As electronic networks become more robust and widespread, they are beginning to attract the attention of retail banks. Like ATMs and phone banking before them, however, they tend to be seen as merely one more cheap distribution channel. Accordingly, banks are replicating the branch banking experience on line—even to the extent of creating 3D virtual branches for their customers to navigate through. Such an approach is characteristic of early attempts to use any new technology platform. Consider the first television programs: people stood around microphones in what were essentially radio broadcasts with visuals awkwardly added on.

Efforts like these miss the opportunity afforded by the new medium to rethink the entire value proposition of a retail bank. Some non-bank entrants into the online world are experimenting with an altogether different business model. They are exploiting the unique capabilities of electronic networks and leveraging their own resources through web-based strategies. These strategies unbundle the financial services business and mobilize a broad array of specialized providers to deliver increased consumer value through more innovative products, wider choice, reduced complexity, and lower prices.

These new entrants could pose a threat to retail banks, targeting their most profitable product lines and customer segments. On the other hand, the same approaches are available to retail banks themselves, should they choose to pursue them. However, to do so will not be easy. It will demand a profound shift in mindset and the development of new organizational capabilities.

New entrants, new business models

New entrants into the financial services arena vary in their focus, but all are pursuing a business model unlike that of the traditional retail bank. In general, these new entrants fall into two groups: those that are focusing on a specific customer segment and those that are focusing on a specific transaction category. Both are mobilizing a "web" of participants to deliver key elements of an unbundled business system.

Targeting customer segments

One category of new players, represented in particular by software companies like Microsoft and Intuit, is targeting specific groups of customers, most notably affluent households that are early adopters of new computing and online technologies. Their goal is to develop a trust-based relationship with these customers in helping them obtain a wide range of financial services.

Banks that fear these entrants are seeking to enter the retail banking business miss the point. The new players are not interested in providing specific financial services; rather, they want to focus on the acquisition and management of customer relationships. In essence, they are becoming a new form of intermediary that "unbundles" the customer relationship management element of the retail banking business from the product manufacturing and processing elements. Their distinctive value proposition will be to develop a deep understanding of a specific customer’s needs and to provide access to the best mix of financial services from a multitude of "manufacturers" (banks and other providers).

Banks have, of course, been trying to do this themselves for quite some time, but their information system architectures and organizational structures tend to emphasize products, making an integrated customer focus difficult to adopt. Even if a bank does manage to make the shift, it is hampered by being able to "see" customers only through their use of its products and channels. Unless customers rely on this bank for all their financial service requirements—an increasingly rare eventuality, especially among affluent households—it cannot attain an integrated perspective on the full range of its customers’ transactions and needs. Indeed, it will probably not even be able to determine what share of their financial service business it commands.

Even if banks could overcome this obstacle, they would face another: how to deliver a wide selection of financial products and services. With few exceptions, retail banks still offer only their own products and services. For those customers who are seeking the "best in class" across a portfolio of financial services, this poses a dilemma. Either they must forgo the benefits of one-stop shopping, or they must compromise in terms of the features or price of individual products.

If banks were to shift away from their vertically integrated approach, they would also need to exchange their proprietary, closed business system for an open organizational model. New game players are already adopting such a model to offer consumers integration, independence, and choice. As intermediaries, they are neither biased nor limited by offering financial products of their own. They enjoy the advantage over traditional banks of developing an integrated profile of their customers’ financial service needs. Armed with this, they can create value by tailoring a portfolio of financial products to an individual customer’s requirements.

Some software companies appear to be preparing to play this intermediary role. Through Money and Quicken, Microsoft and Intuit are already well placed to influence financial decision making in over 12 million households. Given the attractive demographics of the consumers concerned, this alone represents a threat to the profitability of the average retail bank. However, Microsoft and others are seeking to extend beyond the packaged software market into online personal financial services.

Microsoft’s brand, customer base, and software expertise give it the clout to shape a web of banks, merchants, and technology partners. Its web includes leading players in each product segment, including Schwab and Fidelity in mutual funds, e-trade in online trading, CheckFree in electronic payments, and over 50 major banks in credit and transaction products. Customers can access these providers via Microsoft Network on the Internet, Money on America Online, or directly via CheckFree’s payment network.

