COMMUNITY
BANKING SPECIAL REPORT
Online
Cost and Service Issues Intersect With
DDA Growth Plans
BY TERENCE ROCHE
Commoditization
of the Internet product prompts a re-assessment
of banking and bill pay contracts. With
delivery costs and usage rationalized,
institutions can focus on effective execution
and marketing to win and retain customers.
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SYNOPSIS | Community
banks support a channel that can cost
about $3 per user per month, or more
than they spend annually on core processing.
As service bureau contracts come up
for renewal, institutions have been
successful in eliminating per user
or usage fees in favor of fixed pricing
for unlimited deployment. Efforts underway
to reduce bill pay costs are meeting
with mixed results. As the Internet
product is increasingly commoditized,
institutions are urged to focus on
where they can differentiate, including
the combination of personal and business
online services for small business
customers, leveraging their investment
in imaging by offering “electronic
filing cabinets” and proactively
focusing on their customers’ security
and privacy concerns.
Maintaining a robust
Internet channel represents an opportunity
for community and small financial institutions
to extend customer service, grow assets
without brick-and-mortar and otherwise
match the market offerings of their larger
counterparts. But strategic planners must
consider online banking’s evolution
as a competitive differentiator and marginal
money-maker in light of its unnecessarily
high expense due to outmoded contracts
with vendors. The spread of fraud also
has the potential to risk the institution’s
good standing with its customers.
While there is no single
big win that community banks can expect
from online banking going forward, incremental
gains are possible to rationalize the use
and expense of the channel while continuing
to provide product innovation and value
to customers.
Phases
of Development
In offering Internet
banking services to customers, community
banks have already passed through two distinct
phases of product deployment.
The first could be termed
the “early adopter” phase,
which lasted until 2002. During this time,
banks could gain a real strategic advantage
by deploying Internet banking before competitors.
Most community banks saw approximately
15% of their checking customers, whom the
marketing department dubbed “early
adopters,” use Internet banking immediately.
Banks that grabbed this first-mover advantage
did indeed steal a bit of market share
from competitors who were late to the game.
Those who combined this advantage with
focused marketing efforts directed to high-balance
customers benefited from the growth of
some very profitable relationships.
Phase two of Internet
banking deployment could be grouped under
the “functionality” category,
a phase that lasted until as late as 2004.
During this time, while the early-adopter
opportunity had vanished, banks could differentiate
themselves, in some cases, with superior
features and functions. The most notable
example of this was bill pay, which was
not widespread in its availability at first.
Banks that offered bill pay could market
it to the early adopter customers who responded
to the initial Internet banking product.
Other functionality
enhancements addressed account transfer
capabilities, statement printing and general
ease of use. However, these incremental
differences were much harder to market,
and share gains resulted as much from unhappy
customers leaving a competitor.
The Internet banking
landscape at this mid-point in 2005 might
be described as the beginning of the “commodity” phase.
Internet banking is a mainstream product
and the ability to competitively differentiate
an Internet offering has been largely eliminated.
Evidence of this commoditization
includes a significant increase in consumer
acceptance. This year, the number of households
using Internet banking services stands
at roughly 50 million, according to a recently
released survey by the Pew Internet & American
Life Project. This amounts to 47% growth
in just two years.
For most community banks,
online banking supports somewhere between
25% to 40% of all checking accounts, making
it second only to debit cards as a means
of electronic access. Only the very small
or specialty (i.e., non-retail) banks don’t
offer online banking. We estimate that
90% of all bank customers have access to
some Internet banking product.
Growth of bill payment
has been equally robust, and most banks
see between one-fifth to one-quarter of
all Internet banking customers using bill
payment and making an average of six payments
per month. In a recent American Bankers
Association survey, community bankers identified
online services as second only to customer
service as a factor in attracting new checking
account customers — more of a driver
than fees, branch locations, ATM locations
or community ownership.
Another sign of the
channel’s maturity: Small bank costs
of offering the channel are no longer offset
by income earned. With Bank of America
Corp.’s 2002 decision to make Internet
banking and bill-pay free and most community
banks needing to follow suit, the ability
to value-price these services has disappeared.
Without a “breakeven” pricing
option available, banks now support an
additional channel cost that in most cases
costs them about $3 per month for a user
of online banking and bill pay. This cost
borne by community banks could be as much
as one-fourth higher than that sustained
by large banks.
In addition, the Internet
banking vendor community has shrunk dramatically.
Five years ago, there were easily 150 vendors
and products in the Internet banking space.
