Lots of Cash, Little Profit

  The automated teller machine, once one of the financial industry's most reliable moneymakers, is undergoing a metamorphosis. An ATM deployment boom beginning in the late 1990s by banks, credit unions and independent sales organizations looking to ride the surcharge wave literally turned terminals into cash machines for their owners.
  But an abundance of so-called "off-premise" devices away from bank and credit-union branches, increasing consumer resistance to paying fees, and the growing use of debit cards by consumers at the point of sale for purchases and to get cash back, is reducing deployers' transaction volumes and revenues. The shift is leading more ATM owners to sell their portfolios, uproot less-profitable devices, and incorporate new strategies to add value to their programs. Some deployers also are considering returning ATMs to their original role in the 1970s as extensions of the bank branch without an overt emphasis on profit.
  "ATM growth is occurring so much faster than increases in transaction activity that many deployers, and particularly ISOs, are pulling back off-premise machines due to deteriorating economic conditions," says David Lott, a director at Collective Dynamics LLC, an Atlanta-based consulting firm. "It is the law of supply and demand. There was a frantic rush to put out terminals and the market is clearly saturated."
  After electronic funds transfer networks in 1996 began allowing ATM owners to implement user fees-or surcharges-on their devices, U.S. terminal placements exploded with the machine base increasing from 165,000 in 1997 to 371,000 in 2003, reports CCM sister publication ATM&Debit News. For the same period, the percentage of off-premise machines-which typically are situated in retail locations and generate the bulk of surcharge revenue-rose from 40.6% to 64.2% of the installed base.
  But ATM volumes are not keeping pace with installations, resulting in flat or declining activity at many machines. Each U.S. ATM generated an average of 2,432 monthly transactions in 2003, down 38% from 3,919 monthly transactions in 2000 and off a full 64% from 6,772 transactions in 1993, according to ATM&Debit News.
  "Banks and ISOs went overboard with their ATM deployments when they were permitted to surcharge," says Chuck Scavelli, ATM program manager for Cleveland-based KeyBank, one of the largest terminal owners with 2,300 machines. "They were too optimistic in predicting the number of transactions they would be getting."
  Terminals situated at bank and credit-union locations are generating an average of 3,484 monthly transactions compared with 1,500 monthly transactions at off-premise financial-institution machines. Boston-based Dove Consulting, in its 2004 ATM Deployer Study, attributes the higher on-premise volume to consumers' association with making deposits and withdrawing cash at branches; few competing ATMs located near branches; and a desire by cardholders to avoid surcharges and other fees by using only terminals owned by their debit card issuer.
  The majority of off-premise volume is so-called "foreign" activity-transactions initiated with cards that were not issued by the ATM owner. Most financial institutions charge foreign fees to their cardholders for using other institutions' machines. Issuer-imposed foreign fees help to compensate institutions for the interchange they must pay to ATM owners for their customers' foreign transactions. Interchange is set by EFT networks and typically ranges from 50 cents to $2 per transaction.
  But most foreign transactions also are surcharged by the ATM owner, which means the cardholder can get hit with two fees totaling $2 to $3 for a single transaction. To avoid these fees, cardholders in droves are voting with their feet to use only their own institutions' ATMs. As a consequence, they're disrupting the cash-flow projections of the ATM owners who bet on steadily increasing fee revenue.
  The result: Declining surcharge revenues and increases in some operating expenses are forcing more deployers out of the market, or causing them to reduce their base of off-premise terminals. Last year, for instance, New York-based American Express Co. sold more than 1,700 of its ATMs to Houston-based Cardtronics Inc.
  In addition to cash replenishment and maintenance costs, off-premise deployers also typically pay rent to retailers to situate machines at their locations, and often split surcharge revenues with the merchants. The average monthly rent for off-premise ATMs was $250 in 2003, up 34% from $187 in 2001, Dove reports.
  Many large banks, however, are maintaining or expanding their ATM networks because the machines, in addition to generating revenues, remain important tools for acquiring and retaining customers who value self-service banking. Indeed, most banks originally situated terminals to provide convenience to cardholders and cut labor costs by moving activity away from branches.
  "The economic impact is causing banks to rethink their ATM strategies, but there won't be a big pullback in machines because their ATM footprint can be a differentiator for institutions," says Jessica Ip, an author of the Dove study. "It still is important to have a wide distribution of ATMs from a customer-service perspective, but from a revenue standpoint, it is less attractive than it once was."
  The lowest-performing ATMs are owned by independent sales organizations and average just 355 monthly transactions, according to Dove. Unlike financial institutions, ISOs do not have an "on-us" card base and a well-known brand to attract users.
