IBM Global Services eStrategy Report B2B Payments …€¦ · IBM Global Services eStrategy Report B2B Payments Are Coming; Banks Must Prepare By Jennifer Franklin, Dan Latimore Over

IBM Global ServicesIBM Global ServicesIBM Global ServicesIBM Global Services

eStrategy ReporteStrategy ReporteStrategy ReporteStrategy Report

B2B Payments Are Coming; Banks Must PrepareB2B Payments Are Coming; Banks Must PrepareB2B Payments Are Coming; Banks Must PrepareB2B Payments Are Coming; Banks Must PrepareBy Jennifer Franklin, Dan Latimore

Over 200 vendors have developed business-to-business epayment solutions thatOver 200 vendors have developed business-to-business epayment solutions thatOver 200 vendors have developed business-to-business epayment solutions thatOver 200 vendors have developed business-to-business epayment solutions thatoffer different ways to make Internet-based transactions more reliable, secure andoffer different ways to make Internet-based transactions more reliable, secure andoffer different ways to make Internet-based transactions more reliable, secure andoffer different ways to make Internet-based transactions more reliable, secure andefficient. While these solutions have not yet gained significant traction withefficient. While these solutions have not yet gained significant traction withefficient. While these solutions have not yet gained significant traction withefficient. While these solutions have not yet gained significant traction withbusinesses at large, banks must develop a B2B payment strategy in order to protect,businesses at large, banks must develop a B2B payment strategy in order to protect,businesses at large, banks must develop a B2B payment strategy in order to protect,businesses at large, banks must develop a B2B payment strategy in order to protect,and, if executed well, enhance their relationships with corporate customers. A criticaland, if executed well, enhance their relationships with corporate customers. A criticaland, if executed well, enhance their relationships with corporate customers. A criticaland, if executed well, enhance their relationships with corporate customers. A criticalfirst step is becoming familiar with the evolving marketplace and identifying thefirst step is becoming familiar with the evolving marketplace and identifying thefirst step is becoming familiar with the evolving marketplace and identifying thefirst step is becoming familiar with the evolving marketplace and identifying thethreats and opportunities that it presents.threats and opportunities that it presents.threats and opportunities that it presents.threats and opportunities that it presents.

Executive SummaryExecutive SummaryExecutive SummaryExecutive Summary

Non-BankVendors Are Accelerating Change In The Payments Space; Banks MustNon-BankVendors Are Accelerating Change In The Payments Space; Banks MustNon-BankVendors Are Accelerating Change In The Payments Space; Banks MustNon-BankVendors Are Accelerating Change In The Payments Space; Banks MustRespondRespondRespondRespond

At the heart of every business-to-business (B2B) transaction sits the payment function.Conducted primarily through traditional means today (e.g., paper checks and creditcards), payments are a process ripe for the efficiencies that the Internet can deliver. Tothis end, non-bank vendors of online payment solutions are developing systems thatenable corporations to initiate payments online, wrap payment instructions with theirremittance data, and integrate robust payment information into existing ERP andaccounting systems. Prodded by the innovations of these new entrants, banks will overtime begin to offer their corporate customers these new functionalities in order to defendtheir position at the center of the cash management relationship.

While the Internet has not fundamentally changed the B2B payment value chain,providers of online payment services have effectively unbundled its elements, enhancedthem, and rebundled them in new and compelling ways. Corporate interest, not yet fullyunleashed, will accelerate as critical mass is reached and powerful network effects drivefull-scale adoption of value-added payment services. Despite the threat to their margins,banks must be prepared with a strategic response or risk deteriorating or lost customerrelationships.

B2B PaymentsB2B PaymentsB2B PaymentsB2B Payments

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In this eStrategy Consulting study, Mainspring Inc (now a wholly owned subsidiary ofIBM) concludes:

• Large Banks Will Become Resellers of Value-Added Payment Services

• Corporate Customers’ Appetite for Value-Added Services Will Drive the Timing ofBanks’ Payment Offerings

• Banks Must Either Be Leaders or Fast Followers in the Value-Added Payment Space

• Banks Must Leverage Core Competencies to Avoid Becoming CommoditizedProcessors

MethodologyMethodologyMethodologyMethodology

This eStrategy Report is based on an eight-week consulting study of business-to-business (B2B) payments completed by Mainspring Inc’s eStrategy Direct onlineconsulting service. A strategy consulting team conducted research and analysis toassess the state of the B2B payment market, determine key implications, and provide e-business banking executives with frameworks to guide their decision making. Theunderlying eStrategy Consulting Study provides, where applicable, an in-depthassessment of customer experience and needs, industry structure and competitors,technology and vendors, as well as legal and regulatory influences. The Study isdesigned to help e-business executives identify and assess strategic alternatives, thendetermine their best path forward. eStrategy Direct clients have complete access to morethan 20 industry-specific and cross-industry eStrategy Consulting Studies each year, aswell as monthly one-on-one access to consultants via interactive consulting sessions.


