First Union Bank customers can buy KeyCorp's Victory mutual funds at First Union's Web site. KeyCorp customers can buy First Union's Evergreen mutual funds at KeyCorp's Web site. And beginning this March, Web sites for both banks will be selling Charles Schwab & Co.'s Schwab One supermarket of funds, which sells 600 no-load mutual funds that compete with the banks' own funds.

All three of the financial services companies mentioned are potential competitors. So what's going on here?

After hundreds of years in the financial manufacturing business, and enjoying the glamour associated with being fundamental pillars of commerce, banks are becoming stores, embracing a retailing business model and relinquishing the traditional art of underwriting loans for the modern practice of collecting fees. And it might not be so bad, though the long- term implications are likely to be far-reaching, including an acceleration in bank consolidation, which brings in its train inevitable unemployment. "(Banks) are either going to be retailers, or they're going to be product manufacturers; both are very legitimate roles, but very different skills," says San Francisco-based Lenny Mendonca, a principal of McKinsey & Co. "(But) if the institution isn't good at selling what you're good at, (unemployment) is exactly what's going to happen."

This is no abrupt event. Banks have been securitizing their receivables, shedding assets, boosting their fee income, and buying back their stock while continuing to measure profitability as return on assets for years-a practice unpunished by the stock markets.

Banks may have had to do something for themselves after the disaster of the 1980s; but they deserve credit for embracing the sea change created by aging Baby Boomers suddenly concerned with retirement minus Social Security and recognizing that the market value of established distribution networks is reinforced by the trustworthy image of banks in the public's minds. Credit them, too, for recognizing the value of the electronic channel to expand their franchise and capture profits they might otherwise have lost.

Still, it's bemusing to see banks adopting the old merchant truism that when you can't sell the product, sell the store. "It's all about being able to gather our clients' assets," says Jack Kopnisky, president of Cleveland-based Key Investments Inc., and a KeyCorp evp. "Forty percent of investors go directly to (mutual) funds or to a place like Schwab today. We could stick our head in the sand and say, 'Well, we're going to assume that 40 percent of our customers want to go somewhere else where they can get what they want;' or we can do something about it and say, 'Hey, we have a product that will offer you the same thing as going to (another fund).' So you do sell the store."

The allure of coopetition

KeyCorp, Charlotte-based First Union and San Francisco-based Schwab announced their reciprocal relationship, which some say amounts to a "virtual" institution, in mid-December of last year, following six months of negotiation. Reportedly, the toughest part of the process is the technical discussion-especially in deciding how the financial details would be passed through the Schwab back office and onto the funds themselves.

"I would separate the strategic issue from where the hard work actually is," comments Daniel Leeman, Schwab's evp of business strategy. "The hard part, operationally, is getting the systems to talk to each other, keeping the costs low, and keeping the quality of the information flow what it needs to be."

No less interesting than the technical aspects of the deal, though, is the question of why institutions like KeyCorp and First Union, both of which have big dreams for their respective futures, would cooperate with potential competitors.

First Union officials were unavailable for comment at deadline, but for KeyCorp officials, the issue of possibly losing a few customers paled in comparison to what it could gain by striking such a bold-albeit non- traditional-strategic alliance. "In our view, at least from a regional perspective, (First Union and Schwab) are not necessarily our competitors today," says Kopnisky. "What we're most concerned about is whether our clients get the best products and services. It doesn't necessarily matter that we are competitors."

The creation of virtual, one-stop-shop financial institutions is spurred by coopetition; competitor or not, certain market scenarios, proponents argue, are requiring banks to think outside of their traditional roles to become care-takers of the customer relationship. "The first thing you have to understand is that we still own the client," he adds. "They're dealing with KeyCorp, not First Union. The business case is that we're able to provide that service to our client and maximize the return off the entirety of our relationship with that client."

When the financial services pie is divided, each bank gets a per- event fee-usually four to five percent of the acquisition price per transaction-and the fund company earns on-going servicing and management fees.

That there is money to be made in such ventures is unsurprising; this deal would have gone nowhere if the parties had thought otherwise. The real question, and one apparently unaddressed by business analysts, including academics and the Federal Reserve Board, is which actually pays better-manufacturing and owning assets, or collecting fees.

