Online Bill Payment: A Path to Doubling Profits
For many banks, the online channel is an ongoing source of perplexity. Although banks have made huge investments in developing and running the channel, their hopes of using it to cut costs and attract new customers have never been realized. A fundamental problem is that many institutions think of their online bank as an expense – not as the potential profit driver that a few leading banks have accurately perceived it to be, much to their advantage.
In an article that The Boston Consulting Group published two years ago, we emphasized the importance of getting online customers more active on bank Web sites – not just getting them enrolled – and of effectively integrating the online channel with bank branches and call centers.1 The importance of these initiatives for increasing share of wallet and improving retention among existing customers – top priorities for most banking executives – was recently reinforced by a detailed BCG benchmarking survey involving 20 of the largest U.S. banks.
Today, some U.S. banks are turning to the online channel to strengthen their payments business, using the “flow” of transactions to increase their “stock” of deposits and loans. A core product in this effort is online billpay, which allows customers to pay their personal expenses electronically through a bank’s Web site. The transaction is then fulfilled by an automated clearing-house payment or by a check cut through the bank’s back office (a function that is typically outsourced). In a market in which the vast majority of consumer payments are still made using paper, online billpay offers customers a fast, easy alternative to writing and mailing physical checks.
What is striking, however, is that although the product is generating significant buzz, only a small minority of financial institutions are realizing online billpay’s full potential. A large portion of efficiency-ratio gaps among banks can be explained by whether the banks are in the top or bottom quartile in billpay penetration – a difference worth several billion dollars in market capitalization for a top-ten bank in the United States. Although the banks in our benchmarking survey had similar technology, brand recognition, and size, penetration rates differed by a factor of ten from the highest to the lowest quartile. Moreover, our survey revealed that active billpay customers are twice as profitable as offline customers and that active online customers who do not use billpay are still one-third more profitable than offline customers.2 These benefits typically take about three years to realize from the point of activation.
Where does this increased profitability come from? The drivers – including increased spreads from deposit and loan products, higher fee income, and enhanced retention – relate predominantly to revenue rather than cost. To the surprise of many, these benefits are not the result of demographics or selection bias but of changing customer behavior prompted by the deeper relationships that online banking and online billpay help create. The core truth is that customers who bank and pay bills online – even after adjusting for age, income, and income-producing assets – are far more profitable than offline customers. And the benefits evolve quickly. BCG research (involving event-study methodology with demographically adjusted control groups) that compared the profitability of individual customers before and after just one year of online-banking and online-billpay activation showed increases of 20 and 40 percentage points, respectively.
Banks that work to deepen billpay penetration – and that take a proactive, holistic approach to online banking in general – will be best positioned to seize an advantage over their rivals in the increasingly competitive U.S. banking environment. An initial step in that process is to understand how online billpay fits into the overall payments landscape.
Payments businesses comprise many of retail banking’s most profitable, high-transaction services, such as checking accounts, credit cards, debit cards, and lockbox accounts. In large institutions, payments are often responsible for 40 percent of total revenues and 33 percent of profits. But payments can be difficult to manage since their economics cut across banks’ traditional silos and are often buried within various products and processes. Today a few leading banks are learning how to rigorously measure and track profits that originate from payments. As a result, they are gaining highly useful information for increasing transaction volume and fee income.3Such initiatives are especially important in markets that are undergoing major shifts in payment vehicles, such as the United States.
Moreover, the movement toward electronic payments that has gained momentum globally over the past ten years is expected to continue. (Electronic payments for personal expenses are already the norm in many markets, such as Western Europe.) Our research and proprietary models suggest that the volume of global electronic transactions will grow by roughly 9 percent annually through 2010, while physical check volume will shrink by more than 1 percent per year. In the United States, where the number of paper payments is much higher than that of electronic payments, we expect paper check volume to fall by more than 3 percent per year (with back-office paper-item processing falling more than twice as fast by 2005 as the sharing of check images grows). Given this trend, online billpay’s strategic importance for banks should only increase.
Until now, U.S. banks have achieved only modest success in getting customers to become active Web site users and adopt online billpay. For the institutions in our survey, the median level of households enrolled in online banking – those with a registered password or PIN – was only about one-third. Less than two-thirds of those enrollees actually used the site monthly, and only one-sixth of that active group used billpay monthly. The median penetration of active billpay for all checking-account customers was under 4 percent.
However, based on the experience of institutions that are achieving the most success with online billpay, there are specific and proven steps that banks can take to improve their performance.
Customers who use online billpay typically visit their bank’s Web site three times per month. The bank therefore assumes a deeper presence in their lives. And interacting with a Web site is a far different experience than simply writing out a check and mailing it to the local dry cleaners. While customers are online, they see their up-to-date account balances and are exposed to other products and services the bank is offering. These frequent interactions help build a sense of partnership and “doing things together” that most banks are trying to engender with their customers. Our study suggests there are four initiatives that can help billpay reach its potential for your bank.
