Business Question

MiniCase
Robinhood: Democratizing Investing or Robbing Investors?
Our mission is to democratize finance for all.
Robinhood Markets, Inc. is a financial services firm best known for its commission-fee
stock trading app, which went live in 2015. The Robinhood app is popular with Millennials and
Gen Z; it had 23 million users (in 2022). Indeed, users doubled during the Covid-19 pandemic,
when people were stuck at home and flush with cash from stimulus checks. Many young people
started investing using the Robinhood app. More than 50% of Robinhood users are first-time
investors.
Just six days after going public in 2021, Robinhood’s market valuation reached $60 billion.
At the IPO, Robinhood had a mere 2,800 employees. In comparison, Goldman Sachs, one of the
oldest and most prestigious investment firms, had 44,000 employees and a peak valuation of $141
billion (also in the summer of 2021). How did Robinhood accomplish such a remarkable feat?
Baiju Bhatt (left) and Vladimir Tenev, who met as undergraduate physics students, founded
Robinhood Markets, Inc. (in 2013) with the mission to “democratize finance for all” and the belief
that “the financial system should be built to work for everyone1. Robinhood went public in 2021
at a valuation of $32 billion, making the founders billionaires. Tenev is Robinhood’s CEO, while
Bhatt serves as chief creative officer.
Cindy Ord/Getty Images
Robinhood Disrupts the Financial Services Industry
Stock trading was traditionally a conservative, low-tech industry in which consumers had
to visit, mail, or call their stockbrokers. Consumers also faced exorbitant commissions and
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additional fees. The first wave of disruption arrived with the internet, an external technology shock
that decreased barriers to entry to the financial services industry. New entrants such as TD
Ameritrade and E-Trade launched a novel business model by providing online trading for retail
investors.
A retail investor is a non-professional who buys and sells stocks and mutual funds using a
brokerage firm such as Charles Schwab, among others. In contrast, an institutional investor pools
funds to invest on behalf of others, such as hedge funds, mutual funds, pension funds, and
university endowments. While retail investors use their own money. institutional investors invest
on behalf of a third party. Because they trade in large quantities, institutional investors receive
preferential treatment from large financial institutions, such as research insights and lower fees.
As a consequence of new brokerage firms entering the industry in the wake of the internet
disruption, the financial services industry fragmented, providing lower costs, better service, and
many more choices for retail investors.
To launch the second wave of disruption, Robinhood founders combined technological
innovation with business model innovation. They initiated a novel approach to retail investing. In
addition to commission-free trading, Robinhood introduced fractional share trading. That is, an
investor can buy a small slice of a stock. For instance, fractional trading enables anyone to own a
small part (say $50) of Alphabet, where one share costs more than $2,000, or Warren Buffett’s
firm, Berkshire Hathaway, where one share costs $400,000.
The two founders of Robinhood, Baiju Bhatt and Vladimir Tenev, who had been developing
automated trading software for Wall Street before starting Robinhood, envisioned high-speed
trading on smartphones with a user-friendly mobile trading app that made investing fun. Instead
of relying on the traditional financial infrastructure (which is costly, clunky, and requires highpowered PCs for day traders), investors would use their smartphones to communicate with trading
centers and execute trades. Using smartphones as a distributed trading platform was made possible
by ever faster wireless internet connections, such as the new 50 standard, which is 100 times faster
than 4G (or LTE).
Relying on smartphones also allowed Robinhood to create an appealing, visually attractive,
and potentially addictive interface by hooking young users through gamification. That is, retail
investing was turned into a fun, app-based game. For instance, investors would see confetti rain
on their screen after their first trade. The numbers in the amounts of money displayed would click
into place like the images on a slot machine. Investors also received text messages with emojis
congratulating them on their transactions. In addition, Robinhood provided fun interactive tutorials
that made investing less intimidating for first-time users. The Robinhood founders used these
tweaks, borrowed from behavioral psychology, to encourage inexperienced investors to trade
often. Why? Because the more users trade, the more money Robinhood makes.
Instead of generating revenue by charging users fees on trades and commissions, as in the
business model used by existing online brokers, Tenev and Bhatt realized they could make money
by selling user orders to large financial firms, so-called ··payments for order flow.” When a user
places an order to purchase stocks in the Robinhood app, that offer is passed on to market makers.
Large financial institutions such as banks are market makers because they are able to pool buyand-sell orders from many clients and can offer instant transactions by providing prices for selling
and buying shares. Robinhood matches the user’s order to a market maker based on who offers the
best price. In this sense, Robinhood is a two-sided trading platform that matches retail investors
with market makers.