Through this initiative, Microsoft is positioning itself to become a trusted and objective intermediary. By working with many financial institutions and information providers and leveraging their expertise, brands, and products, it is able to augment its own capabilities and deliver seamless personal financial services to customers. Its recent development of Open Financial Exchange, which standardizes the format for transferring financial information between organizations, will make it even more attractive to new participants and customers. Microsoft is betting that the faster its web grows, the greater will be the opportunity for those involved. It stands to profit in a variety of ways: through transaction fees, data manipulation, advertising revenue, premium services, and packaged software sales.

Targeting transaction categories

A different set of new entrants are targeting individual product categories within financial services and seeking to become the preferred location for buying and selling them. Rather than trying to own customers by serving them across the full range of their financial needs, these players want to own specific types of transaction, such as mutual fund sales or insurance policy purchases. They are aggregating buyers and sellers for these transactions in tailored environments that support the needs of both.

Like the other type of new entrant, these players have no interest in entering the banking business—at least, not as traditionally defined. Instead, they want to become "market makers" by attracting the lion’s share of customers for an individual transaction category. They are gambling that no bank will be able to match their economies of scale or depth of choice in that category. However, they welcome banks’ participation in their transaction environments as manufacturers of specific products or services; all they want to do is take their cut from the transactions generated. Intent on "unbundling" the bank along the product dimension by offering specialized information and breadth of choice, these players are the financial services equivalent of retailers like The Home Depot and Circuit City.

Examples are starting to emerge in retail banking’s highest-growth areas. Charles Schwab has made impressive inroads into mutual funds with OneSource. Customers are able to access this service by a variety of means including Internet, Microsoft Network, and telephone. Its value proposition is compelling: convenience (24-hour access, a single statement), extensive information and advice (SelectFunds list, software), range of choice (1,200 mutual funds), and low price (half of the funds are no load, no fee). The results have been dramatic: Schwab has already captured 50 percent of US online trading in mutual funds.

InsWeb represents another early example of a market maker, this time in insurance. Although it did not start up until late 1995, it has gained the participation of 19 insurance companies and over 5,000 agents and brokers. Buyers can access InsWeb at any time, learn how to evaluate insurance policies from an unbiased intermediary that puts them under no pressure, and, when they are ready to make a purchase, complete the transaction either on line or with the assistance of a conventional insurance agent.

At present, market makers like these are operating in only a few product categories. However, it is not hard to imagine similar initiatives targeting other protection products, term deposits, and consumer lending products such as auto loans, mortgages, and credit cards.

"Hollowing out" the retail bank

These new initiatives are still in their infancy, and uncertainty persists as to how they will play out. All the same, there is a substantial risk that the trajectories of the two groups of entrants will combine to create a "squeeze play" on the profitability of retail banks. The customers that these new players are trying to attract represent a significant share of a typical bank’s profits.

Within affluent households in the United States, computers are already widely used. One estimate suggests that as many as 75 percent of households in the top income quintile now own at least one PC. While relatively few are using online banking applications today, the advent of compelling applications and attractive value propositions will attract many more users.

The new entrants are targeting separate segments of this affluent market. The first group focuses on customers who like their financial affairs to be integrated, but also want to be able to choose from a wide range of providers. The second group targets self-directed customers who want to cherry-pick the best product in each category in putting together their own portfolio. Such customers seek out "category killers" where they can be assured of the broadest selection, the deepest information, and the best price for any given product or service.

New entrants seek to own the cheapest distribution channels, the most valuable customer relationships, and the most lucrative fee-based businesses

Taken together, the two groups of entrants have the potential to siphon off the most profitable customers and the most attractive products from retail banks. They seek to own the cheapest distribution channels, the most valuable customer relationships, and the most lucrative fee-based businesses. Their "hollowing out" of the retail bank is the continuation of a trend that began with the unbundling of transaction processing a decade ago. Focused players like Fiserv, EDS, and ALLTEL prospered by aggregating volume across hundreds of banks to capture scale economies.

If the new entrants succeed in capturing the customer interface, retail banks will be left with fewer value-added roles in the financial services chain. The first step in avoiding this hollowing out is for retail banks to understand the new strategy these entrants are employing.

Web-based strategies

Whether their focus is on customers or transactions, the new players are united in pursuing a business strategy that is quite different from the traditional retail banking model. Their web-based strategy is one that has become a standard means of competing in the computer and high-technology industries, but is only just beginning to emerge in more traditional settings.

