Breaking the virtual bank
By Vanessa Richardson
Redherring.com, February 22, 2000
Only seven percent of U.S Internet users do their banking online, due to concerns about security, restricted ATM access, and a lack of customer service. But Internet banks -- and the venture capital firms that fund them -- are not daunted by the lack of momentum.
"As much as $600 billion of the market value represented by today's financial service companies may eventually be moved online," says Bill Ford, a partner at General Atlantic Partners in Greenwich, Connecticut. To claim a share of that market, investors are betting on Internet banks that cater not only to tech-savvy consumers with checking accounts, but also to business-to-business (B2B) customers.
Two Internet banks this week announced first rounds of venture funding. Virtual Bank, a Web site to be launched in April, raised $37.5 million from venture capital firms J.H. Whitney, Palisade Capital Management, and Wyndcrest Partners; corporate investors General Electric (NYSE: GE) and DaimlerChrysler (NYSE: DAJ); and individual investors including MCI Worldcom (Nasdaq: WCOM) CEO Bernie Ebbers, Starwood Hotels (NYSE: HOT) CEO Barry Sternlicht, and Miami Dolphins quarterback Dan Marino.
CompuBank, an Internet bank based in Houston that's been operating for a little over a year, has shifted its strategy from serving consumers to focusing on small businesses. Its B2B switcheroo attracted a first institutional round of $38 million from Softbank Finance, GE Financial Assurance, Goldman Sachs (NYSE: GS), and Marsh & McLennan Capital (NYSE: MMC).
VIRTUAL BANKING REALITY
There are currently more than 30 Internet banks in operation. That's not including national and regional banks with Internet branches. All are trying to reach the 20 percent of U.S. households that Goldman Sachs says will be banking online in the next two years. Of course, not all of them will succeed. "Net-only banks tout the economies of scale they can provide, but that doesn't appeal to customers who also want a local branch and ATMs to go to," says Jack Staff, chief Internet economist for Zona Research.
Virtual Bank is different, says its CEO, Rory Brown. The former systems consultant for Arthur Andersen started the company, based in West Palm Beach, Florida, last April. He says "traditional" Internet banks want to focus on just one part of the business -- signing up deposit accounts -- and outsourcing the rest. "Look at Wingspanbank.com. They send people to E-Loan (Nasdaq: EELN) for mortgages and thus haven't developed a relationship with the customer," he says.
Virtual Bank will instead focus on lending -- offering credit cards, auto, home, and equity loans and other lines of credit in one integrated system and platform. "We're not going to convince people to deposit with us, because brokerages are taking their money instead," says Mr. Brown. "The only thing banks can do is focus on the lending side, because that's where they have the licensing advantage. So we plan to be a full-service lending operation."
Its value proposition: customers who sign up for an auto loan and then come back for a home loan only need to answer two or three additional questions before being approved. The site will list other institutions' rates, but Mr. Brown is confident its figures will be competitive because of its integrated platform. "Our cost per account is less than Citigroup (NYSE: C)'s because of our economies of scale," he brags.
SURFER DEMOGRAPHIC
Virtual Bank is targeting a select market. "We're thinking employees of dot-com and Internet companies, because they're the thought leaders of Internet usage," Mr. Brown says. He believes such tech-savvy Internet users will like the ease and speed of banking online; for those who still want customer service, Virtual Bank will open offline branches in 12 high-tech areas, including Silicon Valley, Austin, New York, and Boston, within the next 18 months. "Our offices will be staffed with private bankers, but clients won't come to deposit funds," he says. "We're a cashless bank."
Further plans to penetrate this market include teaming up with companies' human resources departments and offering them banking services as an employee benefit. "We'll be like upgraded credit unions for, say, Intel (Nasdaq: INTC) employees, as we develop a personalized bank just for them," Mr. Brown envisions. Virtual Bank is in discussions with several high-tech companies but won't announce any deals until its Web site launches in April.
CompuBank has already enjoyed some success with consumers but is turning away from its original customer base to focus on businesses. CEO Frank Goldberg says the new $38 million funding is earmarked for infrastructure and building brand awareness among small businesses. "We plan to offer them a cash management tool, which is the key to their survival," he says.
