The Big Payoff

It’s the next wave. It’s what customers want. It’s the best thing to hit banking since the automatic teller machine. It’s the Internet. But waitu00e2u20ac”bankers thinking of putting a lot of money in this shining new system instead should be training their eyes on the horizon. Today there are still big bucks to invest, infrastructure to build, and customers to convert. Even with the aura of sophistication and the competitive edge that the Internet supposedly provides, most bankers want to know when they’ll see the big payoff.

Ask any banker offering services on the Internet today to explain their cyberbank strategies, and bottom-line profits will rarely enter the discussion. And with good reason: Financial institutions aren’t making any money on the Internet. Indeed, for some, the Internet more aptly resembles a black hole than it does an electronic superhighway capable of carrying information at near lightening speeds.

Still, this economic reality hasn’t kept financial institutions from setting up shop on the Internet. Any financial institution worth its salt today has, at a minimum, an electronic-style brochure touting its products and services to savvy Internet surfers. Most of the nation’s largest financial institutions, and a growing number of small- to mid-sized institutions, also offer customers the ability to perform routine banking functions onlineu00e2u20ac”like checking account balances, transferring funds between accounts, and paying bills. For these institutions, it’s not a matter of losing money on the Internet, but of losing customers by not being on the Internet.

And to a certain extent, the market is aware of who is moving forward and who isn’t. Analysts say that being on the Internet shows a certain level of technological sophistication.

Where the payoff comes from achieving that level of sophistication, say those familiar with the Internet banking business case, is seven to 10 years after the initial investment is made. That’s when large enough numbers of customers are using the Internet to do their banking that the institution can displace substantial costs and use its electronic connection to cross-sell services. “That’s what everyone is after ultimately,” says Matthew Lawlor, chief executive officer, Online Resources & Communications Corp., a McLean, Va. outsourcing company that specializes in consumer interactive services.

A report released earlier this year by Meridien Research drives home this point. As of late last year, Meridien estimates 35% of financial institutions were offering customers the ability the initiate transactions via the Internet. But simply giving customers the option of online transactions is not enough to create a competitive advantage, concludes Octavio Marenzi, the research director who authored Meridien’s report. He predicts that upwards of 90% of top North American banks will be offering Internet-based transactions by the year 2000.

Upfront costs

Even so, Merenzi doesn’t expect consumers to flock in droves to the Internet to do their banking. At best, he says, there will be four million home banking customers by 2000, and only about half of those individuals will be accessing those services via the Internet. “It will take a long time before the Internet becomes a significant channel,” he says.

And until that happens, bankers will be spending substantial sums establishing their sites on the Internet. “The reality is that this is a very significant investment, and until people start using it in significant numbers, you’re going to lose money on it,” Merenzi says.

Few bankers will disclose precisely how much money they’ve spent to date creating an Internet banking presence for their institutions. For many, it’s not an easy task to get their arms around the costs.

Ed Neumann, director, Dove Associates, Washington, D.C. estimates that even the most sophisticated Internet banking sites can be built for under $500,000. But that doesn’t take into account the fees charged by Internet service providers, which hinge on the number of servers needed to support a site and the security procedures needed to ensure no one with nefarious intentions gains access to the bank’s mainframe computers. Those charges, Neumann suggests, can mount to an additional $500,000. Then there are the fees charged by companies that process the bill payments initiated by consumers on a bank’s Internet sites, like Checkfree Corp. of Norcross, Ga., which average $3 to $6 per customer per month. And there are also the customer service costs associated with familiarizing customers with the nuances of Internet banking.

Altogether, a large bank can expect to spend in excess of $1 million year to support an Internet presence, suggests David Schehr, director of operations and research at Mentis Corp., a Durham, N.C., research firm that tracks banks’ technology expenditures. For smaller banks, the tab is significantly less, but at upwards of $200,000 a year, by Schehr’s reckoning, it’s still a substantial sum. Balance against those costs the fact that even the most successful banks are attracting 3%-5% of customers to online banking services, and it’s difficult for some observers to understand the economics of Internet banking.

“I don’t think any company should put a tremendous amount of effort in terms of money and management resources into this,” says analyst Katrina Blecher, Gruntal & Co.

Of course, there are lower cost alternatives. Outsourcing the function is one way community banks can make their presence known on the Internet with a smaller initial outlay.

“For once, the promise of technology being able to level the playing field is coming true,” says Al Dominic, president of the Retail Products Delivery Group for M&I Data Services in Milwaukee. Dominic says community banks he works with generally pay $50,000 on the front end to get their customized site up and running, then $3 per account each month. And while that’s $3,000 a month for 1,000 Internet accounts, Dominic points out that those customers are likely to be among the bank’s most profitable.

