Tech LiTe

  After gorging on technology investment for years, the card industry took a decidedly more moderate approach in 2002-a trend likely to continue in 2003. What are the implications for long-term competitiveness?
  The question troubling card-industry leaders as 2003 begins is like some knock-off of Shakespeare's Hamlet, "To spend or not to spend?"
  The question applies to technology investments in everything from computers and software to telecommunications systems, the idea being that productivity improvements will sooner or later justify the cost. The same goes for spending on new, high-tech products that will boost sales.
  For the card industry, the answer had been a no-brainer. If you wanted to beat the competition, you had to invest in developing new products and services while building system enhancements.
  But the economic doldrums since 2000 may have changed the answer for many.
  For many credit card issuers, chargeoff rates are still high. And for merchant acquirers and transaction processors, volume growth is slower than it was in the go-go 1990s, particularly on the credit card side. Reduced revenue growth can mean less money for research and development.
  Still, cards are an R&D-intensive business and there are many proponents for continued spending. Tough times offer winning companies the opportunity to pass competitors that have hunkered down to ride out the storm, according to Cathy Corby Parker, senior vice president of product marketing and management at Tempe, Ariz.-based merchant processor Vital Processing Services.
  "In this industry, you've got to keep investing," says Parker. "You don't have the luxury to say, 'The economy is soft. Let's pull back.'"
  The transaction-processing business requires constant upgrades of core systems infrastructure, she says. Competitive demands also drive spending on platforms to support new products like smart cards and growing services like customer-loyalty packages.
  But some managers claim it can pay to lay low. The situation is akin to race car drivers who have made an art of riding right behind the leader, "drafting" for some laps until the time comes to make a passing move.
  Chris Alexander, chairman and chief executive of point-of-sale terminal maker Hypercom Corp., says his firm has cut R&D spending and instead is devoting its resources to expanding the market for its ICE terminals introduced in 2000.
  "We are focusing on corporate goals," Alexander says. "We're not just doing something for the sake of technology."
  For the business world beyond cards, there was a spot of good news from a December information-technology spending survey conducted by international investment-banking firm, The Goldman Sachs Group Inc. The report's name, "From the Swamp to the Treadmill," summed up all too well the mood of the IT managers at surveyed multinational Fortune 1,000 companies.
  Information-technology spending will rise only 2% to 3% in 2003 with most of the increase coming in the second half of the year, according to Goldman. The firm found that over the long haul, IT spending would increase at an annual rate between 6% and 7%.
  Similarly, recent studies of the card industry's R&D spending plans indicate an unspectacular rise this year.
  Big Comedown
  IDC Meridien Research predicts that spending on information technology in 2003 will grow about 6% to $21.35 billion from $20.15 billion in 2002 for firms in its consumer-banking category, which includes large banks and publicly traded card processors. Framingham, Mass.-based IDC defines IT spending as internal and external expenditures on all technology requirements including hardware, software and services in addition to staff salaries and benefits.
  While the total is up, the growth rate represents a big comedown from the dramatic increases of 19.3% in 1999 and 11.6% in 2000, according to Bill Bradway, group vice president, retail financial services. Those increases were driven by a combination of Internet euphoria and preparations for Year 2000 computer conversions, according to Bradway.
  By 2001, the Internet bubble was popping and Y2K spending was virtually complete. Firms still spent on technology, though the growth rate from 2000 to 2001 slumped to 4.6%.
  But the growth cycle for consumer banks forces them to pump more money into technology if they want to remain strong, says Bradway. "The attributes of a survivor is to keep growing and to use technology to support the bigger organization on a cost-effective basis," he says. "Technology is the driver for successful financial institutions to garner new customers and develop new products."
  That may be true, but keep in mind that about 90% of all IT spending by the finance industry is on maintenance-not new projects, says Octavio Marenzi, managing director at Celent Communications. The Boston-based research and advisory house estimates financial institutions' IT spending will grow by 4% this year, about the same rate as in 2002.
  Banks are reluctant to invest in new technology because they still have a hangover from overspending several years ago, especially on Internet-related schemes that didn't pan out, according to Marenzi. This pullback comes despite 41-year-low interest rates driving down borrowing costs and boosting banks' bottom lines.
  "Banks (today) are much more sophisticated consumers of Internet technology," he says. "There's a healthy skepticism of what technology can do for them."
  Instead of creating new projects, Marenzi says, financial firms will devote their technology spending in the next few years to the modernization of legacy (mainframe-based) computer systems. Also, the merger and consolidation trend will continue, which means system-integration projects will eat up funds.
