Banks all over the country are mobilizing to take ground in the on- line investment services business-deemed high-profit, low-cost territory that can make them plenty of money while enabling them to hold onto customers. But if they're not careful, taking on the E-Trades and PC Financial Networks of the world could mean victory for well-established defenders.

To many, electronic investing is where the action is. "Every financial services company in the country will be offering some sort of on- line investment service within

the next 12 to 18 months," predicts Blake Darcy, CEO of Jersey City, NJ-based PC Financial Network (PCFN), a subsidiary of DLJ Securities Inc. "Banks are going up against entrenched competition-(companies which) are very focused, whereas banks are going to want to do on-line brokerage just to hold onto their customer base. It's going to be tough for banks, for that reason."

Some pros in the on-line investment services business think banks shouldn't even bother trying. "What people are saying is, 'I'm going to give less control (over my life) to my banker because I'm getting more educated at work and through the media, and I can do this stuff myself, not pay a high premium and have more control (over my future),'"says Christos M. Cotsakos, president and CEO of San Francisco-based E-Trade Group, Inc.

Banks have plenty to worry about from Cotsakos and his ilk, all of whom seem headed for glory in nonbankdom. E-Trade and Lombard Brokerage Inc., also based in San Francisco, have plans to eventually offer a full range of bank-like financial service options, including on-line checking accounts.

Betting the Numbers

But banks can't be blamed if they think they have something to offer as well. As Martin Mayer, a noted banking expert and author points out, banks have their own forces to put on the field as well as significant advantages. "The guys with the big edge in that business are the banks," says Mayer. "They're tied into people's computers with payment services, and while they haven't been able to sell brokerage services from the existing offices terribly well, as people get more and more used to dealing with their bank through their computers, the banks will have an edge."

Some banks are already deployed. Citibank, for one. And First Chicago NBD opened an on-line investments business this May. BankBoston says it's "evaluating the ability to offer investments on-line."

Many observers agree with Mayer that banks can take significant market share in the business. But they also point to potential problems. "The banks can definitely get involved here," Forrester Research Inc.'s David Weisman says. "They have call centers, and many of them have discount brokerage capability today. The problem is that their brokerage arm is usually a poor stepchild, and most banks don't have a brand name associated with great investment advice; most of their brand is associated with (its) being a safe place to keep money until someone can move it someplace where it can do more for them. As we move forward, this is going to be about helping emerging affluent consumers manage best-of-breed portfolios."

Banks may or may not take the enemy's colors in this particular battle; but there's little doubt that statistics, logic, and common sense combine to suggest that for once, there's more light than heat to be found among enthusiasts of on-line brokerage services.

According to 1990 statistics from the U.S. Census Bureau, total U.S. population between 45 and 64 totaled 46.37 million. The total population between 20 and 44 was 99.77 million. And in 1993, defined benefit and contribution plan recipients were clustered in the 37 to 64 year age group, while 401(k) beneficiaries tend to be among those in the younger category, according to the Social Security Administration.

The last category of individuals are those most likely to be both computer- and Internet-literate. And since 401(k) recipients have to make more decisions about their investments than beneficiaries of more traditional pension plans, they are de facto more involved with their investments, more knowledgeable about them, and less likely to leave their capital in low-yielding savings or interest-bearing checking accounts, or CDs. And since knowledgeable people tend to act on their knowledge, these people-the bulk of the population-are more likely over time to invest for themselves. Ergo, on-line investment services.

Staking a Claim

The only questions seem to be: Given the choice, will people acting on their own seek expensive, full-service brokerages, or will they choose price over service, and go for on-line discount brokers-some of them offering free trades? And how can banks turn this fundamental phenomenon to their advantage?

If the first answer seems obvious, it isn't, which is where the battle territory emerges. According to a study authored by Forrester's Weisman, the territory in dispute won't be on-line discount brokerage, with its free-to-$12 trades. On-line discount brokerage, after all, is a commodity business, driven by price, inevitably falling margins and, consequently, ever-smaller profits. By definition, the future of that business will be ferociously competitive and will inevitably find itself dominated by a few providers after an expensive blood bath.

