IN 2013, STANFORD UNIVERSITY students Baiju Bhatt and Vlad Tenev came together to build a mobile stock trading app, Robinhood, which proved to be an instant hit among retail investors in the U.S. In an industry plagued with high transaction and broking charges, Robinhood created a niche for itself since its commercial launch in 2015. But the saga did not make for a happy reading.

The company, which raised $5.6 billion from private investors prior to the IPO, is floundering. From its public issue price of $38 a share in July 2021, the stock is down 90% from its high of $85 and 73% from its IPO price to $10.39 (January 27, 2023).

For an app that has notched up 22.9 million users with 12.2 million monthly active users, the meltdown has its reasons.

The pandemic-fuelled boom in retail trading is fizzling out. Further, Robinhood’s revenue stream from cryptos is in question. Not just that — it is blowing away money. In 2021, the brokerage firm incurred a $862 million loss on a net revenue of $978 million in the nine months of 2022.

The deep red is on the back of unbridled operating expenses of $1.3 billion. Neither a FAANG challenger nor a Salesforce in the making, yet the company spent half a billion ($529 million) on technology and development, and general and administrative expenses cost it another $728 million. Irony is that these numbers come amid a layoff of 31% of Robinhood’s workforce (now at 2,400). Though Tenev took the blame by stating, “this is on me” in August 2022, the turn of events was expected from a firm whose ambitions were given wings by hungry VCs, including the likes of Andreessen Horowitz, DST Global, New Enterprise Associates, and Tim Draper.

Back home, the Bengaluru-based Kamath brothers, Nithin and Nikhil, have done something similar by leveraging tech to disrupt the broking industry with their no-frills app, Zerodha.

But the difference between the two is how the brothers have built their business. Robinhood’s free commission compromised the interest of its clients as the U.S. Securities Exchange Commission revealed that the company sold order flow to the market maker that gave it the best rebate rather than the one that offered the best price for its clients. The Kamath brothers, on the other hand, have avoided all the pitfalls made by Robinhood in its quest for supremacy.

Bootstrapped from Day Zero, Zerodha has not only outsmarted traditional brick and mortar broking firms, but is also way ahead of other online rivals, Upstox and Groww. What makes it stand out is its financial performance — raking in profits of ₹2,094 crore on a revenue of ₹4,964 crore in FY22 (See: Neighbour’s envy, owner’s pride).

Having beaten bank-backed brokerages, including ICICI Securities, Kotak Securities and HDFC Securities, Zerodha is a case study of how new-age consumer tech businesses can be built profitably instead of the burn-your-way-to-growth VC model. Not surprising Nithin, too, had VCs reaching out to him for a tango. “I have spoken to almost all VCs, but hearing our philosophy around raising capital and running the business, the conversation never reached valuation talks,” says the 43-year-old, whose father was a branch manager at Canara Bank and mother a music teacher.

The “philosophy” in some sense is the invisible moat around Zerodha, whose founders, including 36-year-old younger brother Nikhil, have been valued at ₹14,130 crore in the Fortune India-Waterfield Advisors 2022 ranking of dollar billionaires.

Playing It Straight

A combination of English and Sanskrit words “zero” and “rodha” (obstruction),” Zerodha began 12 years ago by offering equity trades both for traders and investors at ₹20 per trade, becoming the country’s first discount broker. Down the line, they made delivery trades free and limited ₹20 to only equity and F&O trades.

In doing so, between FY11 and FY12, Zerodha’s customer base grew from 1,500 to 110,000. But the twin effect of Jio’s aggressive data plans and Aadhaar-enabled verification proved to be a turning point from 2016. Physical forms paved the way for seamless onboarding of customers. The effect was visible when in just one year (FY17), new customer additions stood at 170,000 — more than what Zerodha had cumulatively added since its inception. Since then, there has been no looking back, with the brokerage seeing a 10x jump from 1 million in 2019 to 10.2 million users as of September 2022.

Nithin, who initially started out as a franchisee of Reliance Money, is cognisant of the fact that the fortunes of his business are intricately linked to market sentiment. “If you map the mid-cap index and our customer addition graph, it is very clear that when there is a market frenzy, there are more sign-ups,” he admits.