  Major issuers will see incremental IT spending increases in 2003, says Theodore Iacobuzio, director of consumer credit for Needham, Mass.-based consultancy TowerGroup. The emphasis will be on maximizing the profit from existing customers rather than garnering new cardholders.
  "The top 10 issuers have three challenges: How to keep the profitable (customers); how to make the marginally profitable more profitable; how to lose the non-profitable," says Iacobuzio. "That's where their money is going."
  The result will be spending on data mining and more sophisticated account segmentation to enhance profits.
  Marenzi says some major financial institutions will choose to outsource much of their technology needs. He notes that American Express Co. last year hired International Business Machines Corp. in a $4 billion, seven-year agreement. IBM also is in negotiations with J.P. Morgan Chase & Co. in a deal that could be worth an estimated $7 billion.
  Vital's Parker is in full agreement with the outsourcing trend, claiming that financial institutions often can get more return from their dollars spent with outsource specialists than on dollars spent for in-house technology development. "We love it," says Parker.
  The in-house versus outsourcing debate aside, the current sluggish environment is the time to grab market share from complacent or nervous competitors, according to Parker. "They may decide it's time to pull back," she says. "That's when you create a market-share shift."
  Wireless payment is a good example of a product that is now only a niche but that the industry has to be prepared to support as it grows, she says. Last September, Vital forged a three-year pact with U.S. Wireless Data Inc. Together, the two will serve 90% of the mobile-telephone coverage areas in the U.S.
  While not revealing spending on R&D, Vital's co-owner, Total System Services Inc. (TSYS), will spend about $50 million in 2003 on upgrades to its own TS2 processing system, and improvements to several of its customer-service systems, says Kenneth L. Tye, executive vice president and chief information officer. That doesn't include operational spending on enhancements to telecommunications systems.
  A Sign
  TSYS has been a major R&D force in the card business, spending about $200 million in the 1990s to create, build and implement TS2. Columbus, Ga.-based TSYS claims that building TS2 from scratch today would cost $1 billion.
  The investment appears to have paid off. TS2 has made TSYS a first-tier processor, handling transactions for issuers like Bank of America and Providian Financial Corp. and both the cobranded and private-label card processing for Sears, Roebuck & Co., Target Corp. and Nordstrom Inc.
  So it may have been a sign last year when TSYS chose to go the outsourcing route. It too chose IBM in a five-year, $194 million deal. TSYS gets access to IBM's vast array of computer processing power as well as fiber-optics communications technology, says Tye. The outsourcing decision was based on cost considerations and the capacity that IBM offered.
  "We (now) have more computing power, more storage," he says. "We can implement fiber technology. That reduces our costs," adding that "with this economy we look carefully where we spend and where we spend customer dollars."
  The growing demand for computer capacity by the industry is due to new service requirements such as nightly analysis by credit-scoring systems and the expansion of products like smart cards, according to Tye.
  TSYS produces smart cards for clients such as Providian, but those cards have used single-application chips, says Tye. The world is migrating to multi-application chips, which means more capacity will be needed to handle programs like loyalty and other hoped-for uses, he says.
  International expansion also drives capacity needs. Some Asian languages demand two bytes to store a character compared to one byte needed for an English character. So TSYS spent $8.8 million through September 2002 expanding TS2 to accommodate Asian language requirements.
  The world's largest card processor, First Data Corp., with estimated revenues of $6.9 billion in 2002, wouldn't disclose its plans for R&D spending for 2003. A spokesperson for Greenwood Village, Colo.-based First Data, however, notes that the company's spending on system conversions and development to secure customer contracts totaled $178.8 million in 2001 and $155 million through the first nine months of last year.
  One powerful force that could drive card-industry tech spending is the government, which is attempting to thwart terrorism, in part by tracking suspected terrorists' financial transactions and the money-laundering operations that fund them. The year-old USA Patriot Act puts some monitoring requirements on the card industry, but exactly how or if that is translating into technology upgrades is still unclear.
  "The Federal Deposit Insurance Corp. and state agencies are focusing on disaster recovery," says TSYS' Tye. "We're also seeing greater interest by our customers."
  Meanwhile, financial institutions shouldn't forget the threat from a lone computer hacker or a criminal enterprise, according to Omaha, Neb.-based Solutionary Inc. Only the U.S. government tops financial institutions as a target for sophisticated computer criminals, according to Solutionary, a security consultancy to issuers and other financial institutions as well as Internet retailers. And being a repository for consumer card data makes issuers and processors huge targets in the finance category.
