Geoff Penney of Charles Schwab Corp.: Bleeding edge, and proud of it

Schwab’s profits are recovering, but investments in technology didn’t have to. They never flagged, says CIO Penney.

How important is technology to Charles Schwab Corp.? Geoff Penney, the company’s chief information officer, has an answer that few, if any, rivals can top. “We have two CIOs on the executive committee,” he boasts. “There are a lot of firms in the U.S. that don’t have even one.”

Penney, a Schwab executive vice president, has held the CIO job since 2001. His predecessor and current boss, Dawn Lepore, Schwab’s vice chairman for technology, operations and administration, also sits on the executive committee, along with chairman Charles Schwab, CEO David Pottruck and seven others.

“Schwab should be on anybody’s list of top technology innovators,” says Jaime Punishill, a principal analyst at Cambridge, Massachusettsbased Forrester Research. “The organizational structure certainly speaks to that.”

In information technology spending, however, San Franciscobased Schwab didn’t even crack the top ten in a recent brokerage industry study by Boston-based research firm Celent Communications. Schwab’s 2004 budget of $730 million is roughly $130 million less than that of No. 10 Bear, Stearns & Co. and $2 billion shy of No. 1 Merrill Lynch & Co’s.

Of course, Schwab is historically a retail firm, focused on fewer businesses and lacking the back-office complexity of a top investment bank. But Schwab depends heavily on technology and gets plenty of bang for its buck. It serves half of its 8 million customers online and is aggressively upgrading its professional and institutional research and trading capabilities.

Says Forrester’s Punishill: “This is a firm that constantly asks itself, ‘How can we make things better for clients?’ Technology is always part of the answer.”

Technology also has a bottom-line impact: While Schwab enjoyed a 32 percent increase in first-quarter revenues, to $1.19 billion, expenses increased just 17 percent, to $943 million, and net income surged 127 percent, to $161 million.

“We’re very much back to business,” says Penney, comparing the improved results with the company’s 3 percent and 52 percent declines in operating income in 2002 and 2001, respectively. “In recovery periods we don’t forget about cost-effectiveness, but we begin to really think about innovation and how we can help restore growth to the top line as well.”

A native of London, Penney, 58, earned a BA and Ph.D. in inorganic chemistry from St. John’s College, Cambridge. He pursued business technology, he says, because “I was interested in problem solving, and I wanted to do it in the real world rather than the laboratory.”

After three years managing systems for Eastman Kodak Co.'s U.K. subsidiary and three years as a project manager at London financial software house BIS Applied Systems, Penney joined Bankers Trust Co. in 1976, managing technology projects in London and New York until 1993. He then spent four years with Fidelity Investments in Boston as a senior vice president of technology before jumping in 1997 to Schwab as head of financial products and international technology.

Penney recently discussed Schwab’s technology with Institutional Investor Assistant Managing Editor Jeffrey Kutler.

Do you oversee technology for all the business units?

Most of the technologists in the firm report to me. That includes all technology services -- operations, infrastructure, the networks and the desktops. A second group of people work with our business leaders but also report to me. They attend both my meetings and those on the business side. This cross-collaboration ensures that we build systems that fit together and integrate well, while at the same time understanding and being responsive to the business. We are organized to combine the best of centralized cost-effectiveness with the best of decentralized responsiveness.

How have the recent market cycles affected the tech organization?

When I joined in February 1997, technology was 1,200 people. At the peak, in 2000, we employed 3,700. In 2001 and 2002 we reduced our spending and capacity substantially, and today we have about 2,500.

Did the crunch force you to hold spending down, and has it loosened up?

Over several years spending has been basically flat. The mix of the spending, however, has changed substantially. We’ve been saving on operational costs and increasing our investment in technology. At Schwab there is an insatiable demand for technology. At any given time there are ten good ideas for every one that we have the bandwidth and money to execute. Rather than cut technology, we want to invest as much as possible while minimizing the ongoing production and maintenance costs.

Are you saying that Schwab’s investment in technology never slackened off?

Despite the more prudent spending, investment in future technology didn’t stop. For example, in the years of the downturn, we did a huge amount of work on our investment advice offering for individual investors. Also during that time we worked on the wireless channel. Our cost-reduction efforts included reducing capacity in terms of equipment as well as people and institutionalizing cost-effectiveness techniques from which we can continue to benefit long term. Part of that came from converting to an Intel-based computing platform using the Linux operating system. We also launched a considerable effort around autonomic [or automatically managed] computing, which we call organic IT, and grid computing [drawing capacity as needed from a network of computers].

What do those trendy concepts say about Schwab’s willingness to test the bleeding edge?

We always look for innovation. We do not like to waste money. But we are very happy to be close to the bleeding edge. Indeed, Schwab has a long history of building technology that enables business change to happen. In the 1970s, Chuck Schwab made the key decision not only to bring the firm’s back-office computing system in-house but also to connect all of the client representatives to the system through terminals that enabled us to pass orders to the market directly. The cost model was very different from wiring or phoning orders across the country, and it enabled the discount brokerage business to thrive.

Do you have an R&D function?

Being on the West Coast, we have a lot of access to emerging technologies in Silicon Valley. Our four-person advanced technology group develops a view of what’s coming in each technology area, looking for interesting examples and taking them to the technologists who work in the business. It’s essential to get to prototype and pilot as quickly as possible -- that’s what you have to do with advanced technology.

When did you decide to shift to Linux?

We made the decision in the third quarter of 2002. We had a pretty big plan for 2003, beginning with the conversion of some production applications that were not too risky. But we built that up rapidly, and our big move was converting the Schwab.com Web servers in July 2003. It took only a few months to go from that decision to multiple million dollars of savings. We could do that because Linux is close to Unix, and we have a fair amount of Unix expertise in-house.

Is there more benefit from Linux than the pure cost savings?

What I’m most interested in is the hardware savings. The easiest way to move a Unix workload onto Intel-compatible hardware is to use Linux. But we also have a terrific relationship with Microsoft, with some very important business applications running on its technology. That’s also on an Intel platform, which is fine.

What’s exciting on the horizon?

One development that’s top of mind is Schwab SoundView Capital Markets and the integration [of Schwab’s January merger with SoundView Technology Group]. I believe there will be real demand for top-class trade executions in the Schwab Liquidity Network with research that is truly independent of investment banking. Now we have all the capabilities of institutional research -- fundamental research from SoundView, policy and economic research from Washington Research Group, investment analytics for quantitative research (with much of the same mathematical modeling used in the Schwab Equity Ratings for individual investors) and technical analysis from John Mendelson in our Market Analysis Group. Add these independent research capabilities to our execution capabilities, and we are in a very strong position to bring about change in the way institutions buy and sell equities. I’m hoping that we do for institutional

investors what we did for individuals a generation ago.

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