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Key FindingsKey FindingsKey FindingsKey Findings

Large Banks Will Become Resellers of Value-Added Payment ServicesLarge Banks Will Become Resellers of Value-Added Payment ServicesLarge Banks Will Become Resellers of Value-Added Payment ServicesLarge Banks Will Become Resellers of Value-Added Payment Services

One of the core functions of a bank has always been to process payments on behalf of itscustomers. The only choice that businesses had was which bank to use; these trustedfinancial guardians had a monopoly not only on the payments, but also on the (limited)information that was attached to them. Today, though, there are more than 200 vendorsof payment-related services, many of whom have banks’ game squarely in their sights asthey target their products directly at businesses with the goal of displacing banks as thecentral point of contact for cash management.

The Current SituationThe Current SituationThe Current SituationThe Current Situation

Source: Mainspring, Inc..

SupplierCorporate customer

Bank 1 Bank 2

Current Situation: Banks Control the Customer Interface

Trading partners engage in commerce through bank-sponsored cash management programs

Customer Interface


Bank 1 Bank 2

Current Situation: Banks Control the Customer Interface

Trading partners engage in commerce through bank-sponsored cash management programs

Customer Interface


4

The ThreatsThe ThreatsThe ThreatsThe Threats


These new providers play across the payments spectrum, from some who providespecific services like escrow, to others who offer an integrated suite that spans the valuechain, from invoicing to paying to reporting. While the new vendors will not control theback-end payment networks (like ACH), they are trying to hijack the customer interfacesby dramatically improving the ease and transmission of payment information.

Threat: New Entrants Control the Customer Interface


Bank 1 Bank 2

New EntrantsCustomer Interface

Threat: New Entrants Control the Customer Interface


Bank 1 Bank 2

New EntrantsCustomer Interface


5

While payment vendors are not fundamentally altering the trading value chain, but areinstead unbundling, enhancing, and rebundling it. Some are attacking it by offeringinnovative online services confined to specific value links (monoline offerings), whileothers are augmenting and rebundling it by providing information wrapping and analysisservices.

Rebundled Value ChainRebundled Value ChainRebundled Value ChainRebundled Value Chain


INFORMATION WRAPPING:PAYMENT

+MessagingRemittance

Deferred/Real-time payment




INFORMATION ANALYSIS:PAYMENT

+Reporting

Integration with AP/AR systems


+Reporting


Dispute ResolutionInvoiceOrder ReportPAY














+Reporting



+Reporting



+Reporting



+Reporting


Dispute ResolutionInvoiceOrder ReportPAY Dispute ResolutionInvoiceOrder ReportPAY


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Bank RoleBank RoleBank RoleBank Role

Bank technology vendors have introduced the possibility of change. This does not meanthat they are going to win the game. Instead, they have begun to force banks to consideroffering these new services. Ultimately, corporate customers will be the beneficiaries ofaccelerated innovation and the compelling value proposition of increased control anddecreased costs. Banks, too, will benefit over time as their processing costs are lowered,but they’ll have to be proactive in offering value-added services if they are to mitigate therisk of being relegated to a secondary relationship with their customers, or, worse, havingtheir customers move to another institution. And in the short-term, banks will face a certainamount of pain. Because they profit from inefficiencies in their customers’ processes(e.g., float, lines of credit for working capital needs), these streamlined procedures will eataway at their margins.


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Banks face six broad categories of strategies that they can pursue singly or incombination.