  Jeff Guilfoyle, the company's vice president of systems and security, says financial institutions will be spending more on security this year, driven by the Sept. 11, 2001, terrorist attacks and last November's arrest in New York of three men alleged to have gained access to confidential credit information on more than 30,000 consumers.
  Computer viruses and worms will become even more sophisticated in 2003, according to Guilfoyle. Also under threat are retailers. Merchants will see more "brute force" attacks on their systems as hackers push through hundreds of bogus card numbers simultaneously, he predicts.
  Protecting its database and ensuring customer privacy will remain top concerns at merchant processor Global Payments Inc., according to Barry Lawson, executive vice president and chief information officer.
  Global wouldn't break out its R&D spending, but Lawson says 2003's will be about the same as 2002's. Global processed 2.7 billion transactions for over one million merchant locations during fiscal 2002 ending last May.
  'What-If'
  Lawson says Global will be investing in technology to expand its presence in the government, mail-order and recurring-payments segments. The Atlanta-based firm is building on its so-called Global Access Advantage online merchant information service, which was rolled out at the end of 2001. The goal is to shift more customer inquiries to the Internet, thus reducing phone calls and the need for personal staff involvement.
  "We want to expand that with more information and enhance the ease of use," says Lawson. "Now that it's in place we can be more creative, do more 'what if' on the information that is available."
  One firm that is unapologetic about easing off on tech spending is Hypercom. The Phoenix-based terminal maker and marketer reduced its R&D spending from $41 million in 2000 to $29 million in 2001. Through September of last year, Hypercom spent $18.8 million on R&D-related work. As for tech investment this year, Alexander says Hypercom will spend about the same as it did in 2002.
  The reductions came after major investments in development that led to the 2000 introduction of its ICE line of terminals, Alexander says.
  "We were doing too much, too fast," he says. "Now we are down to more normal levels."
  Eagerness about the ICE line may also have led Hypercom to introduce six products in less than two months. "We learned it makes sense not to bring out an entire product line at one time," says Alexander.
  Hypercom took a special charge of $16.1 million in the third quarter of 2002 to write down restructuring costs and discontinued product inventories. Alexander stresses the charge has no relation to the R&D spending cuts that began two years ago. The restructuring was due to near term economic and political issues in Latin America, he says.
  Old Fashioned
  The goal now is to expand the market for its existing product line with China offering huge opportunities. Hypercom manufactures all of its terminals there with the exception of some that it outsources in Brazil. Alexander says that the integration of China into the World Trade Organization will spur tourism and business development, leading to the potential sale of millions of terminals.
  The recent past has been a challenge, admits Alexander. Many Chinese merchants use an old-fashioned sprocket-style printer on their terminals, while ICE terminals come with a thermal printer. So Hypercom adapted.
  "We added the sprocket and came up with the next generation," Alexander says, adding that the philosophy at Hypercom these days is "we will leverage what we do well and add features."
  Plans call for Hypercom to shift into non-traditional areas for terminals. That includes printing of hunting and other licenses for government agencies along with biometric readers at airports.
  "By 2007, our goal is 50% of our revenue coming from non-traditional areas. Now it's less than 10%," Alexander says.
  Back in September of 2001, TowerGroup estimated that IT spending by the merchant-acquiring sector would grow 6% annually from 2001 through 2004. The study may be dated but the numbers still appear valid, says Iacobuzio. TowerGroup includes acquirers, processors and independent sales organizations in the merchant-acquirer category.
  In 2002, the industry segment spent an estimated $1.06 billion on POS terminals, transaction software and back-office technology. That should rise to about $1.13 billion in 2003, according to Tower.
  The bank card associations tend to keep quiet about their tech spending. But like the proud owner of a refurbished 1960s sports car, MasterCard International can't help crowing about its GTO.
  Being Careful
  That stands for Global Technology Operations, the 550,000-square-foot, $300 million processing center and campus that MasterCard recently completed in O'Fallon, Mo., near St. Louis. The Purchase, N.Y.-based association invested $136 million in the land and building and another $160 million to develop and deploy the computer upgrade to its BankNet network.
  MasterCard estimates that 97% of its transactions will be routed through O'Fallon and brags it takes 130 milliseconds, or less than two-tenths of a second, to authorize, process and store a transaction through the system's 95 miles of copper wiring and fiber-optic cable. Transaction settlement also will be processed through the GTO, though separately from the authorization side.
  Determining where to best put your resources is always a hard decision, made more difficult today when resources are so tight. Card-industry leaders seem to be saying they will be spending on R&D this year, but in a careful and moderate manner. After years of the so-called bubble economy, maybe moderation is the key to long-term sustainable technology development.