SAN FRANCISCO (The Red Herring) - This past Mother's Day, Wells Fargo Bank tested a new theory about the significance of the Internet for financial institutions.
"We offered the ability to order flowers over our site, and 700 customers took advantage of the promotion," recalls Dudley Nigg, executive vice president of Wells Fargo's online financial services group. Wells Fargo (WFC), which in May 1995 became the first institution to offer Internet banking services, commands an online customer base of 480,000 and records more than 300,000 Internet banking sessions per day. Technology is changing this bank's business strategy in more ways than enabling it to sell flowers and other convenience products online, Nigg says: "Once you have a customer base, the only limitation on what you can sell is your own imagination."
Recently, Nigg's imagination carried Wells Fargo into the online discount brokerage business through its WellsTrade service, announced in August, and into partnerships with Microsoft, Intuit, America Online, and MSFDC (a joint venture between Microsoft and First Data). And this is only the beginning.
Wells Fargo's aggressive foray into the online medium reflects a change taking place in the balance of power between financial service providers and developers of finance-related technology products and services. "Technology is simultaneously an unstoppable catalyst for change, a colossal problem, and a strategic solution for just about every financial services firm," says William Storts, managing partner of Andersen Consulting's Financial Ideas Exchange, a facility visited by many financial institutions' executives for strategy consultations. But despite whatever challenges technology may pose, banks are increasingly showing a new understanding of how it will transform and energize their industry.
Over the past few years, the Chase Manhattan Group, Citibank, Bank of America, Banc One, Wells Fargo, and others have reallocated and increased overall IT spending, partnered with important technology players, and made direct investments in high-tech startups. As a result, they have introduced more fee-based revenue sources into their business models and gradually moved away from net-interest revenue, a less predictable source of income. For these banks, the toughest battle lies ahead: a struggle with aggregators of online financial content and services for direct access to customers. As banks keep increasing their technology investments, a new and complex set of partnerships will form between banks and Internet portal sites, and consolidation will continue as some banks drop out of the game.
In the early '90s, banks typically spent most of their technology budgets on systems for employee use and for upgrades and maintenance of existing facilities--that is, on internal development. Only about 3 percent was funneled into external development of new systems. As Lorraine Hricik, the chief information officer of Chase Manhattan Bank's Global Services Group (the revenue-generating division of Chase Technology Solutions, which took in $2.3 billion in 1997), recalls, "Our margins as transaction processors got squeezed in the early '90s, and we realized we were in trouble. Technology companies were beginning to have closer ties with the customers than the banks had." Chase had to broaden its business strategy to include external, technology-driven products and services like Internet-based home banking in the retail space and systems integration in the commercial space. (For a firsthand account of how technology has changed banking over the years, see "The Wriston Watch.")
By 1995, when U.S. industrywide technology spending measured about $25 billion, the percentage dedicated to external IT projects had risen to 20 percent, or $4.3 billion. Gary Craft, an analyst with BancAmerica Robertson Stephens, believes that the figure will approach $8.6 billion by 2000.
What are banks doing with the additional IT resources? They're building and testing Internet-based home-banking systems, biometric technologies, smart cards, and more (see table, below). The emphasis is on anything that will help banks better understand the purchasing patterns of their customers, reach those customers more directly and efficiently, and ultimately enable more cross-selling of financial products. Just 7 Web-banking services were available three years ago; by year-end, that number will approach 600, predicts Thad Westhusing, business development manager for Microsoft's desktop finance products division. The total will continue to increase as the number of households conducting online financial transactions rises to 20.9 million by 2003, according to Forrester Research estimates.
The results are encouraging for the banks, but the new technologies are also giving rise to new and different competitors. Some, like San Franciscobased NextCard, are direct rivals that promise to offer financial products faster and at lower costs than traditional banks can. NextCard sells an Internet Visa credit card that eliminates the need for companies to mail monthly statements. NextCard guarantees online credit approval in less than 30 seconds and offers services like automated balance transfers. Traditional banks are already acquiring such startups: in March, Canada's Royal Bank Financial Group purchased Security First Network Bank, the first fully transactional Internet bank.