Web-based strategies start from the assumption that the best way to manage risk and build capabilities and scale rapidly in highly uncertain environments is to mobilize the resources of many companies. We are all familiar with joint ventures and other forms of alliance as vehicles to supplement a company’s resources and skills. Webs differ from these more conventional business relationships in three respects.

First, a web typically involves a much larger and more varied group of companies than a joint venture or alliance. Most of the latter embrace two or three companies—ten at the most. Webs, on the other hand, encompass hundreds or even thousands of companies with diverse skill sets and business models.

Hence the second difference: because so many companies must be mobilized if it is to succeed, a web tends to rely on much more informal business relationships and coordination mechanisms than a joint venture or alliance. While these often involve detailed legal arrangements, a web depends on the market-based alignment of economic incentives and on the adoption of de facto standards to coordinate multiple initiatives. Legal relationships take too long to negotiate and, once negotiated, are too inflexible to be viable in rapidly changing, uncertain environments.

Third, a web requires a shaping platform that entitles one or two companies to play the role of web shaper. It is their responsibility to define the standards that all members of the web will observe and to create the economic incentives that will draw more companies into the web.

Technology, customer, and market webs

Three different types of web-based strategy can be identified. Webs based on technology standards or architectures have become a key element of competitive strategy in the computer and multimedia industries; witness the fierce competition between the Microsoft/Intel web and the Apple Macintosh web. Novell rose to prominence by mobilizing a web of companies behind its network operating system, which became a standard for local area networks. More recently, Netscape has rallied many players behind its efforts to make the Internet a robust platform for electronic commerce.

In customer webs, the shaping platform is the detailed profile of customer segments compiled by the web shaper. This is the game that companies like Microsoft and Intuit appear to be playing in financial services by leveraging the information capture capabilities of their personal financial management software and related Internet platforms.

Market webs organized around product categories are shaped by companies that develop a location for the sale of a narrow set of products, define processes for these transactions, and then aggregate a critical mass of buyers and sellers in their market spaces. Schwab’s OneSource and InsWeb are market webs. The shaping platform in market webs is the ownership of the market space for a product category and the definition of broadly accepted processes for the execution of transactions within it.

The power of webs

The power of web-based strategies is enormous, especially by comparison with those of traditional integrated players

Whether the focus is on customer or market webs, the power of web-based strategies is enormous, especially by comparison with the strategies of traditional integrated players. When markets are changing and outcomes are uncertain, integrated players have to make huge commitments of resources that expose them to risk. Banks’ customary emphasis on ownership and control often drives them to hedge their bets or adopt "fast follower" strategies to manage risk. Unlike banks, however, web shapers can afford to take big bets by mobilizing the resources of other companies behind a particular opportunity, while at the same time limiting their own exposure. This allows them to act much more aggressively than integrated players.

Webs not only help to manage risk through financial leverage, but also reduce risk by maximizing the potential for innovation in uncertain environments. While large integrated companies have to assume the full burden of innovation, web shapers can unleash a much broader range of initiatives from hundreds or thousands of web participants. The cumulative impact of this dispersed innovation can overwhelm any single organization’s efforts. Webs thus stand a better chance of coming up with superior solutions. Such an approach is more like that used by leading retailers and consumer goods companies than that used by traditional financial services players.

Webs also help to reduce costs. Traditional integrated companies have to perform all the activities associated with developing a service and delivering it to the customer. Inevitably, any one company will be superior in cost performance at some activities, inferior at others. Webs allow a company to unbundle its activities and focus exclusively on those for which it is the lowest-cost provider. It then relies on other members of the web to perform the activities for which they are the cheapest providers. The web thus delivers the cheapest total service to customers by leveraging the experience and capabilities of all its members.

The new entrants in financial services are betting that they can exploit web-based strategies to become much more successful than large integrated banks in delivering superior service to the most profitable customers. They are developing webs that require the collaboration of numerous other players, from independent financial advisors to major software and telecommunications companies, in the belief that the efforts of so many participants will overwhelm the scale and scope advantages that retail banks have traditionally enjoyed. In the business model of this new game, scale and scope advantages are built at the level of the web, not the individual company, ensuring greater flexibility in times of growing uncertainty.

