Mobilizing for E-Strategy

By Kenneth Cline

As Bill Harrison accelerates Internet strategy at Chase Manhattan, he must pick his targets carefully and safeguard current earnings.

A major challenge facing top banking strategists is wringing optimal performance from traditional business lines while simultaneously transforming their companies to compete in e-commerce. Unlike the lavishly-funded dotcoms, traditional banks get clobbered by investors when they spend too heavily on their Web ventures. Banks also are held to a higher standard on earnings, while many of the newcomers have latitude to operate at a loss for extended periods of time.

This dilemma is being played out at Chase Manhattan Corp. The nation's third largest bank is struggling to shed its decades-old image of a volatile money center bank while trying to stay at the forefront of developments in the emerging world of e-commerce. Chief executive William B. Harrison Jr. has publicly embraced e-commerce as one of Chase's highest strategic priorities since taking command in June 1999. He speaks frequently on the subject and even took his top executives on a tour of West Coast technology firms.

Not everyone embraces the new image of Chase, however. Wall Street hasn't completely forgotten about the lending and trading debacles encountered by the predecessor entities prior to the 1996 merger of the old Chase and Chemical Banking Corp. Some analysts point out that many of Harrison's Web initiatives are still in the embryonic stage, and that the company's overall revenues remain heavily dependent on market-sensitive business lines such as trading and venture capital investing.

Harrison is clear-eyed about the magnitude of the selling job before him. Insists the 57-year-old executive, "The new Chase is a very different organization, characterized by leadership in business lines, improved financial discipline and sharpened risk management. Market perceptions tend to lag the realities of changed performance, however, so the only way you change investor views is by delivering consistently."

Harrison is devoting a quarter of a billion dollars annually to e-commerce initiatives. Well and good, analysts say, but he's got to muster these resources in a way that doesn't hurt near-term profitability – and deploy them wisely. Like his counterparts at other major U.S. banks, Harrison is wrestling with the issue of how to nurture an entrepreneurial approach to e-commerce without alienating traditional business lines. His answer is a new business unit, chase.com, which serves as the focal point for Internet-related initiatives. To coordinate the unit with the rest of the company, he also formed an Internet council comprised of senior executives from all of Chase's major business lines.

There's no guarantee of success, however. Many analysts perceive chase.com as a halfway measure that neither immunizes the Internet business unit from the bureaucratic entanglements of the traditional bank nor adequately integrates e-commerce into the overall company. It's too early to accord market value to the infant unit, moreover, which came into being only last June. Nor is it assured that Chase's current robust returns from trading and venture capital investing will hold constant. A major market upheaval would both crimp resources available for reinvestment in e-commerce and re-ignite investor concerns about earnings stability.

"The proportion of revenues derived from capital market activities is at a historic high at Chase, and that concentration creates more risk," says Michael Mayo, a banking analyst with Credit Suisse First Boston. "Viewed over the course of the last decade's bull market, Chase's market-sensitive revenue trends do show some stability. But how far do you want to extrapolate those trends?"

Degrees of Separation

No matter how the revenue debate plays out, Harrison has no choice but to look ahead. The competitive landscape of financial services is changing at a dizzying pace, and coping will require a series of organizational transformations that can only be accomplished by elevating e-commerce to a top strategic priority.

The threat is real: banking's traditional product- and geography-centric service model is being steadily supplanted by an electronic system that enables customers to access all manner of providers at will. "Bill Harrison gets it," says Morgan Stanley analyst David B. Hilder. "He understands what Internet technology is capable of doing to the financial intermediation business."

The question then becomes how to approach e-commerce within the confines of a traditional business model. Within the past year, most of the major banks have appointed senior executives, or "e-commerce czars," to lead their Internet initiatives, and they have adopted a variety of structures to support those czars. Bank One Corp. and Citigroup carved out separate business units that operate with a great deal of autonomy. By contrast, FleetBoston Financial Corp. and Wells Fargo & Co. empowered their individual business lines to pursue Web ventures.

Chase is somewhere in the middle.Executive vice president Denis O'Leary, the bank's designated e-commerce czar, runs chase.com as a separate unit. The explicit intent is to nurture a Silicon Valley-type entrepreneurial culture outside the normal bank bureaucracy. But O'Leary also remains within the Chase chain-of-command, reporting to vice chairman Neal S. Garonzik, and his unit is charged with facilitating "new economy" initiatives throughout the company. Along with Harrison and Garonzik, O'Leary co-chairs Chase's Internet council, which includes representatives of all the bank's major business lines.

