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A sobering glimpse into the future: Traditional financial institutions are upstaged by online entrepreneurs.

1Jun

Corporations and individuals wanting to finance their purchase of Gateway computers once faced an obstacle course of credit applications and credit checks. The five-hour process, though brief by some standards, nevertheless kept San Diego-­based Gateway Inc. from sending phone orders instantly to the factory floor so that assembly could begin immediately, and customers' products could be shipped in their familiar cowhide-patterned boxes.


As cumbersome back-office processes go, few are better candidates for automation than sales finance. In Gateway's case, for example, the company wants to make financing an easy alternative to credit-card purchases, and with good reason. Besides surrendering a slice of its thin profit margins to the credit-card company up front with every purchase, Gateway also relinquishes the chance to make money in the financing arrangements. And for Gateway, there was also a problem with high credit-rejection rates because the old system relied on a single lender to manually review applicants. A perfect place, one might think, for a friendly banker to step in.


But it wasn't Gateway's banks that solved the problem. Instead, it was Dedham, Massachusetts-based eCredit.com that helped Gateway slash the length of a credit decision to a mere 15 seconds last year and sharply increase the percentage of approvals. "If you are Gateway, selling more than $9 billion of computers, and there are a large number of credit applications being rejected, you're sitting there with a fairly big challenge," says eCredit CEO Venkat Srinivasan. "We said, 'Why not add more lenders to the network?'" While that might seem a simple fix, it actually hinged on the use of an intricate credit- scoring system that automated the sales financing. By turning the loans into commodities in that way, Gateway could create a pool of three financial institutions to compete for the business, and to take on more credit risks than a single lender would.


"It has become a big part of our sales process," says Gateway CFO John Todd, who is thrilled with how fast orders are now being turned into shipments--and with the decline in customer use of credit cards. Indeed, since 1997, Gateway has increased its financed sales fivefold, to more than $2 billion. "Having this financing capability makes it much easier for customers," Todd says. "And it has significantly improved our bottom line."


Gateway's success with eCredit offers corporate bankers a sobering glimpse into the future--one in which traditional financial institutions are often upstaged by online entrepreneurs boasting technologies that streamline a range of banking services. Take the case of managing bill-payments, long a bread-and-butter function of the corporate bank. Certain upstarts, such as Bottomline Technologies, of Portsmouth, New Hampshire, are launching E-billing systems that may one day bypass the banks. Or consider what the banks' customers are doing with online supply chains, through programs that are usually facilitated by high-tech aggregators. There, banks are having to learn to dance to a new tune, participating as finance partners for such marketplaces--if they are involved at all.


In fact, just to stay even with the newcomers' online capabilities, and with customers' demands, many traditional banks are signing alliances with Web entrepreneurs. The alliances seem most active in the areas of cash management and trade finance, fields in which lots of Internet-based technology is being developed and the competition is most severe. But that's not to say that other, more-traditional offerings, such as investment management and corporate lending, are immune to future online battles. The revolution in online business banking, in other words, is well under way. And while CFOs like Gateway's Todd consider getting banks to provide online services "an uphill battle," the penalty for nonparticipation is severe: disintermediation by a cadre of nimble upstarts promising better, simpler, and faster corporate-banking alternatives.



The Next Hurdle

All told, North American banks pumped $90 million into Internet corporate-banking applications during 1999, according to TowerGroup, a financial consulting and research firm, in Needham, Massachusetts, which tracks bank spending on technology. This investment in the banking industry's future pales, however, when compared with other priorities. In 1999, for example, Citibank earmarked nearly 10 times that amount--$863 million--for venture-capital activity. Citi's capital expenditures on premises and equipment, meanwhile, consumed more than $1.5 billion.


To be sure, expenditures are on the rise. Tower estimates that banks' investment in Internet-related corporate banking applications will increase by 34 percent annually to reach $290 million in 2003, with huge outlays expected for both self- developed systems and acquired technology. Such spending on services, hardware, and software will top $400 million in 2005.


There are a number of reasons why the progress in taking corporate banking online has seemed glacial so far-- especially compared with the relatively rapid Web conversion of consumer banking. Not least, corporate banking requires more- complex solutions. "The work for businesses involves the problem of how to network multiple organizations with multiple business-to-business [B2B] clients," according to Bank of America Corp.'s former managing director of syndicated finance research, Michael Rushmore, who helped plan E-commerce strategies for the Charlotte, North Carolina­based giant. (Those strategies will involve some restructuring, as well as technology investment and partnering.) Such complexity has kept banking ventures on the Internet "somewhere in the top half of the first inning on the B2B side," he admits. "That's clearly the next wave--and the next hurdle--for the industry."