Bank StrategiesBank StrategiesBank StrategiesBank Strategies


For banks with a corporate customer base, the question isn’t whether to offer enhancedpayment services, but when. In the Mainspring, Inc. study, we detail the consequences ofall seven strategies. In summary, neither the first nor the last is realistic. Of the remainingfive, financial institutions must evaluate each of them – new fee income from differentiatedservices, increased access to customer data, increased retention – with the risks andcosts of acting precipitously. Risks include failure to execute (thereby potentially drivingcustomers away and undermining credibility for those who stay), and lack of customeradoption, which will hurt the economics of the investments. Costs include the expensesassociated with implementing and maintaining a new, parallel system on top of thesystem used to process paper transactions, which aren’t going away any time soon.Much like retail Internet offering, B2B payment systems will decrease per transactioncosts, but increase overall payment processing costs for the bank as a whole.

Marketplace/ Interface Between Trading

Partners

Online Financial Services Suite

Technology

Consortium

(1)Host eMarketplace

(3) Form Consortium

(2) Provide Online Financial

Services Suite to eMarketplace

(4)Partner with Technology Companies to Develop

Payment Company

(5)Invest in Payment Technology

Companies

(7) Wait and See

Back-end

Front-end

(6) Partner with Technology Company to Provide Online Payment Services>>Best Strategy

Marketplace/ Interface Between Trading

Partners

Online Financial Services Suite

Technology

Consortium

(1)Host eMarketplace

(3) Form Consortium

(2) Provide Online Financial

Services Suite to eMarketplace

(4)Partner with Technology Companies to Develop

Payment Company

(5)Invest in Payment Technology

Companies

(7) Wait and See

Back-end

Front-end

(6) Partner with Technology Company to Provide Online Payment Services>>Best Strategy


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To help decide when to take the plunge, banks should develop a strategy forapproaching the market, monitor developments in it, and dive in when appropriate.

Banks should take heart; they currently possess an enormous competitive advantage inthe payment space relative to new entrants. Their payment experience, credit capabilitiesand large customer bases give them an important edge that cannot be readily duplicatedby this emerging class of competitors.

• Payment experience: Banks have been handling payments for years and havedeveloped a core competency that cannot easily be duplicated. This hard-won basecan be used to branch into new, value-added payment services.

• Credit capabilities: Non-bank vendors will not be able to provide credit directly.

• Large customer base: Bank customers have strong relationships with the banks thatprovide their treasury and cash management services and have developed systemsand protocols that let them trust banks to execute financial transactions securely.

Most new vendors entering the payment space must develop both a customer base andtrustworthiness from scratch, a labor-intensive and expensive process. Consequently, ascorporate customers become interested in the value proposition of electronic payments,they will turn to banks first.

As banks respond to increasing corporate demand for payment services, they shouldgenerally not invest heavily in building functionality that already exists. Many of these newvendors have developed payment technology expertise that they are willing to sell,license or co-brand. Banks can look to those providers for applications that will augmenttheir payment offerings and save themselves significant development costs.


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Corporates’ Appetite For Value-Added Services Should Drive Banks’ TimingCorporates’ Appetite For Value-Added Services Should Drive Banks’ TimingCorporates’ Appetite For Value-Added Services Should Drive Banks’ TimingCorporates’ Appetite For Value-Added Services Should Drive Banks’ Timing

B2B epayments offer clear benefits for payers, payees, and, over the long term, banks.We believe firmly, though, that corporates are going to have to be the ones drivingepayments, and that the size of the benefits will have to be counterbalanced with thedifficulty of changing behavior. Corporations have, after all, invested significant time andeffort in developing payment systems that work, even if they don’t work perfectly. Existinginternal processes handle purchase orders, invoices and payments with built-in securityand quality assurance protocols. Simply put, “if it ain’t broke, why fix it?” That said, webelieve the potential benefits of these new payment systems are sufficient to surmountthis inertia.

Electronic Payment: Value PropositionElectronic Payment: Value PropositionElectronic Payment: Value PropositionElectronic Payment: Value Proposition


• Automated reporting and analysis• Automated payment scheduling and

initiation• Reduced payment initiation expense• Automated accounts payable posting

Benefits for B2B Payers• Consistency in billing and receivables• Improved cash forecasting• Potentially accelerated payments• Reduced payment processing expense• Automated accounts receivable posting• Non-repudiation of payments

Benefits for B2B Payees

Benefits for Both

• Improved information flows• Reduced set-up costs-no proprietary software or hardware installation for ASP models• Reduced maintenance costs for hosted applications

>> >>

>>

• Automated reporting and analysis• Automated payment scheduling and

initiation• Reduced payment initiation expense• Automated accounts payable posting

Benefits for B2B Payers• Consistency in billing and receivables• Improved cash forecasting• Potentially accelerated payments• Reduced payment processing expense• Automated accounts receivable posting• Non-repudiation of payments

Benefits for B2B Payees

Benefits for Both

• Improved information flows• Reduced set-up costs-no proprietary software or hardware installation for ASP models• Reduced maintenance costs for hosted applications

>> >>

>>


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While banks can’t force their customers to adopt electronic payments, they cannevertheless begin a dialog to see what their attitudes and concerns are with respect topayments. Learning first-hand about these concerns, then addressing them directly, canhelp demonstrate that the risks and costs of switching are manageable. The backing of astable institution like a bank (rather than just a new entrant) will also be an importantindicator of the sustainability of an offering.

