Most online business banking/cash management programs have featured ACH origination functions for many years. CompuBank was the first to put the service in front of retail users a year ago (OBR 10/98). Several other banks, including USAccessBank (OBR 2/99) have added the feature, but it’s still not widely available.

However, even the bank currently offering Web-based ACH origination are missing two key ingredients for the Net:

•  bank account masking (for the recipient)
•  email integration

We expect the Internet banking platform vendors (Digital Insight, S1, Online Resources, Q-UP, etc.) to quickly add this feature, both the straight ACH interbank transfer, and the more private person-to-person variety described here, to their retail offerings (probably in partnership with Checkfree and/or other payment specialists). Two years from now it will likely be an expected feature of a Net banking service. However, there is still time to jump in front of your peers by launching person-to-person payments in the next six to nine months.

Person-to-Person Revenue Streams

1. Transaction fees from sender and/or recipient

2. Funds conversion fees (moving money out of the digital cash system into real money)

3. Float income (like a prepaid cash card)

4. Abandoned funds (like travelers checks)

5. Currency exchange fees (translating money into different currencies)

6. Funds guarantee fees (good funds guarantee, like credit cards)

7. Escrow service fees (shepherding the delivery of the goods before releasing funds; like COD)

8. License fees from banks and others using the system

9. Sponsorship/advertising revenues

10. Revenues/commissions from credit lines attached to the P2P accounts

Source: Online Banking Report, 11/99

One reason investors are excited about the person-to-person payment space is its ten potential revenue streams (see table below left). That’s nine more than many Web-based companies who rely solely on banner advertising.

•  rush payments
•  large-dollar payment surcharges

Hypothetical P2P Payments Fee Schedule*

Source: Online Banking Report, 11/99

*see the table for an example using this fee schedule

Pricing Example*

Source: Online Banking Report, 11/99

*using fee schedule from previous table

Business Case: If person-to-person payments roll out in a rational fashion (not likely, see Pricing on previous page), with providers pricing the service above cost and appropriate for its value, reasonable profits could be expected. With the price schedule outlined on the previous page, banks could expect annual gross revenue of $28 per customer and profits of $15 to $20 per year (see below for calculations).

Scenario: YourBank.com has 100,000 users. Each user makes two person-to-person payments per month, one for less than $100, which is free, and the other averaging $175. The split between same day and two-day delivery is 50/50. Ten percent opt for funds guarantee/insurance at an extra fee.

Results: As shown in the table below, a total of 2.4 million payments would be processed, 1.2 million of which would generate fees. Total fees collected would be $2.8 million, or $28 per customer. Variable costs would vary by bank, but shouldn’t be more than $5 to $10 annually per customer, resulting in gross profit of about $20 per year.

Revenue Calculations*

Source: Online Banking Report conjecture, 11/99

*optimistic scenario where competition does not drive the price to zero

It’s impossible to predict precisely how these systems will play out as the product matures. Expect to have a jumble of competing, and non-interoperable systems in use until the market shakes out with a “standard” system in five to ten years. However, we can describe the basic functionality, which is relatively straightforward:

Prime Ecommerce Application: Buyer A purchases an $11 CD from Seller B on eBay. Neither party wants to reveal their bank account information to facilitate an ACH (electronic) transaction. Buyer A could stand in line at the 7-11 to get a money order, but that takes time and money, hardly worthwhile for an $11 purchase. So usually Buyer A sends a personal check, exposing their bank account number to Seller B, and delaying shipment by two weeks as Seller B waits for the check in the mail, deposits it at their bank, and waits some more to make sure it clears. Internet payment eliminates virtually all the delay and lost privacy as follows:

1. Seller provides Buyer with Seller’s unique ID and a link to a trusted Web site to arrange payment.

2. Buyer logs into the trusted payment site (registration required for first time users) and instructs the server to transfer money from the Buyer’s account to the Seller’s account. Only the trusted server knows the bank account numbers of each party.

3. An ACH entry is made debiting the Buyer’s account for the $11 purchase price.

4. Seller automatically receives an email informing them that payment has been initiated.

5. Another email is generated to the Buyer and Seller after the transfer clears the ACH system (48 hours maximum), informing both parties that good funds* have been transferred.