Understand the economics. In an era when many households seek financial services from a variety of sources, it has been clearly shown that online-billpay customers and active Web-site users tend to consolidate share with their primary provider. Data show that banks are thus more likely to sell such customers loan products like mortgages and revolving-credit accounts and to receive increased fees from customer transactions with both credit and debit cards. Today, about 75 percent of large banks still charge for online billpay, but most waive the fee for about 40 percent of enrollees. A holistic view of the economics clearly supports waiving the fee, or eliminating it altogether, in order to generate customer usage. Only a modest increase in billpay penetration – typically less than 1 percent of customers with demand-deposit accounts – offsets the lost fee revenues. Some banks are starting to understand this, and we expect that within 12 months less than 50 percent of banks in the United States will be charging for billpay.
Create the business case. Increasing billpay penetration to top-quartile performance can be worth more than $1 billion in market capitalization for a large financial institution. Take an organization with 3 million retail-customer households, each generating $400 in annual profit for the bank. Households that actively use online billpay will, on average, double their profit contribution within three years. There-fore, increasing penetration from 2 percent to 8 percent would add 180,000 households, each generating an additional $400 annually for a total of $72 million in additional profits. The typical large bank in the United States, with a price-to-earnings ratio of 15, would gain more than $1 billion in market value by effectively leveraging the power of the online channel. (The bank in this example moved from the third to the second quartile.) So when the economics are viewed holistically, the channel presents a significant opportunity to increase shareholder value.
Integrate the online channel with the rest of the bank. Surveys show that customer retention and effective cross-selling hold the top spots on many senior-management agendas. Online billpay, with its capacity to drive both improved retention and share consolidation, is an excellent vehicle for pursuing both of these initiatives.
For example, debit card usage in the United States is still fairly modest. Roughly 70 percent of demand-deposit accounts at the banks we surveyed have a debit card. And just 60 percent of those accounts (42 percent of the total) actually use the card for non-ATM purchases. But active billpay customers are 35 percent more likely to use their debit cards for non-ATM purchases, which generate higher transaction fees for the bank because they are typically displacing cash or a paper check. The economics still hold if the debit card purchase is displacing a credit card, because even a top bank typically has card penetration of only one-fifth of its checking-account customers. Increasing debit card usage is a goal for most retail banks, and an integrated online channel can have a direct and positive influence.
Create quick wins. Banks are sitting on a wealth of customer information regarding direct withdrawals, check-writing activity, and cash-spending habits. For online-billpay customers, banks also have electronic payee information. Institutions can leverage these data to create targeted, customer-specific offers. By building on the deposit-account relationship, banks can also create products that cannot be easily replicated by nonbank competitors.
For example, the checking/credit card combined account – in which the card is really a charge card until the account falls below zero – is a powerful customer proposition that monoline credit-card companies cannot offer because they simply don’t have checking accounts. Since the checking account is the key product and typically generates the most profit (in total dollar terms) for retail banks, institutions should look for ways to strengthen it and use it to gain share of wallet in related products. Increasing online-billpay penetration should be part of this process.
There can, of course, be difficulties to overcome with online billpay. For example, internal frictions within the bank can develop around the waiving of fees, which causes the bank’s Internet group to lose direct revenue. The problem is that benefits from increased billpay penetration aren’t typically measurable using day-to-day metrics, and all departments rightfully want credit for their performances. One potential solution is to create a “shadow” profit-and-loss statement for the Internet group in order to give it due credit for new online and billpay customers. Moreover, while waiving fees has been shown to make good economic sense and increase penetration, it is also critical to break out of the silo mentality and think about customers in a holistic manner. Banks that genuinely integrate their online offerings with the rest of the institution – and that stimulate cross-channel communication and cooperation – will gain the most.
In the end, the winners will be those that succeed at teaching customers how much online billpay has to offer and at proactively signing them up for the program. Among the tools that banks in the United States can use to integrate online banking and billpay into retail functions, and to achieve increased penetration are:
Online billpay is a lever that can be used in myriad ways. It can improve your knowledge of how customers think and behave. More important, it will help customers get to know you – and what you have to offer – better, which will lead to improved cross-selling, higher profits, and enhanced retention. In a financial services landscape where so many products have limited potential and so many banks are struggling with their Internet channels, billpay may represent one of the last great online opportunities.
Co-author: Jack Whitt is a project leader in BCG’s Chicago office.
1See “Activate and Integrate: Optimizing the Value of Online Banking,” BCG Opportunities for Action, January 2002. The article is available on www.bcg.com.
2Active billpay customers are those who pay a bill online at least once per month. Active online customers are those who use their bank’s Web site for other purposes, such as moving funds among accounts, at least once per month.
3 For a comprehensive discussion of current payments issues, see “Making Payments Pay: Organizing for Success,” BCG Opportunities for Action, September 2003. The article is available on www.bcg.com.