What banks can do

While new players have deployed web-based strategies to enter the financial services arena, these strategies are also available to existing players with the right capabilities and mindset. A few traditional retail banks have elected to pursue them even though they entail radically redefining the banking busi-ness and developing a new set of skills. At the majority of banks, however, senior management do not even consider this option when they evaluate the opportunities created by the online environment and the threats posed by new competitors.

Most banks today are pursuing what might be described as a "fortress" strategy, defending themselves against new entrants while waiting for more clarity in the online world. Outside the United States, many seem to believe that regulatory barriers will continue to protect them from the incursions of new entrants. Meanwhile, most American retail banks view electronic networks as an opportunity to lock in their customers by creating deeper relationships through more frequent, less expensive interactions. The fortress strategy has the benefit of relying on traditional sources of advantage; it plays to the strengths of current retail banks. The risk, of course, is that these sources of advantage may not be enough to keep out new entrants that rely on a totally different business model.

Retail banks should at least hedge their bets by experimenting with the web business model. A bank could choose, for example, to unbundle "manufacturing" from "distribution" in a single product category such as mutual funds. This would allow it to maximize the reach of its proprietary funds while simultaneously creating a Schwab-like value proposition for its own customers. A more radical response would be for banks to adopt web-based strategies across their business. This would have the virtue of taking the new entrants’ business model and applying it against them, but calls for profound organizational changes if it is to be executed successfully.

Early initiatives

A few banks are experimenting with a hybrid response, but none yet seems prepared to move to a pure web-based strategy

At the moment, a few banks appear to be hedging their bets by experiment-ing with a hybrid response, but none yet seems prepared to move to a pure web-based strategy. The "hedgers" range from large players such as Chase Chemical to smaller regional banks such as Salem Five. They are establishing a presence on the Internet by mobilizing other companies to deliver a broad range of offerings to augment their own financial services. This allows them to offer their customers non-banking services while preserving traditional banking activities for themselves.

Chase Chemical has opened a series of web sites that target particular segments among its customers. The Adventure Site is for those with an interest in recreational vehicles; here, they can find information on trailer parks, share experiences with other RV owners, and even obtain a convenient list of speed traps on highways across the nation. Naturally, for customers thinking of buying a new RV, Chase Chemical provides a guide to RV loans—but only those it offers itself. Similarly, it operates a Boat Mania web site for recreational boat owners and an Around the House site for people interested in home improvement.

Salem Five, a New England bank, has assembled a regionally focused web of providers to augment its standard retail bank products. Its web site offers a wide range of services to customers interested in visiting New England, including a guide to restaurants and entertainment in Boston and Cape Cod, complete with maps and directories. For those considering relocating to the area, Salem Five offers lists of houses for sale and information on movers.

Key strategic choices

Banks interested in adopting web-based strategies must first determine what kind of web to target. Customer webs focus on maximizing a bank’s share of wallet of a target customer segment by mobilizing a broad range of financial service providers to address that segment’s needs. Market webs seek to aggregate a critical mass of buyers and sellers within one transaction category, such as auto loans or credit cards.

Within any web that it might target, there are a number of possible roles a bank could play. Web shapers are the one or two companies that own a shaping platform, take the initiative to mobilize other companies around it, and define a set of standard practices or policies to coordinate participants’ activities. In customer webs, the shaping platform could comprise established relationships with one or more target customer segments and initial profiles of these customers’ financial service needs. The shaping platform in market webs is the physical or virtual space in which transactions take place. Web shapers are typically eager to take risks; they bet heavily to convince prospective members of their conviction, and are willing to share benefits with other participants.

Banks that choose not to play the shaper role will become adapters within their webs. They must define a clear niche that will help them differentiate themselves from other participants. They might choose to focus on particular products or services and take the lead in innovation, tailoring, or cost position within the web. Or they might concentrate on providing certain back-office processing services for other participants, such as credit card or trust fund processing. The key to success as an adapter is the focus and agility to become "best of breed" within the web by quickly adjusting to the evolving needs of customers and other participants.