Hence, in a business where sentiments can change overnight, the only way to keep growing profitably is to keep costs under control.

As a rule, the firm stayed away from two big cash guzzlers — especially for start-ups — advertising and marketing spend, besides aggressive hiring.

Nithin knows the game well when he says: “One can stop marketing costs at any point of time but not your human cost. You can’t be just hiring and firing. So, we’ve been very conscious of that aspect.”

For instance, take the case of Upstox, which claims to have crossed 10 million customers in June. The Mumbai-based company became a Unicorn last November when it raised $25 million in a Series C round led by Tiger Global at a valuation of $3.5 billion. While financials for FY22 are not available, a five-time jump in business promotion expenses to ₹113 crore saw losses widen 89% to ₹72 crore even as revenue nearly tripled to ₹429 crore in FY21. One of the big costs was advertising and marketing as the firm tied for cricketing events with the ICC, BCCI and Tamil Nadu Premier League. “We have a plan of getting profitable in the next two years. We can speed that up or we can slow that down. It’s just a matter of how much you also want us to scale up,” one of its three co-founders Shrini Viswanath was quoted as saying. But given the start-up’s ambitious plans of adding 20-30 million users by FY23, and 100 million in 5 years, the road to profitability is far from easy.

Similarly, in October 2021, Bengaluru-based Groww raised $251 million as part of its Series E round led by IconiQ Growth and other investors, including Tiger Global, almost tripling its valuation to $3 billion in a little over six months. The company, which claims to have over 20 million users on its platform, has around 2 million users on its stock investment platform, Next Billion Technologies, which was launched in July 2021. Though Next Billion clocked revenues of ₹40 crore in FY21 and turned profitable with ₹2.73 crore, the parent entity, Billionbrains Garage Ventures, posted losses of ₹107 crore on a consolidated revenue of ₹52 crore.

Nikhil, who primarily spends time on treasury and risk management at Zerodha, points out that while they take competition seriously, the writing on the wall is clear. “Today you have a new entrant, tomorrow there might be another. However, to be honest, if you earn ₹20 on a transaction but spend ₹10K to acquire a client, it’s a tough business model as you may need to monetise the transaction by selling some other product, which may not be in the interest of the user,” says Nikhil.

Zerodha, though, has not been burning cash to acquire customers either. In fact, the sign-up fee of ₹200 that it charges per customer while on-boarding partly contributes to its overall revenue. “We make money on customer acquisition unlike competition which is losing money. So, it’s almost like a negative customer acquisition cost (CAC),” says Nithin.

That’s a big deal.

Krishnan ASV, analyst at HDFC Securities, mentions that despite being a capital-light business, high customer acquisition costs incurred by fintech brokers have resulted in losses. He, however, expects these costs to decline once the industry matures and operating leverage drives profitability.

The reason behind Zerodha’s success, besides the first-mover advantage, is that it adhered to a philosophy of not chasing growth at any cost. “We never started a year saying we need to get to these many users. That’s also a reason why we didn’t go for external funding. Because once you raise money, you are obligated to run the business in a certain way which, in turn, will make it hard for you to acquire customers without having to spend,” says Nithin.

In fact, while most businesses talk of customer-centricity, walking the talk in a digital era — where data can reveal more about a customer — is tough. Zerodha chose not to bombard customers with offers and updates. In fact, the company moved its sales team — that would call back customers who signed up but didn’t finish onboarding — to a support role. The move paid off as it didn’t make any difference to the onboarding rates.

In keeping with that ethos, Zerodha has also not been pushing its margin funding business, which is currently a separate entity. “Margin funding is a very lucrative business and can easily make up for 25% of revenues for large broking firms. But it’s really a horrible product for customers as you are just enabling their greed,” says Nithin. The company is now offering the services as a counter to any potential outflow of assets under management. “We don’t want our customers moving out to another player to just pledge their securities for a loan,” he adds.

The Tech Edge

Even as Zerodha is playing it by the ear when it comes to product offerings, the constant endeavour is to create better user experience by leveraging on its tech stack.

