Sizing Up Souped-Up ATMs

By Bill Stoneman

They talk, they connect to the Internet, they can sell stamps. But ROI question precedes spending on mandated upgrades and new powers.

The ATM as we know it has proven itself to possess a singular power: it's an effective cash dispenser. By virtue of its value to customers, there seems to be no debate that the ATM is a critical delivery channel. What is up for discussion, however, is whether the ATM can and should be empowered to deliver more than fixed sums of cash. And, to put a finer point on the question: Should and will banks support a bulked up ATM flexing a $50,000 price tag?

Banks are under pressure to upgrade their ATM networks. Fraud protection, legal and operating system issues are forcing institutions large and small to either put new technology into existing machines or buy the next generation of ATMs. New ATMs offer robust functionality including the imaging of checks, transmitting of personalized marketing messages and even the sale of movie tickets. The ATM could, in effect, become a more diverse delivery channel.

But, this is not an easy issue for banks seeking to find a direct return on investment. Usage per machine has plummeted in the last few years, dramatically weakening the direct financial return from ATM networks. Ultimately, an individual institution's decision to upgrade/revamp or outsource its machines altogether may depend upon whether it can see beyond the upfront cost of new machines to revenue-generating or cost-saving opportunities.

Pressing Decisions

The most immediate need facing ATM owners is the debit card network requirement for strengthening encryption of the personal identification numbers used at ATMs. In industry jargon, this is known as "Triple DES" (Triple Data Encryption Standard), referring to three layers of data encryption standards. Though some older machines cannot be retrofitted with Triple DES, most can with the installation of a new keypad and relatively inexpensive software for an estimated cost of $1,000 per ATM on relatively new machines.

At the same time, regulations under the Americans with Disabilities Act (ADA) require ATM owners to make their machines accessible to the blind. A federal agency, the Access Board, issued guidelines in July that eventually will require voice guidance systems on most new machines. Bankers estimate the cost of installing voice guidance systems, where possible, at anywhere from $2,000 to $9,000. (Representatives of NCR Corp. and Diebold Inc., the leading ATM manufacturers, decline to provide prices of their products or upgrades.)

Then there's IBM's intention to stop supporting its OS/2 system, on which most ATMs run. This provides an incentive, although not a requirement, for financial institutions to switch to Microsoft Corp.'s Windows technology. More important is the range of functionality that comes with Internet-based communications, which are easier with Windows. Check imaging, disseminating marketing messages and even non-financial products sales would require this new functionality that many experts believe is in the future for ATMs.

The question: Is a complete upgrade indicated now or are banks better off settling for a partial and cheaper revamp, realizing that it that may need re-doing in another year or two? Millions ride on that decision, since the choice that costs less initially is likely to be more expensive in the long run.

The age of an institution's machines also needs to be considered. Michele Mullee, a senior vice president for ATM channel management with Cleveland-based KeyCorp, notes that machines up to about four years old won't require significant upgrades to meet the Triple DES and ADA requirements. But machines seven years and older are likely to need replacing, even though they're otherwise working fine. KeyCorp, typical of most banks, has a mixed fleet, with some machines more than 10 years old.

Declining Usage

Historically, the main role of ATMs was to provide customers with a convenient way to get cash. To some extent, they were also seen as tools for shifting customer traffic out of branches and thereby reducing branch costs. "Banks never even thought about having ATMs make money," says Tony Hayes, a managing director of Boston-based Dove Consulting Group Inc.

That view began to change in 1996, when ATM network operators lifted their ban on machine owners imposing surcharges on transactions. Previously, only the financial institution holding a customer's account could charge for ATM access.

Perceiving an opportunity to generate revenue from ATM usage, banks and independent operators alike started installing additional machines at a frenzied pace in the late 1990s. The total number of ATMs in the U.S. exploded from 187,000 in 1998 to 371,000 last year, according to Dove Consulting. Total usage, estimated by Dove at 11 billion transactions last year, grew over the same period, but at a much slower pace — and there-in lies the problem. As charted by Dove, the average monthly usage of bank-owned, on-premises ATMs dropped from 4,603 transactions in 1998 to 3,404 last year. The drop-off was even steeper at off-premises locations.