The monthly maintenance fee is an obstacle that has “delayed the rolling out of the product” for many banks, Dominic says. Consumers don’t like feesu00e2u20ac”but without charging fees, banks want to know how they can recover the cost.

“The profitability of the account has to really be taken into consideration,” explains Dominic. M&I has several tools that can help the banks it works with understand customer profitability and make sound decisions with regard to building an Internet banking delivery channel.

Eye on the prize

Those who champion Internet banking, however, caution that you can’t build the business case on dollars alone. Lawlor, for example, points to benefits like customer retentionu00e2u20ac”only half as many online customers, about 8%-10%, defect a financial institution in a given year, compared to 20% of non-online customers, he claims. There are also the benefits of expanded account relationships, reductions in paper handling costs (a bank can save $0.07 to $0.15 on each check payment converted to an electronic payment, he says), and savings on staff and communications costs. These last cost savings come from weaning customers off costly toll-free telephone numbers (which the bank pays for) and shifting them to the Internet (which they pay for). Longer term, he continues, banks have to build in the ability to effectively engage in one-on-one marketing.

Tripp Johnson, senior vice president, Crestar Bank, clearly has his Internet banking sights set on the long term. “Internet banking and Internet bill payment are not what make money for a financial institution. What makes money is building a one-to-one relationship with each customer using this channel and being able to offer tailored products and services to those customers.”

Johnson envisions the day when Crestar can truly mine the data it accumulates on its customers so that the bank can fashion special offers for Internet customers, perhaps offering cut-rate interest rates on the assumption that it costs less to initiate a loan online than in person. The upshot, he says, is substantial savings over mass marketing to the bank’s entire customer base with direct mail techniques and higher rates.

A $24.9 billion institution headquartered in Richmond, Crestar hired Johnson away from Memphis-based First Tennessee last year to orchestrate its Internet banking activities. He immediately began targeting the top 40% of the bank’s customer base and as of late February, Johnson was counting 28,000 customers as regular visitors to Crestar’s Internet site. What’s more, he estimates 1,000 new customers a week have been signing on for the service since the beginning of January, “with zero advertising.” At this rate, Johnson says he’s optimistic Crestar can move 10% of its estimated one million customers to the Internet by the end of 1998.

It’s a lofty goal, but one Johnson considers achievable, in part because of Crestar’s geographic market. The bank’s largest footprint, Northern Virginia, has the highest concentration of personal computer and Internet users outside of the Silicon Valley, he claims, and is considered the birthplace of the Internet.

Another bank that has been successful in moving customers onto the Internet is Wells Fargo Bank. With the Silicon Valley in the shadows of its headquarters city, San Francisco, Wells was the first bank to offer Internet banking, setting up shop on the Internet in May 1995. Today Wells reports 450,000 people, or about 10% of its retail customers, are banking online. (Not all of these are Internet customers, as online banking also refers to traditional, direct connection home banking services.)

Susan Weinstein, a Wells Fargo vice president with responsibilities for online banking services, rejects suggestions that Internet banking is unprofitable, countering that it’s a matter of definition. Although Internet banking requires a large systems expenditure, in terms of getting the service up, it’s a nonrecurring expense, so there are savings to be had if you amortize that investment over a sufficient period of time, Weinstein suggests.

“We see this business as a value-added service to the bank as well as to the customer,” she says, adding that it costs substantially less for a bank to handle a customer transaction over the Internet than it does at a branch. Translation: if you ignore the money spent on systems and just focus on the per-transaction cost savings, there’s a clear value to a bank being on the Internet.

Front runners

There’s also value to being first. Centura Bank, a $7 billion asset bank based in Rocky Mount, N.C., was the first in its state to offer online banking in October 1995. And Jack Meckler, product and channels manager, says he’s convinced being first helped Centura win over new customers. Now that its behemoth cross-state competitor, NationsBank, has joined the Internet banking fold, Centura’s online banking presence serves less to differentiate the bank, but it remains a vital part of the bank’s operating strategy.

“We don’t look at it as a product, we look at it as a delivery channel,” explains Meckler, adding that Centura’s investment in Internet banking today “will pay off in the future, in terms of efficient delivery.”

NationsBank senior vice president Chuck Hieronymi is similarly optimistic. The benefit to be derived from online banking, he says, clearly is long term, when an institution can generate sufficient transaction volumes to drive down overall costs and enhance its efficiency ratio. “The ability to enhance your efficiency ratio is clearly unmatched over time,” he says.

An analysis offered by Lawlor of Online Resources supports this suggestion. At a typical credit union, Lawlor estimates, it costs $1.07 to service a customer at the teller window, $0.35 to field a customer service telephone call, $0.27 to support an automated teller machine transaction, and $0.01 to handle a customer transaction initiated via the Internet.