Nithin credits Kailash Nadh, CTO at Zerodha, who has a PhD in Artificial Intelligence, for keeping the tech engine running. “The only reason we are where we are today is because of our tech and products. Kailash doesn’t like to be called a co-founder as he joined late, but he is as much a founder in the business as I am,” says Nithin.

For someone who doesn’t invest in the market, Nadh has perfected the tech of investing by evangelising free and open-source software (FOSS). “From the outside, all modern trading apps kind of look similar, but what would be unique about us is the scalability of the systems we have built. I met Nithin in 2012 and we started the tech company in 2013, so we had, thankfully, had the luxury of time, nearly a decade, to build things from the first principle,” says Nadh.

Right from support tickets to sales CRM (customer relationship management) to HRMS (HR management systems) and even the e-mail utility everything is built on the FOSS platform. “It saves us tens of millions of dollars. I think FOSS is the truest form of art, where you build something for the greater good of the community and give it away for free,” says Nithin.

The tech architecture is not only good in terms of performance given the number of users it can handle, but also by the number of people engaged in building it. “We built the entire business internally with a tech team of just 30 people,” mentions Nadh. Of the 30-member team, just four members manage the entire trading platform that processes over 10-15 million orders a day.

Further, by adopting FOSS as its mainstay, Zerodha has been able to foster a culture of innovation through strategic investments. For instance, developers are free to create securities-related APIs that can be plugged into its IT architecture. “Launching a securities-related app can be tedious as it involves a lot of legal hassles given the tight regulatory framework. At Zerodha we do the dirty work of dealing with the paperwork and legalese, while the developer can just focus on building the application,” says Nithin. One such initiative is Small Case, which allows customers to create a basket of stocks or ETFs that reflects a strategy, idea, or theme. Then there is Coin, an app for mutual fund investment, Varsity, a portal with free modules on markets, trading and information. To sensitise customers against the pitfall of penny stocks and stocks with poor fundamentals, there is also an intuitive intelligence software, Nudge, that forewarns clients about risky trades. Importantly, none of the initiatives tries to promote the broking business overtly or covertly.

Not surprising that Zerodha has been able to onboard millions of users without having to double tech expenses. “In my view, competition lacks the tech to support such a scale of business today. We have been able to go from 2 million to 10 million customers without increasing our team size, because we have used tech to optimise and improve every single process. We didn’t hire more people to solve these problems like our competitors did over the past two years,” says Nithin.

Continuous iteration has ensured that the tech platform is free of legacy issues and any new offering does not face glitches. “The probability of something going wrong in an unknown way reduces greatly if you don’t pause often to fix old things. Ironically, the result is that you end up building a lot of new things easily and safely. In fixing all the problems, you might lose three or four months now, but the end result is that you might end up saving two years of pain in the creation of new product or features, whatever that is,” explains Nadh.

Though the tech team has been around for more than a decade, Zerodha has built its platform in a way that any new person joining the team can come up to speed within a short span of time. “The technology has been built keeping in mind the eventuality that at any point in time it will be easy to hand over the reins to someone else. Everything is automated, well-documented, and well-screened. So, tomorrow, even a beginner can come up to speed in a matter of weeks,” says Nadh.

The Way Ahead

During the cyclical uptick seen over FY21 and FY22, discount brokers added 75% of incremental customers with Zerodha at the top (See: The select club). According to Krishnan of HDFC Securities, this shows the preferences of new-to-market clients. More importantly, the revenue market share analysis suggests that discount brokers have gained at the cost of smaller standalone brokers. It’s a clear giveaway that the broking game is today concentrated in the hands of a handful of online and full-service brokers.

Nitin Aggarwal, group CFO & CEO - broking, Religare Enterprises, believes trading online has become a way of life. “In fact, we were the first full-service broker to have launched a mobile trading app 13 years back, but it never took off. But today more than 70% of our volume comes from the digital medium,” says Aggarwal, whose retail firm has over a million customers.

While for traditional brokerages its business as usual, the likes of Upstox and Groww have VC money fuelling their growth. But unless they turn profitable, their growth is just a chimera. For now, Zerodha’s numbers are striking — their profit in FY22 makes up for the cumulative profits of full-service brokers for FY22. Yet, Kamath is under no illusion. “The last two years were peak bull markets. We are unlikely to be able to grow over and above last year’s revenue and profits for a while,” says Kamath.