CompuBank's heavyweight funders will help with the transition. "They know the financial services space so I don't know we could have done any better," says Mr. Goldberg, who is the former CEO of Security National Bank, now part of Compass Bancshares (Nasdaq: CBSS) in Houston.
MEETING THE CHALLENGE
Still, it will not be an easy process. "The functional and service issues [for the business market] are different from the consumer market," says Chris Musto, an analyst for Gomez Advisors. The first criterion is supporting multilevel access. "Different people have different access levels for invoice-paying and checkwriting," he says. Then there's the issue of accommodating large payments and withdrawals, handling lending processes, and setting up the payroll, which are all more complex tasks than issuing checks.
Even more daunting is the competition CompuBank will face, Mr. Musto adds. "The top twenty banks have millions of small-biz customers, so they're not just idly standing by. They're looking to develop strategies that protect those relationships." Citibank is currently developing a portal for small businesses, and Chase Manhattan Bank has declared an interest in the market.
Venture funds Capital Z Partners (an investor in Lending Tree (Nasdaq: TREE), Loantrader.com, and iExchange.com) and General Atlantic Partners are also eying the online banking market. Last week the investors announced the formation of eFinanceworks, a new company "focused on the formation, support, and development of eFinanceworks, a new company "focused on the formation, support, and development of e-finance."
The two have jointly committed $300 million for startups focusing on banking, brokerage, insurance, and mortgage services. Incubating space will be available in New York City this summer, with ventures in London and Hong Kong to follow.
X.COM
While CompuBank targets businesses, consumers are often less intimidating as customers. Take the success of X.com, a one-year-old Palo Alto startup that has backing from Sequoia Capital and new CEO Bill Harris, former CEO of personal-finance giant Intuit (Nasdaq: INTU). Since its launch in mid-December, the site has signed up 190,000 customers, says its chairman and founder, Elon Musk. The 28-year-old Mr. Musk is taking a mass-market approach and aims to have more than Wells Fargo (NYSE: WFC)'s one million customers by the end of the year.
Customers are attracted to the person-to-person payments via email, the $20 initial sign-up bonus, and the $10 referral bounty for getting others to join. "X.com has the first viral marketing approach in banking, and people seem to be going for it," says Mr. Musk. The question is whether X.com can convert customers into profits.
Mr. Musk says the company will make money by introducing an integrated brokerage and by beefing up electronic payment tools and integrating them into the eBay (Nasdaq: EBAY) and Yahoo (Nasdaq: YHOO) auction sites and into other Internet merchants. "We aim to be a combo of Western Union, Visa International, and Citigroup," he says.
PAYING THE BILLS
Electronic bill payment was touted early but hasn't been widely adopted. Mr. Brown of Virtual Bank thinks that bill adoption will still take a while to catch on. "If you try to set it up yourself, it takes two hours," he complains.
"Consumers don't want to go to a site and just pay their utility bill and phone bill and then have to go offline to pay their mortgage and cable," says Mr. Staff of Zona Research.
The tide may be turning, though. Last summer, Chase Manhattan, First Union (NYSE: FTU), and Wells Fargo joined Sun Microsystems (Nasdaq: SUNW) and Netscape to create Spectrum, a routing service for bill payment. In response, electronic billing leaders Checkfree (Nasdaq: CKFR) and Transpoint, the joint venture of Microsoft (Nasdaq: MSFT) and First Data (NYSE: FDC), agreed to merge on February 15, and the combination will be aggressively promoted on Microsoft's MSN and Moneycentral sites.
How the online banking market will shake out is not yet clear. Dataquest expects one-third of the 60 to 100 new online banks to fail within the next three years, regardless of whether they have offline support. The reason: Customers don't yet find Internet banking compelling. "Most of what you can do now online you can do over the phone," says Mr. Staff. "What's the incentive for change?"
Focusing on niche markets like savvy consumers or small businesses may become a more common strategy. And Mr. Goldberg of CompuBank is optimistic. "Remember, we're at the very early stage of this. If the industry starts educating and people start talking about it, growth rates will compound. So what if it takes a few more months or years than experts expect? At the end of it all, [the Internet] is where financial transactions will take place." |
