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 / First Quarter 1997 / Issue 6(originally published by Booz & Company)


The Internet and Retail Banking

But the high profitability of Internet banking customers is likely to prove a mixed blessing for banks because of two other changes coming down the Internet pike: lower switching costs and new competition.

Switching costs are an economist's way of quantifying how difficult it is for consumers to change banks. According to the study, Internet banking promises to reduce those switching costs by almost 80 percent.

These lower costs, in turn, will open the door to a slew of new competitors. For example, much as they have done in the credit card and health care industries, marketers experienced in targeting discrete groups will no doubt home in on the highly profitable Internet banking customers. Using sophisticated marketing techniques, these competitors will attempt to "cherry pick" the banks' customer bases.

Banks that fail to respond quickly will be caught in a classic case of adverse selection similar to what major credit card issuers faced in the early 1990's and the Blue Cross/Blue Shield plans faced in the 80's. As the banks' most profitable customers are "skimmed" by the cherry pickers, the banks' average service costs will increase, making them less competitive.

To make matters more difficult, the Internet is also creating an entirely new species of financial services competitor. Termed "Integrators," these institutions sit between the banks and their customers. There they serve as the customers' financial gatekeeper: creating a consolidated picture of their finances, providing information and advice and suggesting the lowest-cost, highest-value products and services.

One early version of an integrator is Intuit's Quicken Financial Network. In a hint of things to come, the Quicken site already offers a life insurance quote service that lets consumers review educational material and then shop for and purchase insurance policies all over the Internet. In return, Intuit gets a small commission from the insurance carrier that the customer selects.

Extend that same arrangement to, say, certificates of deposit or checking accounts and it is easy to see why these integrators could quickly become powerful as well as controversial players in the banking business.

In the end, the study found that the net effect of Internet banking would be to put a significant number of a financial institution's most profitable customers into a highly competitive arena. Once there, the customers will find that they can not only switch institutions easily, but that they will have hundreds of alluring alternatives to choose from. Not a pretty picture for bank executives and shareholders.

Learning to Succeed in the New Environment

How will financial institutions hold on to their customers in this new environment? The early signs are that two key elements will play a role: customer knowledge and decision-science capabilities.

Almost all financial institutions have customer information, but very few have true customer knowledge. For example, although almost any institution can tell you what products its customers use, very few can reliably tell you how profitable their customers are or what products they are likely to need next.

Customer knowledge in and of itself will not help a financial institution. To be successful, the institution must be able to translate that knowledge into customized product and service offerings that appeal directly to the needs of individual consumers. This is where decision-science tools -- like predictive models, data mining and intelligent agents -- come in. These leading-edge tools will help a financial institution act on customer knowledge and deliver truly personalized services and products.

Ultimately, the idea is to create products and services that are so unique and useful to customers that it once again becomes difficult for them to switch to another institution.

It remains to be seen whether financial institutions can actually accomplish this goal. But one thing is sure: if they don't, they will put some of their most attractive customers at risk.

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