01 Feb 2000

Financial Services 24/7

The Emergence of Online Banking
by Susan Young


"What did people do before ATMs?"

That's a question that causes most twentysomethings to draw a blank. They don't remember the days when people conducted their banking - face-to-face with a teller - between 9 a.m. and 3 p.m. on weekdays. The idea of making out a check to "cash" at the bank seems odd to them, and the notion of writing a check at the corner store to get money in a pinch suggests a scene from a Norman Rockwell painting.

It is only a matter of time, online banking enthusiasts say, before the process of writing a check, sealing it in a stamped envelope, mailing it, and waiting about a week for it to clear will be equally unfathomable. Technology is transforming the banking industry so rapidly that anything less than around-the-clock electronic access to bank accounts seems unthinkable. While predictions vary widely as to how soon and to what extent online banking will become a routine part of most people's lives, there is no doubt that technology - especially Internet technology - is having a huge impact on the financial services industry. With much hype and headlines, Web trading has revolutionized the securities business, and the rapidly consolidating banking industry is reacting to similar challenges. As trendy financial dot-coms with huge technology and advertising budgets emerge offering everyone an equal - and inexpensive - chance to trade stock, apply for a loan, buy insurance, or pay a bill, traditional financial firms are repositioning themselves to compete in this brave new world.

The transformation ignited by the Internet is creating a new paradigm in the financial services industry, characterized by surprising business structures. "The competitive landscape is changing dramatically," says Dwight B. Crane, the School's George Fisher Baker, Jr., Professor of Business Administration. "There are many challenges for firms in figuring out how to position themselves," notes Crane, who has taught finance and banking at HBS for many years. As consumers get more accustomed to using their computers to bank and trade, it becomes less of a hassle for dissatisfied customers to take their business elsewhere. With new Internet-only banks and brokerages popping up regularly, established firms must find innovative ways to hold onto their customers.

"Traditionally, strategy was institutionally driven - insurance companies sold insurance, for instance - so that it was sufficient for firms to be operationally effective," continues Crane. "Now strategy is much more customer driven, and a firm's brand is more important than ever." Marketing that brand, in fact, has become so essential that most startups spend huge sums to get the word out about their offerings. A typical new player, for example, might spend over $100 million in advertising. "There is a big rush for market share," explains Crane. "Firms are gambling that when the dust settles, they will be one of the survivors."

F. Warren McFarlan, the Albert H. Gordon Professor of Business Administration at HBS, likes to look at this complicated new world in terms of what is changing and what is staying the same. A longtime observer of technology's impact on business, McFarlan has been in-trigued by recent developments in the financial services industry. He notes that while the cost and time it takes to handle transactions are decreasing, "the need to have confidence in the people on the other side of the structure is as strong as ever."


HBS senior lecturer Sandra J. Sucher worked at Fidelity Investments for a dozen years before joining the faculty in 1998. Her recent research has focused on the issues facing financial institutions in the Internet age. "Banks have often been slow to adopt technology and to change what they do," she observes. "But the competition that the online banks are sparking is forcing traditional banks to innovate."

Sucher's case study on Wingspanbank.com brings many important issues to the fore. Wingspanbank is an Internet-only bank that markets itself with the claim, "If your bank could start over, this is what it would be." Created in a record four months and launched with a huge advertising campaign last summer, Wingspanbank provides one-stop shopping for financial services. Its user-friendly interface is designed so that customers only need to fill out one application for all the products it offers. The services that Wingspanbank offers include checking and saving accounts, bill paying, and certificates of deposit, as well as access to other financial services such as credit cards, mortgages, mutual funds, insurance, and discount brokers, all conducted online. Because Internet-only banks have lower overhead costs, they can pass savings on to consumers, and because transactions are electronic, they can be done faster and at the customer's convenience.

In her case study, Sucher chronicles the shockingly fast-paced creation of Wingspanbank and highlights many of the issues that online banks must consider: how to partner with vendors, develop products, market the brand, and build and test the technology. Wingspanbank has joined with Lycos Inc. and Juno Online Services in an effort to attract more clients, and it is banking on retaining customers by offering benefits such as discounts when using a Wingspanbank credit card at certain e-commerce sites.

At first glance Wingspanbank appears to be a hugely successful startup, and in a way, it is. However, Wingspanbank's financial backing comes not from a venture fund or an IPO but from a surprising source: Bank One Corp., whose more than $250 billion in assets make it one of the country's top five banks.

Led by a team from Bank One's First USA division, Wingspanbank was created completely outside the Bank One structure. From a consumer's point of view, there is no visible relationship between the two banks. While there is some pooling of technology and personnel, economies of scale are not shared between the two independent divisions, and they are, in fact, in direct competition with each other. If a Bank One customer, for instance, were interested in online banking, she might visit BankOne.com and learn what services the bank provides. She could also, however, surf over to Wingspanbank.com to find its more elaborate and competitively priced offerings and easily decide to close her Bank One account. "It is not uncommon for new delivery systems to compete with old ones," notes Dwight Crane. "But the Wingspanbank model takes that notion to unique extremes." Bank One realized that one way to beat - or at least understand - the competition on the new online playing field was to back its own startup. If Wingspanbank takes off - and the jury is still out - Bank One can apply what it has learned to BankOne.com. If it fails, Bank One has not jeopardized its primary customers or its name.