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Next, the market maker executes the trade, earning money on the difference between its
buying and selling prices for those specific stocks (called the “spread”) and passing a percentage
back to Robinhood. The more its millions of users trade, the more money Robinhood makes.
especially from so-called day traders, who trade multiple times a day. A fun phone app with
seamless functioning encourages more transactions, especially by young users who spend hours
each day on their smartphones.
Combining technological and business-model innovations poised Robinhood to enter the
financial services industry as a disruptive innovator. First, Robinhood provided a no-cost solution
to an existing problem and entered the market from the bottom up. Second, Robinhood brought in
a new customer segment that had been underserved by traditional retail brokers: young, first-time
investors. Individually, this customers segment is a low-margin business, but having millions of
people trade several times a day generates large fees earned from payments for order flow. Indeed,
Robinhood earned $2 billion in revenues (in 2022), almost all from payments for order flow. Third,
locking in young, first-time investors allows Robinhood to grow with them as their financial
situation improves over time and their demand for additional financial services increases.
Robinhood did everything it could to target a younger audience, appealing to the zeitgeist
of anti-elitist and anti-capitalist sentiments amongst Gen Zers, even though owning stock in a
publicly traded company makes a person a capitalist in the purest sense. (Karl Marx based his
analysis of the economic system on two key production factors where capital exploits labor.) The
company tailored its business model for this particular consumer segment and even chose its nameRobinhood Markets, Inc.-to channel the popular folk hero who steals from the rich and gives to
the poor.
Robinhood’s emphasis on first-time investors was hypercharged by the Covid-19
pandemic. Many young people were stuck in their homes, unable to work but receiving
government stimulus checks. Given the ready accessibility of Robinhood, many decided to become
first-time investors. An investing frenzy was exacerbated by the bull market duria1g the pandemic.
The opportunities it provided for becoming rich quickly created FOMO (fear of missing out),
driving more people to use the Robinhood app. During the pandemic lockdown, the power of
individual retail investors banding together on online forums such as Reddjt’s WallStreetBets
became apparent as they drove up meme stocks such as GameStop from a valuation of $200 million
pre-pandemic to more than $12 billion (an appreciation of 6,000%) at the height of the Covid
outbreak.
The confluence of technological and business model innovations with the pandemic
contributed to Robinhood’s enormous $60 billion stock market valuation, driving a paradigm shift
in the industry. Robinhood’s new model for retail investing forced other financial services firms to
provide commission-free trading and user-friendly apps.
Robinhood Investors Are Robbed
One year after its successful IPO, Robinhood’s market cap had dropped by 90%, to only
$6 billion. What happened?
The factors contributing to Robinhood’s meteoric rise also caused its downfall. This
situation is called the Icarus Paradox, after the Greek myth in which Icarus is trapped on the island
of Crete with his father, Daedalus, who is an inventor. Daedalus makes ·wings from wax and
feathers so both can fly away. Daedalus warns his son not to fly too close to the sun, but Icarus
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ignores his father’s sage advice. He soars through the skies and loves flying ever higher. But he
flies too close to the sun and the wings melt, causing him to plummet to his death.
In a business context, the Icarus Paradox describes a situation in which a business fails
rapidly after great success. The failure results from the very strengths that led to success in the first
place2. Robinhood’s slick, gamified user interface (UI) proved dangerous and addictive.
Robinhood’s mission of “helping the little guy” was fraudulent in several ways, and its business
model and operations became subject to intense scrutiny in the heavily regulated financial sector.
Although Robinhood’s app is intuitive and easy to use, it also provides inexperienced
investors easy access to complex trading instruments such as options, other derivatives, and
cryptocurrencies. Due to their volatile nature and hidden, often unlimited downside exposure,
tl1ese categories can lead to enormous losses for novice investors. However, these exotic
instruments are incredibly lucrative for Robinhood, generating over half of its revenues. As
previously mentioned, day traders are Robinhood’s most profitable users. Robinhood encourages
users to trade several times a day with its slick UI, which lights up in bright green and red,
constantly sending notifications and raining confetti. Researchers found that Robinhood’s users
traded around 40 times as much per dollar in their account compared to customers of Charles
Schwab, another online brokerage firm3. Heavy day trading would be in keeping with Robinhood’s
mission if it weren’t for the fact that day traders mostly underperform market averages, a fact well
established in the finance literature.
The downside of gamification to encouraging heavy trading in exotic instruments by
novice investors came to the fore when a 20-year-old student and Robinhood day trader committed
suicide after believing he owed $730,000 in a sophisticated options trade gone sour. Alex Kearns
was a student at the University of Nebraska living at home with his parents in a Chicago suburb
during the pandemic. Robinhood’s aggressive tactics were implicated in his suicide note, where he
wrote: “How was a 20 year old with no income able to get assigned almost a million dollars worth
of leverage?4“ In reality, Kearns had several outstanding options that could have in part covered
his financial obligations. But he was misled into believing that he owed almost $1 million based
on the information displayed on the app combined with the complexity of these trades.