6. Seller ships the goods, slashing the shipment delay from two weeks to two days.

The basic person-to-person payment engine can be used to drive a number of other applications. The three most important are interbank transfers among the user’s own accounts; interfamily transfers where the recipient doesn’t mind sharing account data with the sender, for example a college student receiving money from his/her parents; and automated versions of both.

•  Interbank Transfer to Your Own Accounts (aka SelfPay): The P2P payment structure can easily be used to transfer funds among one’s own accounts at any financial institution or brokerage, as follows:
  •  Bank account info is registered at a trusted payment site, e.g. PayPal.com.
  •  User logs in and designates amount to be withdrawn from account A.
  •  User designates amounts to be transferred to account B.
•  Interbank Transfers to Family Member Accounts (aka FamilyPay/StudentPay): Same as above except the user also registers family member bank accounts to receive funds.
•  Automated Interbank Transfers: The next logical step is to augment the manual transferring of funds with automated, rules-based systems. The easiest application would run on calendar days, e.g., transfer $500 from account A to account B on the 15th of every month. But once the transfer engine is coupled with a statement aggregation function (see PayTrust), it gets far more interesting. Users could establish transfer rules to accomplish financial goals such as: minimizing loan interest paid or maximizing deposit interest earned. The scan-and-pay companies, with their rules-based bill payment mechanisms, are already on this path.

* In the U.S., Reg. E consumer protection claims would still have to be addressed if the buyer claims they didn’t get what they paid for.

Niche Offerings: A full-featured payment engine can also be deployed in a variety of niche applications:

Niche Market Offshoots

It’s surprising that no system has emerged to handle the immense volume of person-to-person payments generated by online auctions. In August, Prudential estimated that 66% of eBay auctions were converted into sales (the remaining 34% had no winning bidder). If that percentage held through the entire third quarter, eBay sellers delivered about 24 million “bills” to winning bidders, or eight million per month.

Yet, less than 7% of sellers allow payment by anything other than snail-mailed paper (see table below). eBay purchased BillPoint in May in order to offer an electronic (via credit card) payment solution. The company says it will be available by year-end. In the meantime, PayPal.com has begun to emerge as a payments alternative on eBay. It’s not as well known as BidPay, which mails Western Union money orders for a minimum of $5 per item. But as soon as participants discover it is free and real-time, it should catch on quickly.

eBay Sellers Accepting Remote Payments¹

Source: OBR search on eBay.com, 11/29/99

(1) number of eBay auction listings mentioning the company as a payment alternative; 3.4 million total listings 11/29/99

(2) Transactions are eventually charged to credit cards for all types

(3) Up from 3 on 11/22/99

Person-to-person payments are on the verge of gaining even more momentum with the entry of at least three providers in the next four to six months, including Checkfree (see table below):

Person-to-Person Payment Entrants

*working name, not actual product name

This is merely the tip of the iceberg. We estimate there are several hundred companies working on various payment and stored value schemes, from eWallets, to universal gift certificates, to new global currencies. A partial list is provided on the next page. In addition, financial institutions are expected to jump into the market leveraging their existing IT systems, risk management, and customer service organization.

Other Online Payment Entrants

Sources: Online Banking Report, 11/99; The Industry Standard, 11/15/99; Release 1.0, 10/18/99

With the exception of Checkfree, whose CTO, Ravi Ganesan briefed us extensively on his company’s plans (Nov. 18), the P2P payment providers aren’t talking much. Confinity’s VP of Strategy, David Sacks, wouldn’t even tell us how many employees they had (Red Herring reported 14 in July). In our five years of covering Net banking, we’ve never run into this level of secrecy. Even though it makes our job more difficult, we can’t blame them. With $100s of millions, if not billions, at stake, it pays to be cautious about what you tell outsiders.

As you can see from the chart below, many of the most interesting Internet banking products can easily be offered by non-banks. During the past five years in OBR, we’ve looked at all of them, but it was mostly theoretical. No matter how good they looked on paper, without being able to point to real-life examples, making a business case was difficult (see OBR 7/99 and 7/98).

All that is changing very fast. Fueled by an unprecedented pool of venture capital, innovative startups are swarming to the relatively untapped financial services and payments space. In second quarter, we witnessed the launch of three scan-and-pay bill management companies, CyberBills, PayMyBills.com and PayTrust. In third quarter, we saw the launch of three financial statement aggregators, VerticalOne, Yodlee, and PayTrust. And now in fourth quarter, we are watching at least one person-to-person payment company go live, PayPal.

