As cyberspace grows, financial institutions need to modify their competitive strategy. They need to understand the evolution of industry structure and what kinds of companies will be winners and losers.

The strategic game board helps, by illustrating the impact of a new technology on an industry.

Firms begin in the lower left, competing in the broad market according to accepted rules. But these rules change, and firms must adopt one of the four strategies shown.

The Type 1 strategy, at the lower right, is to stay in the broad market, investing in leading but proprietary technology.

Type 2 firms, at the upper right, are usually new entrants using information technology to lead in selected segments only.

Type 3 players (upper left) compete for laggard or other customer segments immune to a new technology.

Lastly, many players stay in the lower-left box as Type 4 users of the Type 2 players.

Let's look at an example.

The international transfer of funds became extensively automated during the 1980s. Money-center banks invested heavily in the Type 1 strategy. But a new entrant, Swift, became a Type 2 industry, providing a global utility. Today it connects 6,266 banks, brokers, and securities clearers.

Almost all banks became Swift users, putting severe pressure on the Type 1 players. Some overinvested in information technology, and margins dropped dramatically, even as volumes and productivity rose.

This pattern is not unique. Industry unit costs have declined, allowing employment to remain constant and noninterest expense to grow tepidly at 4.7% annually. Many Type 1 players have had to sell out their specialized, automated lines of business, such as merchant processing, trust and custody, or credit card issuance.

Internet strategies are likely to follow this same pattern.

Type 2 players are generally aggressive new entrants competing under new rules. Examples include the portals, the financial product finder sites, loan aggregators, bill payment players, advice and information sites, function providers, and intra-industry utilities like the IMX Exchange for mortgage brokers and lenders. Also included are the inchoate Web outsourcing subindustry, home banking vendors and other Internet financial application providers.

An example of a Type 3 player is Astoria Federal, the sixth-largest thrift. It offers no home banking or transactions on its Web site, because its local customer base is expected to lag in adopting the Internet.

Most large players adopt a Type 1 strategy. Some are aggressive, but most are ambivalent-and don't move as quickly as they could.

For example, stock-quote engines are very popular, yet few big banks have one on their Web sites' front page. Some banks even charge for their stock-quote server, though 500 Web sources already offer quotes.

Credit cards are an Internet natural. Yet only 3.4% of card solicitations this year will involve inbound Internet, and only 7% of new accounts will be booked on the Web. To date, five of the top seven card issuers do not offer cardholders Internet access to their accounts.

Internet search engines make products and rates easy to find and compare. Since banks fear the commodity competition this invites, most refuse to post full product data. Yet this is ultimately futile. As Internet comparison shopping gains steam, all will be revealed. (The inevitable defense will be complex product and rate modifications to make direct comparisons more difficult. In fact, Internet products may differ from others, complicating a bank's ability to offer its products through multiple channels.)

Internet-only banks are Type 1. Instead of changing the game, they simply convert their cost advantage of having no branches into high rates. Yet because of easy access to the technology, there are no entry barriers.

What will happen in the future?

A Type 1 strategy is inherently costly and risky. Large players can absorb the costs and appeal to their many existing customers. But few will gain the competitive advantage they seek.

Aggressive strategies, like Bank One's, may well pay off-but are costly. Bank One's First USA unit has deals with AOL, Excite,, Yahoo!, iVillage, GeoCities,, CBS, etc. The company is also likely to introduce a stand-alone Internet bank soon, one not using the Bank One brand.

Because Internet adoption will take decades for some segments, a Type 3 approach will work for some players. However, most financial institutions will end up with a Type 4 strategy, using the services of a Type 2 new entrant.

As a result, the Internet will not kill community banks. Their perceived risk is that the Internet transcends geography and accelerates the demise of low-cost deposits. However, the Internet will not soon make obsolete either currency or checks, the twin papers that require local brick-and- mortar presence.

In fact, each of the United States' tens of thousands of financial institutions will soon have a Web site, just as all of them have phone numbers. (There are at least 6,000 such financial institution Web addresses listed in Yahoo! today.) The technology behind the Web site will be a commodity available from outsourcers in a few years.

How many firms are following each of these strategies?

Of the top 100 banks, brokers, and insurers, perhaps 10% have already moved to a Type 1 strategy.

The rest have not moved to Type 2 or 3 but are still caught up in ambivalence and moving cautiously. Perhaps their premonition is that every large player will move to Type 1 eventually and that the competition will be self-defeating. They fear that the immense power of Web technology will quickly make it an expensive commodity. Yet investing late with no good reason is the worst option of all.

There are already hundreds of Type 2 players, attracted by the rich potential rewards of being an Internet company. Failure rates will be high, but at least 50 or so should survive as major industry forces.

It is worth noting that some highly successful "new game" credit card players, like Capital One, MBNA, or Providian, began business well over a decade after credit cards first took off. Similarly, some of tomorrow's new Internet successes haven't even started.

Literally tens of thousands will become Type 4 players, integrating purchased Internet technology into their current customer base and work flow procedures. Of course, this will take a decade at least.

In summary, the Internet may not have the significant industry effect that many observers see. There will be some new winners and some quashed laggards. But the overall number of firms destroyed or made by the Internet will be small compared with the size of the industry.

Most of today's ambivalent laggards are waking up and won't get hurt too badly. Share will shift slowly, and the technological pace is still fast enough to allow future leapfrogging.

The real value, as usual, will go to the customers, not the institutions. Mr. Teixeira is president of Tower Group, which is based in Needham, Mass.

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