The big money, not to mention temporal power, has always come from owning assets. They could be manufactured or bought, but taking the market risk of ownership has been how money has been made since King Croesus first began minting it in the Sixth Century B.C. Times haven't changed much: Goldman-Sachs & Co., the Wall Street powerhouse, has made oceans of money by buying and selling assets through its merchant banking operations.

Yet now, banks and many other businesses are embracing a business model that abandons the tried-and-true source of wealth and power for mere money, which goes as easy as it comes. It seems to defy common sense. But advocates say it's all a question of what's meant by ownership; and the best business model, they say, focuses on expertise instead of a universal approach to particular industries.

never underestimate brand

Looked at this way, intangibles like reputations and name brands that capitalize on established distribution networks are just as valuable as owned assets-minus the latter's volatility and administrative problems. Low volatility means more predictable earnings per share. Fewer administrative problems means wider margins. And when distribution becomes more important than product, distributors become stronger than suppliers.

Eric W. Hartz, president of cyberspace-based Security First Network Bank, subscribes to the distribution powerhouse principle. He cites the Home Depot model in retailing as comparable with what's happening in banking. "For years, (hardware manufacturers) had the hardware stores at their beck and call, but Home Depot and Sam Walton came along and flipped it," he says.

This model has been aborning for years in finance circles, and banks and government have been full partners in creating it, beginning with securitizing home mortgages. It's taking banks into unfamiliar waters. But not every banker finds them uncomfortable. "Technology makes virtual corporations much easier to create," says KeyCorp's Kopnisky. "In our case, what we're trying to do is control the distribution channel; if it's more effective to own the manufacturer, we will, but we want to be the best at distributing. It's all about the best deployment of capital."

And there are those who don't buy that owning assets is where the money is. "My view is there's a lot more value in the brand name and the distribution system (than in owning assets)," says Schwab's Leeman. "My own guess is that we'll see a lot more banks than people expect will survive because the local distribution system and the brand has some real power."

Anyway, while it's easy to be categorical about where the virtual institution approach to retail financial services delivery is taking banks, it's unlikely that banks will be abandoning their manufacturing capabilities entirely anytime soon. Companies like Goldman, Sachs make plenty of money by underwriting securities and managing accounts, both fee- based businesses; as banks and non-banks come increasingly to resemble each other, it's unlikely the example of Goldman-or J.P. Morgan & Co., for that matter-will be ignored.

It's much more likely that some banks will choose to specialize in one area or another, while others will continue being broad-based institutions. Direction will depend on the people making the decisions. "If you want to paint it most starkly, the retailing business looks like the Gap or WalMart; the financial structuring business looks like investment banks; and there's a processing business that looks a lot like an ADP," says McKinsey's Mendonca. "Those are completely different cultures from each other, and from what is the amalgamation of a bank."

what's a bank anywAY?

Mendonca says that there will not be one type of universal bank; rather, there will be wide differences in what universal banks are. "(But) a lot of them will end up attempting to become retailers of a wide range of financial services and will feel down the road that the word bank in their name will be as constraining as the S&L business felt the words 'savings and loan' did awhile ago."

And in any event, the advent of the virtual institution may not be the last word on this subject. Business has its fashions, and fashions go in cycles. It wasn't so long ago-the 1970s-that Harold Geneen, who built ITT into what many consider the prototypical conglomerate, was considered a hero in the nation's business schools. Geneen owned; Geneen managed; money was made; many followed. And consider today's Kohlberg, Kravis & Roberts, of New York, which has been rumored to own an asset or two.

Now, the argument is that companies are better off pared to their core competencies than doing everything; assets are what go home at night, and reputation, public trust, and the ability to market are more valuable assets than physical things or the ability to create them. But this may turn out to be merely a philosophical apogee. "As competitors consolidate, you wind up with two, at which point you get splinter companies that specialize and do well, and the cycle starts again," says KeyCorp's Kopnisky. "It's a cycle, (and) it keeps repeating itself. There's opportunity to recycle and go back to pure ownership as we change. So the virtual corporation isn't the only way to operate."


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