The Internet and the Future of Financial Services: Transparency, Differential Pricing and Disintermediation

The Internet has had a profound effect on the financial service sector, dramatically changing the cost and capabilities for marketing, distributing and servicing financial products and enabling new types of products and services to be developed. This is especially true for retail financial services where widespread adoption of the Internet, the standardization provided by the world-wide web, and the low cost of Internet communications and transactions have made it possible to reach customers electronically in ways that were prohibitively costly even 5 years ago; indeed, pre-Internet attempts at the online distribution of retail financial services were outright failures in the mid-1980s. The concurrent growth and de-facto standardization of Internet-enabled personal financial management software (e.g., Quicken and Microsoft Money) have also contributed to an increasing array of low cost and potentially richer ways to provide information and transaction services to customers. The growth in Internet-enabled products and service has been rapid in some sectors and slower in others. Retail brokerage has seen a dramatic change with more than 15% (Salomon Smith Barney, 2000) of brokerage assets now managed in on-line trading counts, and substantially more if "traditional" brokerage accounts and mutual funds with on-line access are included. Similarly, approximately 10 million US customers currently use on-line banking (O'Brien, 2000) and 39 of the top 100 banks offer fully functional internet banking (ePayNews, 2000). Many banks and brokerages are on their second or third release of their on-line delivery platform. Credit cards, while not radically transformed in operational aspects of the business, have begun to have some volume of new origination on-line. In addition, leading credit card companies such as Capital One Financial have been some of the largest "traditional" companies in the use of Internet advertising (see www.adrelevance.com, 1999). More regulated and complex financial products such as mortgages and insurance have had some origination volume on the Internet (an estimated $17Bn of mortgages will be originated and ~$400mm in insurance premiums will be sold online in 2000). For these sectors, the adoption of on-line origination has been much slower and concentrated in entrants, rather than incumbent firms. However, despite the small level of originations, the Internet has become a significant and growing source of product information - it is estimated that about 10% of insurance customers and 15% of mortgage customers have used the internet to shop for these products (Forrester, 1998; McVey, 2000). This may ultimately affect product purchase and pricing structure, irrespective of the delivery channel. Internet companies have also played a role in many other segments of the industry such as financial information and news, rating and comparison services, and even some areas where one might think the Internet would have a less significant role, such as financial planning and investment banking. While the continued growth rates are uncertain and the penetration for the more complex products has not yet been shown to be widespread, it is safe to conclude that the Internet will play a significant role in consumer financial services for a large subset of customers, and that this role will be significantly different across different sub-sectors of the financial industry. In discussions of the Internet impact on the financial services sector, the emphasis has often been placed on the direct cost-saving effects of using the Internet to provide transaction services. These potential cost savings are indeed significant and in the long term may lead to significant creation of value. However, there also substantial barriers to realizing much of this value. In some industries, such as the credit card industry, many of the potential gains from automation have already been realized, and in others, the gains may be concentrated in only a few areas of the value chain. For products which are sold through branches or agents (banking, mortgage and insurance), realization of cost savings will require a difficult and time consuming redesign of the retail delivery system. Finally, many of these efficiencies are accompanied by improved customer convenience. To the extent that consumers respond by consuming more services, particularly those that generate costs but not revenue, overall costs may not be substantially reduced. This has been the experience of previous innovations in retail financial service delivery such as automated teller machines (ATMs). Computers, and more recently the Internet, are best described as "general purpose technologies" (Brynjolfsson and Hitt, 2000), like the electric motor or the telegraph (Bresnehan and Trajtenberg, 1995). For general purpose technologies, most of the economic value they create is associated with their ability to enable complementary innovations in organization, market structure, and products and services. However, at the same time, these complementary changes are often disruptive to the existing structure of an industry (Tushman and Anderson, 1986; Bower and Christensen, 1995), leading to significant redistribution of value among industry participants and between producers and consumers. To understand the true impact of the Internet on the financial service industry, it is therefore necessary to identify how the Internet affects the critical drivers of industry structure, and how it enables or necessitates changes in products and services. This will necessarily be difficult, as it is hard to isolate the contribution of the Internet separately from the effects of other complementary innovations, and to distinguish Internet effects from other of long-term industry trends and exogenous factors. While obtaining precise numerical estimates of the productivity effects will be hard, in many cases the direction and general magnitude of the impact on productivity, profitability and consumer surplus (consumer value) will be clear. We see three principal issues that will determine the transformation of retail financial services: Transparency, or the ability of all market participants to determine the available range of prices for financial instruments and financial services; Differential pricing, in which finer and finer distinctions must be made among groups of customers, setting their prices based upon the revenue streams they generate, the costs to serve them, and their resulting profitability; Disintermediation or bypass, in which net-based direct interaction eliminates the role previously enjoyed by financial advisors, retail stock brokers, and insurance agents. Each of these will affect the roles to be played by financial service providers, the sources of profits available to them, and the strategies they may choose to pursue in order to earn those profits. However, different financial products will be affected differently by each of these issues in both the nature and the magnitude of the effect. In addition, these factors are often interdependent - for example, differential pricing is often a necessary response to increasing price transparency to prevent erosion of margins, and the ability to deliver sophisticated (although typically not complex) pricing strategies to customers may be affected by the incentives and structure of the distribution system. For these reasons, we will organize the remainder of the paper around the discussion of these effects as they apply within different sectors in financial services. The emphasis of our analysis will be on the primary sectors in retail financial services: credit cards, deposit banking, mortgages, brokerage, and insurance. Our focus is the retail segment because it has been the most radically transformed by the Internet to date, primarily because the retail business has the most to benefit from the reduction in customer interaction costs, the ability to reach mass markets, and the reduction in the role of geography in determining the strategies of financial services providers. Much of the computing- and communications-enabled transformation in the relationships among financial institutions or between financial institutions and consumers of wholesale financial services (for example, brokerage houses and exchanges, or large firms and their commercial lenders) have already occurred or were well underway before the Internet was commercialized. For these markets, the economics of computing and networking were still favorable under previous generations of technology. Many of the commercial financial services that are likely to be transformed by the Internet, at least in the medium term (3-5 years), are those that closely resemble retail services (such as commercial mortgage, short term lending, leasing, cash management, and the like). That is not to say that business to business (B2B) e-commerce opportunities do not exist in the financial sector - only that many of the medium term opportunities that are directly a result of the Internet are closely analogous to changes in the retail sector, and the others are probably more closely related to organizational and market innovation rather than a result of ubiquitous and low-cost communications technology.

