Cash Cows?

By Lauri Giesen

Thinning margins have beset the off-premises ATM business, but efficiency and service keep some players alive.

When owners of automated teller machines were given the ability in 1996 to levy surcharges on transactions conducted on their terminals, a lot of banks took the term "money machines" literally. They thought they could rake in cash faster than they could dispense it.

For institutions that had previously regarded their ATMs mainly as cost centers required to serve established customers, it was a beguiling notion: deploy additional machines to catch more non-customer traffic and watch those $1.50 and $2 surcharges pile up. A few banks even launched massive deployments in distant geographic territories.

Six years later, the business of "off-premises" ATMs looks a lot less attractive. A surge of competition created a glut of installations across the country, depressing per-unit transaction volume. And while banks struggled with thinning margins, some lean nonbank independent sales organizations learned to thrive in that environment.

"A lot of banks loved the windfall they saw when surcharging first came about, but they didn't always invest in the technology and infrastructure to make ATMs profitable," says Allana Kellogg, president of Kellogg Group, a St. Louis-based consulting firm that specializes in payment services.

Unable to compete with the nimbler ISOs, many banks have retreated from off-premise ATM deployment, instead focusing on in-branch and drive-up machines used primarily to serve their own customers. Even when they do go outside their branches to place a machine, executives these days tend to think more about how a particular unit will serve established customers than the potential revenue kick from non-customers. To that end, they focus mainly on high-traffic locations, such as malls, supermarkets and airports.

A few institutions, however, have managed to keep their off-premises ventures in the black. They do this by closely calculating expected transaction volumes at a given site and the level of non-customer volume needed to make an installation profitable. Like real estate, ATM deployment is a business where location is critical.

Progressive players are also looking at other products and services they can provide from their ATMs, beyond simply dispensing cash and taking in a few deposits. "Mini-statements" are popular, for example, and providers are becoming more bullish on check-imaging services and Web-enabled services. Experiments with wireless ATMs are also underway.

The upshot is that banks can no longer simply deploy ATMs and wait for the money to roll in. They need a well-defined strategy that considers both the extra value that will be provided to customers and the efficiency required to stay competitive.

Cost Differential

Ever since ATMs first became common in the 1970s, banks have primarily viewed these machines as a service enhancement, something they need to provide customers for competitive reasons. The early economics of the business focused on encouraging customers to substitute this low-cost channel for more expensive teller help in the branches, although customers generally thwarted this goal by maintaining their branch activities and then adding a layer of ATM transaction volume.

The economics began to change in 1996 when both Cirrus and Plus, the national ATM networks owned by MasterCard and Visa respectively, lifted bans on surcharging. That affected provisions in regional ATM network rules, which said that ATM owners could only surcharge on transactions that ran through regional networks if they were also surcharging on the ones that ran through the national networks. Once the owners could surcharge on national transactions, they could surcharge on most regional ones.

Surcharging then became a national phenomenon. According to Dove Consulting Group Inc., the total number of ATMs grew from 139,000 units in 1996 to 324,000 by 2001, a 133% gain in five years. The average surcharge rate for offsite ATMs is now $1.48.

Banks were among the largest players. In 1997, the former Banc One Corp. of Columbus, Ohio, announced plans to deploy 20,000 terminals nationally, up from the few thousand it already in the market, most of which were in branches. The bank signed deals with national retailers including Mail Boxes Etc. and Sears.

That program quickly went awry. It turned out that Mail Boxes didn't generate enough foot traffic into its mailing and packaging stores; transaction volume from the Sears ATMs also fell short. Critics said the Sears machines should have been installed in a more visible spot, near the main doorway, instead of deep into the store next to the customer service desk. After only about a year, the bank yanked many of the unprofitable terminals and scaled back its off-premise strategy.

Although Banc One's set back was the most high-profile example, banks generally have not fared well with their off-premise ATM deployments. The reason: increased competition and deteriorating economics. As the number of machines grew by 133%, the number of transactions per-machine declined significantly between 1996 and 2001, from 6,399 to 3,494 per month. "Declining revenues no longer justify many installations," says Tony Hayes, director of financial services practices for Boston-Based Dove.

While nonbank deployers experienced the biggest decline in per-unit transactions, they were able to compensate by lowering their operating costs. Dove's study estimates that ISOs with fewer than 1,000 ATMs spend $732 per terminal per month, including operating expenses and depreciation, while large banks average $1,534.

To begin with, ISOs typically don't carry a lot of executive and operational overhead. More importantly, they purchase low-cost cash dispensers instead of the expensive full-function machines preferred by banks.