Person-to-person (P2P) payments are not new. In fact, the paper payments business (personal checks, money orders, cashiers checks) continues to grow. According to The Green Sheet www.greensheet.com 68.8 billion paper checks will be processed in 1999 (U.S.), up 2.2% from 1998’s total of 67.4 billion; and an increase of 30% from 1989 (52.9 billion).

What is missing is a Web version of these products. The Web has spawned a whole new marketplace of sales between parties that have never met and never will. eBay has popularized the phenomena with its P2P auctions. In third quarter, eBay 36.2 million auctions, nearly four times the number in third quarter 1998 (9.2 million). In fact, eBay’s registered user base of 7.7 million is approximately equal to the entire online banking user base across all U.S. financial institutions.

Truly Virtual* Retail Banking Products

Source: Online Banking Report, 11/99

*companies don’t have to be a bank to offer these “banking” services

Definitions

Virtual \Vir"tu*al\ adj: being such in essence or effect though not formally recognized

Virtual Banking: noun: banking services delivered outside a brick-and-mortar environment

Real Virtual Banking: oxymoron: banking delivered outside a regulated financial institution

Sources: Webster; Online Banking Report, 11/99

Call us obsessed, but we’ve been anxiously awaiting the arrival of the banking equivalent of Amazon.com (see Building
the Amazon.com of Financial Services, OBR 6/98). Every year we go through the exercise of putting together a business case for the development of a Real Virtual Bank (see definitions above). During this process, we always get the urge to start one ourselves. So next year, we’ll do that in a virtual sense, building it within the pages of OBR and
on a portion of our Web site we’ve dubbed, TheBankofDreams.com.

PayTrust’s “mybank” automatically retrieves the user’s bank account information, subtracts uncleared PayTrust payments, and displays the results.

While we believe that traditional brick-and-mortar financial institutions will continue to serve the lion’s share of online users, a hybrid company will soon emerge, one that provides many of the same services as a traditional bank, but without actually being a bank. Sort of how Quicken operates on the desktop as an electronic checking account without actually holding the deposits. We call this a Real or Truly Virtual Bank.

Why would you want to forego the sure deposit income associated with a bank charter and FDIC insurance? A few reasons:

•  Cost of compliance: Let someone else hold the deposits and deal with SAS 70 audits, call reports, CRA mapping, OCC auditors, and so on.
•  Capital reserve requirements: Regulated financial institutions must maintain capital ratios that limit their flexibility compared to non-regulated Web companies.
•  Speed to market: Regulatory approval has delayed some launches by a year or more.

Problems in Building the Amazon.com of Financial Services

Source: Online Banking Report, 11/99

Two New Internet Banks Raise the Bar for Virtual Banking Services

The Net-Only Scorecard

Source: Online Banking Report, 2/99; estimated account totals as of 2/28/99

¹Includes multiple accounts for the same customers; estimates +/- 15% on Telebank, SFNB, NetBank; +/- 50% USAccess, CompuBank

²Technically not a Net-only bank after purchase by Royal Bank of Canada in Oct. 1998.

³The majority of accounts were generated prior to the introduction of Net banking in late ’97.

⁴As of Mar. 9, 1999, reported by the company.

Just as non-banks are using the Web to encroach on your turf, you can build new Web-based businesses that wouldn’t have been feasible just a few years ago. One such business if automated financial management and bookkeeping services.

Eventually, it won’t be enough to simply offer robust cash management and online balance reporting to your business clients. With the Web as the ideal platform for building industry- and customer-specific service offerings, you’ll need to be more creative to make a name for yourself in the small business banking marketplace, circa 2001.

You can bet the big banks will be creating killer small business Web sites to make up for any perceived service disadvantages. In turn, community banks will need to fight back with online offerings that enhance their level of personal service delivered to local businesses. Luckily, vendor offerings will make even the most complicated Web-based service affordable to the smaller financial institution.

Whether you are small or large, we think you must pay attention to the accounting and billing needs of your business clients. Intuit has made tremendous strides in serving that need, and as they move into offering more and more financial products to their accounting software customers, banks will feel the pinch. Banks should consider teaming with Web developers to build small business financial and customer management systems that could be deployed in the next 18 to 24 months. By then, bill presentment will be picking up steam and can be incorporated into your Web-based solutions. Intuit will have it. Yahoo! will have it. You should too.

