Internet banking software and service vendors: change agents

As banks prepare to enter the 21st century, they are responding to consumer demand to use the Internet as the medium to conduct personal finance transactions.

The nascent market for service providers and vendors of online banking applications will start to explode in 1999. The combined revenues of Internet banking applications and services will grow at a compound annual growth rate of 272% between 1998 and 2000, from $193.8 million to $2.67 billion.

The Internet banking services market will rapidly eclipse the Internet banking applications market in revenues. Starting from a 50-50 split in combined revenues in 1998, by the year 2000, services will own a 75% share of the U.S. revenues at $2 billion. A portion of these revenues will be from transaction-based fees.

Many banks are responding to the demand by building sophisticated Web sites with interactive features. For example, Wells Fargo, one of the first major banks to invest in the Internet, recently told Wall Street that its online customer base grew to 650,000 in December 1998 from 20,000 in 1994. However, only a small number of banks have full transactional capabilities on their Web sites.

The rapid growth in banks' adoption of the Internet in 1998-2000 is in contrast to 1997, when Web-based systems spending at banks was relatively low. According to IDC's most recent Global IT Survey, banks spent 4.1% of their IS operating budget on Web-based systems in 1997 - while insurance companies spent 8.3% of their budgets on such systems.

There are signs that banks are paying closer attention to the Internet as an important channel through which to deliver services. Last year saw the rapid expansion of the online banking applications and service markets, which barely existed a year earlier.

Some of the key trends within the banking arena include the following:

* Applications sales will soar. U.S. sales of Internet banking applications reached $96.5 million in 1998, up from less than $20 million in 1997. In 1999, the market is expected to grow 250% to $337.8 million due to widening acceptance of the Internet and tremendous changes in the financial services industry that will leave banks, insurers, and brokerages competing for customers in a free-for-all environment.

* Service revenues will grow faster. As many banks turn over the development and hosting of their Web sites to outside firms, the revenues for these service providers are expected to grow 592% to $674 million in 1999 [ILLUSTRATION FOR FIGURE 1 OMITTED]. Service revenues will continue to outpace license sales as bank Web sites attract new users.

* Internet banking will play a critical role. While the U.S. banking applications market is growing at a tepid 9.5% annually, Internet banking software sales will be outstripping that number and will account for nearly one-third of the total banking/finance application revenues by 2000 [ILLUSTRATION FOR FIGURE 2 OMITTED].

* Market acceptance. Banks, despite their risk-averse tradition, are beginning to embrace the Internet to deliver financial data to consumers and businesses on a real-time basis so that they can view and pay bills, transfer money between accounts using their ATM passwords, or even complete complicated cash-management tasks such as wire transfers.

* The pitch. More than two dozen vendors and service providers have started to capitalize on the online banking applications marketplace. The pitch from these vendors is simple: Turn your bank into a virtual financial center that can deliver the offerings of any physical bank as well as the ability to cross- or up-sell financial products from car loans to 401K plans.

In an era when a premium is paid for any product or service that can win customer loyalty, these online banking solutions - with prices ranging from $895 at SBS Corp. to a few million dollars at Security First - are being touted as the panacea for banks looking to simultaneously increase market shares and retain existing customers.

MARKET OPPORTUNITIES

More than 1,200 U.S. banks and credit unions signed with online banking applications vendors and providers to build fully transactional Web sites in 1998, according to IDC estimates. This year, 7,200 banks and credit unions are expected to acquire online banking applications and services, at a total cost of $1 billion. A fully transactional Web site allows bank customers to complete certain kinds of transactions over the Internet, such as bill payment, fund transfers, and stock purchases.

The return on such investments is encouraging. For example, at Digital Credit Union in Maynard, Massachusetts, more than 15,000 of its 90,000 customers now access its Web site regularly for information about their accounts. In addition, Digital Credit Union's Web site generates between 2,000 and 2,500 loan applications in a given month; these applications were processed manually in the past.

In Madrid, Spain, Bankinter recently launched its Web site and, within two weeks, had signed up 5,000 users, creating 15,000 transactions. Today, Bankinter's site has more than 60,000 users, or 10% of its customers, and generates $100 million worth of transactions every month.

The steep growth of the online banking applications market is likely to continue for another 18 to 24 months. One reason is that some of these projects could take as long as six months to complete, depending on the complexity of a bank's operations and its requirements. Other vendors are hoping to accelerate growth through quick deployment. First Data, for example, is touting its capability of building a fully transactional bank Web site in 30 business days for $30,000.

There are an estimated 9,000 banks and 11,000 credit unions in the United States. IDC projects that 42% of them will have fully transactional Web sites by the end of 1999 [ILLUSTRATION FOR FIGURE 3 OMITTED].