The numbers do show that the frenzy is slowing (See: Grin and bear). Hence, the caution is not without reason.

Currently, 70% of Zerodha’s revenue comes from broking and trading fees, 15% from treasury (the company’s own funds invested mostly in debt and fixed deposits), float (unused customer funds) generates 3-3.5% as they are parked as short-term FDs with clearing corporation and, and the remainder (15%) comprises account opening fees, annual maintenance charges, DP charges, and others. Since equity investing is free, it’s the active trading clients that end up subsidising non-paying equity investors. Nearly, 85% of Zerodha’s trading revenue comes from 10-20% of the traders.

While most full-service broking firms have advisory services, Zerodha has, thus far, stayed away. But now with depositories and asset management companies, too, expected to join the account aggregator framework, it will be easier to gather financial data about a customer. Nithin wants to make the most of the new tech paradigm. “The first and most important step of advisory is to be able to profile a customer correctly. Currently, the biggest problem with risk profiling is that I need to know your financials to be able to draw a balance sheet of sorts to understand and correctly advise. Once the aggregator account framework comes through, it will be the right time to attempt this,” he adds.

Also in the works is a mutual fund — passive products targeted at long-term investors, especially millennials looking at a nest egg. “India today needs a passive-only AMC as all existing AMCs are sailing in both the boats — active and passive. So, there is an opportunity to be a thought leader in the passive-only space as 25-30 year olds do not know what is the right investment for them. We need to simplify the investing experience and take the noise away from the likes of hybrids, balanced, and index funds. We will offer goal-oriented funds with a targeted date wherein equity and debt allocation will keep rebalancing as the customer ages,” says Kamath.

Even as the company is awaiting approval from Sebi for the MF, it plans to join the NSE IFSC Exchange based out of Gift City in Gujarat. The idea is to offer U.S. stocks to Indian investors given that the NSE IFSC trades in 50 popular U.S. stocks such as Apple, Amazon, and Tesla in the form of unsponsored depositary receipts. “From a relative standpoint, some companies in the U.S. have more value to offer. They are not as frothy and expensive,” feels Nikhil.

While there are no financial targets that Zerodha’s team strives to achieve, the singular focus is to improve profitability. “Every year we allocate 10-15% of our profits for bonuses and hikes. So, everyone in the company is focused on the profitability of the business and no other metric,” says Nithin.

That also means Zerodha is judicious about its staff strength. “Our team size has been constant at 1,100. Barring a couple of senior management exits, attrition is largely confined to the support function level,” says Kamath.

The reason for the high level of stickiness is also because of the culture. In the absence of any business pressure, the 30-member tech team is not only the smallest but also the most productive. “They have done well because the business team never interfered or pushed the tech folks to create a product or a feature. Even in other functions, there is hardly any interference. For example, Nikhil manages treasury. I have never interfered in his decision, nor has he interfered in how I run the business. It’s similar for Venu Madhav, who manages our operations,” says Kamath. Agrees Nadh, “The core team of Zerodha is not staying on because we have ESOPs. It’s more like a social club…of people who like to hang out and work together.”

With age on their side, the Kamath brothers have a long runway to nurture their legacy. “Even if revenue goes to zero, we have over 13 years of runway. Our net worth as a percentage of total customer funds is now more than 25% — the highest globally. Everyone on our team also holds significant stock options and is invested in the business doing well, which can only happen if you have a happy customer,” says Nithin. There are no plans to go public with the company, wherein the brothers own 85% and the rest comprises ESOPs. “If you don’t need the capital, it (listing) becomes an exercise in vanity,” says Nikhil.

In a business that thrives on greed and fear, the Kamath brothers are an exception — underscored by the launch of the Young India Philanthropic Pledge, which comprises signatories under 45 years of age willing to pledge 25% of their wealth. “Profit and valuation are by-products of us having accidentally built our business around the time that India was seeing its biggest bull market. If the bull market dies, so will our profit and valuation. But what will be a constant is our philosophy,” says Nithin. And as long as Zerodha remains true to its ethos, it will remain the true Robinhood of India’s retail investors.

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