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Last Updated
February 16, 2003



The Internet in Banking 

The next generationn

Internet banking has a long way to go before it becomes of real importance in terms of revenue generation and market share in the industry. In spite of this fact, the battle for mind and wallet share in this nascent market is already well under-way.

Many companies are investing heavily in Internet services and in building an Internet brand. Penetration may be low, but it is growing and the profile of users of on-line banking services is particularly attractive .

These are early days, however, and further rounds of market transformation and dis-intermediation will lead to considerable fallout amongst both traditional bricks-and-mortar and newer on-line players. This year is likely to see the start of the next phase as 'second generation' Internet businesses launch into the marketplace. These newcomers' business models will go far beyond the on-line mimicking of traditional banks, which has been the modus operandi of on-line banks to date. These models will begin to generate the new attitudes, expectations and behaviour amongst customers that will drive real change in the incumbents and in the industry as a whole.

Retail banking in the UK is now largely dominated by a small number of large, national players following a decade of consolidation and vertical integration. In spite of this evolution in the industry, banks continue to operate at fairly low levels of efficiency and have yet to focus their attention effectively on their source of income - their customers. Put off by the prohibitive costs of IT for enormous back-office systems and by the failure of new channels such as call centres to deliver promised cost savings through branch closures, most banks have been slow to adopt the Internet as a means of improving their processes and customer relationships.

Even the early 'first generation' on-line banking businesses have been able to show the cracks in the edifices of the established players. The business models may be unimaginative and service levels inconsistent at times, but their more innovative culture and vastly reduced cost base has enabled them to deliver far greater value to their customers.

The real struggles and truly significant changes, however, will follow later this year as banks, potential competitors, customers, industry observers and investors start to realise the true potential of Web technologies.

Vertical Disintegration
Second generation business models (see Figure 1), will be focused around the break-up of the current end-to-end banking corporation. The current emphasis on the customer relationship as a bank's most important asset will disappear. Disintegration will demonstrate the value of business-to-business relationships, providing support for the retail of products and services to consumers that are increasingly disloyal and costly to acquire. These new competitors will have the advantage of being able to focus exclusively upon developing exceptional competence in one area alone. Transaction processors, for example, will be able to co-ordinate their businesses around cost reduction and driving volume without being compromised by the overhead structure of a large retail operation.

Vertical players in the banking supply chain will invest in and leverage Internet technologies to lower their operating costs, improve efficiency and strengthen their customer relationships and brands. Those new entrants that are focused on owning the customer relationship will use the web, call centres and converging technologies such as mobile telephones, to interact with their customers and to provide deep and relevant information as, when and where it is needed. Operational savings will be passed on to customers by product providers in the form of better rates (Egg and Marvels rocked the credit card market in Autumn 1999 with their low-rate Internet credit cards).

Bricks-and-mortar banks will be unable to compete with the operational efficiencies of these more focused competitors who do not have to compromise between investment in new channels and maintenance of an older and extremely costly infrastructure. Having built mass-market businesses driven by market share as the key measure of performance, they are left with a diverse customer base that has divergent needs.

Fragmentation Of Customer Segments
Cable television provides us with a model for the fragmentation of customer segments as improved communication technology and greater capacity permits more effective targeting of distinct groups. The impact of the Internet in this respect is twofold: the technology itself permits focused dialogue with tightly defined groups of users; Internet penetration and adoption has acted as a social sieve, filtering consumers into layers reflecting wealth, education, age and attitude.

New On-line banks focused upon the profitability of their customer relationships rather than relationship volumes will be able to create structures targeted to suit the requirements, and the wallets, of their target customers. Multiple banking experiences will emerge to suit multiple niche customer groups. Customers will have greater choice but will also be required to pay for the infrastructure they require: many users will continue to value physical and direct relationships with their banks but this will cost them more than the use of a website or Internet kiosk.

In line with this new focus on profitable relationships, banks focusing on ownership of the customer relationship will be forced to seek new sources of revenue. Margins on current account management have been squeezed almost to nothing and the Internet is driving commoditisation across most banking product categories, reducing the value of cross-sales of financial products. The most profitable relationships will occur as relationship management companies reach across traditional industry lines and generate revenues from the advertisement and sale of many types of products and services relevant to the needs of their customer segments. Related categories are not hard to find, personal tax return assistance, advice on education planning or retirement planning would be of high value to customers. More intimate contact with customers would result in increased loyalty and even more detailed and valuable customer information could be collected. High street banks have already seen the value of expanding into new product areas such as travel or home insurance. Established banks do have the trusted brands as assets, however the addition of banking products to the product portfolios of the supermarkets and Virgin demonstrates the threat presented by other consumer brands.

Bricks-And-Mortar Branch Networks; A Liability But Also An Asset
Physical banking, as noted above, will not disappear. However, margins are likely to be low as consumers are loathe to accept the higher costs associated with this channel and push for rates comparable to new competitors. Branch networks will have to shrink and branches, particularly in costly high street locations or with low footfall, will become liabilities. "..The very physical presence of a local branch, however, is an advantage that the Internet cannot replicate or undercut. Banks have the opportunity to leverage their strong position within local communities..."

Media convergence has been heralded as a key trend for 2000, with the introduction of Internet services over mobile telephones and interactive television leading the charge. In retail sectors, however, the convergence of on-line and offline business will generate the greatest opportunities. Brands, extended on the more effective communications medium of the Internet, will take on a new meaning when placed back into the physical world. Of all 'transactional moments', the physical one will remain the most valuable. Physical locations, able to create a broad experience that stimulates all of our senses, will have the greatest capacity to capture our attention, our time, and our money. There can be no doubt that physical contact is a key driver in the development of strong personal relationships.

