One

We have no choice: to stay competitive, bill payment must be free.

There is some truth to this. Twenty-two of the fifty largest U.S. banks now offer bill payment free of charge to their entire online banking base. And the big banks, especially Bank of America, are making a lot of noise about their free bill payment services. And it does strike a chord with consumers who naturally would prefer it be free, and tend to believe it should be free, because of the incorrect assumption that it lowers the bank’s processing costs.

However, online users are not naïve. They know there is a downside to free services. It could be less privacy, inferior product quality, or distracting advertisements.

Two

We’ll make up the lost fees
with improved retention.

There is no doubt that bill payment usage is correlated with higher retention. But that’s the case with nearly every add-on service from savings accounts, to credit cards, to safe deposit boxes, or Saturday branch hours. Assuming customers like it, every account added increases retention.

It is true that electronic bill payment creates higher exit barriers (aka “switching costs” or “customer lockin”) than a simple savings account. However, it’s entirely possible that within a few years someone will invent a wizard that automatically moves a user’s bill payment setup, merchant info, and history from one bank to another.

Three

We’ll make up the lost fees with
 higher balances.

Again, we’ve seen the research and it points to a strong correlation between bill payment use and customer profitability. As Bank of America and others have demonstrated, the “extra” profits from the bill pay group vs. the control more than make up for the extra costs. In Bank of America’s case, they showed an overall profit lift of 30%, after netting out the 10% increase in cost to service the account due to the bill pay subsidy .

This is the best argument for free bill pay, and it may even have been true in the 2000 to 2003 period analyzed by BofA. Early adopter bill pay users were a profitable group; they may have had a tendency to add accounts at the bank that was providing them the latest and greatest services, including bill pay. Complicating the analysis, however, is the fact that the banks offering free bill pay, Citi and BofA, for example, also tended to have the best overall online banking services. Was it the free bill pay or the killer website that drove the incremental balance growth? Bank America made a billion dollar bet that it was the bill pay.¹

Four

Eventually payment processing
costs will decline.

Clearly, end-to-end electronic processing has lower transaction costs than paper. However, electronic bill payment comes with an implicit customer service component absent from paper checks. When a paper check fails to reach the payee, no one expects the bank to track down the problem and make it right.

With electronic payments, the banks, and its processor, are required to troubleshoot and fix problems, even when the error was outside their control. As quality and volume increase, these costs will decline. But it will be difficult, if not impossible, for electronic transactions to have lower marginal costs if customer service expenses are factored in.

¹ Bank of America’s stake $400 million stake in CheckFree gave it extra incentive to promote free bill payment.