To make inroads, banks will "have to build the infrastructure first," says Rajeev Agarwal, senior research analyst for wholesale banking practice for TowerGroup, who adds that this may be difficult, because "on the corporate side, all the bank units are very much managed as independent businesses." Often, reorganizations like the one Bank of America is considering are needed to allow Web-enabling initiatives to cross traditional organizational boundaries.


But it's also true that, until recently, banks have perceived their corporate clients' demand for online services to be relatively tepid--in part because businesses are so sensitive to the security issues connected with conducting large transactions through the public Internet.


When New York­based Citigroup Inc. mentioned a range of potential Web-based client services 18 months ago to its advisory board, made up of the CEOs of top customers, "everybody was kind of ho- hum, saying they'd rather talk about the real business of the day," says Ann Cairns, division executive for E-commerce at Citicorp, widely considered a front-runner in corporate online banking. Then last September, when the bank-customer group revisited some of the online initiatives, Cairns found that the executives seemed to have suddenly been won over to the wonders of the Web, and were putting pressure on their finance functions to get up to speed. "Eventually, the finance people started coming to us, wanting to know how we could help the company operate more efficiently on the Internet," she says.



Internet- Resistant Problems

However quickly the banks now want to move, it isn't fast enough for some customers. At London-based BP Amoco's U.S. unit, CFO Eileen Kamerick says she has had to push hard to speed the availability of Web- based cash management and electronic billing. It's a modernization project to which the company gives a high priority, even while its hands are full acquiring Atlantic Richfield Co. and creating a landmark supply-chain marketplace. A Web-based system, she says, "is not just something you use for procurement, it's something you use to change the whole company."


Citibank, in particular, the main cash-managing bank for BP Amoco, is being solicited to help overhaul systems that have long been bogged down with old- fashioned paper exchanges and lock boxes. But while Citibank may be "running ahead of the traditional merchant banks," when it comes to facilitating E-commerce, Kamerick says, "they're behind some of the initiatives we have at Amoco."


Cisco Systems Inc., too, sees its banks as resistant to Internet- based modernization. "I would characterize moving the banks in this area as slow," says Rick Timmins, vice president of worldwide sales finance at the San Jose, California, maker of networking devices. "The whole banking settlement process is something we're working on with the banks to change. It's a cumbersome process."


Gateway's John Todd agrees. "Today, we require all of our banks to be automated and Web-capable," he says. But basic automation is only a start, and he observes that some areas, such as foreign exchange, seem to be unusually resistant to Internet-based solutions. Still, in most areas of Gateway's relationship with its banks, primarily Wells Fargo and Norwest, Todd expects significant progress this year in moving more business online, based on "how rapidly their offerings have been changing just in the last six months."


Quality Dining Inc., of Mishawaka, Indiana, submitted a request for proposal to six financial institutions when searching for cash management services. While all six banks were able to provide the company with the necessary services, only two--Netherlands-based ABN AMRO and Bank of America-- had enough of a Web offering to meet the company's needs, says Kimberly Carnine, cash manager of the franchiser of Burger King and Chili's restaurants. With the eventual winner, ABN, "everything we were looking for has now been Web-enabled, with the exception of wire transfers," she says, adding that ABN has said that wire transfers will be available later this year. Quality Dining uses software systems outside the bank for a number of functions, including its cash concentration via automatic clearing house (ACH) file creation, through which financial institutions electronically batch and send payment files to the receiving banks.



Reebok Takes It Slower

On the other hand, a number of corporate customers worry that the banking industry is moving too fast. "The banks would like to think that ACH is going to replace checks. That's not going to happen" anytime soon--at least until "critical mass" is reached in the accounts receivable arena, says Susan Farnsworth, assistant treasurer for athletic-footwear manufacturer Reebok, in Stoughton, Massachusetts. "Retailers dictate how they're going to pay us, whether it's by wire or ACH, and the bulk [of payments] still comes in on paper. How do you deal with mom-and- pop sporting-goods companies down in the town center? Are they going to pay you electronically?"