With these sensitivities in their back pocket, banks make a compelling economic case forswitching payment systems to those corporations that have large payment volumes.

Savings ModelSavings ModelSavings ModelSavings Model

Source: Mainspring, Inc. analysis; vendor, treasury and bank interviews, Apr

100,000 103,000 106,090 109,273 112,551

$76,731 $79,033 $81,404 $83,846 $86,361

$21,000 $21,630 $22,279 $22,947 $23,636

$5,479 $5,644 $5,813 $5,988 $6,167

$150,000 $154,500 $159,135 $163,909 $168,826

AssumptionsError Reduction:

• Error rate-2%• Error reduction-95%• Hours/error-4• Wages/hr-$10.10

Staff Reduction:• Staff reduction-2

people/100,000 transactions• % reduction in clerks-50%• Annual salary/clerk-$21,000

Cash Efficiency:• Days improved-2• Annual payment volume-

$20mCost Savings:

• Cost of traditional tx-$3• Cost of electronic tx-$1.50

($100,000)

($30,000)

($130,000)

-

NPV at 15% $633,569

Discounted Cash Flow

ModelYear 1 Year 2 Year 3 Year 4 Year 5

Annual transactions

Error Reduction

Staff Reduction

Cash EfficiencyTransaction Processing

Cost SavingsTotal Savings

- - - -

($10,000) ($10,300) ($10,609) ($10,927)

$260,807 $268,631 $276,690 $284,990

$243,210 $250,507 $258,022 $265,762 $273,735

$253,210

-

($11,255)

Year 1 Year 2 Year 3 Year 4 Year 5Initial Investment

Cost to Integrate

Cost to Train/Maintain

Benefits

Total

$260,807 $268,631 $276,690 $284,990$253,210

100,000 103,000 106,090 109,273 112,551

$76,731 $79,033 $81,404 $83,846 $86,361

$21,000 $21,630 $22,279 $22,947 $23,636

$5,479 $5,644 $5,813 $5,988 $6,167

$150,000 $154,500 $159,135 $163,909 $168,826

AssumptionsError Reduction:

• Error rate-2%• Error reduction-95%• Hours/error-4• Wages/hr-$10.10

Staff Reduction:• Staff reduction-2

people/100,000 transactions• % reduction in clerks-50%• Annual salary/clerk-$21,000

Cash Efficiency:• Days improved-2• Annual payment volume-

$20mCost Savings:

• Cost of traditional tx-$3• Cost of electronic tx-$1.50

($100,000)

($30,000)

($130,000)

-

NPV at 15% $633,569

Discounted Cash Flow

ModelYear 1 Year 2 Year 3 Year 4 Year 5

Annual transactions

Error Reduction

Staff Reduction

Cash EfficiencyTransaction Processing

Cost SavingsTotal Savings

- - - -

($10,000) ($10,300) ($10,609) ($10,927)

$260,807 $268,631 $276,690 $284,990

$243,210 $250,507 $258,022 $265,762 $273,735

$253,210

-

($11,255)

Year 1 Year 2 Year 3 Year 4 Year 5Initial Investment

Cost to Integrate

Cost to Train/Maintain

Benefits

Total

$260,807 $268,631 $276,690 $284,990$253,210


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Electronic payments are subject to significant network effects, that is, the morecompanies that use them, the more valuable they become to all users. Becauseincreased levels of information can be exchanged with a greater variety of counterpartsas adoption increases, once a certain critical mass of users is reached, adoption will hit atipping point, and growth will accelerate sharply. Those who have been waiting for othersto demonstrate viability will be satisfied, and the utility of the solution will be great enoughthat the calculated benefits exceed the switching cost.

