Overlooked Exposure

By Anthony J. Lipp and Jay D. Norman

The coming electronic revolution will impact commercial bankers to an equal or even greater extent than their retail counterparts.

Retail banking is the predominant frame of reference for deliberations about Internet strategy for financial institutions. Among practitioners and pundits alike, the overriding emphasis is on consumer-related activities such as PC online banking (e.g., account inquiry, balance transfer), household bill payment, and stock trading.

From one perspective, such consideration is entirely appropriate, given the significant role that consumers play in the financial system. To the extent that this preoccupation excludes commercial banking from Internet strategizing, however, it could prove dangerous indeed. In fact, surprisingly little research has been conducted to determine the impact of electronic bill presentment and bill payment on the commercial side of the house.

That's asking for trouble, given that the growth of electronic payments could hurt commercial bankers in at least five ways. Online alternatives could pinch revenues from lucrative cash management services. Institutions could lose close relationships with corporate customers. Float revenue -- the extra interest incomerealized between the time a payment is authorized and actually executed -- could be reduced. Valuable customer information could be lost to competitors. And banks could lose standing in the payments system.

Fortunately, this gloomy scenario need not be the dominant referent for online commercial banking. To the contrary: alert strategists know that the flip side of an eroding paper-based operation is exploding opportunity in electronic avenues. Business-to-business electronic commerce is doubling every four months, according to PricewaterhouseCoopers estimates. And by 2002, the projected value of goods and services traded online will reach $434 billion -- a nearly twelve-fold increase from 1998's anticipated volume (chart, this page). The majority of the growth will come from business-to-business transactions.

The catch, of course, is that financial institutions must overcome increasing competition from a variety of powerful new rivals if they are to stake their claim in electronic commerce. As customers make the technological and emotional leap from human-facilitated, paper-based transactions to computerized ones, they seem to place less importance on the type of provider than on the utility of the service itself. In other words, long-standing banking affinities can't be counted on to carry the day in online competition. By virtue of their choices, customers will define the winning online service arrangements, features and marketing pitches. This will obligate aspiring providers to focus keenly on the market, as opposed to longstanding internal patterns and preferences.

For commercial banking strategists, the implications are at least threefold. One, product development efforts increasingly must be centered on online propositions that enhance billers' electronic business models. Commercial banks also must find innovative ways to capitalize on new streams of customer information available in the electronic environment. And, finally, wholesale and retail bankers must collaborate fully if they are to capitalize on the Internet-driven revolution in bill presentment and payment.

What's at Stake

To understand commercial banking's vulnerability to electronic transactions, look no further than lockbox operations, a traditional service in which banks sort and reconcile clients' oft-tangled paper bills and receipts in exchange for processing fees. On the wholesale side, banks often receive $1 per item for processing paper payments. The high charge reflects the complexity of dealing with torrents of automated checks issued by corporate accounts payable departments that carry no remittance information. Even allowing for all the nettlesome work banks must undertake to sort the accounts, margins on a wholesale lockbox operation are often lucrative, typically ranging from 30% to 50%.

Equally troublesome is the prospect of diminishing float. In the electronic world, every bill payer -- from the consumer to the small and large business alike -- is sure to delay payments until the due date. For banks and billers, this translates into diminished interest income on customer funds earmarked for as-yet-unexecuted payments, which often stay in an institution's coffers for as long as a week in advance of payment dates.

Banks won't have a clear field in developing replacement business lines, however. It's hardly a secret that numerous software and electronic processing service providers want a big chunk of the action. And no wonder: by some projections, annual cash management revenues will grow to nearly $13 billion by 2005, up more than 50% from 1996.

Rather than an abstract quest for dollars, the approaching market share battle in electronic payments revolves around customers and key relationships. For example, third-party bill payment providers such as CheckFree Corp. and MSFDC, the joint venture between Microsoft Corp. and First Data Corp., are proposing "consolidator" business models that would make them the prime conduits of bill presentment and payment information in certain market segments. If this model is successful, electronic providers will be able to build direct relationships with merchant billers.

A painful truth for banks is that many of their corporate customers probably will welcome this development. Although we are not aware of substantive research on prospective biller acceptance, early projects suggest that electronic bill presentment and payment services will touch off a market rush. According to industry estimates, approximately eight million bills can be viewed online today. By 2002, annual electronic bill presentment volume is expected to exceed two billion transactions (chart, this page.)

