In a free economy, demand generates its own supply. But sometimes the reverse happens: Supply creates its own demand. Such is apparently the case in the field of electronic bill payments.

After years of investing, and often losing, a lot of money in schemes designed to persuade a somewhat indifferent public to discard checks, suppliers of electronic alternatives are finally making progress. Responding to a crescendo of Internet hype, consumers seem poised to embrace bits. There are currently some three million subscribers to assorted electronic payment plans. More important, subscriptions are growing at an eye-popping 10% a month.

The word "subscriber" should be qualified, however. Literally, a subscriber is one who underwrites. But there are few bill payers willing to underwrite the hefty investment needed to realize a national electronic bill payment setup. Consumers appear to want the convenience, but they won't pay for it-as evidenced by the fact that prices for electronic bill payment, once set as high as $20 a month by overconfident suppliers, have since been slashed to around $5 and even less. (A few leading banks, in fact, provide the service gratis.)

But if the payer won't ante up, perhaps his counterpart, the biller, will. The economics supports this argument. It now costs the consumer essentially 32 cents (the postage) to pay a bill. It costs the average biller twice as much (conservatively 65 cents) to prepare and mail that bill, together with the inevitable accouterments (ads) that swell its mailing cost.

About how much will billers save by having their bills electronically presented to on-line customers? Our research shows that most billers are willing to pay up to 40 cents per item. At that level, given that there are about 20 billion bills currently mailed each year to consumers and small businesses, billers face the happy prospect of eventually realizing annual savings of around $5 billion (relative to the current cost of $13 billion). The billers' gains are, of course, for the most part the post office's losses.

This means that suppliers of the electronic service can look forward to an $8 billion annual revenue stream-without any contribution at all from the consumer. Assuming a conservative after-tax margin of 10%, that $8 billion revenue stream equates to nearly a billion dollars in profits.

Not a bad business, provided it is approached properly. Such an approach obviously emphasizes the billers, but since they won't participate without adequate payer representation, the approach cannot neglect consumers either. Nor can it realistically bypass the banks. That's because, at least for the time being, people want what is traditional-a bank or thrift involved in the payments system.

Few of the aspiring or actual entrants into this business have troubled to touch all bases. A nonbank joint venture like Microsoft/FDC focuses on billers. Checkfree, another nonbank participant, concentrated on consumers but slighted billers and banks until it recently changed its strategy. For their part, the banks have wooed consumers but not billers, at least not with comparable ardor.

The bank attitude toward the business is beginning to show an urgency proportional to its importance. In truth, banks can't pass up the opportunity to provide both electronic bills and electronic payments despite the fact that in so doing they will sacrifice profits from paper- based businesses that electronics will render obsolete (e.g., lockbox and check processing) and sustain an as-yet-unknown amount of deposit- and float-income loss.

The principal reason is that payments represent a bedrock bank interface with the customer upon which a variety of highly profitable relationships are based. If customers can be persuaded to do the untraditional-make payments through nonbank third parties-banks may lose information critical to making credit decisions and to cross selling. This loss will profoundly affect businesses such as small-business lending that rely heavily on checking account activity for evaluating creditworthiness.

Would banks retain the capability to monitor small-business payment activity if bills were being presented and paid electronically via a system controlled by nonbanks? Microsoft executives argue that the data on bills and payments it receives will remain the property of the banks and merchants. But such assertions do not lessen bank fears of (1) losing control over that data or (2) having to share control with third parties. In the first instance, banks could lend to small business only with the greatest difficulty. In the second, the profitability of that lending would be seriously crimped by prospective competitors. The same fate could befall the credit card business and consumer lending in general-activities especially vulnerable to the enhanced cross-selling opportunities potentially available to nonbank providers of electronic payments services.

The principal bank effort to turn back this challenge and retain control of the payments business is being orchestrated by the Integrion Financial Network, a consortium of 18 major North American banks, together with International Business Machines Corp. and Visa. Equipped with a technology platform from IBM, the bank consortium is offering an end-to-end service capability. Customers will opt to pay their bills, and banks will settle the transactions, electronically debiting customer and crediting biller accounts with Integrion's system.

The consortium appears to possess all the attributes needed for success, boasting (1) a common processing platform, (2) a dominant communications standard, and (3) significant transactions scale based on a huge subscriber base. (The retail customer base of Integrion's owner-banks represents more than 70% of U.S. households.) Integrion is currently piloting its bill payment service and is likely to offer bill presentment in the near future.

We estimate that as many as 15% of consumer and small-business bills will be paid electronically by the year 2001. Based on such volume, industry participants stand to make a tidy profit-in the case of the Integrion banks, perhaps enough to offset a good deal of the pain of declining paper-based payments income.

But there is a major caveat. The enthusiasm of service providers could well wane if competition remains as intense as it has been. Our analysis reveals that (1) the up-front investment required in this business is beyond the level affordable to any but the largest players and (2) huge economies of scale exist. As a result, we forecast that there will be room for less than a handful of profitable end-to-end service providers. Given more, the resulting price cutting and the costs of creating duplicative service infrastructures are likely to turn abundant black ink into the red stuff. Customers might benefit from lower prices, but service providers would join the post office as losers. In consequence, an industry shakeout would occur.

In fact, industry consolidation is already in full stream. MasterCard exited the on-line bill payments business in 1996. Integrion acquired its rival, Visa Interactive, in August. And a number of smaller players, including technology providers, transaction processors, and others, are busy forming alliances in an attempt to put together the capabilities required to become a major player (or align themselves with one). Indeed, electronic bill payment and presentment may well become that rarity, an industry which consolidates even before it takes off.

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