Although there will be continued consolidation in the banking industry, the pace is expected to moderate because of the emergence of technologies that provide a more effective and cheaper means for banks to expand. By relying on the Internet, banks are able to sell products in faraway markets - and end previously achievable only through the acquisition of local banks or by building expensive branches and ATM machines.

The bottom line is that online banking applications may well be a powerful tool for banks seeking to attack their weaker competitors while fending off threats from anyone that tries to invade their territory.

The biggest competition for online banking applications companies and service providers remains in-house development efforts. Conservative financial institutions have long considered internal technology development a sacred part of their operations because of its strategic importance. However, the need to compress time to market, the shortage of skilled programmers, and the trend toward outsourcing are all making internal development an increasingly unattractive option for banks.

For those financial institutions that are willing to use commercial applications, the payoff could be substantial. Security First, a major Internet banking vendor, estimates savings of at least 50% for banks that go with an off-the-shelf package rather than building their own Internet banking solutions.

INTERNET BANKING APPLICATIONS VENDORS

Internet banking applications vendors include companies such as Broadvision, Corillian, Edify, Home Account, Home Financial Network, Jack Henry & Associates, Open Solutions, Phoenix International, and Prologic. These vendors typically charge at least $100,000 to set up a bank Web site. Jack Henry is the exception; it charges $40,000 for its Net Teller module, which can only be run on its proprietary core processing system.

After the launch of a site, these vendors do not charge a recurring fee for each bank customer who uses the Web site. Instead, they charge an ongoing maintenance fee that ranges between 15% and 18% of the price of the applications.

These vendors will build a Web interface for the banks, focusing on such qualities as personalization, product differentiation, and customer relationship management.

THE WINDOWS NT FACTOR

As an increasing number of banks are severing their ties to mainframe systems by adopting a distributed computing environment, new opportunities have arisen for companies such as Corillian, Open Solutions, Phoenix International, and Prologic. With their NT-based client/server solutions, these vendors have transformed the core processing operations at scores of banks and credit unions. "Core processing" refers to the way banking software handles a bank's core accounting functions (such as general ledger). The need to deliver real-time data to their customers online has reinforced banks' commitment to run their data centers with powerful relational databases like SQL Server and Oracle.

Vendors like those mentioned above are betting that the databases will become so versatile that a whole range of executables and applications will be embedded in them and users will be able to make direct queries over the Internet to obtain customized information, bypassing the need to search for data from some legacy applications.

This idea is particularly appealing to banks that are smaller but more technically savvy. For example, Crews Banking Data Center, which has three banks in Florida, chose Phoenix International to overhaul its core processing system and add new features like Internet banking. Compubank, an Internet-only bank, chose Prologic to handle its back-office operations.

Internet banking solutions may become an important selling point. For example, Savings Bank of Manchester in Connecticut installed the Internet banking module from Open Solutions along with its Complete Banking Solution. The entire project cost close to $1 million, but Savings Bank expects the system to yield savings of more than $500,000 a year.

Despite such implementations, many of the nation's top 100 banks have steadfastly held onto their mainframes and considered the Internet banking applications quite distinct from their core functions.

That's where middleware offerings such as that from Corillian come into play. Corillian's Voyager platform will connect a bank's mainframe and a Web front end hosted by an interface vendor such as Home Financial Network. This could become a viable alternative for banks that want to straddle the old world and cyberspace.

INTERNET BANKING SERVICE PROVIDERS

Service providers have always played a pivotal role in the banking industry. Vendors such as Electronic Data Systems and Fiserv have been handling the core processing tasks for large and small banks for decades. Over the past two years, a new wave of service providers has entered the marketplace, fulfilling the Internet banking requirements of these institutions. These providers include companies such as Integrion, Security First, Digital Insight, Q-Up, nFront, Virtual Financial, Fundsxpress, First Data Direct Banking, and Online Resources Communications Corp.

For an initial implementation fee of $20,000 or more, these providers can set up and host bank Web sites. Some of these service providers, such as Online Resources, offer proprietary applications. Others, like M&I Data Services, license applications from vendors such as Security First and resell them to their customers.

After their sites are launched, the banks pay the service providers anywhere from $2 to $5 per month for every customer who signs up for the service. Today, a recurring fee of $3 per user per month seems to be the norm, but it can fluctuate if volume discounts are offered or banks have additional requirements such as bill payment or 24 x 7 technical support.