And the battle also won't be in full-service brokerage and its $150 trades. That business is meant for the top few percent of the population who have complex financial needs and the money to pay people to handle it for them. Margins on this business are wide, but numbers of accounts are few; of the nation's 100 million households in 1993, only 4.8 million-5 percent-had annual incomes north of $178,234, according to the Census Bureau. About 19 million households-20 percent-had annual incomes of $103,846 or more.

The battle ground will be in offering so-called mid-tier on-line brokerage services to people in the first and second wealth quintiles, a business which, Weisman projects, will total some 60 percent of the total on-line investing market by 2001. These two wealth quintiles represent some 30.2 million households, with an average net worth of $199,449, according to the Census Bureau. The average net worth of the entire rest of the nation's households is $55,181.

This service, which is still aborning, combines automated trading and limited investment advice from National Association of Securities Dealers (NASD)-registered Series 7 reps with on-line analytics and research resources, allowing providers to use Internet-based customer services like personalized Web pages and push technology while building brand-name value that can be sold at a modest premium-and fat margins.

Green Fields Ahead

As things stand, then, banks are well-positioned today to take significant market share in this business-if they use their resources right. As Mayer points out, banks have the computers and brand names necessary to take early market share in the on-line investment business. "Given the way you can handle pricing on the computer over time, I should think (banks) should be able to offer a range of (investment) services at different prices," he says. "And as they expand the range of services they'll be offering, they should be able to pick up a bigger piece of the Internet brokerage business than they were able to do with walk-in or telephone brokerage businesses," at which banks have not had notable success.

But this may not be enough, says E-Trade's Cotsakos. The on-line investments business, he says, isn't about competing anymore on price; it's about competing technically. "What's really important is, how efficient are you in your back office, so you can keep delivering value to the consumer, keep your price steady, and add value back in (by adding) some products, features and services," he says.

What his competitors-including banks-will be doing, he says, is taking their brokerage businesses "and trying to go electronic. What we are is a technology company that leverages information through an all- electronic business model. We don't get involved in the brokerage end-we disintermediate that-and we don't have the cultural baggage or the legacy systems baggage; there's a heritage model and a green field model, and we're the green field model."

Snake-Oil or Shrewd Strategy?

As a result, says Cotsakos, banks who want a piece of the future should form alliances with him now-before, as he plans to, he adds co- branded credit cards, cash management accounts, mutual funds, on-line checking, and debit cards to his product line, and becomes a nonbank. "Either (banks) get it and they can't do it, or they don't get it and don't do it, or they won't do it because they don't get it," he says. As a result, banks have two choices, as Cotsakos sees it: "The best way for them to go is to partner with us, or they can try and do it themselves. The problem with that is, this is a different culture; high tech is fast moving, very innovative, fast-moving, (and) you can't be wed to a heritage model."

If a bank decides to form a partnership with E-Trade, it would get a deal in which the fee per transaction would fall with rising volume, plus the advantage of an alliance with E-Trade, says Cotsakos. And E-Trade would remain fully branded on the bank's Web site, he concedes, rather than offering the bank invisibility, and therefore would essentially be using the bank as a funnel for its own business.

Different from E-Trade, invisibility is exactly what companies like PCFN and Lombard Brokerage Inc. offer banks who want a fast entry into the on-line investments business. At press time, Lombard, for instance, was in negotiations to provide on-line services to three large banks, according to chairman V. Eric Roach. His company, which, like E-Trade, is moving toward a financial supermarket model since its acquisition by Dean Witter, Discover & Co. (pre-Morgan Stanley merger), recognizes that banks have a vested interest in serving-and preserving-their customer base. "What we're finding is, they want us to become their entire brokerage arm-to handle the service issues, the call centers, the electronic piece, to integrate it with their bank. The real decision (then) is, do they do it under their brand or ours? We really don't care, but banks want to do it under their own brand; so it becomes like private labeling."

