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Electronic bill payment and presentment: the options for banks are becoming clear.

The options for banks are becoming clear

After several years of growing investment in online banking, banks are now faced with an important decision: what to do about electronic bill payment and presentment (EBPP) - and when. EBPP enables consumers and businesses to receive, review, and pay their bills electronically, offering advantages of both cost and speed over the way most bills are paid today. By taking paper out of the billing process, EBPP could save billers, customers, and other constituents in the United States over $2 billion annually by 2002.

For banks, EBPP represents something of a threat, in that it could lead to customer attrition and erode several revenue streams: the float associated with paper check processing, cash management fees, and other revenues associated with traditional payment processing. These revenues could be partly protected if banks were to provide - and shape - EBPP.

But EBPP also has an important strategic dimension as it promises to become an integral part of a bank's overall online banking service. EBPP can add value to the core checking account by making transactions more efficient and enabling customers to consolidate their financial information more easily. Moreover, online interactions can be used to create a more intimate relationship with the customer and promote and deliver other online products and services. If banks fail to embrace EBPP, they could be preempted by brokerage firms, financial management software providers, and others seeking to strengthen their position in the online financial services market. In addition, if these players control EBPP, they are likely to divert payments from the traditional bank networks, thus affecting wholesale revenue streams.

Currently, banks are the trusted center of bill payment for most consumers. They are likely to be able to extend this relationship on line because they are in the best position to consolidate EBPP across multiple billers. In addition, they have a head start, already possessing a three million strong electronic banking customer base that is expected to grow to between 10 and 12 million over the next four years.

However, we believe that it is only the biggest US banks that need worry about adopting EBPP quickly and shaping the models that deliver it. The rest can afford to be fast followers.

Clear benefits

The current total of relevant payments in the United States - and thus the potential US market for EBPP - is 27 billion recurring billing transactions per year, a figure that is growing by about 1 percent a year [ILLUSTRATION FOR EXHIBIT 1 OMITTED]. This 1998 total includes the 15 billion consumer-to-business transactions that are recurring, such as monthly telephone bills, and the 12 billion business-to-business transactions that take place in the United States each year.

Billers benefit most from EBPP because it slashes the cost of interacting with the customer. It reduces paper handling and postage, cuts down accounts receivable because of its faster bill payment cycle, lowers expenses related to payment errors, and results in more efficient credit risk management. On an average bill of $100, billers are likely to save as much as $1.90 per transaction in total [ILLUSTRATION FOR EXHIBIT 2 OMITTED].

If EBPP penetration reaches 7 percent of recurring transactions by 2002, biller savings will amount to $2.2 billion annually. Moreover, billers are likely to reap indirect benefits from their enhanced ability to interact with customers. A cable television provider, for example, could offer customers the opportunity to sign up for additional premium channels when they pay their cable bill.

Payees, both consumers and businesses, can derive some direct economic benefit (such as savings on postage and envelopes) from EBPP, but most are likely to find it simply very convenient. They can pay bills electronically in the same "batch processing" way they do today, but at the same time take full advantage of the possibilities of the Internet to consolidate their bills and access their account. In other words, they can conveniently access all billers from a single online location that is integrated with their main checking account, enabling them to view their account balance and activity details while paying bills.

For bill consolidators - the intermediaries that consolidate bills from multiple billers at a single online location - EBPP is a battle for influence over consumers, with high stakes.

Yet the direct revenue opportunity attributable to EBPP itself is only modest: consolidators and technology providers will likely share a transaction revenue stream of no more than $0.32 per transaction. As a result, even if 15 million US households (roughly 15 percent of the total) become active users of home banking within five years, and if EBPP achieves 50 percent penetration of their bills (both rather optimistic assumptions), EBPP revenue will still be less than $380 million in 2002 (Exhibit 3). However, dominance of the EBPP market could provide an entry into other payment markets such as online credit or debit card payments, or indeed into a much broader range of e-commerce markets.

Emerging EBPP models

At the highest level, EBPP can be separated into two models:

Direct models require the consumer to visit each biller's Web site individually to pay bills. Under this model, billers such as utilities and mortgage companies will need to build the capability both to present and to receive payment for bills directly on line if they are to take advantage of the opportunity to maintain control over and enhance the customer relationship. Direct models are likely to be successful in biller-to-business payee relationships where the biller represents a large portion of the bills of the payee and the number of bills per payee is quite high. A typical consumer or small business with a wide range of biller relationships, on the other hand, will want to have EBPP consolidated and integrated with access to its demand deposit account. For these less concentrated biller-to-payee relationships, direct models will be unlikely to succeed.

Consolidator models enable consumers to access multiple bills at a single site. Unlike the direct model, which can succeed with only limited collective industry action and using a variety of different standards, the consolidator model demands cooperation between consolidators, billers, and financial institutions. We believe that although direct models may prove viable for business-to-business payments, they will ultimately fail because consumers will prefer the convenience of bill consolidation.

