Are you tired of hearing about all the threats of nonbanks encroaching on banks' traditional markets? Brace yourself one more time, for the most significant threat yet. Automatic Data Processing Inc., the country's largest payroll processor, has acquired access to the payment system by obtaining a bank charter. On the surface, it looks like a simple cost- cutting measure to reduce the bank-imposed expense of wire transfers by gaining direct access to the Federal Reserve System. The move does make ADP less dependent on banks for payroll processing. But the real opportunity for ADP - and the real threat to banks - goes far beyond settlement services. Most businesses today, whether large or small, rely on an outside payroll processor. As a result of intense competition, both national and regional payroll processors are finding it increasingly difficult to grow their businesses and maintain profit. Their markets are saturated and their services have been relegated to commodity status. Despite this position, the payroll processors are in a very unique servicing position. For most Americans the third-party payroll servicer is the first entity in the payment system value chain to process, allocate, and account for funds. Payroll processors are responsible for not only producing payroll checks but originating the electronic transfer of funds for direct deposit, savings, investments in 401(k) accounts, taxes, and other funds transfers.

As we move further away from paper and branches to electronics, the ability to capture the funds at their originating source becomes a competitive advantage. Certainly the government saw the value of the payroll interface when it imposed the collection of taxes at the point of payroll. The government further relied on the payroll origination point for the direct distribution of tax-deferred dollars into 401(k) plans, medical reimbursement accounts, and other defined benefit programs. Charitable organizations such as the United Way have exploited the power of point-of- payroll processing by promoting deduction plans that nab the money each pay period. And credit unions, relying on the payroll interface with their sponsoring organization, used point-of-payroll processing to spawn one of the biggest nonbank deposit bases in the financial services industry today.

Payroll servicers like ADP own a unique franchise within their customer base: They are the first entity to process the funds once they are earned by employees. The systems that the payroll processing industry has built represent a funds distribution channel. This channel has been provided in the background, with little or no brand awareness by the employees receiving their paychecks. The payroll processing industry has, for the most part, been content with being a "carrier" of information and value, transferring the actual dollars and brand awareness to banks.

But the big opportunity for payroll processors is the same as for other data distribution channel operators like phone companies, cable television stations, and on-line computer services vying for competitive space on the emerging information superhighway. The owners of today's information channels are aggressively looking for ways to leverage their electronic access and reach to customers by getting into the "content" business themselves. The winners in the "channel" business leverage the access and reach they have with customers to increase the transaction volume that passes through their channel.

The formation of ADP Savings Association of Allentown, Pa., could signal a new round of nonbank competition from those with electronic channels that can be used to reach consumers directly and provide financial services.

A payroll processor with untethered access to the payment system can do far more than reduce its electronic funds transfer costs. It can begin to capture the funds distribution and processing at the point of payroll, the same way the government captures taxes or United Way secures donations. With point-of-payroll processing, companies like ADP can begin to wrap the commoditized payroll transactions with value-added services at the place of employment.

This is significant, because consumers today demand increasingly greater convenience of financial services. The payroll servicer, by combining its computer system capabilities and access to the payment system, could enable employees wishing to "bank at work" to avoid the delays involved in dealing with a financial institution that is 5, 10, or 2,000 miles from where they earn a living. The payroll processor can use its client companies' existing personal computer networks to create electronic storefronts for such things as bill payment services, investments, loan origination, and other traditional banking services.

The typical processing scenario may go something like this: In addition to the traditional allocations, the payroll processor could provide electronic remittance notices to employees allowing them to authorize, through a corporate personal computer, payment of their bills directly from their earnings. The employee could also set up predefined allocations so that excess earnings are swept automatically into mutual funds and the remainder is put into a demand deposit account. Employees could have access to cash through checking accounts and debit cards.

In this scenario, the payroll processor intercepts funds as they are paid to the employee and then provides true one-stop financial processing and information services to the employee so he or she can do banking without a bank. The potential exists for the payroll servicer to leverage its existing processing channel not only as a carrier but also as a content provider. Payroll processors could eventually build the equivalent of an electronic supermarket for financial services, possibly even providing cyberspace to banks and others in their electronic outlets, the same way that grocery stores provide shelf space to packaged goods manufacturers. This represents a new, low-cost distribution channel for banks trying to expand their customer relationships. However, it requires that they collaborate with would-be competitors and be willing to provide access to their services over a nonproprietary distribution channel.

This collaboration/competition model is one that we see successfully used in the personal computer software industry. For example, Microsoft Corp. today offers a software distribution channel, better know as Windows. With more than 60 million Windows-equipped personal computers, Microsoft has a market share above 80%. If your company offers word processing software for PCs and you want to reach 60 million potential buyers, you must make your product compatible with Microsoft's Windows, even though you must compete with Microsoft's own "house" brand, Word for Windows. But as with the supermarket, product branding becomes extremely important when you are relying on third-party distribution channels, because banks can be vulnerable to not only "house brands" but other competitive offerings more attractively packaged on the cybershelf. Combine the capability to intercept funds at the point of payroll and the elimination of interstate banking restrictions under the Interstate Banking and Branching Efficiency Act of 1994, and suddenly a payroll processor with a bank charter, like ADP, has a national "nonbranch" banking presence through every one of its serviced companies. ADP has the capability to offer national banking services while avoiding the high overhead and staffing requirements of a brick and mortar infrastructure. ADP could leverage its existing "infostructure" to deliver banking services at a fraction of the cost paper and branch-based delivery structures impose on banks, thrifts, and credit unions.

Banks, thrifts, or credit unions fishing downstream in the river of intermediary assets might find that the funds flow is dammed right at the point of payroll - and that ADP owns the dam. Richard K. Crone is a senior manager in KPMG Peat Marwick Financial Services Consulting Practice in Los Angeles. Mr. Crone can be reached by electronic mail via the Internet at

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