Despite its best efforts, BSE Ltd has ended up with nearly zero market share in the equity derivatives segment, the largest category in the exchange business in India. And notwithstanding a 120-year head start over NSE, its market share in the cash equities segment has dwindled to 13.4%, from 33% ten years ago. Put together, BSE has only a tiny sliver in the market for trading Indian equities.

But it’s making the most of its toehold. So far this financial year, transaction fee income in the equity segment is running at an annualized rate of Rs138 crore, and has nearly trebled since FY15 (Rs48.5 crore). Average daily turnover, meanwhile, has risen by just 22% during this period.

The huge jump in fee income has been possible because of a differential pricing strategy. Since 1 January 2016, trading members have been asked to pay 10 basis points (bps) as fees for a large number of stocks that are exclusively traded on BSE. Last year, fee for a sub-set within this so-called exclusive segment was raised to 100bps. Such charges are unheard of in the Indian exchange business.

NSE, for instance, boasted in its FY17 annual report that transaction fee for cash equities was 0.3bps on its platform, compared to 3.8bps at Singapore Exchange and 1.5bps at London Stock Exchange. BSE’s higher fees for the exclusive segment are possible because of a lack of competition for these securities. Regional stock exchanges, a possible source of competition, have been defunct for years now. And NSE simply isn’t interested in the market for penny stocks. “Small stocks come with associated baggage," said a person familiar with the exchange’s thinking.

BSE’s strategy aligns well with the advice of management gurus. “To be successful, a low share company must compete in the segments where its own strengths will be most highly valued and where its large competitors will be most unlikely to compete. (It is) important that the management spends its time identifying and exploiting unique segments rather than making broad assaults on entire industries," says an article published in the May 1978 issue of Harvard Business Review. The exchange has had similar success, although in smaller measure, by raising listing fees a few years ago.

“Another characteristic of successful low market share companies is that they are content to remain small," the article titled Strategies for Low Market Share Businesses states. With BSE, this hasn’t always been the case.

Till less than two years ago, the exchange was doling out incentives to try and get a slice of the equity derivatives market. In all, it spent around Rs275 crore in its liquidity enhancement schemes, although at the end, there was nothing to show for it.

BSE’s equity market operations have become far more profitable after it started thinking small. But not everyone is convinced this is a great business strategy. Analysts at Nomura Research say in a note to clients that the market for penny stocks is prone to cyclicality and shrinks dramatically in a weak market. Besides, since this is a highly regulated market, it’s possible that the exchange may be asked to bring down charges in the future.

From an investor’s perspective, BSE’s ability to make the most of its toehold in the equities market is heartening. Nomura’s analysts estimate that core operating profit has risen at an annual average rate of 29% between FY15 and FY17 largely because of the hike in transaction fees. Excluding transaction income from illiquid securities, core profit grew at a rate of just 4%, they estimate. And unlike at the time of the IPO, when all of its pre-tax profit was on account of income from investments and deposits, this revenue source has contributed a much lower 60% to pre-tax profit this fiscal. BSE also recently announced a deal with a large number of mutual funds whereby it can monetize its Star MF platform.

All of this should have enthused investors. But BSE’s shares have fallen below its IPO issue price of Rs805. This is partly because of selling pressure after the lock-in on pre-IPO investors lifted earlier this year. According to an institutional investor, the selling is largely by brokers who have held BSE shares for years. In hindsight, the seemingly high demand during the IPO—the issue was subscribed 51 times—seems to have been driven by low supply. Why else should the shares trade lower after an improvement in the exchange’s earnings potential?