Three consolidator-based EBPP models are emerging: the closed-system model, the shaper-controlled model, and the standards-based model.

The closed-system model

In the closed-system model, a single vendor controls all aspects of the EBPP system, architecture and service, and builds proprietary interfaces with billers. This vendor is the exclusive consolidator of bills, but may work with electronic banking sites and others to give consumers access to these bills. CheckFree, the leading electronic bill payment network provider, operates on such a closed system.

In 1997, CheckFree had an 80 percent share of the bill payment market, or nearly three-quarters of the current $150 million bill payment revenue stream from 2.2 million customers. It has enlisted most of the top banks, developed a biller database of 3 million businesses, and, through IBM, secured the technology capability to integrate the back-office systems of billers and banks. However, it has not unbundled the value chain in a way that would allow it to share value with other players, or that creates economic incentives for adoption. CheckFree controls and operates the entire system, having its own employees install custom software at participating biller and bank sites. As a result, it has high costs for setting up new billers and banks, and high transaction prices.

Despite CheckFree's success, we believe that this model cannot succeed in the longer term, since it will never build the scale that others with more open systems and standards are likely to achieve. Perhaps in recognition of this, Checkfree appears to be opening up its system to allow a greater level of participation by other players.

The shaper-controlled model

In this model, a single player controls the overall architecture of the system but parcels out portions of the EBPP value chain to other players. In this way, it creates incentives for the various technology vendors, banks, payment and transaction processing service providers, suppliers of personal

financial management software, billers, and independent software integrators to do whatever they can to promote adoption and challenge the spread of competing standards. TransPoint, the EBPP business owned by Microsoft and First Data Corporation, is an example of a shaper-controlled consolidator, with EBPP clearly part of a broader agenda for the two companies in electronic financial services [ILLUSTRATION FOR EXHIBIT 4 OMITTED].

TransPoint has unbundled the EBPP value chain in several ways. It is building its base of billers by encouraging biller remarketers (which might be banks or other companies with relationships with small businesses) to enroll small billers and plug them into the TransPoint system. For this service, biller remarketers will receive revenue (perhaps $0.16 per transaction). TransPoint also relies on a large pool of Microsoft resellers and systems integrators to install its software and servers at biller, biller remarketer, and bank sites.

The standards-based model

In this model, billers, banks, and consolidators agree on a common architecture, but implement it individually. By contrast with the shaper-controlled model, no single central player is pushing the standard; instead, each party stands to benefit from its success. The UNIX operating system and fax transmission standards are examples of rapidly evolving technology standards that have not been shaped by any single company. OFX and Gold are two standards-based EBPP consortia emerging in the United States.

Billers, banks, and consolidators all have incentives to push for common standards. Billers would retain control over both the format of bill presentment (perhaps, for example, choosing to advertise within the format) and the billing process. If they can be actively shaped to a structure favorable to banks, the standards will be more likely to retain participation in valuable wholesale services (including cash management and lockbox) and new EBPP consolidator services. Consumers would still get consolidated billing and, at the same time, benefit from even easier access to banking account information.

Despite these incentives, it may still be difficult for participants to agree on a common standard. Banks are likely to be at odds with billets over transaction economics and control of the customer interface, preferring a model that charges high payment fees and limits the ability of the customer to interact with the biller. Billers are likely to prefer a model with low payment fees that gives them the opportunity to communicate with the end customer. Banks are also likely to find themselves at odds with such financial services attackers as Schwab and Intuit, which advocate open standards and have much to gain from building customer relationships on the Internet.

But EBPP is likely to take off only when a critical mass of billets, service providers, technology providers, and banks begins to act in concert to promote one or more EBPP schemes. Like computer operating systems and fax machines, EBPP is an increasing returns business because it derives substantial scale benefits from network effects and investments in complementary technology. The greater the number of consumers and billers that participate in a given network architecture, the more valuable the system.

Moreover, technology investments in an EBPP standard are largely a fixed cost that can be leveraged over a growing customer base. History shows that strong increasing returns environments result in a single standard across an industry. In the absence of some non-market force such as a monopoly, a strictly closed consolidator model will not be successful. A shaper-controlled or standards-based model is likely to create the convergence necessary to kickstart EBPP.

What should banks be doing?

If banks want to see the adoption of an open-standard EBPP model that is bank-friendly, they have no choice but to collaborate both among themselves and with others (such as technology vendors). Even the largest banks do not have the reach and credibility to be shapers on their own. Collectively, however, they could influence the development and adoption of a particular open standard. That said, not all banks have to lead the way in EBPP. How each bank should proceed will be determined by its online financial service strategy as well as by the size and nature of its wholesale and retail bases.

Online strategy

For those banks that see online services simply as a low-cost service channel rather than as a primary means of improving customer retention or providing new services, there is little need to influence the development of EBPP standards. Their focus will be on getting EBPP benefits to customers when they can be made available cost-effectively.

