For more than a year, banks have been advised by consultants and other industry observers that it was time to focus more on their payments businesses, specifically by managing payments outside their traditional product silos. While a few banks heeded the call, most continue to take a wait-and-see approach.
Such caution is ill-advised and could be detrimental long term. A strategic focus on payments is one of those few "imperatives" that is both doable from an organizational point of view and also promises an early return on investment. The key is to approach the task with a viable strategic framework, using an information collection and presentation tool known in some quarters as a management "dashboard."
Fundamentally, a dashboard provides a framework for analyzing competitive and economic issues within the context of specific market metrics and precise options for product, pricing and positioning. A dashboard provides an institution with an at-a-glance view of how it's performing in various areas and measures its progress against its goals. Management dashboards are designed to help foster understanding, align commitment, focus attention and often, but not always, allocate resources on a transitional emphasis that transcends normal, day-to-day activities — essentially prompting the institution to prioritize and commit the entire organization to certain activities.
Typically, the new emphasis can be articulated only by less-baked and unproven benchmark measures (e.g., market size, product margins) of initiative and performance because necessary assessment mechanisms and accounting/IT tools have yet to be developed. Over time, transitional dashboards either go away, or become a part of the normal complement of information technology (IT) reports and business unit monitoring. That's what happened during the Y2K period, for example, and when banks were subject to money laundering scrutiny in the wake of 9/11 and the passage of the Patriot Act. Essentially, a dashboard allows an institution to turbo-charge its response to a specific issue before that response settles into a day-to-day routine.
The rationale for using a dashboard approach to deal with the converging payments environment is three-fold. First, payments provide the core of many banks' business overall, accounting for between 35% and 40% of revenue and income — this tends to be demonstrated once payments activities across various product lines are defined and accounted for.
Second, payments operations and processing have been systematically outsourced to processors for two decades, resulting in banks directly controlling less than 20% of the $220 billion in payment industry revenues today.
Finally, many components of the retail payments business are under attack by non-banks and non-banking products, threatening to erode, perhaps permanently, the ability of banks to benefit in the future from their historical franchise. As the mass migration of payments from physical to electronic forms marches on, the threats to this most genuine of bank heritages will only grow.
Beyond the considerable danger of surrendering full control of their payments destiny, the nation's retail banking institutions face additional challenges.
Most retail banking customers don't care how or why banks can't make payments the way they want them made. They just expect payments to be handled efficiently and cost-effectively, and will shop their business accordingly.
Forecasters such as the Boston Consulting Group (BCG) project a steady 3% to 4% decline in revenue-per-unit on payments products for the foreseeable future, meaning that banks must invest in both better productivity for existing products, as well as newer products that have better margins, in order to maintain or grow profits.
Wall Street has caught on to the strategic importance of payments, with analysts routinely grilling bank executives on how they're doing in this core business sector. Lapses in articulating and demonstrating prowess translate into lower market valuations.
Having set the backdrop, then, for the need to develop a payments dashboard, the following is a point-in-time report on the work involved in creating a payments measurement discipline. We'll discuss the challenges of taking such a project on and the drivers of a dashboard prototype in the context of a relatively new payments product that might otherwise be relegated to a payments silo operating well under management radar.
Mounting a proportional and sustained response to the emerging payments "mandate" is a far from trivial task. The forces of change across the payments space are compelling banks to rethink their decision process on products, markets and competitive positioning along several dimensions.
This sort of sweeping change in a core part of the business has prompted many financial institutions to take the plunge and get started with re-engineering their payments strategy and operations from soup-to-nuts. Getting started down this path, however, has proved daunting for most banks, owing to the lack of IT tools and approaches for extracting the necessary data about payments from legacy product silos.
Historically, these silos came about as new banking products aimed at specific markets emerged and were managed in a monolithic way. There was no real mandate to look across the enterprise for a holistic view of things until the turmoil in payments began. While IT support vendors, such as Oracle and IBM, are busy fielding purpose-built database management tools to achieve an enterprise-wide view of payments, banks still face the daunting task of getting started, relying largely on manual methods.
As the table above suggests, early embracers of payments dashboards are often forced to start from scratch, developing and applying new data definitions, new data collection techniques, new cost accounting calculations and new report formats.
As experience grows, these manual tools are iteratively tested and improved, and eventually work their way into mainstream IT tracking and reporting activities — generating true and relevant dashboard metrics automatically.
We contend that there are four basic drivers in creating a payments management dashboard:
Step #1: An internal assessment of the importance of the payments businesses to the institution;
Step #2: An evaluation of the customer perception of the institution's payments capability;
Step #3: An analysis of the institution's operational performance and efficiency;
Step #4: Communication of the institution's relative market position and performance in the industry.
The table extends the drivers by providing key components, typical metrics and examples of the types of analyses to be done for each.
The Difficulty Inherent in Understanding Payments
A 1999 Federal Reserve study revealed that among the top 25 bank holding companies, payments revenue and income averaged 40%. But, the range was between a low of 4.5% to a high of 74.9%, meaning that there's considerable variation between the extent to which our largest banks rely on their payments businesses.
Typically, one of the highest hurdles is extracting the specific portion of revenue and cost from a given product line. For credit cards and wire transfers, almost all of the activity is payments-related, so it's easy to count. DDAs are a bit trickier. Do you count the interest arbitrage for a relatively dormant set of deposits earning a less than 2% rate of interest the same way you would a non-interest-bearing checking account, which is primarily used to make payments and transfers? Probably not. Another consideration: fees from overdrafts can carry huge margins of 90% or more but put customer satisfaction and loyalty at risk. Should they be netted out for customer attrition and retention offsets? Probably so, if the financial institution wants to remain viable in the business.