Today, there are fewer than 30 products
with credible market viability, including
those offered by core vendors. While there
are still some differences in functionality
among these solutions, all of them can
be described as adequate. Going forward,
financial institutions are likely to base
their partnering decision as much on price
as on functionality.
The
Cost of Delivery
Internet banking is
a significant non-interest expense at banks
today. There are cases of community banks
whose annual costs for Internet banking
are higher than those for their core systems.
Many banks signed their original Internet
banking and bill-pay contracts several
years ago when usage volumes were quite
low and many vendors were still incurring
high development costs. These contracts
included some kind of per-account charge,
activity-based pricing (e.g., per bill
paid) or a combination of the two.
Now, as products have
matured and volumes have increased significantly,
those same pricing schedules no longer
make sense. In fact, many community banks
have been so successful that the earlier
pricing structure is now punitive. As contracts
have come up for renewal, community banks
have been pushing vendors, with some success,
to provide more fixed pricing that eliminates
per-user or usage fees. For example, a
flat enterprise fee for Internet banking
with unlimited deployment is growing more
common. Limited use of a cash management
product for higher-end business customers
can be included, with some limit on the
number of customers.
Bill payment costs,
whether a flat fee with some cap on the
number of bills or priced per payment,
have been slower to reduce. Vendors have
been pushing banks to sign bill-pay agreements
for longer terms. Many community bankers,
sensing that the cost trend for bill pay
will follow that of debit cards and ATMs
(i.e., growth produced lower transaction
fees) are attempting to shorten the terms
of their contract to position themselves
to take advantage of market pricing pressures.
They are likely to be glad they did.
A few community banks
that have developed their own Internet
banking systems have been motivated by
lower total costs. A handful of others
have attempted to pay bills themselves.
However, concerns about the increased regulatory
focus on risk and privacy have for the
most part limited interest in this.
Rationalizing
Usage
Community bankers should
also consider using profitability and demographic
information to encourage and, potentially,
discourage usage. Many studies have shown
that customers who use Internet banking
are more profitable, which validates the
view of many banks that their more profitable
customers were, in fact, early adopters
of the Internet. These same studies show
that Internet banking customers are more
likely to stay with the bank.
For the first time,
based on their increasing deployment of
data marts and other information management
systems, many community banks have three
valuable pieces of information that can
be used to maximize their investment in
Internet banking systems. The first is
good customer profitability information.
The second is good channel usage information
by customer. The third is good internal
Internet banking costs. Used in tandem,
these can be used to improve relationship
management and/or cost. For example:
- Highly profitable
customers not using Internet banking
can be identified and possibly convinced
to sign up;
- Less profitable customers
who are heavy users of all channels — branches,
call center and Internet — can
be proactively migrated to the Internet
and other self-service channels that
should cost less on an incremental per-transaction
basis;
- Unprofitable customers
may be avoided entirely when prospecting
for new Internet banking customers. While
the relationship between Internet banking
usage and customer profitability is accepted
in the industry, there are no statistics
showing that signing up unprofitable
customers will make them profitable.
Doing that, in fact, simply adds cost
to an already unprofitable customer.
As a result, many community banks are
starting to be more selective about who
they sign up for Internet banking and
bill pay, at least until their cost structure
changes.
Another promising combination
of demographics and systems can be seen
in the marketing of banking services to
Gen X (ages 28-39). Many community banks
have identified this group as a key target
market for new business. A recent study
by the Pew Internet Group showed that in
this age group, 60% of respondents had
tried Internet banking, far higher than
Gen Y (18-27 years old), baby boomers or
any other age group. Community banks with
good demographic information will make
sure that their deployment among key age
groups matches the industry.
Promoting customer broadband
access is another approach to stimulating
usage. Other than security issues (see
below), lack of broadband speed is possibly
the leading reason that customers don’t
use Internet banking. The Pew Group study
revealed that while 63% of those customers
with broadband access had tried online
banking, only 32% with dial-up connection
had done so.
This is certainly understandable.
There have been many benchmarking studies
on Internet response times, including one
by Gomez Inc., which have shown broadband
performance to be as much as six times
faster than dial-up — a five-second
response on broadband takes 30 seconds
on a dial-up line. Interestingly, that
same Gomez study stated that as many as
45% of all banking customers access Internet
banking through bandwidth considered to
be dial-up speed (56KB or lower).
Broadband is also much
more reliable in terms of availability.
It stands to reason that if convenience
is the key driver of Internet banking usage,
and speed/reliability are key components
of convenience, broadband access is almost
required in the long term.
For many community banks,
particularly those in rural areas where
broadband access may be relatively new,
matching new areas of broadband availability
with sign-up campaigns may produce results.