The attraction for billers (such as public utility companies) is obvious. Depending on the eventual extent of customer participation in online billing arrangements, their outlays for printing, postage and administrative expenses could shrink substantially.

The potential damage to banks, though possibly less obvious, is of great magnitude. Why? Electronic payment alternatives could undercut relationships between merchants and financial institutions, thereby limiting banks' ability to cross-sell profitable commercial banking products to payments-intensive customers.

Remember, the payments business is as much about the movement of information as the routing of money. Increasingly, in fact, the value to be gained in the payments systems will come more from managing and distributing information and less from executing transactions. If electronic providers are successful in diverting myriad paper-based transactions away from banks and through their own electronic conduits, they will gain an extraordinary opportunity to work more closely with the corporate customers -- and provide them with fresh products based on information retrieved from the electronically-processed bills.

Witness what's happened with First Data's U$A Value Exchange program. First Data compiled an extensive database of credit card transactions with participating banks and turned it into a salable product. Using purchased transaction information from First Data, member banks can better target their products and services to current and prospective customers. Prospecting and cross-selling become so much easier if you know customers' spending patterns. But what bank can claim to offer such information?

Lull Before the Storm

One serious trap to be avoided is assuming that there's no urgent need to plan for tomorrow, simply because the pace of change appears slow today.

When the market does begin a more noticeable tilt toward electronic payments, however, an era of potentially rapid and profound change will unfold. How should banks prepare?

An essential step for every institution is identifying the strengths that can and must be carried into new electronic markets. Given that customer relationships are so crucial, banks should classify their most important commercial customer segments, analyze how each segment could be better served by electronic means, and begin to develop business propositions and strategies that will facilitate customer migrations while retaining relationships. Institutions can infuse such exercises with other strengths -- such as brand awareness, expertise in risk management and high levels of public confidence -- so as to give themselves the best chance of differentiating offerings from those of nonbank rivals.

By capitalizing on brand strength, for example, banks could become the enablers of new electronic financial communities, bringing together the services consumers want and the consumers vendors need. Yes, commercial enterprises of any size can set up Web sites. Who hasn't been intrigued by advertisements proclaiming the ease with which village craftsmen in Italy use the Internet to sell their goods into, say, the American Midwest? But every buyer still wants to know whether the goods will be shipped as promised, just as sellers worry whether they will get paid. Already positioned as trusted intermediaries, banks could easily step into this electronic role, which builds on what they do today as providers of letters of credit.

Bringing superb creativity to the formulation of new online business strategies will be difficult for many banks -- and understandably so. Tight management of risk and transaction integrity is crucial in banking. Along with extensive regulation, this fosters a managerial mindset that is more concerned with internal controls than with innovation and leapfrogging the competition.

Deliberations about new online ventures perhaps will help managers broaden their vision and lift their ambition. An early lesson of the Internet is that there's more to electronic commerce than technology. With the development of Web sites and intra- and extra-nets comes an opportunity to formulate totally new business strategies and overhaul longstanding approaches. Banks should grasp this chance to reshape ineffective and inefficient lines of business. It's also the moment to deepen customer relationships and find fresh ways of building shareholder value.

To prosper, banks must leverage the relationship that comes from having the biller's deposit account, and focus on building products and services that add value to the biller relationship. Ahead lies a host of opportunities to develop new products and services. For instance, banks could gain market share by developing an ability to aggregate multiple electronic bill presentment and payment providers. Or they could manage a pre-authorized payment debit service, and come to market with an array of credit products.

No one can say for sure where the Internet is going to take us, and the impact of electronic bill presentment and payment on the commercial side of financial institutions is still murky. Much will depend on market acceptance and changing customer behavior.

But this much is clear: Electronic bill presentment and payment will affect the entire bank, and managers must think about the effects on all departments, not just their own profit centers. From a managerial perspective, online threats and opportunities should be seized upon as catalysts for organizational integration. The retail and commercial divisions should be encouraged to come out of their traditional silos and collaborate more closely to build value for the whole institution.

It is time to start thinking about how to deepen relationships with business clients as they migrate into cyberspace. Impending market changes will have a significant impact on traditional commercial banking, especially on paper-based activities. The pressure is on senior banking managers to formulate compelling responses.

Mr. Lipp is a principal consultant and Mr. Norman is a partner and leader of the global financial retailing practice at PricewaterhouseCoopers, New York.

Copyright © 2003 by Banking Strategies, published by BAI.

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