Les Riedl, a consultant with Atlanta-based Speer & Associates, notes that many banks feel they need the full-function machines in order to take customer deposits. ISOs, by contrast, don't bother with deposit-taking, which saves them lots of money and still meets the needs of their market. Even ATMs operated by financial institutions are used mostly for cash withdrawals (77% of transactions), according to Dove.

A full-function machine typically costs about $30,000, Riedl says, while "a decent low-end" cash dispenser can be had for about $4,000 to $5,000, with some costing as little as $2,000 a unit. According to Diebold Inc., one of the nation's largest ATM manufacturers, 76% of ATMs purchased by banks today are full-function machines. Even looking just at off-premise machines, 42% of bank-purchased units are still full-function, according to Diebold.

ISOs also typically use dial-up connections, which slow transactions by a few seconds but usually offer a substantial monthly communications savings over dedicated phone lines. Many banks, on the other hand, must spend more to support dedicated phone lines because they lack the ability to support dial-up units. Their on-premise machines are almost entirely connected to dedicated lines, often tied to the phone system in the branch, and many banks simply extend that to the off-premise units.

Some providers are exploring wireless technology as an alternative. PNC Financial Services Group, for example, recently installed 67 wireless ATMs in non-branch locations and expects to place 100 more by year-end. While wireless does reduce telecommunication cost, it's also less reliable and less robust in functionality than land-line telephone.

Outside telecommunications and the machine itself, one of the biggest ATM expenses is the cost of funds and servicing. This is an area where banks should enjoy an edge over ISOs, but often do not. Banks are allowed to use "vault cash" — funds that they are required to keep on hand to meet regulatory requirements — in their ATMs while ISOs often have to "buy" cash, usually from banks. However, at many low-volume locations, ISOs have the storeowners use their own cash in the machines. This also eliminates the cost of sending armored cars to refill the terminals. Banks shy away from this strategy, citing tighter security and accounting procedures.

Location, Location

Despite the industry's difficulties overall, a few banks have found success in the off-premise market. Rather than trying to amass a large stable of terminals, these institutions have focused on finding prime locations that will generate large transaction volumes.

One example is Cleveland-based KeyCorp, which has 700 ATMs deployed outside its branch network, 680 of those units located at Arco gasoline and convenience stores throughout five Western states. Within that territory, KeyCorp has a significant retail presence in Washington and Oregon, but doesn't have any branches in California, Arizona and Nevada. As a result, it expects nearly all of its ATMs in those latter three states to be used by non-customers.

"With our off-premises program, we're not looking at where established customers will use ATMs, but rather at where we can generate the most revenue," says senior vice president of ATM services Michele Mullee. Like most banks, KeyCorp is bypassing locations where only a few hundred transactions a month are expected. "There aren't many financial institution deployers who want to participate in that end of the market. Our costs are too high," Mullee says.

To find the high-volume spots, KeyCorp works with brokers who bring prospective deals to the bank. Also, the bank's commercial accounts department often recommends its retailer clients as possible deployment partners. For example, KeyCorp was able to strike a deal with a casino in Washington state by using its commercial banking department as an agent.

Another bank that has been aggressive in ATM deployment is Pittsburgh-based PNC, which has 2,400 ATMs in off-premise locations. While 1,300 of those machines are in supermarkets and convenience stores located in PNC's seven-state market area, the remainder are scattered in shopping malls, university campuses, highway rest areas and airports in 44 states.

James Walker, senior vice president of self-service delivery, says PNC has been placing ATMs in off-premise locations for more than 15 years, giving it considerable experience in evaluating the likely profitability of a proposed site and its servicing requirements. The early deployments, mostly in PNC's primary market, were initiated both as a customer service and to earn interchange revenue — the money that an ATM user's bank pays the ATM owner.

Both Mullee and Walker believe there is room for banks to expand their offsite business by taking over established ATM contracts as they come up for renewal. They also insist that banks have some competitive advantages over ISOs. "We bring a lot more experience in operating ATMs, and as a result, we usually have higher up-times and better service," Mullee says. "We hold our ATMs to the same service standards that we have in our branches. That's important to retailers because they want their customers to be happy with the service — and they won't be if the ATMs are down a lot."

But there's no question that the business is getting tougher. There's the problem of rising rents, for example. Some retailers simply charge a flat rent for ATM placement, but others now seek a percentage of the ATM surcharge on every transaction — often from 30% to 50%. Banks are finding it harder to justify these higher rents with per-machine transaction volumes declining.

Dove has found that most big banks can make up for their higher costs because they generate more revenue on their ATMs than the ISOs, due to their insistence on high-volume locations. But that may be harder to accomplish in the future. Hayes notes that nearly all the high-volume locations have been snatched up. And most growth in deployment is likely to come from those ISOs that can support locations with relatively low volumes.