Chase executives say some degree of independence is necessary to generate fresh thinking among chase.com's employees. But some analysts caution that any degree of separation between e-commerce activities and traditional business lines simply introduces another level of bureaucracy into the traditional banking structure. "Ultimately, the Internet will be a component of almost every financial product," says Octavio Marenzi, managing director of Celent Communications in Cambridge, Mass. "Doing this in a separate business unit is really a stopgap, short-term solution."

t's far too early to say whether chase.com constitutes a durable business model. This structure dates back only to last June, when Harrison replaced Walter V. Shipley as CEO. And chase.com has already undergone one management change, with O'Leary replacing retiring vice chairman Joseph G. Sponholz in January. As Harrison says, "It's early days yet."

Late to the Party

Early days perhaps, but Harrison's e-mobilization comes not a moment too soon. At least on the retail side, Chase has lagged behind its peers. A Gomez Advisors survey last November ranked Chase ninth among the largest banks in terms of online market share. Worse, its customer satisfaction index hovered at the same low level. "When it comes to delivering Internet services to the retail consumer, Chase is relatively late to the party," says Chris Musto, director of financial services for Lincoln, Mass.-based Gomez.

Harrison's catch-up strategy on the retail side includes an embrace of electronic bill presentment and payment, the process of delivering bills to a customer's PC. Last year, Chase announced its participation in Spectrum LLP, a joint venture with Wells Fargo and First Union Corp. Spectrum has designed a "switch," or network through which member banks can send and receive bills processed by the major technology vendors and other banks. Providing banks with the ability to aggregate most of their customers' bills at one site is expected to boost consumer acceptance of electronic bill payment, and therefore of online banking in general.

Chase uses chase.com to manage its interest in Spectrum, as well as its equity stake in Seattle-based ShopNow.com, an online shopping portal that offers products and services from more than 40,000 merchants. Chase is positioning itself as the preferred credit card at this site, where its cardholders receive special discounts. If the arrangement works as expected, Chase will deliver value to its existing customers while opening up a channel for acquiring new ones.

There's some sentiment, however, that Chase actually may have more opportunity on the business-to-business side of e-commerce. While the bank does operate a national consumer business, with leadership positions in mortgages, credit cards, and auto finance, its retail franchise is ultimately circumscribed by the narrow reach of its branch network – essentially a three-state patch of the northeast (New York, New Jersey and Connecticut) and part of Texas. Unless Chase engineers a major branch acquisition – something Harrison does not list as a priority right now – the company faces natural boundaries on its online retail effort, since most Internet banking customers remain wedded to physical locations for handling their service needs.

Chase faces no such constraints on the business-to-business side of e-commerce, where it can leverage its commercial/wholesale bank, a global powerhouse that operates in more than 50 countries and has relationships with 70% of the top 1,000 multinational corporations. One of chase.com's most promising projects, in fact, is New York-based Intellysis Electronic Commerce Inc., which provides an Internet network for major corporations to purchase supplies. Chase acquired a 33% stake in this electronic procurement company back in 1996, an investment now overseen by O'Leary's group.

Harrison describes Intellysis as a means of protecting Chase's position in the payment system as it gradually moves online. He also touts the possibility of a big one-time gain should Intellysis conduct an initial public offering, which is widely expected to occur in the first half of this year. Merrill Lynch analyst Judah Kraushaar estimates this could produce a $1 billion after-tax gain for Chase.

Halfway Measures

Despite all the activity with Spectrum, ShopNow.com and Intellysis, some e-commerce consultants downplay chase.com as more public relations than substance. They point out that Spectrum remains in the formative stage while Intellysis is an ongoing relationship inserted into the Internet unit's portfolio. "Chase.com is great for public relations and makes Wall Street happy that Chase is going after the Internet. But the proof will come when chase.com introduces something that will fundamentally challenge the company's existing business model," says Jaime Punishill, with Forrester Research in Cambridge, Mass.

Consultant Daniel W. Latimore describes chase.com as "a kind of halfway measure." One limitation is that chase.com has no real authority outside its own small domain. O'Leary, for example, has no oversight of Chase's investment banking and venture capital units, which are also heavily involved in the new economy. "I don't see this type of model sticking around in perpetuity," says Cambridge-based Latimore, director of e-strategy, financial services industry, for Mainspring Inc. "Either it will be spun off or it will be folded back into the rest of the bank."

Chase executives say they have no immediate plans to spin off chase.com, despite some public discussion of that option last year. But O'Leary agrees that chase.com is likely to look quite different five years from now. "Financial services itself will be redefined," he says. "What was the traditional company and what was the dotcom unit will be essentially merged into something new."