Looking at the big picture, we see strong synergies between banking and accounting. Prior to the Web, there wasn’t a cost-effective way to bridge the gap between financial data housed in your mainframes with that housed in the PCs of your small business clients. Today, the Web is the ideal medium for tightly integrating your banking services with your clients’ accounting activities.

Intuit has already built impressive software-to-bank linkages for QuickBooks and Quicken customers. To some extent, the shrink-wrapped software is a Trojan Horse, positioning Intuit-controlled links to its partner banks right on the desktops of your best clients. You can fight back by incorporating billing, accounting, and financial management functions on your Web.

We think businesses would be very receptive to Web-based financial management services running on encrypted, secure and trusted servers controlled by the bank. The services would encompass these areas:

*Approximate. Price would depend on a number of factors, including size of company, competitive offerings, quality of service, etc.

You may be thinking, “We’re a bank not a software company. How can we compete with Intuit or Netscape in creating a compelling virtual CFO?”

Answer: You may not have a choice. The big Web companies are moving into your turf in partnership with large financial institutions. Witness the sweeping alliance Netscape recently inked with Citibank. And that’s just the beginning according to Edward Horowitz, the head of the bank’s advanced technology group. We expect to see Citibank integrating payment and banking functions into the Netscape’s virtual office.

Deciding when to launch a novel small business service is more difficult. All the cliches are running through your head: stick to the knitting, walk before you run, stay away from the bleeding edge, and so on. Why rush into an unproven area such as Web-based accounting?

Answer:

•  You can be the first to integrate banking functionality into small business management software. The virtual offices we’ve previewed primarily deal with team collaboration and communications functions, e.g. virtual intranets to help employees work together. And we can’t find anyone offering virtual accounting or bookkeeping services, yet.
•  By focusing on back office banking and accounting issues you will be able to differentiate yourself and offer services highly complimentary with your core banking services.
•  If you can successfully pioneer a robust Virtual CFO product, you could license it to other banks, recouping your investment and then some.
•  You can head off further inroads into your revenue base from Intuit partner banks.

The electronic checkbook is the foundation of any small business banking Web offering. Like foundations in the real world, it’s fundamental to the stability of your Web services, but there isn’t much you can do to differentiate it from other banks. It’s what’s on top of the foundation that will attract buyers.

Nevertheless, a good virtual checkbook must include the following functions:

•  balance inquiry across all business and personal accounts maintained at your bank
•  transaction history including basic look-up/search capabilities to find all transactions by date range, by type, by check number range, and by transaction amount
•  bill payment
•  email to and from the bank

Other desirable features:

•  different authority/access levels for each account
•  templates for common reports such as transactions by quarter, transactions by check number, etc.
•  email integrated with bill pay including:
  • forms for creating payee communications quickly
  • filing system that stores all previous communications with the payee
  • search function for finding text strings in previous messages to payees
•  fax/email statement
•  balance notifications
•  transaction confirmations
•  wire transfer and ACH initiation
•  downloadable directly into personal finance, spreadsheet, and/or accounting software programs
•  email notification when bills are presented
•  email forms for communicating different matters to the bank quickly
•  permanent storage of all communications with the bank with search capabilities

An example of Netopia’s virtual office from Netscape nvo.netopia.com . This particular template is for a mortgage broker who could create a 10-page Web site complete with downloadable application in a few hours. Cost? Just $20/mo, or $200 for a year. Netscape also offers templates for 14 other business types.

Create a place within your Web for small businesses to set-up a home base for work and collaborating on the Web. These services are commonly called virtual offices or intranets. We also like the names virtual desk, briefcase, or banker. The Web services could also be marketed to the estimated 39 million U.S. households with a home office (source: IDC/Link, 1995). ð

There are a number of virtual office vendors on the Web. The most visible is Netopia, which provides private-branded offices for users at Netscape’s NetCenter, GeoCities, and others. Netopia’s product currently focuses primarily on communications, offering real-time chat, email, IP telephony, and so on (see screenshot on previous page).