Hayes expects ATM usage to do nothing but continue to drop. As consumers make increasing use of debit cards, he says, they use less cash. And consumers who want cash increasingly get it at the same time that they use their debit card to make a purchase. Also, consumers have become savvier about avoiding surcharges and now make a point of withdrawing cash at machines owned by their own bank.

"The fee income bonanza created by surcharging has been competed away and, despite the widespread belief to the contrary, most banks and credit unions now lose money on their ATMs, even with surcharge income," Hayes wrote in Dove's 2004 ATM Deployer Study, published in May. According to the report, operators lose $260 a month at each on-premise ATM and $242 a month at each off-premise machine.

In such an environment of diminished revenue expectations for ATMs, and significant costs to meet marketplace and regulatory mandates, some bankers are at a loss to demonstrate a return on their heightened investment. "I don't think we could advertise that our Triple DES is better than your Triple DES," says Edward A. Kennedy, senior vice president for operations with First Commonwealth Financial Corp., Indiana, Penn.

Uncertain Deadlines

Positioning the ATM for the future essentially means moving to Windows and wiring the machines for Internet-protocol communications, though not necessarily actually connecting machines to the Internet. With Windows and Internet communications, it's much easier to start taking deposits without envelopes, capturing images of checks and transmitting Image Replacement Documents (IRDs) to the bank's back office for processing, which could reduce the cost of servicing ATMs and handling checks deposited in them. This technology also facilitates hooking the ATM network into a bank's customer relationship management system and disseminating different marketing messages to different users.

PNC Financial Services Group Inc. recently began using a tool that Windows and Internet-protocol communications make possible on about 200 of its machines. Offered by the Star electronic funds transfer network and called Content Manager, this tool allows information to be transmitted to machines electronically, obviating the need to send programming technicians to each machine. PNC and the convenience store chains in Louisville and Philadelphia that host its machines display brief advertisements on the screens before transactions are initiated and while the transaction is being processed, says Shelly Chandler, vice president for self-service banking with the Pittsburgh-based bank. Since it previously took as long as two weeks to load a new message at all of the bank's retail partners' stores, the merchants did not update campaigns as frequently as they'll be able to now.

Some relatively new ATMs use computers that can run Windows. In many cases, however, moving to Windows can't be done without a significantly more expensive decision to replace the computer inside. Totally replacing existing machines with Windows-based units may cost between $25,000 and $35,000 per ATM. Add in image capture capability and the cost could rise to $50,000.

Assuming a decision is made to upgrade, machine availability may be a hitch. Banks across the country are calling on the manufacturers for upgrades and new machines at the same time as one another. "The challenge is going to be that the suppliers don't have the equipment for all the upgrades," says Key's Mullee.

Banks that move too slowly could find themselves out of compliance when they finally decide to act because manufacturers will be hard pressed to keep up with the demand at that point, says Timothy Hoyle, chief operating officer of IRB Consulting Group Inc. in Millsboro, Del.

Return on Investment?

So, how are institutions faring at parsing their way through the decision-making process?

Consultant Hoyle says "the smaller institutions are sitting back and waiting," based on his experience advising community banks. NCR and Diebold representatives report that larger banks are generally taking a more comprehensive approach to security, disabilities law, operating system and enhanced functionality issues, resulting in major replacement programs.

Chicago-based Bank One Corp., for example, had announced plans last fall shortly before its acquisition by J.P. Morgan Chase & Co., to either upgrade or replace its entire network of 4,000 machines in just three years. Similarly, National City Corp. of Cleveland has announced a $30 million, 30-month program to upgrade its network of 1,580 ATMs, including the replacement of more than 1,000. All of these ATMs will have voice guidance systems at the end of the upgrade.

KeyCorp, which owns 2,200 ATMs, has decided to convert to Windows-based machines, but on a relatively slow timetable. It upgraded 36 ATMs and replaced 28 in 2003, and expects to upgrade or replace 200 this year, then roughly triple that pace in 2005 and 2006, still leaving it a long way from the finish line.

