears to be walking a fine line. For instance, though its brand carries substantial weight, it is trying to separate itself somewhat from Discover Brokerage and has reiterated on several occasions that the online brokerage is its own separate entity.

But Michael Gazala, a senior analyst at Forrester Research in Cambridge, Mass., thinks Morgan Stanley has very deliberately entered the game. “As a parent company,” he says, “Morgan Stanley wants Discover Brokerage to be as strong as possible” — especially against incredibly stiff competition. Mr. Gazala points out that Discover Brokerage Direct (formerly Lombard Brokerage) has been part of the “family” since January 1996, when Dean Witter acquired it. Why would Morgan Stanley suddenly grant the unit access to its research, he asks, if not to provide it with an advantage in the online wars?

“One of the ways you do this is with equity research,” he says. “After all, the advantage of having Morgan Stanley as your parent is that you can call upon its analysts.”