The most full-featured offering is HotOffice www.hotoffice.com profiled in this issue . The program has many desirable features that bank customers could use, but some of the most useful are lost amidst all the fancy bells and whistles that wouldn’t be used by the average small business. For instance, HotOffice is cluttered with collaboration tools so geographically diverse teams can “meet” on the Net to discuss issues, post documents, communicate with each other via message boards or real-time chat.

We think banks could create their own simpler and easier to use virtual offices integrated with banking and financial matters. A further emphasis on local content/links could keep you ahead of the competition. Here are the features we recommend:

•  Calendar/datebook/reminder service integrated with bill payment (OBR 6/98).
•  Virtual safe deposit service that automatically stores financial and other files in secure, encrypted, off-site back-up files not accessible by anyone but the owner (not even bank personnel); can be retrieved on CD for disaster recovery (OBR 3/98).
•  Free email with emphasis on secure communications with bank (OBR 3/98).
•  Email notification services (OBR 8/98).
•  Virtual receptionist that tells visitors how to get in touch with someone at your business.
•  Company message boards.
•  Ability to post documents to the Web that can be shared with everyone or just authorized employees and/or customers.
•  Unified messaging service which provides a single Web page where users can send and retrieve email, faxes, and voice messages (for more information visit the Web site of JFax www.jfax.com and VirtualPlus www.messagepoint.com )

Side Note: You also might consider setting up virtual offices for your own loan officers and other customer-contact personnel.

Time Direct is a virtual time card for employees and contractors to track project hours, submit them for review, and receive payment (if applicable).

The Virtual Bookkeeper expands on the functions of the Virtual Checkbook and office.

•  Billing statements and invoicing via email, fax, or snail mail; includes reminders, and confirmations.
•  Online cash-based accounting functions including data entry, categorizing, and basic report generation.
•  Bill payment/accounts payable monitoring functions such as email notification when payment transactions are awaiting authorization by business owner; email flags when payment transactions don’t clear in a reasonable time.
•  Autopay function that pays certain bills automatically each month when presented or when preauthorized by client (now supported in software from Edify www.edify.com ).
•  Full interbank transfer capability to and from any financial institution supporting ACH payments.
•  Statement integration functions across bank and non-bank accounts (see MileageMaximizer
  OBR 8/98).
•  Virtual credit card terminal with integrated email and hooks to accounting systems.
•  Lock-box service for paper check processing with full integration to client’s accounting system (see Accounts Receivable: Other).

• ð

Just like the real world, the Virtual CFO takes the data entered by the bookkeeper and puts it into a broader perspective that allows a business to be more profitable. The following features could be added to those already offered in the Virtual Bookkeeper, Virtual Office, and Virtual Checkbook modules:

•  Online payroll with paper or direct deposit paychecks, and electronic payroll tax payments.
•  Online federal and state tax return preparation and filing.
•  Full-fledged double-entry online accounting services.
•  Complete disaster recovery services including a redundant data center. Here’s an area that banks have a great amount of in-house expertise that could be turned into a profit center.
•  Complete Web-based customer file management and communications services including integrated:
  •  invoicing/billing with Web integration
    (e.g., bill presentment)
  •  payment services/inquiry via the Web
  •  email/fax/voice messages automatically confirming payment
•  Access to a CPA-on-call to handle questions. The CPA could deliver advice publicly on your Web, privately through confidential conversations with your business clients, or both.
•  Automatic excess funds allocation to minimize interest expense and/or maximize interest income. For added value, the funds “sweep” could go to investment and loan accounts at any financial institution (not just yours).
•  ECommerce services for hosting secure transactions (more on that next month).
•  Accounts receivable management that automatically notifies the business owner and/or customers when accounts are past due; includes linkages to Web-based payment window (below).
•  Virtual payment window that clients can display on their Web site to accept credit card or check/ACH payments online; includes integrated messaging confirming orders.
•  Extensive management reporting easily customizable using drop-down menus; for example, revenue reports by customer, accounts receivable aging, quarterly P&L; etc.
•  Mail merge capabilities that works across any medium, email, fax, page, voice message, or snail mail; option to outsource snail mail services to a mail house; label printing utility.
•  Retirement plan administration including Web views for participants; includes email statements.
•  Project tracking module integrated with reminders and other Virtual Office services.
•  Employee expense reporting, approval routing and reimbursement services (see Expense Reporting below for more detail).