STRUCTURAL DIFFERENCES AMONG FIRMS: A POTE TIAL SOURCE OF COMPETITIVE ADVANTAGE INI THE APPLICATION OF 16YFORMATION TECHNOLOGY

Information systems are seen as strategic business tools, frequently essential to a firm and central to its competitive strategy. Their importance is now acknowledged. But information technology -- equipment and services -- is available to all firms, and most applications can be duplicated; often the copying firm enjoys the advantages of newer and better technology, learns from the experience of the innovator, and offers comparable services at reduced costs. When can an information system convey sustainable competitive advantage? We believe that the benefits resulting from an innovative application of information technology can be defended if: o they are so closely tied to the strategy of the innovating firm that competitors do not wish to copy them o they exploit unique structural characteristics of the innovating firm -- aspects of vertical integration, degree of diversification, or unique skills and resources -- so that competitors do not benefit from copying them We introduce here a model of the firm, based on value chain analysis, that highlights differences among firms; the model then guides the search for defensible opportunities for competitive advantage that exploits these differences

Rational Data Base Standards: An Examination of the 1978 CODASYL DDLC Report

The CODASYL Data Description Language committee\u27s 1978 Report incorporates numerous enhancements and language changes made since the earlier 1971 and 1973 reports. Unfortunately, the major design limitations associated with these earlier specifications, in particular a schema facility too closely related to machine rather than enterprise requirements and an extremely limited subschema facility, are retained. After examination of these limitations, we suggest that the recent CODASYL specifications remain inappropriate as either an instance of an ANSI/SPARC three-schema architecture or as a candidate for a national data base system standard. A long term strategy for the development of a more rational proposal for standardization is suggested. And a short term strategy is offered, one that permits rational planning for and implementation of data base conversions to occur today, without concern that subsequently developed standards might render obsolete the conversion effort and data base management system selected

The Impact of I.T. on the Degree of Outsourcing, the Number of Suppliers, and the Duration of Contracts

It has long been accepted within theinformation technology (IT) researchcommunity that IT should have a profoundimpact on industrial organization. However,there has been as yet on the changes to be expected in the design of firms or industries; rather, there is an apparently inconsistent collection of conjectures and analyses. We are now able to offer an integrative framework for describing the impacts of IT on an industrial organization. Our analyses generally support the "move to the middle" hypothesis that states that the impact of IT on the organization of economic activity is to lead to a greater degree of outsourcing where this increased outsourcing is done from fewer suppliers with whom the buyer has long-term relationships.

Individual Privacy and Online Services

We explore consumer trade-offs between better performance through tailoring of online services to their individual needs and greater privacy as a result of reduced disclosure of personal information. We show that individuals have different willingness to accept loss of privacy that is a function of (1) the individual and his/her preferences, because the variation in demands for privacy is not uniform across individuals, (2) the service Domain, because individuals demand more privacy in some Domains than they do in others and (3) these differences themselves differ among consumers as well

Justifying Contingent Information Technology Investments: Balancing the Need for Speed of Action with Certainty Before Action

