Payments revenue accounts for more than 50% of total banking revenues. This revenue is characterized by consistency.
Beyond revenue, holding a critical place in the payment stream provides other, vital benefits to banks. Information generated by payments can be used to identify cross-selling opportunities.
The underpinnings of this comfortable position, however, are beginning to erode as the payment system experiences a fundamental restructuring. When it is complete, banks' role in payments will be reduced, shrinking profit margins at best and cutting off access to customers and customer information at worst.
By a wide margin, checks continue to be the preferred method of payment for monthly bills in the United States, according to Booz-Allen & Hamilton's analyses of payment methods in several developed countries. Consumers in other countries do not exhibit a similar reliance on checks, pointing to the possibility of change in the U.S. mind-set.
Furthermore, since 1991, electronic payments have grown at double-digit rates, while check transactions grew just 2.3%.
Nonbank competitors have a hold on many aspects of the electronic payment market. For example, transactions are moving to credit cards, where nonbanks have a 45% share of the market. Off-line debit cards, attractive because of their merchant fees, are being ambitiously marketed by nonbanks. Merrill Lynch is the third-largest off-line debit card issuer.
At the front end of the payment stream, a proliferation of choices continues to lead consumers away from traditional, bank-supported, paper- based payments. In addition to products already mentioned, electronic cash, electronic checks, Internet banking, personal computer banking, and others are emerging as viable payment options.
The advent of messaging standards such as OFX (Open Financial Exchange) rules for exchanging account and transaction information over the Internet could be ominous for banks. OFX enables software providers, including Microsoft and Intuit, to create value-added services at the front end of the payment chain. And common messaging standards would make it easy for consumers to comparison shop for individual banking services, creating new competition and margin pressures.
These developments have the potential to cut off banks from both their traditional payments revenue and the less measurable but potentially important customer information stream. Instead of being the linchpin of a consumer's financial flow, banks risk being relegated to the role of a payments utility. Meanwhile, software providers could become the integrated retailers controlling information and guiding the customer relationship.
The challenge for banks is to determine how to use new payment technologies to increase the value of service provided to customers and ultimately enhance profits and profitability. Therefore, the challenge is to maintain a dominant position as the customer's financial services provider.
Banks still have considerable strengths to exploit.
First and most important, banks remain the consumer's principal interface to the payments system. Many institutions are building data bases to understand how they can better serve their customers. Thanks to a history of safety and good service, consumers strongly prefer financial institutions over software and technology companies for activities such as bill presentment and payment.
Corporate customers, too, indicate a preference for electronic relationships with a financial institution. Banks' demonstrated ability to be effective with large customer service operations helps them retain this favored position among retail and corporate customers. And the stored- value/deposit business is still valuable, especially in the retail and small-business segments.
Providers of personal financial management software, such as Intuit's Quicken and Microsoft's Money, have a lead on most banks in creating the interface necessary to become the primary provider of a full range of consumer financial services. To prevent major erosion in their cvustomer position, banks must move quickly to "brand" themselves as primary providers of electronic banking and financial management services through whatever distribution and servicing media the customer desires.
The key for banks will be to provide these in a way that improves customer control and convenience, increasing the customer's ties and loyalty to the institution. Banks will need to develop a better understanding of how their customers want to be served in this new environment, and they will need to tailor services to the various segments.
We have seen a few financial institutions get serious about exploiting payments system change. They fall into two groups. A couple of players are staking big bets on their ability to become network providers or processors for everybody else in the financial services industry. But only a few large institutions have the skills, resources, and appetite for this kind of strategy.
Most banks land in the second group-they have the potential to provide value-added services in the new payments world. In this group, a few players have recognized that the development of payment vehicles and delivery channels gives them a real opportunity to offer new value-added services to customers.
These institutions are moving to build true retailing capabilities and the powerful branding necessary to create and sustain a dominant position in distributing financial services. These efforts include creating relationships versus selling financial products; understanding segment needs and customizing products and delivery systems to meet them; developing a "retailing" orientation versus a "manufacturing" orientation; and, perhaps most important, recognizing organizational barriers to change and eliminating them.
What many banks lack, however, is management focus and commitment. Building alliances with software companies, processing companies, or other banks can help in either gaining the necessary on-line capabilities or offsetting the costs of supporting multiple customer access points. However, attention must be paid to creating and delivering customer value, retaining control of the interface, and controlling and owning the customer information.
Management has to have the strategic vision and commitment required to support the development of fundamentally new business systems.