Mixing Wholesale and Retail Banking on the Internet
November 24, 1998
CFO Alert: Richard Crone is vice president and general
manager of Cybercash, Inc. Based in Reston, Va.,
Cybercash is one of the world's leading providers
of electronic commerce payment solutions. The
second part of this article will appear in next w
eek's CFO Alert.
Get ready for a sea change. Up to now, a defining feature
of most home banking deployment strategies has been
the decision to outsource bill payment.
Today, however, with the advent of Internet bill
presentment and payment (IBPP), a growing number of
senior financial executives within bank management are
re-evaluating the impact of this outsourcing decision on
a bank's overall profitability--particularly as it relates to
offering cash management services to major billers. The
CFO's objective comparison of the cost and revenue
components of on-line bill paying can play an
instrumental role in profitably realigning the retail home
banking and the wholesale electronic commerce
strategies of a financial institution.
Consider first the cost and revenue ramifications of
offering home banking services. Only a handful of banks
in this country perform their own home banking and bill
payment processing services in-house-- all the others
outsource the function. This outsourcing approach
affects both a bank's costs and its level of service.
For example, retail banks that outsource their home
banking and bill payment services are essentially value
added resellers (VARs) for nonbank home- banking
service and software suppliers. As resellers, banks are at
the mercy of an outside third party for the cost structure
of these services.
Is it any surprise that rather than offering these services
on a per- transaction basis, nearly all the major
third-party bill payment providers have chosen to price
their services on a per-account basis? When evaluated
objectively by the bank's CFO, the economics of this
pricing should appear very worrisome. For example, the
normal bundled rate charged by non-bank suppliers of
bill payment services is approximately $5.00 per retail
demand deposit account (DDA) per month. This
typically includes up to 20 electronic payments per DDA
per month. If you assume that all 20 electronic payment
requests are made in a month, the retail bank's
transaction costs equal $0.25 per item. However, the
typical household pays only 12 to 17 bills per month, so
that the effective cost- per-transaction to the retail bank
actually ranges from a barely acceptable $0.29 to a
staggering $0.42.
And the Loss Leader Is ?
The above costs are many times higher than what a bank
would typically incur for merely processing paper
checks. And they are an order of magnitude higher than
what a wholesale bank incurs when processing
automated clearing house pre-authorized payments or
deposits (ACH PPD). This exorbitant pricing structure,
combined with the hefty acquisition and maintenance
costs of " bill pay"-enabled checking accounts, has
brought into question the overall profitability of
"reselling" retail bill payment services for non-bank
providers.
This is why many bank CFOs are now commissioning
customer and account profitability analyses for accounts
linked to the bill payment services of third parties. As a
former consultant and banker chartered with conducting
such reviews, I can tell you that I found these accounts
to be loss leaders at best, principally because of the
costs and outside dependency imposed by the third-
party suppliers. Today's competitive checking account
environment makes it extremely difficult to recover the
costs imposed by third-party bill payment providers,
either in the form of added fees and/or compensating
balances from consumers.
This is not, however, the case with payment services
"sold" to billers by the wholesale side of the bank. In the
case of ACH PPDs, the bank is the supplier of the
services, and costs and processing are under its own
control. Rather than functioning as a VAR, as in the case
of the retail bank, the wholesale bank functions as an
original equipment manufacturer (OEM). As an OEM,
you control your own costs, distribution and, most
importantly, margins.
Consider the following critical differences summarized in
the table below. These differences make it clear why
retail home banking, with its reliance on third-party
payment services, is a shaky foundation on which to
base a strategy aimed at capturing a profitable share of
the emerging electronic bill-payment marketplace:
Retail Home banking
Bank is a reseller of bill paying services to consumers (a
VAR).
Processing costs dictated by suppliers per account.
Cost per account priced at $5.00 per month:
20 transactions = $0.25
17 transactions = $0.29
12 transactions = $0.42
Receiving depository financial institution (RDFI).
Third parties work with billers.
Vs. Wholesale IBPP
Bank is a supplier of cash management services to billers
(an OEM).
Processing costs controlled in-house per transaction.