Right now, ABN AMRO, which handles the company's trade finance, is offering Reebok a Web-based product, but Farnsworth will look at it long and hard before signing on. "I need an understanding that my data is secure there," she says, and that means checking out the firewalls and encryption procedures. "You can talk about it, but you can't touch or feel it," she says of security. When it comes to breaking new Internet ground, "I don't want to be in the forefront of that."


Even hard-charging CFO Kamerick concedes that "getting locked into any one implementation would be a huge mistake." Like other companies, BP Amoco "has dealt with the angst of implementing ERP [enterprise resource planning] systems," she notes. That experience "has taught us that you can't change your business processes overnight, and that you need to remain flexible to adapt to changing business conditions and customer requirements." The need to keep things running smoothly has increased Kamerick's desire to maintain strong relationships with organizations she trusts, such as Citibank and other long-term service providers. "The ability of the new high-tech companies to deliver on their promises needs to be evaluated against the backdrop of established service-provider relationships," she notes.



Cooperative Competitors

For many banks, the mixed reaction of corporate clients to the prospect of more online financial services validates the decision to partner with young high- tech companies, rather than build their own online-banking systems.


Take Citigroup's arrangement with Bottomline Technologies, which will deliver for Citibank customers an online electronic-billing system (called Citibank E-Billing), with the ability, for example, to make adjustments for damaged goods received. "When you're dealing with a business bill, the level of online inquiry tends to be much higher than for a consumer bill, and so does the amount of money attached to it," says Citicorp's Ann Cairns. Bottomline "has basically built a platform that handles this."


Both the bank and the entrepreneurial company benefit from these Internet alliances, Cairns says. And often, the outfits that have developed online banking systems would rather provide them to banks, and not fight the bankers for the business. "A lot of technology companies that have been competitive with banks are finding that they need to be cooperative in this space," she says. The number of alliances the bank has signed reflects how Citicorp "brings a tremendous amount to the Internet--our trusted brand, our client base, and scale in terms of our operation."


Still, Bottomline CFO Robert Eberle says that if banks fail to provide services like the E-billing his company offers, "they may lose some of that lock-box and other business they've had for a long time." Customers such as Fleet Financial Boston and UPS Capital are already using Bottomline's E-billing technology.


Traditional banks are also facing stiff competition for overnight funds, commercial paper, and unsecured promissory notes, all of which are becoming commodities in the Web environment. "As soon as you get away from a commoditizable product, the Internet works less well," says Tom Heagy, CFO of ABN AMRO­North America.



Reinventing The Space

Web-based competition may present an opportunity for banks to revise the entire corporate-banking environment and come up with something that works better for customers. "The whole business-to- business space, if we can do it right, can be reinvented around the working-capital side," says Pam West, Bank of America's E-commerce executive. "It's more than cash management that can be redesigned around the Internet," according to West. "It's credit and other parts of the payment engine of the value chain, too." But before banks can really transform their relationships with corporate clients, they will have to develop some "breakaway strategies," she adds. "Right now, our organizational structures at the bank are not geared to that."


For now, at least, much of the activity in online corporate banking will continue to be in cash management and trade finance. Most of the largest banks have acquired or developed technology to upgrade those services for the Web. Banking experts agree, however, that corporate lending and investment management--areas where banking relationships still matter to CFOs--will be slower to develop on the Web.


Meanwhile, the rise of online marketplaces to manage the procurement needs of clients promises to change banking relationships. Banks, in fact, see a good chance to enhance their image with customers by helping with this new brand of Web- based service--again, often by using alliances with Internet companies.


Citigroup recently created a partnership with CommerceOne Inc., of Pleasanton, California, whose business is E- procurement and Web-based marketplaces. CommerceOne provides the exchange platform infrastructure as its part of the alliance with Citigroup. And the relationship between CommerceOne and Citigroup is expected to grow as more industries create procurement marketplaces, generally following the model established by the Big Three automakers. Of CommerceOne, Citigroup's Cairns says, "They have built a good mousetrap--one of the best-- to allow buyers to transact in the market. We are bringing to the table all our financial know-how."


Among those financial institutions planning procurement services for small and midsize companies, Bank of America has signed on with Ariba Inc., another Internet marketplace concern. The alliance will "leverage Bank of America's procurement clout for the benefit of our clients," says Bank of America's West.


But if the alliances are designed to smooth the road as banks take more corporate business online, there are no guarantees. "The fact is that the Internet is a new world," says ABN AMRO's Heagy. "And if you don't have some failures, you're not taking enough risks."

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