A second group of competitors presents a more complicated threat to banks: companies like Intuit, Microsoft, AOL, and Yahoo that aggregate financial information and services online. Each of these companies positions its Web site as complementary to the banks' offerings. "With Microsoft Money, consumers get broader access to 190 financial institutions, which get to promote their services to a new audience," says Westhusing. And Mark Goines, senior vice president of Intuit's consumer division, adds, "We provide tools that give consumers more convenient access to information they're going to request anyway."
However, Blake Darcy, CEO of the online brokerage DLJ Direct, counters that the information provider is indeed becoming a competitor to the service provider. "Sure, Microsoft has to provide enough content to get consumers to its site," he says, "but as I told [Microsoft president] Steve Ballmer recently, 'At a certain point, you're competing with me for customers' attention. I want them to come to our site.'"
The rules of this new game dictate that to hold the attention of their customers, banks must simultaneously partner with the sites that generate the most traffic and continue to enhance their own content and e-commerce capabilities. (For example, FirstUSA, a subsidiary of Banc One, administers a Yahoo credit card.)
The partnerships come at a price. Financial institutions are paying hefty sums to advertise on the most popular sites. Darcy says DLJ Direct recently agreed to pay AOL $25 million over the next two years to be listed in its brokerage section. Similarly, Wells Fargo partners with AOL to ensure access to new customers, and with Intuit and Microsoft to provide its customers with Quicken and Money. By presenting information about a host of financial service providers, portal sites like Yahoo also heighten competition among the banks, brokerages, and insurance vendors that are attempting to bundle offerings and provide one-stop shopping. As Craft notes, "This is like the opening of an economy. Comparison shopping makes your weaknesses stand out."
Edward Horowitz, an executive vice president of Citibank, sees similarities between the markets for financial content and entertainment. "It's like the TV world; if you don't have a new release every season, you lose viewers," he says. Accordingly, his first goal upon arriving at Citibank (from Viacom) in January 1997 was to speed up the release cycle of new interactive content and services from once every three years to once a quarter.
Mike Riley, producer of YahooFinance, insists the financial portals hold a competitive advantage by promoting user choice. But according to Chuck Hieronymi, a financial service executive of the consultancy Dove Associates, banks will soon move from simply developing engaging content and bundling various financial products to offering competitive third-party products, just as Charles Schwab and Fidelity now offer other institutions' mutual funds. "Banks will have to do whatever it takes to win the relationship with the customer," Hieronymi says. "They'll have to focus as much on earning distribution fees as on creating their own products." Nigg reports that Wells Fargo plans to introduce such a strategy by the second quarter of next year: "If we offer choice too, we believe we'll blunt the competitive advantage of aggregators like Yahoo," he explains.
Banks seem to be in the better position for now. In June Forrester Research conducted a survey of 120,000 consumers in North America; it revealed that 64 percent of consumers would choose a bank to consolidate their financial services, while less than 1 percent would switch to a technology company that offered one-stop financial services shopping under its own name. "The market research available today shows that people are more loyal to their bank than to their brokerage," Darcy says.
Banks in fact may be embracing the Internet at just the right time. Until now, the rapid pace of innovation meant ill-defined and frequently changing standards, and the banks would wisely let the dust settle before making significant investments. With a secure financial communications standard based on the once-competing OFX (proposed by Microsoft, Intuit, and CheckFree) and Gold standards (backed by Integrion, a partnership of 15 banks) due to be in place this fall, banks will be able to take advantage of the opportunities at hand more efficiently than if they had acted sooner.
As banks get a foothold in cyberspace, their investments will continue to flow into the digital universe in the form of technology purchases, equity investments, and even outright acquisitions. "You can't be in the game going forward without this kind of commitment to IT," concludes Jeff Lynn, vice president of IBM's global banking, finance, and securities industries practice.
The pace of consolidation will accelerate as financial institutions search for the best way to compete with feisty startups like NextCard and financial portal sites like Quicken.com, YahooFinance, and Microsoft Investor. And although a handful of banks will respond admirably to the challenge posed by their new competitors, the question of where the banks' domain ends and that of technology providers and information aggregators begins will continue to trouble financial institutions.
"We have to keep the pressure on and the anxiety level up," cautions Bill Fenimore, Integrion's managing director. "Three years from now, the game could be over. It could be Schwab or Banc One, or it could be Yahoo."