Executives need to master different mechanisms for analyzing their firms\u27 investment opportunities in uncertain, difficult times. Rapidly changing business conditions require firms to move quickly, with total commitment and the rapid deployment of capital, resources, and management attention, often in several directions at the same time. However, high levels of strategic uncertainty and environmental risk, combined with limits on available funding, require firms to limit their commitment. In brief, we require high levels of strategic commitment to numerous projects, while simultaneously preserving our flexibility and withholding commitment. Whereas achieving both is clearly impossible, techniques exist that enable executives (1) to identify and to delimit their range of investment alternatives that must be considered, and to do so rapidly and reliably, (2) to divide investments into discrete stages that can be implemented sequentially, (3) to determine which chunks can safely and profitably be developed as strategic options, with value that can be captured when subsequent stage investments are made later; and (4) to quantify and to estimate the value of these strategic options with a significant degree of accuracy, so that selections can be made from a portfolio of investment alternatives. This paper also avoids restrictions of common option valuation models by providing a technique that is general enough to be used when the data required by common models are not available or the assumptions are not satisfied

Regulation of Digital Businesses with Natural Monopolies or Third-Party Payment Business Models: Antitrust Lessons from the Analysis of Google

Some digital business models may be so innovative that they overwhelm existing regulatory mechanisms, both legislation and historical jurisprudence, and require extension to or modification of antitrust law. Regulatory policies that were developed in response to nineteenth- or twentieth-century antitrust concerns dealt principally with economies of scale leading to monopoly power and may not be well suited to the issues of network effects or third-party payer online business models such as sponsored search. From the perspective of information systems economics, we investigate if such third-party payer digital systems require intervention as profound as the government\u27s innovative approach to the problems posed by AT&T in the 1913 Kingsbury Commitment, establishing the first private regulated monopoly. Google provides an example of a company whose innovative digital business model is difficult to fit into current regulatory frameworks, and may provide examples of the issues that might require an extension to regulatory policy

Consumer Informedness and Diverse Consumer Purchasing Behaviors: Traditional Mass-Market, Trading Down, and Trading Out Into the Long Tail

As truly informed consumers are increasingly able to find exactly what they want and willing to pay premium prices to obtain products with perfect fit for them, companies have responded with new product portfolio strategies and new pricing strategies, based on the concepts of resonance marketing and hyperdifferentiation. This is not just consumers’ pursuit of products that are better, but rather better for them. It is not trading up, but rather trading out. In this paper we offer a more complete explanation of changes in consumer behavior, based on consumers’ new-found informedness, and an understanding of consumers’ pursuit of products that truly meet their individual wants and needs, cravings and longings. This paper also contributes to a deeper understanding of how online reviews are linked to sales. Recent empirical studies suggest that consumers use information in different ways in different shopping experiences, and that consumers’ purchasing behavior varies across different online shopping experiences; consequently, the best predictors of the success of different online products will therefore vary depending on what consumers are buying and why and how they are buying it

TURMOIL, TRANSPARENCY, AND TEA: EVALUATING THE IMPACT OF IT ON LONDON'S STOCK EXCHANGE

Evaluating strategic investments in information technology can be difficult. Uncertainties exist in customer responses, competitor reactions, and thus in the actual economic benefits to be realized. Valuing interorganizational information systems (IOS) is far more complex, since the valuation is complicated by issues of bargaining power, and distribution of IOS benefits. Although an IOS may create a net benefit or economic surplus, valuation by the innovator contemplating the investment must also consider who retains these benefits. The distribution is in part determined by the technology's capabilities, but principally by the power and resource endowments of the different IOS participants. Screen-based securities markets represent IOSs that serve many stakeholders including investors, securities firms, and listed companies, as well as the securities exchange or vendor providing the system. The London Stock Exchange's (LSE) £25 million investment in trading technology at the time of its 1986 Big Bang deregulation did not benefit all IOS participants equally. Although the screen-based market produced significant benefits for the Exchange, and for investors, whose transactions costs were reduced, any gains retained by the LSE's member firms, who ultimately paid for the investment, are difficult to demonstrate. The damage done to those parties that paid for technological improvements at the LSE has led to dysfunctional behavior by the member firms, and to some deterioration in the quality of the market. The evidence indicates that an uneven distribution of benefits can potentially subvert the efficient functioning of an important IOS.Information Systems Working Papers Serie

Poaching and the Misappropriation of Information: Transaction Risks of Information Exchange

We address the concept of poaching, the risk that in any transactional relationship, information that is transferred between parties for purposes specified in the contract will deliberately be used by the receiving party for purposes outside the contract, to its own economic benefit, and to the detriment of the party that provided the information. We argue that this form of transactional risk, a component of transaction costs, is increasingly important in our service-centered, information-driven, postindustrial economy. Using case examples and a discussion of the related literature, we demonstrate and discuss the conditions under which shared information creates the potential for poaching, examine the impact and efficacy of traditional remedies for contractual problems in managing poaching, and identify additional mechanisms for managing poaching risk. Our analysis suggests that these risks and their remedies are fundamentally different in nature from those considered in previous theories of supplier relations and contractual governance