What’s Next for Internet Banking Vendors

Is it just me, or has the world of Internet banking vendors gotten boring lately?

Online banking was once a “cutting edge” project that consumed a ton of a bank’s time and attention. Now, banks seem to be approaching Internet banking systems with all the passion and excitement of a voice response unit or an ATM replacement.

This is bad news for the vendors. Internet banking is becoming hyper-commoditized – and “commodity” surely spells mongo pricing pressures in the years ahead. Last year, Gonzo’s own Carl Faulkner wrote about the growing cadre of mid-size banks that are writing their own Internet banking systems (see “An Open Letter to Internet Banking Providers”). These banks simply got tired of what they deemed “egregious” per-user pricing and sought a simpler, fixed-cost solution.

This growing commoditization of the online banking vendor market is evident in the revenue streams of these players. Despite strong, steady growth in the adoption of Internet banking by consumers, revenue growth from the four major publicly traded, online banking vendors can hardly be termed “breakout.”

Vendor	2003 Revenue (3rd Qtr. Annualized)	2002 Revenue (3rd Qtr. Annualized)	Year-to-year growth
S1	$230 million	$271 million	-17%
Digital Insight	$158 million	$136 million	18%
Corillian	$46 million	$46 million	0%
Online Resources	$37 million	$33 million	13%
TOTAL	$471 million	$485 million	-3%

Here’s another difficult fact: after five years of growth and acquisitions for these companies, the current net income of the four combined entities is less than $10 million, roughly a 2% net profit margin and equal to the annual profits of a single $1 billion community bank.

So here, in the early months of 2004, Internet banking vendors find themselves at a crossroads – find new sources of revenue or be smashed into a VRU-like commodity application business. Continued competition from the core system providers is also fueling these commodity pressures.

How are the Internet vendors attacking this revenue growth challenge? Although lucrative, porn and music downloads are simply not feasible under current bank regulations. Vendors can only hope for revenue growth from two places:

• Continued growth in user adoption – According to Forrester Research, just under 30 million, or 27%, of U.S. households will have Internet banking in 2004, a 25% growth rate over 2003. Theoretically, user adoption should give vendors a “locked-in” revenue lift. But here’s the problem: every time adoption increases, banks with per-user contracts see their costs increase. Quickly, these same banks are back at the table to renegotiate price or bring the Internet banking platform in house. By itself, consumer adoption is not a foundation Internet companies can stand on for the future.
• New products and services – Another way to grow revenue is to introduce additional products that banks want and will pay for. While this is a sound strategy for Internet banking vendors, it will be a more difficult road to navigate.

As vendors look for new product sales, some common themes emerge:

• Payment bells and whistles – Internet banking vendors are hoping that adding new modules to their offerings will help grow revenue. For instance, many of the major vendors have partnered with CashEdge to begin offering online money transfers (basically consumer ACH). Online Resources has been promoting its Money HQ aggregation/money transfer capability, but the demand for this capability is still quite weak. The emphasis on making payments and moving money is a good one. However, these bells and whistles just will not add up to significant revenue for the vendors.
• Multi-channel integration – Ahhhh, the new mantra: multi-channel integration – connecting all of a bank’s delivery channels in one seamless Nirvana. Cornerstone expects many Internet vendors to be waving the multi-channel flag during 2004. This is evident in S1’s continued promotion of its “S1 Enterprise” suite of offerings. Enterprise basically has been the linking of the company’s Internet offerings with the branch/call center software acquired from SDI. No bones about it – the Enterprise story is playing well with prospective buyers, but the ultimate business benefits of an Enterprise implementation are still in the air. While S1 reports that its Internet and branch systems now share a common database, it is unclear just what banks are actually doing from a multi-channel perspective. To see breakout product sales, S1 will have to translate a costly Enterprise implementation into real process improvement and business benefits. Other vendors who may play the multi-channel card are Fidelity Information Services and Corillian, who has an alliance with CRM vendor Epicor.
• Business cash management – With the retail Internet channel becoming highly commoditized, Internet vendors are looking to the business side for sales activity. The fact that Internet penetration among businesses is lower than it is among consumers will provide some lift to vendors. However, the cash management world requires significantly more sophistication and handholding on the integration. It not as simple as taking a retail Internet banking product and adding wires and ACH. Metavante’s struggles with the acquired Brokat cash management system demonstrate the challenges with these products. Digital Insight’s recent acquisition of Magnet also signals that vendors may ultimately decide to buy vs. make their ultimate cash management platforms.
• Online lending – Credit unions have helped bolster revenue for vendors like Digital Insight with aggressive online lending activities. Slowly, banks are beginning to follow suit. However, as banks/credit unions become more comfortable with this technology, they, too, will seek a sharpened pricing pencil. With the exception of Digital Insight, most of the Internet vendors’ lending offerings are pretty tame and will have difficulty competing with the Web offerings of loan origination vendors.

As I review the current strategies being employed by Internet banking vendors, I fear they may be missing the boat and quickly heading into commodity land. Looking through the client base at Cornerstone Advisors, I see two mongo opportunities for Internet vendors that are not being pursued aggressively enough.

1. In-house or fixed-tier offerings – Let’s call timeout already. It’s over. Banks aren’t going to put up with costly per-user charges on Internet banking. Instead of promising the stock analysts that all is well and stretching for that last $1.25 a user deal, vendors should be taking a hard look at how their products are delivered and the cost structures behind that delivery. Vendors that provide simpler, in-house options or ASP options with aggressive fixed-pricing tiers will clean up on those that cling to yesterday’s revenue model. Imagine how costly it would be if banks paid hefty fees for every customer who used their automated voice response – we’d be hosed. I am glad to see vendors such as Fidelity Information Systems (the former Hamilton and Sullivan application) and Beacon Software, a startup targeting community banks, beginning to take aim at this opportunity.
2. Customizable Work Flow and Process Integration – Finally, Internet banking vendors need to plan their future by thinking of the Internet as a “platform” and not just a delivery channel. (See “Web of Complexity”). Across the bank, processes are becoming “Webified.” You see it on the intranet, with mortgage and consumer lending, with sales tracking and human resource information systems. As banks roll up their sleeves to move every process to a Web services environment over the next five years, Internet banking vendors better hope they get invited to the party. Banks are actively doing in-house Web development and implementing enterprise work-flow platforms that could ultimately subsume many of the modules provided by Internet banking vendors. The opportunity here is for vendors to convince banks they can provide a head start in their process integration efforts. Vendors need to deliver a tightly packaged, scalable, Web “toolset” that can become the centerpiece of bank process integration efforts. In this respect, successful Internet banking vendors will end up as both software developers and skilled Web integrators.

In terms of toolsets, Financial Fusion has attracted strong attention from larger regional banks, especially with the integration resources provided by partner Viecore, Inc., but it has not significantly penetrated banks below $20 billion. In Cornerstone’s opinion, we are still waiting for the dream vendor that can provide a straightforward, in-house, Internet banking toolset that can price down into the mid-size bank and credit union market.

Banks continue to grow confident in their ability to manage Web applications. With budget pressures abounding in 2004 and banks searching for cost reductions, Internet banking vendors need to realize that the old game is over and a new model must emerge for the long term.
-spw