  Declining volume on ISO machines is helping to trigger consolidations among companies that own and manage the ATMs. Cardtronics, the nation's largest independent owner and operator of ATMs, has acquired eight ATM networks since May 2001, and now owns and operates a network of more than 12,000 ATMs in all 50 states. Company ATMs generated 64.6 million transactions in 2003, with 75% of the volume surcharged. Revenues totaled $110.4 million in 2003, with a gross profit of $22.3 million.
  Helping to drive such consolidation is "irrational pricing" by ATM owners, says Bipin Shah, president and chief executive of Fort Washington, Pa.-based Genpass Inc., a leading ATM driver. Shah says ATM revenues are falling because many consumers are unwilling to pay $2 or more for a transaction that costs banks only a few cents to process.
  "ATMs are a distribution channel to the customer and (consumers) shouldn't be nickeled and dimed to use it," Shah says. "More cardholders are getting ticked off and are no longer going to foreign machines. And we will see a greater trend in that direction."
  In addition to initiating more on-us transactions at their own banks' machines to avoid fees, cardholders also are accessing the growing number of ATMs that are part of surcharge-free alliances. Many banks and credit unions have forged partnerships in which they agree not to surcharge each other's cardholders.
  Within Montvale, N.J.-based NYCE, for instance, the second-largest EFT network with 151,800 ATMs, 2,760 terminals are part of a surcharge-free system known as SUM. The system's 492 participants primarily are located in New York and New England.
  NYCE formed what it calls its "selective surcharge alliance" at the request of small and mid-size members who said they could not compete with the bigger deployers that are able to offer customers a large base of ATMs from which to initiate on-us transactions, says Susan Zawodniak, NYCE executive director.
  Some institutions with large ATM bases also are forming agent-banking relationships in which they enable the cardholders of specific partners to have surcharge-free or fee-reduced access to their terminals. KeyBank, for instance, recently began enabling customers of Birmingham, Ala.-based Southtrust Corp. to use its 2,300 ATMs without being surcharged.
  KeyBank has more than 100 such arrangements and typically receives 50 cents for each transaction initiated by a partner's cardholder in addition to interchange, says Michele Mullee, senior vice president, ATM channel management.
  "We have a mature and widespread distribution channel of ATMs and this is a way to maximize that channel," she says.
  Even with more cardholders avoiding surcharges, analysts say the fees will remain a staple in the electronic banking sector because they still generate strong revenues for many deployers. And machine owners are tweaking their strategies to maximize that income.
  Some ATM owners, for instance, adjust their surcharge rates based on projected machine activity. Deployers might raise rates during high-traffic periods, such as on holidays and paydays, and lower them on quieter weekday mornings.
  "As the cost of running ATMs increases and the machine base grows-which causes the number of transactions at each ATM to go down-all deployers will look at the profitability of each device," Zawodniak says. "And if it not performing satisfactorily, they will move it."
  And a variety of factors contribute to a machine's profitability. In addition to renting space at merchant sites, ATM owners' operating expenses include the cost of maintaining and replenishing terminals, telecommunications fees and back-office operations.
  Dove reports that the average monthly expense for an off-premise ATM dropped 8% to $1,194 from 2001 to 2003. Yet, average monthly off-premise revenues from surcharge and interchange income declined 13% to $952 for that same period.
  "Some banks are retreating from the off-premise market because they aren't willing to pay the necessary expenses," Collective Dynamics' Lott says. "They are concerned with service quality and have high infrastructure costs."
  Many institutions, for instance, will immediately send a maintenance crew to an inoperable machine to ensure that downtime is minimal. KeyBank's Mullee says her institution requires 98.5% uptime at its terminals.
  But despite the expense of supporting ATMs and the cloudy revenue picture, many institutions with widespread ATM networks still expect to expand their off-premise deployments in an effort to boost surcharge revenues. Indeed, KeyBank, which has 60% of its machines located at nearly 900 branches, is searching for additional high-traffic, off-premise locations.
  About 700 KeyBank machines are in BP/Arco gas stations and convenience stores in Oregon, Washington, California, Nevada and Arizona. The bank generates about 900 monthly transactions at its off-premise sites, compared with 3,500 monthly transactions at branches. The BP/Arco machines have a $1.50 surcharge, and the other terminals carry a $2 fee.
  Foreign transactions account for 96% of KeyBank's off-premise activity, primarily because many of the machines are in regions where KeyBank does not have branches, which limits on-us transactions.
  To expedite new deployments, KeyBank, in a recently formed alliance, is using Calabasas, Calif.-based Coast ATM LLC to place KeyBank ATMs in additional locations, including casinos, shopping malls, office buildings and other high-traffic locations, and to offer cash-management services.
  Scavelli says volumes still are climbing at KeyBank's on-premise and off-site locations, and the institution has removed only about five terminals in the last year, none of which was due to revenue issues. Most of the bank's money-losing terminals were taken out in the late 1990s during a "clean-up process," he says.