Harrison's Internet strategy, in any case, does not depend solely on the success of chase.com. It also incorporates the activities of other units of the company, some of them much more visible. The two most important are Chase Capital Partners, a venture capital fund, and Chase H&Q, the investment banking unit formed after last year's acquisition of San Francisco-based Hambrecht & Quist Group Inc. When combined with chase.com, these units provide Harrison with a multi-faceted capability to launch and sustain e-commerce projects.

CCP, for example, has invested in a wide range of Internet/e-commerce companies, such as StarMedia Network Inc., Cobalt Networks Inc., Digital Island Inc. and Triton PCS Holdings Inc. Such relationships allow Chase to monitor the technologies these firms are producing and then, where applicable, purchase them for its own needs. CCP, which has been around since 1984, helps Harrison in another way by offsetting outlays on other e-commerce projects.

When CCP investments go public, as many have in the last two years, during the height of the market's dotcom frenzy, Chase is able to cash out big. Last year, CCP's $1.4 billion in profits contributed 26% of the bank's overall operating profit. "People ask how legacy companies can make money in this e-commerce space. Well, we're doing it, not in terms of operating revenue but as venture capitalists," Harrison says.

Hambrecht & Quist, Chase's recently acquired brokerage firm, provides another critical strength. The San Francisco-based investment banking house specializes in small cap startups in media, telecommunications, information technology and health care – precisely the kinds of companies that are shaping the new economy.

Harrison describes Chase H&Q as the bank's window into the e-commerce world. The unit's officers are able to monitor the latest developments from their vantage point, and then they share their reconnaissance with Chase's hierarchy. O'Leary, for example, says he meets frequently with Daniel H. Case, head of Chase H&Q, as well as Jeffrey C. Walker, who runs CCP. The way O'Leary describes it, Chase has developed a very nonbank-like culture at the highest levels where executives can share ideas and plot strategy without regard for formal titles and chains of command.

This spirit of collegiality is institutionalized in Harrison's Internet council, which brings together representatives of all the company's major business lines. As part of his effort to prioritize e-commerce at Chase, the CEO had every business unit designate a senior line officer with responsibility for Web-enabling that particular unit. These line executives, about 15 in all, meet with Harrison, Garonzik and O'Leary once a month to discuss e-commerce initiatives throughout the company. Says Harrison, "You need some place where it all comes together, one group that is the central repository of information. This helps prioritize the use of what will always be limited investment dollars."

Scarce Resources

Effective prioritization is critical if Chase is to succeed in establishing itself as a major player in e-commerce. Harrison, like any legacy bank CEO, faces constant pressure to maintain current earnings momentum and provide an acceptable return to investors. "The scarce resource for a public company like Chase is not equity, but rather discretionary resources for reinvestment," Harrison says. "You have to carve out as many expense dollars as you can while still meeting your financial targets."

The amount of money Chase has budgeted for e-commerce projects this year, $250 million, is not huge in the total scheme of things – it's only 8% of the company's $3 billion technology budget. But it is money that someday may be needed to compensate for problems elsewhere in the company. Further complicating the picture, Chase is constantly rumored to be in the market for a big-league securities firm. Such a merger, should it occur, could easily distract Harrison from his e-commerce initiatives. It wouldn't be the first time that a major institution announced plans to reinvent itself, only to cast them aside when the next M&A deal came along.

Meanwhile, Harrison has to keep the profit engine humming. Ever since the 1996 Chase/Chemical merger, the "new" Chase has enjoyed steadily improving results. Returns on assets and equity reached 1.47% and 23.7% respectively last year, helped by tremendous gains from the company's capital markets units, which includes trading, investment banking and venture capital. Some core operations are sluggish, however. National consumer services revenue was flat during the second half of last year, for example, and credit card growth is slowing. Moreover, many on Wall Street are concerned about potential volatility, noting that capital markets revenues are tied to the performance of equity and debt markets around the world.

Chase executives argue that their market-related revenues, while volatile on a quarter-to-quarter basis, show a steady upward bias over a period of years, most notably through the long 1990s bull market. Memories are fresh, however, of the world financial crisis sparked by a Russian bond default that hammered Chase's trading revenues in the third quarter of 1998. While Chase weathered the 1998 crisis handily, the next global financial meltdown may be more long-lived. And that would surely impact Chase, which is exposed to the world economy through its global banking operations (which generated 65% of the company's 1999 earnings).

Given a prolonged downturn, would Chase be able to maintain its level of e-commerce expenditures, currently among the highest in the industry? Harrison answers in the affirmative. Whatever external stresses Chase may encounter, he remains committed to his Internet investments, believing them to be essential. "We prioritize that goal over others," Harrison says. "It's just something we've got to do."

Mr. Cline is senior editor of Banking Strategies.

Copyright © 2003 by Banking Strategies, published by BAI.

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