Branches can become physical manifestations of a bank's brand (oak-paneled stability or up-beat minimalism). They can also make a bank more relevant to its customers, enabling targeting not only by demographic segment but also by location. 'Localness' is a driver of value overlooked by companies that focus on the global reach of the Internet. Bricks-and-mortar banks have the opportunity to develop strong customer relationships and distinct identities in a multitude of ways closed to their new on-line competitors. In addition, partnerships and alliances with on-line players that are able to offer low-cost transaction processing and banking products could create unbeatable competitive advantage for physical banks.

The Opening Of New Markets; Opportunities For On-line Banks
Opportunities equally exist that only on-line banks are able to exploit. The increasing digitalisation of the economy and the rapid development of new technology is increasing the distance between the 'haves' and the 'have-nots'. Poorly educated, with low incomes, the 'have-nots' are the chosen target customer segment of few businesses. This social segment is being increasingly distanced from the rest of society by technological barriers.

Stores are emerging that only take credit or bank cards, e-Commerce relies on the possession of these. The incentive for the 10% of UK adults that do not have a bank account, to start to use and benefit from bank services, therefore, is growing.

As this segment receives new motivation for the use of bank products and services, bank structures are emerging that are able to meet this need. Already organisations such as Cash Centres have seen the value of targeting these people, who are estimated to have cashed £1.5 billion of cheques in 1998. The low-cost operating structures of on-line banks will enable them to effectively target this segment. Offering a lower rate than today's money-changers for cashing a weekly or monthly pay cheque, banks will be able to provide debit cards, financial planning services and automated bill payment tailored to the needs of these customers. Operating through kiosk's or offering free tokens for use at Internet cafes, banks will be able to keep investment to a minimum and have the potential to drive huge volumes of business.

Issues And Trends For 2000 Growing Consumer Confidence Eliminates Growth Barriers
As stated at the beginning of this article, on-line banking has yet to take off and growth, at a forecast 25% (see note 1), seems slow in comparison to other Internet forecasts. Lack of consumer confidence in the security of the Internet has repeatedly been referred to as a barrier to the development of Internet banking. Security issues may begin to be resolved through the course of the year. Researchers are racing to develop improved encryption and security technologies. At the same time, smart card and other more secure technologies relating to Internet access through alternative devices, will emerge in 2000 providing new solutions to this problem.

Re-evaluation Of On-line Business Models
One impact of the emergence of 'second generation' business models for on-line banking will be a more critical assessment of these models by investors. No longer will customer acquisition drive company valuations.

New models will reveal revenue and conversion (from browser to buyer) holes in the 'first generation' models. Loss-leading and price war tactics, such as those used by Egg, will be seen to be short-lived and concrete, sustainable margins and revenue streams will be sought. New metrics will emerge for measurement of the performance of Internet businesses, conversion rather than site usage will be a key figure. Banks in particular will need to convert customers who are unlikely to return with any great frequency to purchase financial services such as loans, mortgages or insurance.

A New Approach To Launching Internet Banking Services
1999 saw the launch of a number of Internet banks requiring enormous investment in marketing and loss-leading products to acquire customers. These companies have failed to support their marketed brands with effective and consistent customer service. They have also chosen to compete in the expensive and risky marketing game in which the Internet company that shouts the loudest wins; briefly.

As investors lose patience with giant marketing budgets and customers seek meat on the bone of the marketing message in the form of reliable and secure service, successful companies will seek new ways to get their message across. As traditional banks try to get on the Internet bandwagon without alienating their stakeholders and as Internet banks seek cost-effective ways of reaching customers and delivering a high-quality service, partnerships and alliances will emerge as the key to success.

New Focus On Business-To-Business Models In Retail Banking
'Second generation' models will also highlight the value of efficient business-to-business models in retail banking. As discussed above, the break-up of the vertically-integrated model of a bank will reveal the process in-efficiencies in the back-offices of the established players. Competitors will emerge that are able to offer transaction processing, product and service provision, or information processing services far more cost-effectively than existing players. With the potential to drive massive volume and concrete revenues, these businesses will generate significant market value.


1. There were an estimated 5.1 million users of on-line banking services in the UK in 1998 and 6.8 million in 1999. This does, however, account for half of all Internet users and is estimated to grow at a rate of 25% per year to 12.4 million by 2003. (Source: Intel Market Assessment, 'Financial Services on the Internet in the UK'., December 1998).

2. On-line banking users are young, affluent and well-educated. (Source Forrester Research 'On-line Banking Reality Check' 29 December 1998; Consumers & Technographics Data Insights, 'On-line Financial Services Breakout', 3 August 1998).(Source: Tornado Insider, 'Ride the Right Wave', September 1999)

3. Prime retail real estate will exist at key 'transactional moments', encompassing a location, time and event (in the street at lunchtime, your mobile phone sends you a message reminding you that itÕs you mother's birthday next week and there's a special deal on chocolates at the store you are about to pass, gift wrapping included). Presence at these 'moments' will drive retail sales. (Source: Forrester Research, 'Post-Web Retail', September 1999).

4. In 1999, 4 million UK adults, representing 10% of the adult population, did not have a bank account. This includes the 1.6 million adults that are unemployed. (Source: Marketing Week, 2 September, 1999).

5. Eddie Ford, CEO of Cash Centres, one of the larger UK cheque cashing companies, estimates that £1.5 billion of cheques were cashed at 1,200 centres around the UK in 1998 by the 10% of UK adults that have no bank account. Cash Centres are now considering partnering with a bank to introduce bank accounts for the poor. (Source: Marketing Week, 2 September, 1999).


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