Robinhood’s business model also proved to be problematic in the long run. It turned out
that Robinhood did not offer the best prices for trades to consumers. Instead, it sold to market
makers that paid them more. Rather than users benefiting from the improved prices gained from
market makers, Robinhood and the market makers were capturing most of the value. Robinhood
was found to make, on average, twice as much from every 100 shares traded as competitor Charles
Schwab. This behavior later resulted in an SEC (Securities and Exchange Commission)
investigation that led to Robinhood being charged a $65 million SEC fine and a $125 million
FINRA (Financial Indust1y Regulation Authority) fine.
Additionally, despite marketing itself as a nontraditional financial services firm,
Robinhood was still bound by the same strict regulations and rules that apply to more traditional
stock brokerages. This situation was made clear during the GameStop stock crisis in 2021. As the
GameStop stock took off (“to the moon”) and superheavy trading ensued, Robinhood restricted
trading of GameStop stocks due to the inability to meet collateral requirements under financial
regulation. Tille inability to trade drew the ire of Robinhood users and the public. It also led to
accusations of market manipulation because one of Robinhood’s most significant sources of profit,
the market maker Citadel, had heavily shorted GameStop stock (that is, selling it by betting that
the stock price would fall). Several lawsuits against Robinhood were initiated by investors
claiming they lost out on GameStop’s meteoric rise.
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These factors, along with app outages and negligent security measures that resulted in data
breaches. eroded consumers’ trust in Robinhood. It also appears that Robinhood peaked during the
pandemic because user growth in 2022 was flat. In addition, its users traded much less than they
did during the height of the pandemic. And, because payment for order flow is illegal in Canada
and the United Kingdom and strictly regulated in Europe, there are few places for Robinhood to
expand. The SEC in the United States is also considering stricter regulation for payments of order
flow, which would create severe problems for Robinhood’s business model.
Robinhood’s stagnating user numbers also result from the wide availability of substitutes
in the financial services market. As mentioned, other brokerage firms have changed their business
model to zero-commission as well. The rapid imitation of Robinhood’s innovations meant that the
startup could not protect its temporary competitive advantage. In addition, on a macro level,
economic conditions have changed d1amatically, with tl1e United States experiencing the highest
inflation in 40 years and the onset of a global recession (in 2022). The stock market had the worst
first six months in decades, with the tech-heavy Nasdaq, on which Robinhood trades, dropping by
more than 30%.
Despite these challenges, Robinhood is attempting to move forward. It is focusing on
cryptocurrency and moving toward 24/7 availability of trading to generate more revenue from day
traders, its primary revenue source. Robinhood aims to build crypto and NFT (non-fungible token)
wallets to draw in more crypto and NFT enthusiasts, who generate a disproportionate amount of
Robinhood’s revenue. It is also focusing on features that appeal to more mainstream investors,
such as a stock lending program in which users can lend out stocks in their portfolio to financial
institutions, thereby generating interest, and offering a debit rewards card. Robinhood is doubling
down on its vital money makers and neglecting the thorny issues that turned off regular investors.
While the future is uncertain, many see Robinhood, with its low market cap, as a takeover target.
DISCUSSION QUESTIONS & RUBRIC
1. Have you used the Robinhood trading app? If so, what is your experience? If not, why not?
Would you consider using it? Explain. (20 pts)
2. Delineate the PESTEL factors that supported Robinhood’s rise. How did the startup match its
strategy to take advantage of the opportunities in the PESTEL environment? Identify and
discuss relevant PESTEL factors and their effect on Robinhood’s strategy. (20 pts)
3. Although Robinhood was quite innovative, it could not sustain its competitive advantage. How
did the PESTEL factors change over time to impact Robinhood negatively? Identify and
discuss relevant PESTEL factors and their effect on Robinhood’s competitive position. (20 pts)
4. What does the rapid and successful imitation of Robinhood’s differentiating features (such as
zero commission trades and slick mobile apps) tell you about the competitive intensity in the
financial services industry? (20 pts)
5. The financial industry is one of the most heavily regulated industries. Do you think regulation
hinders competition or encourages corporate responsibility? Explain. (20 pts)
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https://robinhood.com/us/en/about-us/
See Miller, D. (1990), The Icarus Paradox (New York: HarperBusiness): Vermeulen, F. (2009,
Mar.). “Businesses and the Icarus paradox,” Harvard Business Review.
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Barber, B.M., X Huang, T. Odean, and C. Schwarz (2021), “Attention induced trading and
returns: evidence from Robinhood users, “Journal of Finance, http://dx.doi.org/
I0.2139/ssrn.3715077.
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Klebnikov, S., and A. Gara (2020, Jun. 17), “20-year-old Robinhood customer dies by suicide
after seeing a $730,000 negative balance,” Forbes.