KeyCorp executives hope to deliver customized marketing messages via their ATMs, using the same customer relationship management tools that drive direct mail campaigns and product prompts on the telephone and online. The bank, which has $86 billion in assets, might present awareness messages to non-customers who use its machines, Mullee says. An additional possibility is providing check cashing services for non customers to gain some fee income.

But KeyCorp's expectations for these possible ventures are modest. While the marketing outreach is theoretically attractive, for example, banks have to be careful of a potential customer backlash. When asked what KeyCorp would do if customers become annoyed by ATM marketing messages, Mullee says the bank would halt the practice if necessary.

The pace of upgrades also depends on whether banks see only costs or potential benefits along with the costs. First Commonwealth executives, for example, focus on the cost side of the financial equation when it comes to upgrading ATM capabilities. "It is a cost of doing retail business," says Kennedy, adding that he does not believe there is great value in the enhanced capabilities that ATM manufacturers are offering.

First Commonwealth is in the process of upgrading its 107 ATMs to Triple DES. The $6.3 billion-asset bank plans to spend $350,000 replacing 17 ATMs that it picked up in May, when it acquired GA Financial Inc., the parent of Great American Federal, in Whitehall, Penn. And it expects to spend an additional $1 million meeting the Triple DES requirements on 90 other machines over the next 18 months, with a mix of hardware and software upgrades.

Kennedy is uncertain, however, when First Commonwealth will add voice guidance systems to those machines. Like many bank executives, he's waiting to see the final version of the new ADA regulations.

Cash is King?

By contrast, Webster Financial Corp. executives have more faith in the potential advantages of leaping ahead to the next generation of ATM technology. Waterbury, Conn.-based Webster, which has $17 billion in assets, plans to spend more than $11 million over five or six years, beginning this year, to replace all of its 266 machines with new Windows-based ATMs that can accept coin and currency deposits without an envelope as well as capture an image of a check and convert it into a digital document.

Webster hopes that customers will be more willing to deposit cash or checks when they get a receipt for exactly what they put into the machine. While imaging technology will add about $25,000 to the cost of a new machine, vice president for electronic delivery Stephen F. Russell estimates the bank should be able to save $8,000 annually in armored car costs per machine, by picking up deposits once a week, rather than every day. That means that armored car savings alone would pay for the imaging capability in three years, he says. The payback will likely be faster, says Russell, since the bank would no longer need a central deposit department supporting its ATMs. And the payback could be faster still if other banks move to accept imaging technology.

Detroit-based Comerica Inc. expects to meet the Triple DES requirement by the end of this year, through a mix of upgrades and replacements. Installation of new machines will move Comerica toward a Windows-based network. But senior vice president for retail operations Michael Lawson says he's in no rush to abandon OS/2. Voice guidance systems will be installed with some of the upgrades and included in the replacements, Lawson says, but won't be activated until the ADA requirement is known.

These ATM capital investment plans are being formulated without the benefit of a crystal ball, let alone certainty about the role of the ATM in the future. Cash withdrawals have accounted for more than three-quarters of all ATM transactions over many years, according to Dove research. Deposits accounted for just 8% of transactions in 2003, balance inquiries 11%, and account-to-account transfers 2%, Dove reports.

There is some evidence, in a recent survey conducted by Synergistics Research Corp. in Atlanta, that consumers would buy postage stamps, event tickets, transit tickets and pre-paid cards as well as renew their drivers' licenses at ATMs. They'd also likely pay a fee for such services, says William McCracken, Synergistics' chief executive officer. A full 63% of survey respondents in the younger age bracket, 18 to 34 years old, said they'd be interested in advanced functionality.

Still, many in the industry remain doubtful that ATMs will ever prove useful for anything more than dispensing cash. There is the concern about marketing messages slowing down transactions, for example. McCracken acknowledges that even the consumer who expresses an interest in advanced ATM functionality cannot be counted on to wait patiently in line behind someone who is doing business more complicated than getting a quick $100.

"Cash withdrawal really dominates the transaction volume at ATMs," says Comerica's Lawson. "That's really their role as far as customers are concerned."

Mr. Stoneman is a freelance writer based in Albany, N.Y.

Copyright © 2004 by Banking Strategies, published by BAI.

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