Revenue garnered per transaction while also fostering
the commercial deposit relationship.
Originating depository financial institution (ODFI).
Bank works directly with its billers.
Enter IBPP--A New Point of Wholesale Collection
Fortunately for wholesale bankers and the senior
financial managers responsible for maximizing returns
from all parts of the bank, a marketplace has developed
for IBPP services that allows the wholesale bank to
exploit its leading OEM position vis a vis major billers.
IBPP presents banks with a hope of new profits because
it creates an entirely new distribution channel for
low-cost ACH PPDs and their equally low-cost Internet
equivalent, electronic checks. When deploying
electronic bill payment capabilities through its billers--
instead of through third-party "bill pay" suppliers as a
retail bank offering--a bank can leverage its ACH PPD
processing infrastructure to enjoy processing costs that
are a fraction of those charged by third- party suppliers
of bill payment services.
To exploit this opportunity bankers need to be aware of
the current market landscape for IBPP services and
where to best position their services. There are presently
six viable IBPP distribution channels available to your
billers:
Channel 1: Biller's own Web-site (biller direct).
Channel 2: Electronic mail (lowest common
denominator).
Channel 3: Browser subscription (PUSH and XML).
Channel 4: Shared link (AOL Digital Cities).
Channel 5: Thin concentration (requires OFX).
Channel 6: Thick concentration (closed delivery).
These six channels can be divided into two broad
categories: channels controlled by the biller and his
wholesale bank, and channels controlled by third-party
bill payment suppliers, or nonbank concentrators.
Biller-controlled channels, also known as "biller-direct"
channels, include the biller's own Web site (where
biller-registered customers come to directly view and pay
bills), electronic mail browser subscription (using push
technologies), and shared link (light concentration)
channels such as AOL's Digital Cities. Home banking-
based, or "shared" channels, include thick concentration
(where a biller sends all its billing information to a
service bureau that presents bills on behalf of many
billers) and thin concentration (where a biller spreads its
IBPP capabilities among several payment concentrators
or portals). The last two channels, unless your bank is
one of the five banking institutions in the country that
performs its own bill payment processing, are controlled
by nonbank service providers with a cost structure
upwards of $0.42 per transaction or more.
It is the four biller-controlled channels that will deliver
banks' hope for new profits stemming from IBPP. While it
is possible for a bank to work both sides of the IBPP
street by supporting a mix of biller-direct and home
banking- based models, payment services provided
directly by the wholesale bank to billers provide far
greater ROIs and opportunities for growth. This is
because when a bank outsources bill paying to a third
party, it literally throws away many of the opportunities
it has for fostering its valuable wholesale customer
relationships.
Strategies That Protect the Payment Franchise
When a bank outsources its home banking and bill
payment services to an outside party, it is also
outsourcing its relationships with its commercial
depositors. In the retail home banking scenario, the
outside third party facilitating payment processing and
settlement for the retail bank is also the entity
processing the payments on behalf of the biller, instead
of the biller's current wholesale or commercial bank. In
terms of the cost dynamics described above, this
paradigm is akin to robbing Peter to pay Paul. If Peter is
the wholesale bank, it is sacrificing its own profitable
bank-supplied cash management services to pay for the
services of an outside third-party supplier, typically at a
loss.
It does not have to be this way. All banks have to do is
remember their own experiences in deploying earlier
electronic distribution channels. With ATMs, for
example, supply created demand and the bank registered
its own customers. Then came home banking, which
only truly took off when the Internet allowed customers
to go straight to the bank's Web site and avoid third
parties when enrolling to view their bank statement.
Finally, there is direct debit, where payment follows the
bill.
Banks need to marshal this experience on behalf of their
billers today to craft IBPP strategies that enable:
1. Billers to enroll their consumers for IBPP services.
2. Billers to control content and posting.
3. Payment to follow the bill.
Ultimately, each individual bill payer will decide which of
the six IBPP channels is most convenient, and banks and
their billers need to be prepared to eventually support
them all for maximum market coverage. But the channel
that a biller selects first in order to get its foot in the door
will largely dictate its future IBPP success, and the future
of its relationships with its commercial bank.
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