Some adapters may become influencers, working closely with shapers to ensure the overall success of their web. Influencers usually make an early and powerful commitment to one of many competing webs, and bring an asset that is critical to accelerating its growth. In the computer industry, for instance, one influencer is Compaq, which invented a different physical form: a truly portable PC. From the outset, Compaq committed exclusively to the Microsoft/Intel architecture, helping to differentiate it from the Apple platform.

Banks may be able to play the role of influencer within emerging customer and market webs in financial services. The assets they possess—a large installed base of customers, market share of certain products, and a strong brand image of security and trust—will prove valuable in these evolving webs. Indeed, large banks, in particular, may have the power to cast the deciding vote in the competition between webs. To do so, they must be prepared to take risks by committing early—well before a web has proved itself in the marketplace—and by ceding the core role of web shaper to other players. Further, a would-be influencer must establish a track record of rapid, continuous innovation if its influence is to be maintained.

Emerging webs are likely to encourage—if not demand—the unbundling of retail banking’s integrated business system

Emerging webs in personal financial services are likely to encourage—if not demand—the unbundling of retail banking’s integrated business system. Within webs, some companies are likely to emerge as experts in creating and managing customer relationships. Others may specialize in products, developing a stream of innovative offerings. A third group will probably focus on providing inexpensive back-office processing services to support the operations of the other two.

The challenges and opportunities of such a transition can be seen in the evolution of the computer industry. Between 1985 and 1990, dominant highly integrated players began to face competition from an astonishing array of specialized technology providers. Incumbents like IBM, Unisys, and Honeywell lost some $43 billion in shareholder value—30 percent of the industry’s total 1985 value. Meanwhile, new entrants like Microsoft, Intel, and Novell prospered, creating over $30 billion in new shareholder value. The web they shaped is still evolving amid discontinuities generated by the Internet, cable modems, and network computers.

If the emergence of webs in financial services produces a similar outcome, banks will be forced to rethink their basic business, unbundle its components, and determine where to focus in the years ahead.

Requirements for success

If banks choose to pursue some form of web-based strategy, they will face daunting challenges as they make the transition from the familiar environments of the past to the uncharted waters of the future. Some of these challenges involve adjusting the mindset of senior management; others entail building organizational capabilities.

Adopting a webs mindset

Webs demand a mindset quite unlike that of today’s bank management. Retail banks have won their customers’ trust by avoiding risk and tightly controlling all the activities involved in delivering financial services. When risk and uncertainty are high, their natural and understandable reaction is to try to tighten control still further. Instinct tells them to batten down the hatches and proceed even more slowly and cautiously than usual, taking time to analyze the situation and, if necessary, delaying their response until more information is available.

Web-based strategies call for a totally different and initially much more uncomfortable approach. They seek to manage uncertainty by letting go. From a web perspective, the best way to handle risk is to share it by leveraging the resources and capabilities of many other players. First movers and fast adapters are rewarded in this environment. Players that commit early to helping build a critical mass of participants within a web typically win higher returns and more sustainable positions than late entrants. As the Silicon Valley phrase has it, "Time is the devil, and speed is God."

Transforming the organization

Even if senior management is able to achieve these profound shifts in mindset, it faces a still greater challenge in transforming its organization to compete in web-based environments. Companies that prosper in these environments are very different from the traditional retail bank. They have fluid structures that enable them to react quickly to market changes, and they show no hesitation in redirecting resources away from underperforming businesses. Their cultures support and reward risk taking; they both protect innovative initiatives from the demands of the core business and encourage management to find ways to cannibalize it. Rebels, misfits, and eccentrics are cherished as long as they can spur others to discover and seize unanticipated market opportunities.

Organizations like these look outward, not inward. They understand that success is not a matter of what you know today, since that will be obsolete tomorrow. Rather, they try to furnish themselves with a rich set of external information flows to help them constantly refresh their knowledge and challenge conventional wisdom. Then they act on the resulting insights before anyone else does. They understand that they must collaborate if they are to achieve results, and they know how to motivate others to pursue independent actions that support and reinforce their own strategies.

Technological and market discontinuities are combining to generate rapid change and high uncertainty in retail banking. In such an environment, routinely to apply the strategies of the past may be the riskiest option of all. Retail bank management should at least consider some new approaches that have proven successful in other arenas characterized by change and uncertainty. These approaches may not be for everyone—but far better to have considered and rejected them than to be blindsided by a wholly unfamiliar strategy, business model, and organizational approach.