KEY TRENDS FOR 1999

Trends in the market for Internet banking applications and services include the following:

* Consolidation

* Real-time access

* Customer relationship management

* Commercial banking service

CONSOLIDATION

Currently, more than two dozen vendors are providing applications, hosting service and turnkey solutions to create fully transactional Web sites for North American banks and credit unions. However, that number is expected to decrease in the next 12 to 18 months as the pace of consolidation among suppliers continues.

In September 1998, HNC Software acquired Open Solutions (OSI) in order to beef up its client/server banking offerings. Earlier in the year, Intelidata invested $5 million in Home Financial Network, while Broadvision and Security First Technologies swapped shares to form a strategic alliance.

In addition, core processing companies such as Alltel and Fiserv, which have limited presence in the online banking applications market, will begin making heavy inroads either by developing their own products or by acquiring vendors that have proven solutions and customers.

REAL-TIME ACCESS

Increasingly bank customers will want real-time access to their financial records. As a result, banks that run their Web sites in batch mode will find themselves unresponsive to users who need real-time access to information for transactions like stock trading, shifting funds between accounts, and participation in electronic commerce around the clock.

A number of online banking applications companies continue to deliver data in a batch mode primarily because of the difficulties of replacing legacy applications with real-time systems based on client/server systems. Security First estimates that only 25% of its Internet banking solution clients are delivering real-time data to their customers.

IDC believes the likely winners in the online banking applications market will be those that can quickly convert a bank from a legacy environment to one that can offer Internet transactions on a real-time basis.

CUSTOMER RELATIONSHIP MANAGEMENT

The key to success for any online banking applications company will lie in its ability to give banks not just an online platform, but also a high degree of product differentiation. A Web site will then become a bank's strategic weapon to win and retain customers. Customer relationship management tools that enable banks to practice target marketing and customers to configure their own personal finance services will be increasingly important.

Vendors are preparing to offer such products. Bowne, for example, has acquired a number of Internet developers, including Open Sesame, Mountain Lake, and Quadravision, so it can offer end-to-end customer relationship management solutions to financial services companies.

COMMERCIAL BANKING SERVICE

Online banking is expected to spread to business users, particularly small firms that want to complete via the Internet such tasks as wire transfers, interactive stop payments, and detailed reporting with bank statements dating back a few years. For example, Q-Up estimates that one-third of its banks have been offering cash management features online.

Big core-processors are getting into the game as well. Fiserv and Politzer & Haney will start offering an array of online cash management services in the first quarter of 1999.

However, online cash management for corporate customers will be a tough market to crack because of the need to tailor the solutions for individual businesses. Because the value of corporate banking transactions tends to be greater and the customers are more likely to demand personal service, the Internet may not be considered the most user-friendly channel for delivery of online cash management services.

CONCLUSIONS

The future of the Internet banking applications marketplace is promising because these products will enable banks to hold onto their accounts, identify retention risks, and determine whether online users are actually more loyal than regular customers.

Vendors must add more intuitive and personalization features to their applications and service offerings, and they also must be prepared to share the rewards and risks of building a virtual financial center for their clients.

These vendors might also have to deliver applications that could transform a bank into a portal site or an active selling entity on the Internet. A likely scenario involves selling vacation packages on a bank Web site, allowing purchasers to apply for a special-interest loan to fund their trips. But some risk-averse banks may question whether this selling technique would hurt their loan portfolio. If banks reject such ideas because they run contrary to the traditional definition of a bank, growth of these products could be stifled.

Still, the tremendous changes in the financial-services industry are forcing banks to diversify. As more online banking application vendors add insurance policies, stock trades, and other personal finance services to the bank sites they're hosting and developing, their revenue will be coming increasingly from transactional fees and development work. The result is that for every stock trade handled by a vendor like Digital Insight for a credit union's customer, and for every loan package a vendor like Digital Insight is involved in closing, the service provider will get a commission.

However, there is a catch. Not every bank would want to see a third-party company take a big chunk out of its revenues if its Web site proves to be hugely popular. Some banks may even find this commission structure punitive.

In the future, the profitability of online banking applications vendors and providers will be closely linked to the ultimate success of bank Web sites. Currently, a Web site costs a bank anywhere from $20,000 to $100,000 to set up and another $3 per month for every customer it is able to sign up. However, the majority of banks can attract only 5% to 10% of their customer base to their online offerings and instead must continue to rely on expensive existing channels like bank tellers and ATMs to serve the bulk of their customers.

Consequently, banks will want to share with applications vendors and providers the costs of acquiring online users. As an executive at Open Solutions pointed out, banks will probably end up paying their applications vendors based on the savings their Web sites generate.

By Albert Pang Research Manager, eCommerce Software

COPYRIGHT 1999 International Data Corporation
COPYRIGHT 2008 Gale, Cengage Learning