🗞 The Widest Moat That No One Talks About

Happy Sunday! 👋 

Today we’re taking a look at one of the most impressive entrepreneurial stories of the last 100 years. This is the story of Interactive Brokers.

Let’s dive in!

Platform Update

UK & EU Data Now Live

This week, Fiscal.ai expanded its real-time fundamental data feed to the UK & EU markets.

That means, Fiscal.ai clients can now get instant financials, more data history, adjusted metrics, and much more on 5,000+ companies from countries including:

• 🇬🇧 UK

• 🇩🇪 Germany

• 🇫🇷 France

• 🇳🇱 Netherlands

• 🇧🇪 Belgium

• 🇨🇭 Switzerland

• 🇸🇪 Sweden

• 🇳🇴 Norway

• 🇵🇱 Poland

And much more!

Featured Story

The Widest Moat That No One Talks About

Thomas Peterffy is probably the most successful entrepreneur you’ve never heard of.

The 81-year old Hungarian-born founder is worth more than $80 billion as of this writing and is widely considered the pioneer behind the shift to digital financial markets.

Born in socialist Hungary in the middle of World War 2, Peterffy immediately sought a better life. The straight talking free market enthusiast has been vocal that even from a young age, he knew he wanted to live in a country that incentivized hard work and innovation.

So in 1965, at the age of 21, Peterffy was lucky enough to secure a short-term visa to West Germany to “visit distant relatives”. From there, he immediately applied to immigrate to the United States, and after being accepted, he bought a one way ticket to New York City.

As an immigrant with little money and no ability to speak English, Peterffy recalls having a difficult time adapting in Manhattan. Undeterred, Peterffy found work as a draftsman for road maps at a highway engineering firm that paid $65 per week. While not much, it was enough to get him started, and it was where he first discovered his knack for computers helping to automate equations for his colleagues.

4 years later, Peterffy parlayed his unique computer knowledge into a job working for a psychiatrist named Dr. Henry Jarecki who had built a small commodities trading firm on Wall Street. Within a few years, Jarecki’s firm had expanded drastically, and as an early employee, Peterffy’s importance grew.

After the firm gained success in the commodities market, Peterffy implored his boss to expand into options markets. Jarecki refused, so Peterffy decided to venture out on his own.

In 1977, Peterffy purchased a seat on the American Stock Exchange for $36,000 and began trading options. Prior to joining Jarecki’s firm, Peterffy had invented a partial differential equation for pricing options that pre-dated the Black-Scholes model. In an attempt to cut out the errors of human judgement, Peterffy decided to use this formula to dictate his trades.

From Market Maker to Digital Broker

Relying on his formula’s fair value assessments for options proved fruitful.

He started by writing the fair value of various companies’ options on pieces of paper each morning and taking them with him to the trading floor. But over time, his strategy became increasingly digital. Peterffy hired traders and equipped them with handheld computers (the first ever at the American Stock Exchange) which would reflect the latest fair value estimates.

By 1982, the system was working so well that Peterffy, who by this time had hired a few engineers and several traders, decided he needed to name his operation. Thus, Timber Hill was born.

Timber Hill continued to improve their trading strategy by building an information latency advantage. By the early 1990’s, Timber Hill was considered the world’s most formidable automated market maker. Peterffy’s proprietary algorithms were undercutting manual traders on the exchange floors, and he was reaping the benefits.

But Peterffy was at a crossroad. He was coming to the realization that the same technological moat protecting his profits could be turned into a product for the very people he was trading against. He envisioned a platform that linked directly to the burgeoning electronic exchanges emerging globally, providing sophisticated investors with the same pricing models and speed that he had spent decades perfecting for his own use. So in 1993, Peterffy opened the gates to his electronic network with the launch of Interactive Brokers.

Automate Everything

Today, after 3 decades of iteration and digital infrastructure building, Interactive Brokers has among the highest profit margins in the world with a whopping 77% operating profit margin last year.

How is Interactive Brokers so profitable?

One major reason Interactive Brokers is able to generate much higher profit margins than its peers is its specialized focus. Beyond digital trading capabilities, competitors like Schwab and Fidelity offer a full service model that include wealth management services. This approach requires more people, which ultimately means more costs.

Interactive Brokers, on the other hand, has focused exclusively on providing the best possible digital trading platform since its 1993 inception. This has resulted in a far lower headcount.

Today, IBKR has 3,182 employees with the majority of those employees being in engineering and technical roles. This enables IBKR to generate more than $2 million in revenue per employee. Schwab, for reference, has more than 33,000 employees and earns roughly $725,000 in revenue per employee.

But beyond focus, Interactive Brokers has always placed a heavy emphasis on automation.

Today, virtually all of IBKR’s critical functions are automated and managed in-house. This includes everything from their front-end trading platforms like Trader Workstation to their back-end SmartRouting order infrastructure.

This emphasis on automation also extends to more mundane tasks like customer support and loan approvals. While most companies have real people in place to approve margin loans, IBKR automates the entire system from margin loan approvals to position liquidation without the need for human intervention.

Another cost advantage that IBKR has today is its direct access model. Most online brokers (like Robinhood for example) actually act as intermediaries that route customer orders to third-party market makers or centralized trading desks, and rely on specialized clearing firms to handle the back-office settlement of trades. Interactive Brokers has chosen to build a direct approach by purchasing memberships on hundreds of individual exchanges and clearing trades themselves. Although this is a more costly approach up front, it removes the variable fees associated with each individual transaction which benefits IBKR at scale.

While there isn’t any one single reason for IBKR’s ludicrous profit margins, ultimately, it’s a byproduct of building a culture obsessed with cost-consciousness, automation, and scalability.

That’s all for this week. 

If you have any questions on Fiscal.ai or feedback for the newsletter, feel free to reply to this email!