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Frank T. Rothaermel prepared this MiniCase from public sources with Duncan Siebert, who
provided superb research assistance. The MiniCase is intended for class discussion; it is not
intended to be used for any endorsement, source of data, or depiction of efficient or inefficient
management. All opinions expressed and all errors and omissions are entirely the author’s. Revised
and updated: July 8, 2022. © Frank T. Rothaerrnel.
Sources: Huang, V.G., and H. Miao (2022, Jun. 27), “Robinhood shares soar on takeover hopes,”
The Wall Street Journal; Vigna, P., and J. Telesca (2022, Apr. 28), “Robinhood reports 43%
revenue decline; The Wall Street Journal: McCabe, C. (2021. Dec. 9), “Robinhood’s stock fizzles
after splashy public offering,” The Wall Street Journal; Kauflin, J. (2020, Aug. 19). “The inside
story of Robinhood’s billionaire founders, option kid cowboys and the Wall Street sI1arks that feed
on ll1em; Forbes: “Robinhood takes its IPO to the masses; The Economist (2021, Jul. 26);
Rudegeair, P. (2021, Feb. 8), “Robinhood faces wrongful-death lawsuit over young trader’s
suicide,” The Wall Street Journal; “Robinhood takes its IPO to t11e masses; The Economist (2021,
Jut. 26): “High-frequency traders are in the spotlight,” The Economist (2021, Feb. 3); Popper, N.
M. Phillips. K. Kelly, and T.S. Bernard (2021.Jan .30), “The Silicon Valley start-up that caused
Wall Street chaos; The New York Times: Jakab, S. (2022, Jan. 21), “How Robinhood investors
robbed themselves; The Wall Street Journal: Robinhood Markets, Inc. (2021) annual report, and
About Us, https://robinhood.com/u s/en/about-us/.
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1. Have you used the Robinhood trading app? If so, what is your
experience? If not, why not? Would you consider using it? Explain. (20
pts)
1. I have never used the Robinhood trading app. I first became
aware of the app during the Covid-19 pandemic, which is when
the company saw the bulk of its success. The people around me
who used the app were mostly dads, which made me believe that
Robinhood was meant for that particular demographic. At the
same time, I felt as though I was not knowledgeable enough about
trading to use the app to my advantage, nor did I have the types
of funds I felt necessary to take part in trading because I was a
senior in high school at the time. With all these factors combined,
I did not feel the need or pull to use the Robinhood trading app.
Furthermore, I do not believe I would ever consider using the
Robinhood trading app in the future because I believe apps like
Robinhood pursue a strategy that focuses on making users
addicted to their app. Just like gambling, trading can be an
unhealthy addiction, which could ultimately put customers in
financial or physical danger, depending on the severity of the
addiction. Moreover, Robinhood is also on a path of capitalizing on
crypto and NFTs. Though crypto and NFTs can have a high return
on investment for some people, the uncertainty of crypto and
NFTs does not seem like a secure financial decision for me at this
point in my life, so the overall idea of Robinhood is unappealing to
me.
2. Delineate the PESTEL factors that supported Robinhood’s rise. How did
the startup match its strategy to take advantage of the opportunities
in the PESTEL environment? Identify and discuss relevant PESTEL
factors and their effect on Robinhood’s strategy. (20 pts)
3. Although Robinhood was quite innovative, it could not sustain its
competitive advantage. How did the PESTEL factors change over time
to impact Robinhood negatively? Identify and discuss relevant PESTEL
factors and their effect on Robinhood’s competitive position. (20 pts)
4. What does the rapid and successful imitation of Robinhood’s
differentiating features (such as zero commission trades and slick
mobile apps) tell you about the competitive intensity in the financial
services industry? (20 pts)
1.
5. The financial industry is one of the most heavily regulated industries.
Do you think regulation hinders competition or encourages corporate
responsibility? Explain. (20 pts)
1. The heavy regulations imposed on firms within the financial
industry can indeed hinder competition, however, the benefits
that stem from encouraging corporate responsibility greatly
outweigh this. Through regulation, companies are held to certain
standards within areas such as consumer protection, systemic
stability, and ethical standards. Regulations regarding consumer
protection have allowed for an increase in anti-fraud measures,
transparency notices, and fair lending practices. This has helped
build trust between consumers and entities within the industry.
Following the 2008 financial crisis, regulators have required
financial institutions to maintain adequate capital reserves. This
serves as a cushion for firms that may take on risk-taking
positions and further safeguards the broader economy. Many of
the rules firms have to follow promote ethical behavior. For
example, enforcing that fiduciaries act in the best interest of
their clients. Although heavy regulation can hinder competition,
it ultimately promotes the stability and integrity of the entire
financial system.