Beyond the dollars and cents, however, Lawlor confirms that financial institutions today are looking at remote banking in general, and the Internet in particular, as a necessary business strategy.

“Two years ago, when we were missionaries in this business, we spent a lot of time talking about the business case for remote banking. We don’t have too much of a need for that today,” he says. “If you’re going to be in business today, you’ve got to have online, remote banking capabilities.”

NationsBank has a substantial stake in online banking. Although he won’t disclose just how much the bank has invested, Hieronymi says the investment totals in the millions of dollars in hard-dollar costs, plus substantial staff and technology resources.

NationsBank, along with four other big-name banks (Bank of America, First Bank Systems, Fleet Financial Group, and Royal Bank of Canada), holds an ownership stake in Mecca Software, developer of the Managing Your Money software package that these and other banks use as a first step in providing customers with online access to financial services. It is also one of 16 banks that, in late 1996, ponied up $4 million apiece to form Integrion Financial Network, a cooperative data center used by banks to process online banking transactions.

Since introducing NationsBank Managing Your Money three years ago, Hieronymi says the bank has sold more than 500,000 copies of the software. He expects NationsBank Online, which is only now just rolling out nationwide following a market test last year in Texas, to be similarly successful.

“We see absolute rapid growth in the interest and desire of consumers to do their banking electronically,” says Hieronymi.

The fact that NationsBank has name recognition in the consumer sector should work to its advantage over time, suggests Michael Mayo, bank analyst with CS First Boston, New York. “More than likely, customers will gravitate to those banks with well-known names and favorable reputations,” says Mayo.

That’s what Richard Lyons, senior vice president, Comerica Inc., is hoping. A $36 billion asset bank headquartered in Detroit, Comerica just launched an Internet banking site with the support of a third-party service provider. Until March, Comerica had hosted a modest Internet Web site that offered brochure-style information about the bank’s products and was logging about 200,000 visits a month to that site. With an expanded, full-function Internet banking site, Lyons expects to be logging one million visits a month by yearend. “The Internet channel is going to be where brand value makes a difference. As a brand, we have a good image that helps us sell the bank,” says Lyons. “Bank brands need to become the trusted agents on the Internet.”

Uphill climb

There remain many obstacles, however, to moving bank customers to the Internet. One is the penetration of PCs and other devices that can access the Internet. International Data Corp., a Framingham, Mass. research firm that tracks technology trends, estimates that, worldwide, there were 37.9 million consumer PCs linked to the Internet last year; by 2002, IDC estimates the number will increase to 139.4 million. But, again, that’s a worldwide number. Weinstein of Wells says she expects new, non-PC devices, like Microsoft’s Web TV, to greatly expand Internet access. But IDC’s data doesn’t support this theory; only about 7.3 million non-PC devices based on television technology will be available to consumers for accessing the Internet by 2001, according to IDC’s projections. “The Web TV concept is not going to crack this market open,” says John Gantz, IDC senior vice president.

Even among those consumers with access to the Internet, there is at least the perception that this new medium may not be as secure as other methods of doing their banking.

Neumann of Dove Associates agrees bankers should be attentive to Internet risk, but he insists Internet security is a manageable task. “You don’t need NASA-like cryptology, but you need security so nobody can break in and wreak havoc,” he counsels. If you use an outside vendor to support your Internet banking offering, he adds, it will manage that risk as part of the overall service package.

Bankers offering Internet-based services say break-ins aren’t really an issue. The systems, they insist, incorporate the most up-to-date security technologies. And even if someone manages to get by the firewalls that are erected, the way the systems are built, it is not possible to transfer funds between different individuals’ accounts. “If the mainframe is set up properly, and you’re using the best security, a hacker may be able to get in, but all they can do is get account numbers and balances; they can’t steal anything,” explains Johnson at Crestar.

What remains for banks, then, is selling Internet banking. Even the most successful Internet banks haven’t yet figured out how to market the service to customers, some observers say. “No one has explained to the consumer why it is preferable to do business over the Internet,” says analyst Richard Bove, senior vice president, Raymond James & Associates, Tampa Bay, Fla. “Until some bank makes a real pitch to consumers, it won’t work.”

D.R. Grimes, chief executive officer, Atlanta Internet Bank, an Internet-only bank with $138 million in assets, agrees it’s a tough sell to get consumers banking on the Internet. But just like ATMs, he insists, the Internet will someday be an accepted new way for consumers to do their banking. It’s not something any one bank can do on its own, however, says Grimes. Like ATMs, he suggests, it will take a concerted industry effort to stoke consumer interest.

“I don’t disagree, it’s a difficult sale,” says Grimes. “But every time somebody promotes Internet banking, it drives up consumer awareness, and that helps everyone.”