E-finance emerged shaken but intact from the dot-com debacle.
By Jeffrey Kutler
March 2001
Institutional Investor Magazine
And now it’s the big, technology-rich institutions that are flexing their e-muscles.
The Internet was supposed to change everything. It didn’t - but it is transforming finance click by painful click.
Last year the pain was more evident than the progress. The stock prices of public Internet companies plunged. Start-ups disappeared. Funding dried up. But while dot-com businesses crashed and the corporate world recoiled in terror, the biggest banks and brokerage firms dramatically increased their online activities. And they did it without forsaking the historical strengths - back-office infrastructures, branch networks, customer service staffs - that some rushed to write off when the Internet was new and exciting.
The Web may have changed the way people buy books, but it did not sweep all institutional structures aside, abolish the laws of economics and business cycles or eliminate people’s needs and desires for trusted - and human - sources of financial advice and expertise. Those constants played into the hands of companies like Citigroup and Bank of America, Fidelity Investments and Merrill Lynch & Co. After being all but written off, and after running scared for years, they’re as strong as ever, but more responsive to marketplace developments.
In all, the U.S. brokerage industry has opened 18 million online accounts in the past six years. Despite the technology market crash, these accounts generate millions of transactions a year for increasingly automated exchanges and alternative trading platforms. Banks have signed up more than 12 million customers for their Internet services, which are rapidly expanding from basic deposits and loans to electronic bill-paying and sophisticated money management techniques. E-business initiatives are becoming pervasive on the corporate side of banking, complementing the rise of business-to-business networks for information services and product procurement.
This is just the beginning of an irreversible change in the financial services landscape. Take, for example, aggregation, which, more than any other Web-based technology, took the banking and brokerage industries by storm over the past year. In early 2000, wary financial companies fought aggregation - the ability to deliver via the Net a consolidated electronic view of all of a customer’s accounts at all institutions - because it gave more power to their customers, whose loyalty they feared losing. Aggregation, also known as screen scraping, came under fire from consumer advocates who worried that it would open the way to unauthorized access and invasions of privacy.
A year later such fears have gone the way of many dot-coms. Aggregation has gone mainstream. Every major bank and brokerage firm offers it; so, too, do nonfinancial players like AOL Time Warner and Yahoo!. Deryck Maughan, the Citigroup vice chairman who oversees its Internet activities, now thinks that the customers using aggregation seem more likely not to stray. Citigroup ultimately expects to keep them in the fold, not just with an online service, but by “leveraging the brand, customer base and physical plant,” says Maughan. That’s what sets the “clicks and mortar” giants apart from pure dot-coms.
Though still in an early stage of evolution, aggregation demonstrates the potential of financial services married to the Web - and the potency of the institutions capable of harnessing that potential. The power of scale is real in finance.
“One day soon, everything you need - flight itinerary, health care providers, entertainment options, financial data - will be accessible by a simple voice command. You’ll ask your mobile phone, ‘What time is my flight?’ and it will tell you,” says Anil Arora, CEO of Yodlee.com, the dominant seller of aggregation software.
“There’s a critical difference between financial services and businesses like Amazon.com,” says Beth Morrow, senior financial industry analyst with Ernst & Young. “Amazon has to deliver physical goods; its problem is insurmountable if it can’t cover delivery costs. Online financial services is the complete opposite. At a certain point there is no marginal cost for transfers of data. Then you are making more money, not less.”
Small wonder, then, that the biggest financial companies weathered last year’s technology-market downturn and plowed ahead into 2001 with a stronger determination to promote e-finance and e-business initiatives. “It’s not unreasonable to think that a slowdown is coming, but I haven’t seen it,” says David Littlewood, Sun Microsystems’ director of worldwide financial services. “These firms are more and more dependent on technology for competitive advantage. The leading-edge, high-profile projects that we get involved in are proceeding, because they are seen as critical to the businesses.”