Lombard also structures their fees on a sliding scale: the bigger the volume, the smaller the discrete transaction fees. "From the bank's perspective, it's very powerful because it becomes purely incremental," says Roach. "They know they can rely on us, and they can stop the onslaught of all their high-end customers being lured away. At the same time, they avoid the risks of extending their capital, or setting up the business units just to find out they're not so good at it."

Raising Regulatory Issues

PCFN offers a similar deal, says Darcy, who recently split his firm into two units, one named PCFN Technology, Inc., to handle this business. "Banks will turn to companies like ours to hit the ground (running) and get their feet wet, and, if it works out, over time they'll want to do it themselves," he says.

How ever a bank chooses to set up its on-line investments operation- home grown or leased-it still has regulators to consider. If it chooses, it can operate within the bank itself, in which case it reports to the Office of the Comptroller of the Currency under the guidelines published in 1994 as the Interagency Statement on Retail Sales of Non-Deposit Investment Products, as if it were acting as a mutual fund operator.

Alternatively, the bank can create a separate subsidiary, in which case it reports to either the Securities and Exchange Commission, or the NASD. One of Darcy's customers, First Chicago NBD, chose the latter, says Rick Hawes, president of First Chicago NBD Investment Services Inc. "There are all nuances to all those alternatives, and they're all great, and you can do anything you want. The problem is this: you just go out and try to find yourself a clearing broker if you're not a registered company. When you move away from industry standards, you're limited in the things you can do."

First Chicago is clearing its trades through Pershing Securities, a division of PCNB's parent, DLJ Securities Inc. The regulatory issue for banks is still unclear, reports Hawes. Even though bank employees can work in limited securities roles, he says, he's run into pressure to register his employees for Series 6 and 7 securities licenses under the NASD, which raises the question of oversight. "That hasn't really been clarified yet, and I'm very uncomfortable about it," he says.

At the end of the day, and however the bank chooses to structure its on-line investment business legally, it's really a marketing operation-that is, placed outside the bank's main financing business, and an outgrowth of the retailing model so often heard about in the country's board rooms. As such, it's interesting to note how many large institutions, including First Chicago, have chosen the same model adopted by the pros in this business.

This strategy includes a broad selection of models, from in-branch full-service to on-line discount trading, and including mid-tier offerings. This is designed to capture as much business as possible from customers. And while customers are growing in their investment proficiency, they may need advice one day, and cheap trades the next.

This is American Express Co.'s approach with its on-line investment offering, InvestDirect. "On-line (investment businesses) can be seen as similar to the telephone, but different enough to be seen as a separate channel," says American Express's Mark A. Ernst, svp for workplace financial services, whose purview also includes InvestDirect. "But the consumer doesn't see themselves that way," he says. "They see themself as a consumer, and sometimes I want to walk into a branch, sometimes I want to call someone and talk to them on the phone, sometimes I'd like to do this thing on-line, sometimes I'd like some advice. That consumer is not four or five things-they are all those things at different times. That's how we're approaching on-line-another way to reach consumers, but only another way to do that."

Creating Added Value

American Express chose to rent its support for InvestDirect, says Ernst, using Houston-based Telescan for decision support and Atlanta-based CheckFree Corp. for its front end. This allows it to concentrate on learning-and marketing-the on-line business. "As far as the bank's opportunities in brokerage, not only will somebody else grab it if they don't, somebody else already has grabbed the business-they're called full- service and discount brokers," he says.

Despite the entrenched competition and banks' lack experience in the brokerage business, Ernst says that the on-line investment services business creates an opportunity for banks to enter with a unique value proposition their customers could very well be interested in, prompting them to change from the traditional brokerage firms they have typically done business with. "Getting on-line is not the difficult thing; figuring out how to communicate what you are to your customers that's the more difficult problem."


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