Differentiating
Through Execution
Given that Internet
banking has become commoditized, is there
a competitive twist or niche that a community
bank can use to its advantage? Yes. Bankers
can model their Internet banking strategy
on other financial products and services
that have become commodities, such as checking
accounts, ATMs and mortgages. The keys
to success with a commodity product are
in execution, including marketing and packaging.
The following are several
ideas being discussed by community bankers
as they consider how to advance their online
banking channel:
THE
COMBINATION OF PERSONAL AND BUSINESS
ONLINE BANKING SERVICES FOR SMALL BUSINESS
CUSTOMERS.
Many community banks
have strategically targeted the combined
personal/small business relationship as
a key area for future growth. There are
2.7 million small and micro businesses
in the United States, and many have fairly
simple online banking needs that largely
mirror those of retail customers. These
customers are increasingly price-conscious.
New York City-based Novantas recently reported
that four out of 10 small business customers
said that they would move their banking
relationship for a better price.
Many community banks
are using their retail Internet banking
solutions to meet the needs of small business
customers and are bundling systems, services
and pricing. Several banks, such as Compass
Bancshares Inc., Birmingham, Ala., allow
a combination of personal and business
deposit accounts to be used to offset fees.
The bank can track the combined personal/business
balances the customer keeps with them to
justify the combination of business/personal
systems delivery and pricing.
Other community banks
are getting contractual agreements from
their Internet banking vendors that enable
them to offer more feature-rich cash management
systems to the limited number of small
business owners who truly need more functionality — multiple
user sign-on, ACH origination, payroll
integration, etc. This allows them to be
competitive as required, without significant
capital outlay for high-end cash management
solutions.
LEVERAGING
CUSTOMER TRUST BY HITTING SECURITY ISSUES
HEAD ON.
Community bankers must
deal with this discomfort. Customers want
the convenience of Internet banking but
don’t want the risk of fraud. These
are among the options community banks are
considering to build customer trust, even
at the cost of some short-term marketing
opportunities:
- Limiting or eliminating
the use of e-mail for any marketing efforts;
- Policies that state
that the bank will never solicit information
from customers via the Internet banking
system or e-mail;
- Limiting money transfers
to external parties either by limiting
the amount that can occur in any single
transaction, involving a “pre-authorization” process
that requires customers to validate third-party
recipients prior to the initial transfer,
or some proactive contact with the customer
to get approval if the transfer is over
a certain amount;
- Active monitoring
and customer notification for transfers
or bill payments that fall outside of
certain historical ranges, much like
credit card companies do today;
- Regular, ongoing
communications with customers regarding
these and other efforts through branch
handouts, statement stuffers and other
avenues. E-mail initiatives (automated
alerts and marketing messages) have been
limited of late due to strong customer
concerns about online fraud techniques
such as phishing and pharming. Mailfrontier.com recently estimated that 20% of all Internet
banking users do not open any e-mails
from their banks due to this concern.
E-mail is a valuable service and marketing
tool, but only after security concerns
are addressed.
While some of these
efforts could produce heartburn in the
sales and marketing groups, the overall
image of the community bank as the defender
of privacy and security could prove to
be a significant long-term marketing tool
itself. The heavy regulatory scrutiny of
banks and bank technology vendors, long
viewed as just a burden, may turn out to
be exactly what appeals the most to customers.
Community banks, for whom customer focus
and advocacy have long been strategic differentiators,
may find that customers will respond to
this focus on security and privacy.
LEVERAGING
THEIR INVESTMENT IN IMAGING.
Community banks might
consider becoming the “electronic
filing cabinet” for their customers.
In addition to investing in Internet delivery,
banks have made a significant investment
in imaging document and check imaging systems
(see “Paperless & Restless”).
Now, some financial institutions are looking
at offering imaging services coupled with
Internet banking, either as a fee income
opportunity or to secure low-cost deposits.
USING
SCORECARDS TO MEASURE SELF-SERVICE GROWTH.
Community banks will
need to take a disciplined approach to
measuring how customers are using the Internet
channels to reduce the bank’s overall
cost of delivery. Examples of what can
be measured include:
- Loan applications
received via the Internet as a percentage
of total applications;
- Online check orders;
- Online check copies
printed;
- Online stop payments;
- Account history inquiries.
All of these can be measured
to see what percentage of total transactions
was conducted via the Internet rather than
at a branch or through the call center.
Strategies such as these
will allow community banks to leverage
their excellent long-term service and customer
focus to grow and cement relationships.
Questions
or comments about this article? Post
them at the Banking
Strategies blog.
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