ON
RISK MANAGEMENT
Consolidation
and Price Competition Characterize
Vendor Dynamics
BY PAT ALLEN
‘Chicken
tech’ companies have enjoyed stable
revenue and client lists, but analysts
say growth strategies will depend on
customer retention and innovation initiatives.
Will open systems gain a toehold?
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SYNOPSIS | Equities
research analysts Carla N. Cooper from
Robert W. Baird & Co. Inc. and
Peter Swanson from Piper Jaffray score
the effect of recent consolidations
among core processing vendors. While
investors have considered these companies “chicken
tech” because they offer exposure
to technology without the volatility
usually associated with high tech investing,
these strong vendors are nonetheless
vulnerable to price competition, customer
switching and the yet-to-be-determined
effect of open systems.
The multi-year duration
of the contracts, the predictability of
the revenue streams and the virtual absence
of price competition together have made
the universe of core bank data processors
very appealing to investors. It’s
a “chicken tech” play, according
to Carla N. Cooper, research analyst with
Robert W. Baird & Co. Inc., San Francisco,
for investors who want exposure to technology
without having to endure the volatility
usually associated with high tech investing.
It is these companies’ financial
institution customer bases, of course,
that makes their recurring revenue and
stability possible. While their work is
ordinarily in support of investors, Cooper
and senior analyst Peter Swanson of Minneapolis-based
Piper Jaffray & Co. provided their
perspectives at BAI’s TransPay Conference & Expo
in May.
“Investors are
trying to minimize their downside and maximize
their upside, and I don’t think that’s
dissimilar to the judgment that you make
when you make a vendor decision,” Cooper
told the audience of operations, payments
and technology executives. “You want
to, to the best of your judgment, be assured
that the vendor is going to be around for
the duration of the contract and give you
as much or more than what you need, and
I think that relates to their ability to
innovate and bring you new products and
services or new ways of doing business,” said
Cooper.
The industry’s
consolidation is having an impact on vendors
and how they serve the marketplace. While
the number of banks is consolidating, the
number of branches continues to consistently
rise. Vendors have responded by developing
products that take advantage of the industry’s
interest in branch-building. And, Cooper
said, “Every major core vendor that
I know has at least some of their sales
force focused on de novos.”
The vendors, too, are
consolidating, a trend that Cooper said
will yield “a handful of very strong
vendors.”
“If you’re
making a decision to sign up with one of
these vendors, I think you have less to
worry about on the downside. I think those
vendors will probably exist for the duration
of your contract, but I think a very important
question you can continue to ask concerns
the degree of innovation you will see from
those vendors as they review their corporate
strategies, and you go after your needs
as a customer.”
Price competition, a
characteristic of a mature market, is beginning
to surface at contract renewal time, according
to Cooper. “This was a market where
price competition didn’t appear to
exist until the last couple of years ...
I think it’s still fairly benign
but it does appear to be out there.” Cooper
attributes the competition and customer
switching to the consolidations that are
taking place: “Customers tend to
get a bit skittish or simply decide that
they don’t like the direction that
the acquired company is taking, so they
begin to look for new vendors.”
The fear that a vendor
may sunset a system and force a change
causes anxiety across the customer base,
Swanson said. “Consolidation often
leads to more activity in the industry,
more Request for Proposal (RFP) volume,
which can lead to more growth opportunities
for the other vendors.”
Given the maturity of
the market, consolidation is one way the
processors’ management teams can
drive growth for their shareholders. Swanson
added: “As consolidation happens,
it is very important for the companies
that are doing the consolidating to have
a plan in place to try to retain as many
customers as possible of that business
that they’re buying. Wall Street
is very unforgiving ... For those that
don’t have a good plan for retaining
customers of the acquired entity, it just
becomes that much harder to hit your growth
targets, because you’re starting
from a hole, if you have 10% to 15% attrition.”
In addition to growth
by acquisition, vendors are basing their
overall strategies on the following, as
identified by Cooper:
- Across-the-board
re-acceleration of spending. Unlike what
accompanied the “big bang of Y2K,
when there was a fixed deadline,” Check
21 spending will be “evolutionary,” Cooper
said. “Most of the people I’ve
talked with tend to think that Check
21 spending is going to take place over
the next few years,” meaning between
two and seven years.
- Using cross-sales
as a way to drive up more revenue. “If
they’ve sold someone a core system,
they want to come back and sell a voice
response unit or they want to come back
and sell some element of CRM as a way
to more aggressively grow their revenue,” Cooper
said. “That requires typically
some good integration between the core
and the related ancillary products.”
Cooper identified integration
as a high priority issue to vendors. “They
have seen customers come and go over integration
issues. If I have two minutes to talk to
a customer, that’s probably the single
issue that’s most likely to come
up.” However, Cooper said, integration
performance is hard for Wall Street to
measure and understand. “From a Wall
Street perspective, it’s very opaque
but in my opinion, it’s probably
issue number one to the customer.”
- Single vendor strategy.
Acquisitions are undertaken in support
of strategies that seek to address some
(particularly small) financial institutions’ desire
to reduce the number of technology vendors
they use.
- Open systems, such
as those marketed as the new generation
by new market entrants, including Open
Solutions, Temenos and i-Flex. Cooper
said she’ll be interested to see
the impact these and others make in the
industry over the next 10 years. “The
legacy core vendors aren’t sitting
still; many of them have introduced and
created middleware or application programming
interfaces (APIs) that try to address
what appear to be some of the points
that the open systems vendors are making.”
Based on the conversations
Cooper says she’s had with a handful
of bankers — “not a statistically
significant sample of the 8,000-plus banks
out there” — the open systems
issue has three parts: First, open systems
offer a choice of hardware, which some
financial institutions want. Second is
the value of a single database, something
that Cooper believes has mixed appeal to
institutions. Finally, she said, is a consideration
that “has nothing to do with ‘open’ per
se and everything to do with the companies
that stand behind the open systems. Some
financial institutions seem convinced that
these are younger/more flexible companies
to deal with — and will serve them
well, not just in the next two years but
in the next 10-plus years.”
Questions
or comments about this article? Post
them at the Banking
Strategies blog.
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