However, banks with grander aspirations in online banking should act now to adopt EBPP, shape standards, establish partnerships with key technology providers, and develop a presence with key e-commerce players. This is true both for banks that use their online service to provide their customers with a range of products and services from other vendors (such as securities, mortgages, and insurance brokerage) and for those institutions that have chosen to participate directly in some of these new online businesses.

EBPP will create a reason to visit these banks' sites more frequently. Moreover, the battle for eyeballs, traffic, and - most important - quality leads on the Internet makes a regularly visited spot a very valuable piece of real estate, as the performance of Internet portals like Yahoo!, Excite, and Lycos illustrates. As aggregators of high-quality traffic, many financial institutions are in a strong position to capture advertising, referral, and commission revenues from any number of online merchants of financial and other products and services.

In addition, EBPP will appeal to the early adopters of online financial service shopping. Institutions that have led the way in offering online banking and bill payment are likely to have customers who will be early adopters of bill presentment. Provided these customers are attractive to keep, the banks concerned will have to remain relative leaders in EBPP or risk losing them. Leadership will mean access to the broadest possible network of billers, since customers are likely to be less concerned about the specific standards utilized than about having access to their billers.

Wholesale banking position

EBPP threatens a number of sources of revenue related to traditional payments processing, including cash management and lockbox services. Each bank should construct profiles of its customer base and existing product and service lines to gauge the magnitude of this threat. Does it have a large number of consumer billers - such as utilities, credit card firms, cable companies, mortgage companies particularly with national or multiregional franchises? Does it provide lockbox services, or have an alliance with a third party that does? Is it already the prime cash management provider for most of these firms? Does it also have a large retail franchise that will be capable of bill presentment? Answering "yes" to any of these questions will argue strongly for earlier adoption of a wholesale banking bill presentment product and service line.

In the wholesale portion of the business, the gain reaped by billet and consumer from EBPP is likely to be the bank's loss. Banks will be challenged to shift their lockbox businesses away from paper-based processing toward back-end electronic processing utility services. With their increased cash management capabilities and transaction efficiency, electronic payments will reduce the revenues created by float and the margins for efficient paper-processing businesses. Thinner margins and the higher fixed costs of electronic back-end payment processing utilities will force consolidation in the biller consolidator and payment processing business. Many banks will need to decide whether to get serious about wholesale banking, or get out.

Size of retail base

Only the biggest retail banks have the clout to help shape EBPP standards. Moreover, only they have the resources to bear the costs of the technological investments needed in what is a fixed-cost game. Players with the broadest retail base will be in the best position to make the investment in shaping standards because they have the largest amount of demand deposit account revenue and greatest number of customer relationships at stake. By choosing to position themselves as front-end bill presenters, these players can transition and enhance customer relationships on line.

Institutions that have large retail and relevant wholesale customer bases and that also aspire to have a leading Internet banking presence should thus throw their weight behind the development of EBPP standards and business processes. Their retail and wholesale positions mean that revenues and customer relationships are at risk. And they will need a strong EBPP presence if online banking is an important part of their strategy.

Large banks that are less intent on online banking may choose to play a hedge, supporting several emerging standards and EBPP schemes and pushing for convergence where possible. Though they will still need to be on the leading edge of electronic banking because of their relatively large customer base, they will not necessarily have to shape the outcome of the technology, though they should position themselves to develop an attractive and timely offering. They could, for example, support TransPoint while promoting an open standard such as OFX.

Most banks in the United States, however, should be followers: that is, not invest heavily in uncertain EBPP propositions until their value, standards, and technology become clearer. As long as some banks collectively or individually influence EBPP standards, it is unlikely that smaller or less proactive banks will be disadvantaged. Moreover, if EBPP is to be adopted on a widespread basis, it cannot impose a serious disadvantage on any institution, especially banks. While this approach is hardly exciting, it is likely to create the greatest value for many, leaving others to invest in the development of standards, products, services, and, perhaps most important, consumer awareness.

It is clear that EBPP will eventually be important in both retail and wholesale banking, and that it is likely to accelerate demand for online consumer financial services. Although the revenue potential for EBPP processing is relatively small in the near to medium term, the battle for control over standards and architecture is already beginning. For most banks, there is not much they should be doing today other than paying attention and adopting capabilities as they become cheaper to acquire. Bigger and more influential players can take action by supporting several emerging standards and EBPP schemes and pushing for convergence where possible.

The strategic alternatives that we set out in this article were informed by John Hagel III, "Spider versus spider," The McKinsey Quarterly, 1996 Number 1, pp. 4-18.

John Ouren is a consultant in McKinsey's Silicon Valley office, Marc Singer is a principal in the San Francisco office, and Jack Stephenson is a principal and Allen Weinberg is a consultant in the New York office.
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Title Annotation:Current Research
Author:Ouren, John; Singer, Marc; Stephenson, John; Weinberg, Allen L.
Publication:The McKinsey Quarterly
Date:Sep 22, 1998
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