Led by Citigroup, whose technology budget is more than $6 billion, U.S. commercial banking companies will spend more than $30 billion this year on information technology, according to the Needham, Massachusetts, research firm TowerGroup. The securities industry will spend an additional $20 billion. TowerGroup analyst Michael McEvoy says that 80 percent of the banks’ technology budgets is nondiscretionary, meaning that they are so “mission critical” as to be immune from cutbacks. (The securities industry percentage isn’t quite that high because it has been slower to invest in cost-reducing infrastructure.)
That helps to explain why, in the year since Institutional Investor published its first list of pacesetters in e-banking, e-brokerage and related aspects of e-finance, the financial industry has many more Internet accomplishments to celebrate. To be sure, there is no shortage of woe in e-finance. Dot-com excesses certainly hit home in the securities markets: The boom in investing left an overabundance of trading networks and online brokerage firms. Shakeouts seem inevitable.
The change in climate makes this Online Finance 40 different from last year’s - but not so much as to topple Charles Schwab & Co. co-CEO David Pottruck from the No. 1 spot. Even before the Internet’s popularity soared, Pottruck had the clicks-and-mortar religion. Schwab retains its competitive edge even in the face of cost-cutting pressures not seen in the brokerage business for a decade. Predicts Pottruck rival Christos Cotsakos (No. 7), CEO of E*Trade Group: “The carnage is going to be widespread. Only a few companies are going to be able to survive in this environment.”
Survival was a big issue for the Online Finance 40. This year the list includes 20 new names. Most work in major banks or brokerage firms, or in organizations owned by them. Only one of the newly ranked companies - online payment service PayPal - fits the classic description of a dot-com that sprang from a Silicon Valley denizen’s bright idea. A few others came out of entrepreneurial nowhere - foreign exchange marketplace Currenex, money management portal InvestorForce.com and Latin American consumer site Investshop.com - but all benefit from strategic financial backing from established institutions.
Examples of deference to the reigning powers abound. Hoping to accelerate mass acceptance of electronic bill-paying, CheckFree Corp. CEO Peter Kight (No. 6) negotiated a strategic alliance last year with Bank of America, giving BofA a 16 percent stake in the Atlanta-based processing company. Kight hopes to entice other banks into similar relationships.
Many financial services executives view Yahoo! and its mass-marketing power as a competitive threat, but Yahoo! Finance director Timothy Sheehan (No. 3) demurs. “We want to partner,” he asserts. One reason: Yahoo! wants to avoid being regulated as a bank. “The AOLs and Yahoo!s can only push it so far as financial supermarkets,” avers Ted Spooner (No. 21), CEO of Corillian Corp., a leading provider of online banking software. “Sooner or later it becomes confusing to the consumer, who questions the independence of the provider.”
This is not to say that financial companies are home free, or mistake-free or immune to future threats. “The challenge for a Citi, a BofA or a Bank One is in execution: Can they deliver a differentiated product in real time?” says Spooner.
While they work on the basics, they must make sense of advances like wireless technology, which Maughan refers to as “last year’s hype.” Certainly, mobile phones and finance have yet to gel. “We fell into the same trap that we did when the Internet first came along. We assumed that it would work for banking just because a lot of people used it,” says Mellon Financial Corp. e-commerce chief Janey Place (No. 32). But the wireless disappointment didn’t deter Wells Fargo & Co. from announcing in February the first nationwide mobile banking service by a major U.S. bank. Nor did it discourage Fidelity, a leading wireless devotee, from arranging to deliver data to customers’ OnStar devices in General Motors cars.
Before the Internet shocks of the mid-1990s, few financial executives would have been conversant with such subjects. Says Place: “The goal of technology used to be to reduce and manage risks. Now we are using it also to actually compete, to take risks, which is why it’s more actively managed.”
Denis O’Leary (No. 12), co-head of J.P. Morgan Chase & Co.'s LabMorgan development unit, talks the talk of a new and hard-earned swagger of e-finance: “We spend $4 billion annually on technology, and we’re starting to look at that spending not as a budget line item to be rationalized, but instead as a portfolio to be maximized. Now that the tulipomania is over, the new ideas and technologies are going to be put to work by the traditional players in our industry.”