Bells and Whistles

Unable to count on growth from new installations, many banks are adding more services to their current machines, both to provide additional value to bank customers who use the machines, and also to generate more revenue from non-customers.

The Dove study found that mini-statements were the most common "advanced feature" offered on bank-owned ATMs today, provided by 32% of all financial institutions. Stamp-dispensing came in second at 23%, bill payment 21%, advertising 17%, coupon-dispensing 12% and phone cards printed on receipts 7%. Of this group, mini-statements and bill payment would appeal only to current customers, but stamps, advertising, coupons and phone cards might attract some non-customers.

Great expectations were placed on stamps in the '90s, a business case based on using the same mechanisms to dispense stamps as cash while making a few cents on every book sold. But the demand for stamps was less than expected while the cost of filling the machines and dispensing the stamps was higher — not to mention the fact that the stamps were tying up a canister that could be used to hold more cash. Full-function ATMs typically hold four canisters.

Walker says PNC doesn't like to dedicate the extra canister to stamps at high-volume, off-premise machines, but has found success with stamps at branch locations where refilling the machines is easier.

Mini-statements and phone cards have been more successful, according to Hayes, because they make use of the existing paper receipts. Many phone-card programs, for example, don't actually dispense cards, but rather print a code number on the receipt. The cost of the phone service sold is deducted from the customer's bank account. Customers use the code to access the service when they make calls from pay phones. Mini-statements are similarly printed on the receipt paper, for which banks assess a fee.

PNC, however, elicited little demand for phone cards when it offered them at ATMs. Walker notes that consumers who purchase a lot of phone cards typically don't carry ATM cards.

The most promising future ATM applications include Web-enablement, advertising, and applications related to customer relationship management, according to Hayes. Web-enablement and advertising would apply to both customers and non-customers; CRM to existing customers only.

Web-enablement does not mean ATM users can surf the Web, but rather that they can access a limited number of Web pages. The machine owners control what sites are available. A few banks use this to offer information about their car loans, mortgages, other investments and credit products, as displayed on their Web sites. Some installations also permit customers to check the status of their bank-administered brokerage accounts via the ATM.

Dove found that only 5% of financial institutions today offer Web-access on their ATMs, but 30% are planning to upgrade to this technology within the next 24 months. FleetBoston Financial Corp., for example, announced a gradual rollout of 100 Web-enabled ATMs in the New York metro market this past August.

Advertising on ATMs is still in its early stages and faces uncertain prospects. San Francisco-based Wells Fargo & Co. has been among the active banks in this area, having signed deals with high-tech companies, including Internet retailers and Internet service providers, to promote their wares on Wells' ATMs. Meanwhile, Bank of America Corp. recently began displaying full-motion video ads on 2,000 of its machines in California.

Despite the novelty, many of the advertising efforts have not been as successful as expected, Hayes says, partially because only new high-end machines provide the graphic and audio quality that advertisers demand. Also, downloading new advertisements can be cumbersome. And many national advertisers don't want to sign contracts with dozens of ATM owners in order to get national or multi-regional exposure. "Advertisers are unsure about the value of the medium and what they should pay," Walker says, noting that PNC does not sell advertising on its ATMs.

CRM could provide potentially powerful payoffs with established customers. By linking their ATMs to back-office data warehouses, banks could identify and market to customers based on their needs. For example, if a bank knew that a particular customer spoke Spanish, it could automatically communicate in that language. It could also recall that a particular customer always requested $100 at a time, prompting the inquiry, "Do you want your usual $100?" Someone whose car loan is about to be paid off could be asked if he or she is interested in a new loan, while someone who had large sums sitting in a low-interest account could be advised of higher-yielding investment services.

FleetBoston's new Web-enabled ATMs, for example, use this personalization feature to address a diverse ethnic mix in New York by greeting and instructing customers in seven different languages.

Another advanced feature that is gaining popularity is check imaging, according to Mike Tharp, senior marketing manager for Canton, Ohio-based Diebold. Such technology, which would apply mainly to established customers, allows the ATM to display an image of the check being deposited and verify the amount. The customer can then collect the funds to the penny. Many consumers like this added convenience, which also saves the bank some processing costs, according to Tharp.

The demand for check imaging should really take off if Congress passes legislation allowing total electronic truncation of checks. While PNC has been able to reduce its check processing costs through check imaging on ATMs today, for example, the savings will further increase once the bank can do all the processing electronically and throw away the original paper checks deposited in the machine, Walker says.

Right now, it's hard to say which of these value-added services will attract more people, customers and non-customers, to bank ATMs. Given the thinning margins in the off-premises business particularly, however, the search needs to continue.

Ms. Giesen is a freelance writer based in Libertyville, Ill.

Copyright © 2003 by Banking Strategies, published by BAI.

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