Operational Efficiency

With more and more consumers using the Internet to conduct transactions of all kinds and with the size of firms growing, the reliability of technology becomes increasingly important. "The increased use of technology offers huge economies of scale," notes Warren McFarlan, coauthor of the fifth edition of Corporate Information Systems Management: The Issues Facing Senior Executives. These economies have greatly encouraged the consolidations that are now occurring in the banking world.

"The search for operational efficiency has led to mergers," says Dwight Crane. "What were nine banks in Boston, Hartford, and Providence, for instance, is now one megabank. Firms now need to capture a larger share of each customer's business," Crane observes, noting that the lines between financial service sectors are blurring. Today's bank offers many of the services of a brokerage firm, and vice versa. Congress's repeal of the 1933 Glass-Steagall Act that separated the activities of commercial and investment banks (opening the doors for a "financial free-for-all," as Business Week put it) will only increase this trend. Already, Crane asserts, "you can't talk about banking without talking about trading." Thus the "bank" of the future is likely to be a multifaceted online financial services operation that will make today's local commercial bank a historical relic.

The importance of operational efficiency is particularly apparent in the area of trading, where seconds count and system crashes are disastrous. "When Schwab goes down for four hours, it winds up on the front page of the Wall Street Journal," explains McFarlan, who recently authored two case studies on the Charles Schwab Corporation. One of the top online brokerage firms, Schwab handles about four thousand transactions every second, and any amount of downtime can be devastating.

"As organizations serve more and more customers, the bulletproof reliability of their software becomes more important," says McFarlan. He notes that in building its infrastructure, San Francisco-based Schwab was determined to locate its information headquarters in a "nongeologically active" area. The company has housed its two data centers twenty miles apart - in different power grids - outside Phoenix. "A software failure could easily put the whole enterprise at risk," explains McFarlan.

Disruptive Technologies

One question facing the established firms is how to launch their Internet services without disrupting their regular offerings. One of the benefits of developing Wingspanbank outside Bank One was the ability to start from scratch (a fact that Wingspanbank's advertising campaign tapped). "Sometimes a new technology is so disruptive that the normal organization mechanisms are not adequate to get the change through fast enough," says McFarlan, noting that HBS professor Clayton M. Christensen's book, The Innovator's Dilemma: When New Technologies Cause Great Firms to Fail, addresses this phenomenon. Thus, newly entering startups, whose flexibility enables them to make decisions quickly, often have an advantage over the more established operations that tend to be less nimble.

Founded in 1975, Schwab, the nation's pioneer discount broker, is frequently praised for its ability to reinvent itself. The pilot work for creating an easily accessible Internet trading component was done outside of normal operations at Schwab. "Only when it was clear that there was a huge demand for the new way and that it was actually going to replace their existing brokerage did Schwab reorganize. So it was a one-time disruptive technology," says McFarlan.

Firms must also be strategic in anticipating when customers are ready to try new ways of doing things. It took about five years, for example, for ATMs to come into full use, and during that time banks had to continue their traditional services while marketing the use of their new technology. Many of today's consumers are concerned with the privacy and security of conducting business online. These fears are assumed to be temporary as consumers get more accustomed to using the Internet and gain confidence in security measures. In the meantime, firms must be careful not to push their customers into a realm where they are not comfortable.

Two-Way Street

There is a two-way learning curve between the traditional firms and those that are grounded in the Internet. Certainly the Internet-only operations have proved that online financial services are viable. The fact that fifty thousand people signed up with Wingspanbank during its first four months cannot be ignored, nor can the volume of trades that discount firms, such as E*Trade and Ameritrade, are now handling. Clearly the more traditional players have learned that they must be able to compete in this new arena, and they are doing so. Merrill Lynch, Morgan Stanley Dean Witter, and Fidelity Investments, for instance, have actively moved into online trading operations. But it is also true that many of the Internet-based firms have come to value what the traditional firms offer.

At Schwab, for instance, McFarlan discovered that 86 percent of the firm's new online customers opened their accounts at a Schwab branch office. "There is a certain ceremony that most people are used to when large sums of money are involved," he explains. Because customers aren't comfortable using their mouse to hand over significant dollar amounts, they go into a branch office to get started. In response to demand, Schwab has added more than one hundred branch offices in the past few years.

While the playing field is rapidly changing, McFarlan likes to point out that the old players still have a strong competitive advantage. Schwab, for instance, "finds the Merrill Lynches of the world to be much more frightening than the E*Trades," according to McFarlan. Unlike the new online entrants, he says, "once the larger firms get their trading action in place, they can go back and harvest their eternal verities - research, credibility, the brokers' personal touch - and use them to their advantage."

Dwight Crane points to a recent Merrill Lynch advertising campaign to illustrate that advantage. He sees the message, "Our brokers will still be here," as stressing the importance of brokers both to an external audience - those who need advice in making difficult financial decisions - and to Merrill Lynch's internal audience - the fourteen thousand brokers who work for Merrill who are bound to feel threatened by the firm's decision to offer low-cost online trading.

Crane, in fact, views advertising as a window into the future that reveals where financial services are headed. Pointing to a recent issue of Business Week, he notes that close to 75 percent of its ads are for firms with an Internet component. As consumers become more savvy about what the Web has to offer, they will ask for and expect more. Learning from their own and each others triumphs and failures, firms will fine-tune their Internet offerings to meet the demands of their customers. In that context, the future of online financial services presents an especially rosy picture.


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