Trickier still are lending products. A car or home equity loan is essentially a one-time, interest-bearing obligation between the borrower and the lender. Yet the monthly payment aspect is central to the value proposition. Payment amounts are directly correlated to loan amounts, interest rates and risks. Additionally, there are a wide variety of payment mechanics that affect the relationship, such as pre-payments, accelerated payments, partial payments, and late payment penalties and fees. Managing the payment aspects of loans has a lot to do with repayment performance and ultimately line-of-business profitability.
The Electronic Bill Payment Example
The difficulty in transitioning to a payments dashboard and approach can be vividly seen with electronic bill payment (EBP), one of the most dramatic examples of consumers finding their own paths to payment efficiency and cost-effectiveness. Researchers estimate between 20% and 30% of American households pay at least one bill online a month; some pay a dozen or more. Gartner Group projects that 65 million adults will be paying bills online by 2006.
But three out of four electronic bill payers choose to go directly to the biller rather than use bank payment portals or consolidate payments through a third party because this "biller-direct" model enables the payer to be certain that the payment is made as late as one to two days before the due date with no risk of incurring a late fee. EBP is a great battleground and testing area for banks remaining in this potentially huge payments business of the future.
BCG provides an analysis of EBP impacts that illustrates the assessments, knowledge, analysis and new thinking that has to take place in all four of our generic payments dashboard drivers, and the following draws on BCG's work.
Step #1: Internal Assessment of Importance to the Institution
Counting customers who sign up for and use EBP is straightforward since customers must enroll online with their payment account. Assessing and segmenting customer activity levels is also easy. What and how much they pay is readily discernible. And detecting competitive use is easy, too, since online access to the payment account can be monitored. But that's where the simple part ends.
Calculating revenues and income per-unit in a nascent, fast-growing market where external competition (biller-direct models) has the dominant market share proves to be much less straightforward. Although these electronic payments cost significantly less than processing paper checks from the bank's perspective, most banks try to charge EBP customers monthly account or usage fees. Many banks outsource electronic bill payments to third parties like CheckFree Corp., paying per-account fees of up to $5 a month, and it's understandable they want to recover those costs. EBP customers, who are quite savvy and willing to shop their payments business for better deals, resist paying fees, however, resulting in banks waiving those fees about 40% of the time, according to BCG.
And, BCG thinks waiving the fees for these customers is a good idea and tells payment councils to take note: A typical bank with two million DDAs and 144,000 EBP accounts (a 7.2% penetration) could waive all of the standard fees (about $5.5 million a year in income, based on average rates with 60% retention) and recover the lost income merely by increasing EBP account penetration to 7.9%, or just 15,500 households!
Step #2: Customer Perception of Performance
This is true because, as BCG's analysis of a number of large banks shows, active electronic bill payers (those doing six or more payments or transfers a month) are twice as profitable on average than the typical customer. BCG's metrics estimate that the average retail banking customer generates $350 a year in margin, so the EBP customer is worth $700 a year, or an incremental $350.
That $350 a year in extra margin per EBP customer is due to the typical EBP customer using more bank products, maintaining higher balances, conducting more and larger transactions, etc. Not a bad segment to target and prioritize product and marketing resources against. But how many banks have done the spade work necessary to conduct a similar analysis? And how many have examined online account access logs or ACH receiving streams to know what portion of this activity they're actually getting from these customers?
Step #3: Operational Analysis
Moreover, how do banks conduct a proper build-versus-buy analysis, calculating a correct ROI, for deciding whether to outsource electronic bill payment? A monthly per-account cost of $5 for an average bill payer making six payments a month comes to about 80 cents each. Consumers often don't pay that, for reasons cited in Step #1, although there is some evidence that they might pay something for higher value-added features, such as e-mail alerts and notifications. If banks rely on their historic accounting systems, treating products as silos and fully costing each activity within those silos, including payments, the burden of fixed costs and other overhead can often make even the 80-cent charge seem attractive — which is why so much of the EBP business is outsourced. In reality, marginal costs of incremental electronic payments are more like 20 cents to 25 cents, and those fall quickly as Web-based technology takes over operations.
Step #4: Communication of Positioning and Perspective
Doing the preceding cost analysis and channeling efforts to recruit active electronic bill payers would appear to be well worthwhile. To return to the BCG example, the bottom-line benefit of 14,000 incremental customers generating $350 a year in incremental profits translates into $5.25 million a year in profits from this line-of-business initiative alone. At a stock multiple of, say, 19 times, discounted over some assumed lifetime of the customer (EBP customers are much "stickier" than average), the bank's reward for garnering this relatively small number of new customers could amount to more than $750 million in incremental market valuation! It's hard to find many other bank initiatives delivering that kind of upside.
It's also difficult to identify clear-cut cases of banks that have been able to get this process right. Based on some presentations during BAI's TransPay 2004 Conference + Expo, however, one can point to a few institutions that clearly understand the problem and are taking concrete steps to meet the challenges of this new payments environment.
Charlotte-based Bank of America Corp., for example, appointed a payments leadership council with a focus of driving payments business growth across the enterprise, identifying threats, synergies and opportunities; resolving conflict; and influencing the industry/shaping the payments landscape (Step #1). Senior vice president Jonathan Wilk serves as chairman of this council.
For Bank of America and others, much of the early work in upgrading management understanding, direction and control of payments has been focused on these kinds of organizational initiatives, and rightfully so. Appointing a payments guru who then interacts with a payments council typically made up of business-line managers and executives from across the enterprise is a necessary first step.
As time goes on, institutions will surely see the need to continue deeper into the process as the industry mobilizes to once again steer its own future in payments.
Mr. Mott is principal of BetterBuyDesign, a payments system consultancy based in Stamford, Conn
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