The battle lines have been drawn between the incumbents and the new dot.com entrants. Stephen Timewell and Kung Young look at how the two sides are shaping up.

What will the financial services industry look like in 2003? What impact will the Internet have? No one can be sure but it is abundantly clear that radically new business models will be driving the networked economy.

To succeed, firms will need to evaluate innovative strategies that capitalise on both the power of the Internet and the changes in consumer demands. The new millennium represents a massive turning point where the dynamics of markets are changing and the consumer is seizing real power through the technology now available.

In the US, the number of adult Internet users, according to the latest report from The Strategis Group, is now more than 100 million, 50 per cent more than a year ago. Reports suggest that, in the US, online consumer spending in the month before Christmas will increase 10-fold from $15bn in 1999 to to $185bn in 2003.

And the online surge is not only happening in the US. In Scandinavia, MeritaNordbanken has more than one million online customers and Egg, the one-year-old Internet banking subsidiary of the UK's largest life insurance company Prudential has been dubbed the most successful Internet bank in the world with 600,000 customers and $12bn in deposits. And, in Brazil, Banco Bradesco currently has 830,000 Internet banking customers, more than 20 per cent of the country's Internet users.

Speaking at the Bank Administration Institute (BAI) Retail Delivery '99 conference in Miami last month, William Harrison, the president of US banking giant Chase Manhattan, said: "We're still in the early stages of a technology revolution that will far surpass the industrial revolution in terms of its impact on commerce and people's lives.

"Before the net, sellers were generally in control. Buyer information was limited, and services often bundled together making price comparisons difficult. Markets were defined in broad segment terms. Speed was limited by physical constraints, high entry barriers made new business ventures problematic and fulfilment was constrained by physical distribution and by geography.

"Today, the Internet has created a massive power shift to the buyer - and sellers are rushing to adapt their business models. Prices are more easily compared - choice has dramatically increased - and the physical limits of comparison shopping are gone."

Mr Harrison says that market segments of one are now possible through data mining, that dot.com businesses can be set up almost overnight and that virtual net communities are rapidly expanding and supplanting their physical counterparts.

Joel Friedman, a partner at Andersen Consulting, also believes the emerging business model for the electronic economy is being driven by a shift in power from the seller to the buyer who will increasingly demand products and services linked to a specific life goal. Satisfying intentions is the key and, according to Mr Friedman, the electronic commerce model has only begun to address offering value to as many customers as possible, it has a lot further to go. "The basis of this new model is to leverage the customer insight of a network of providers to construct a higher order of value by integrating a broad array of services into a customised intention solution."

So what is happening in the marketplace? Which organisations are getting it, as the current jargon goes? In order to assess the financial services situation in a networked world, the BAI broke the market into two segments, incumbents and new entrants, analysing the various strengths and weaknesses of both.

The incumbent models are further split into three - traditional migrators, continual evolvers and "clean slate" or new e-businesses such as Egg or Bank One's new WingspanBank. The traditional migrator, such as Wells Fargo, has persisted with a single market personality while using multiple delivery channels. This single brand approach has been also used in Merrill Lynch's new online trading product which represents channel augmentation that supports the current product, service and channel mix.

This is in contrast to the "evolver" strategy used by Charles Schwab & Co which seeks to transform the existing business by extending reach in the Internet channel and deepening relationships by meeting customer needs through proprietary or third-party services. Will the incumbents win? While the incumbents can be attacked as the dinosaurs, torn by bureaucracy and their own deadening weight, there are other arguments defending the so-called legacy companies.

Mr Harrison says: "We've got proven products and services, distribution and fulfilment capabilities and financial strength. Most importantly, we bring powerful brands to the game along with millions of customers. Very few of the dot.coms have these advantages, and there is a feeding frenzy going on as they invest huge sums on advertising to capture 'eyeballs' and 'mindshare'. And we have one more important asset - customer trust, which is an integral part of our brand."

So what do the new entrants offer? The BAI refers to Clayton Christensen's theory of disruptive innovation which states that new entrants advancing replacement solutions will eventually uproot and displace market incumbents. But while this looks bad for incumbents, as Mr Harrison notes above, there are other factors at work and the new players will not necessarily have an easy ride.

Nevertheless, the new entrants are hitting hard. And as the BAI notes and shows in the accompanying table: "From the virtual banks, to the product specialists to the electronic marketplace participants, new entrants are pushing the limits of the financial services arena and the operating and marketing capabilities of the incumbents."

One new player which looks set to make a mark is a UK Internet player called Marbles, a subsidiary of US-owned HFC Bank. Marbles was launched on October 15, only six months after its initial approval. Since then it has been attracting applicants at an average 4000 a day and the strategy and structure of the new outfit are particularly targeted. HFC managing director Adrian Hill sees Marbles as "money on the net" but it also has "off the net" capabilities which suits his vision of creating an opportunistic vehicle that will be flexible as well as fit in with HFC's strategy of being the best unsecured lender in the UK.

Mr Hill sees Marbles complementing the one million Goldfish cards already issued by HFC and as part of a "collection of niches" that his organisation can exploit through a cost-efficient 1300-person call centre based in Birmingham. Whether it be Marbles, BankZip.com or E*Trade , new players will eat away at traditional operations and 2000 can be expected to see a further onslaught of new entrants.

Gemini Consulting expects to see in Europe at least 30 new Internet operations in the first quarter alone. But will all these entrants prove profitable? Will Bank One's $250m investment in Wingspan bear fruit? Along with all the e-hype comes a lot of e-myths. Graham Oates of KPMG Consulting says: "The myths that are currently generated about e-business are based on the dramatic change brought about by companies' increased use of the Internet in the past five years.

"This e-revolution has shown how organisations can be run to different rules. But, eventually, the classic rules of business will reassert themselves in this virtual environment and the winners will be the ones that did it first, and did it best." What more can be said about which strategies will prove successful? At this stage, the options are many and nothing is set in stone. But there are clear facts - namely that the financial services sector worldwide faces the challenge of excess capacity and the technology now available has enabled power to shift unmistakably to the customer.

Banks desperately need to rethink their relationships with their customers if they want to stay in business. As BAI asks: "Have you taken the necessary steps to redefine your position in the market, and how your customers perceive you? Do you know exactly who your customers are now, and how they might change in the years ahead? Have you built a flexible organisation that can readily and rapidly shift its course if the need arises?"

Those who can answer 'yes' to the above have the potential to be successful in financial services. Diogo Teixeira, president of Tower Group, says: "Winners will come from banks and securities firms with IT resources who also take action; and from infomediaries who build the needed new functionality. Banks won't get blown up, far from it; but they will get more disaggregated than ever."

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