  A Gamble
  While gamblers' propensity to pay surcharges makes the casino a particularly attractive ATM market for KeyBank and other machine owners, potential gaming volumes eventually could be slashed if more establishments enable customers to use debit cards and other plastic for payments.
  Indeed, Global Cash Access, a Las Vegas-based processor, last year released QuikPlay, a patented transaction process that supports debit card acceptance at slot machines. Casino patrons initiate payments by swiping their cards through terminals situated next to the machines and then keying in withdrawal amounts.
  Credits, based on the amount of a withdrawal, are automatically transferred to the slot machine, or players can choose to have a bar-coded ticket with the withdrawal value dispensed from the terminal. Users then can insert the ticket into any slot machine for playing credit, or use the ticket to obtain cash from self-service devices. Withdrawal fees, including surcharges, are the same as for casino ATM transactions.
  To help compensate for possible transaction declines at terminals in casinos and other sites, more deployers are using ATMs to offer products and services. In Dove Consulting's survey of 134 leading ATM deployers that account for more than 144,000 machines, 31% of respondents said they already offer mini-statements at terminals; 30% have advertising printed on receipts; and 25% sell stamps from machines.
  In addition, 15% of respondents said they offer coupons at ATMs; 10% provide full statements; 9% have full-motion video advertising; 8% sell telephone card minutes; and 7% supply cell-phone minutes.
  Some analysts, however, say the deployers offering such items are not efficiently using their ATMs, and the activity is unlikely to generate strong income.
  "The last thing you want to do is increase the line at the ATM by selling products, " says Penny Gillespie, senior analyst at Forrester Research Inc., a Cambridge, Mass.-based advisory firm. "It's always been a double-edge sword where banks want to minimize the length of the transaction, and still offer robust transactions to pull volume and fees into the ATM."
  About half of KeyBank's on-premise ATMs dispense stamps, and Scavelli says all new machines will be ordered with extra canisters to enable the bank to offer stamps at more locations.
  While he will not disclose volumes, Scavelli says the services are offered as a customer convenience and are not generating profits. KeyBank previously sold advertising on its receipts, but ceased the practice because it was unable to attract national marketers, which made the activity too expensive to maintain.
  "Advertisers only have a set amount of dollars in their budgets and they wouldn't commit to advertising on ATMs because it is an unproven market," Scavelli says.
  More deployers, however, are expecting increased deposits at terminals as a result of the Check Truncation Act, also known as Check 21, which was signed into law by President Bush last October.
  Check 21 will enable cardholders to deposit checks at ATMs without placing items in an envelope. After the check is inserted into the device, an electronic image of the item will appear on the ATM screen, with value then credited to the cardholder's account. The check will be truncated at the terminal and a cash transfer will be initiated through the automated clearinghouse.
  The truncation of checks at the ATM is expected to streamline institutions' processing costs, and it is triggering greater interest in machines that can support the activity, says Cassie Metzger, director of strategic development and global marketing for North Canton, Ohio-based Diebold Inc., a leading ATM manufacturer.
  While Metzger says demand for both full-function ATMs and cash dispensers is strong, some analysts predict that new regulatory requirements-which are likely to increase the expense of situating and maintaining machines-could also be a factor in driving some deployers out of the market.
  Terminal owners, for instance, will need to add functionality to run so-called Triple DES encryption. The Data Encryption Standard (DES) is an algorithm that is used to protect sensitive information, such as personal identification numbers.
  With DES, a binary number called a key is used to encrypt and decrypt data. The DES algorithm uses a 56-bit key length, but Triple DES specifies three rounds of encryption, which effectively increases the key length to 168 bits and makes the transaction more secure. Payment organizations have given deployers until 2005 to support Triple DES.
  KeyBank's Mullee estimates that it will cost $4,000 to $6,000 to make each off-premise device Triple DES-compliant. "You may see many ISOs dropping out because of this financial challenge," she says.
  Optimism
  While some ISOs-many of whom already are operating with thin margins-might be endangered, financial-institution deployers tend to be more optimistic about their ATM future.
  Memphis-based First Tennessee Bank, for instance, which operates about 500 ATMs that carry a $2 surcharge, still is experiencing volume increases at all its devices, says Mike Feehan, senior vice president, customer contact. About 60% of the terminals are situated at high-volume retail locations, such as convenience stores.
  "The overall ATM base is getting close to its saturation point, but there always are new retail developments going up which can support additional machines, and the cardholder population still is growing as well," he says. "And Check 21 will generate added transactions and allow banks to cut costs by moving more activity away from the teller."
  Strong volume, low operating costs and ample foreign transactions are three key elements of an effective ATM program. The ability of deployers to adequately respond to the changing market dynamics in each of those areas will determine their level of profitability, as well as the short- and long-term viability of the ATM fleets.