The Tipping PointThe Tipping PointThe Tipping PointThe Tipping Point


Illustrative

20002001

Minimal adoption

Mass adoption

Tipping Point

2002

2003

1999 2001 2003

Use

rs

2005

Tipping Point

Illustrative

20002001

Minimal adoption

Mass adoption

Tipping Point

2002

2003

1999 2001 2003

Use

rs

2005

Tipping Point


12

Vendors would like to reach the tipping point as quickly as possible, so many areattempting to accelerate adoption by approaching corporates directly. Although webelieve that this bypass of the banks will ultimately be unsuccessful, the challenge willnevertheless force banks to act to defend the space that they are best positioned tooccupy.

Banks Must Either be Leaders or Fast Followers in the Value-Added Payment SpaceBanks Must Either be Leaders or Fast Followers in the Value-Added Payment SpaceBanks Must Either be Leaders or Fast Followers in the Value-Added Payment SpaceBanks Must Either be Leaders or Fast Followers in the Value-Added Payment Space

As large banks consider their options with respect to value-added payment services, theymust bear in mind that payment vendor space is undergoing rapid change; the shakeoutof 200 vendors hasn’t yet occurred. All of the numerous vendors in the space claim tohave a unique approach to the market and that their offerings can integrate with back endsystems. As we look more deeply, though, most have extremely few users, and none hasendured the test of time.

The variety of offerings is immense. Some are broad, while others are monoline. Overtime, firms offering monoline solutions will not survive as standalone entities becausecustomers don’t want the burden of having to cobble together a full-service capability.Consolidation is inevitable and has already begun. Banks that partner too quickly with anon-sustainable or unworkable solution provider will tarnish their credibility and riskcustomer defection. It is better to introduce a solution that works than one that is faultyand alienates loyal customers.

Banks should monitor developments and customer attitudes. While trying to force asolution on those who don’t want it will fail, banks should nevertheless be prepared toimplement an offering when good customers want it. Failing to do so will expose therelationship to the threat of another firm that offers superior payment services, and couldpotentially usurp the bank’s current relationship as a primary cash manager.


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Banks Must Leverage Core Competencies to Avoid Becoming CommoditizedBanks Must Leverage Core Competencies to Avoid Becoming CommoditizedBanks Must Leverage Core Competencies to Avoid Becoming CommoditizedBanks Must Leverage Core Competencies to Avoid Becoming CommoditizedPayment ProcessorsPayment ProcessorsPayment ProcessorsPayment Processors

Payment processing is a business that enjoys certain economies of scale, and over time,these businesses tend to see their economic profits drop to zero (that is, the returnmatches the cost of capital). This business, though, is a valuable entrée into otherrelationship-based transactions with corporate customers, and many firms shouldcultivate it to preserve the access that it provides. Non-commodity businesses, likeoutsourced treasury functions and other value-added services, will also provide attractiveprofits. To remain viable entities in the payment arena, banks should become as efficientas possible in the scale, commoditized processing business (or, for smaller firms,consider outsourcing it) and enhance payment services that customers will value and payfor.

ImplicationsImplicationsImplicationsImplications

Banks Need to Offer Value-Added Payment Services Soon But Should Not Go ItBanks Need to Offer Value-Added Payment Services Soon But Should Not Go ItBanks Need to Offer Value-Added Payment Services Soon But Should Not Go ItBanks Need to Offer Value-Added Payment Services Soon But Should Not Go ItAloneAloneAloneAlone

To execute an electronic payment strategy, banks need to pursue two types ofpartnerships. First, they need a technology partner that will provide electronic paymentfunctionality and assure timely deployment. Second, they need a corporate partner toserve as a beta tester of their offering and assure the quality and utility of the product.

The Technology Partner

Banks and technology vendors both have much to gain by partnering with each other.Banks obtain already-developed technology, while vendors gain stability and access to acustomer base.

To prepare for electronic payments, banks should develop their strategy and implementtheir research now. Specifically, they should begin to investigate potential vendorpartners. Criteria for selection include:


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• Ability to augment bank’s core capabilities with a technologically sound andcomprehensive payment and services offering

• Good prospects for long-term survival (which may be enhanced by a bankpartnership)

• Ease of integration with existing systems

The Corporate Partner

No bank should broadly introduce a system before it works well. Keep close tabs oncorporate demand for payment services; in today’s environment, firms are applyingrigorous ROI tests to new investments and methodologies. One way to mitigate the risk ofimplementing a faulty system is to partner with a corporate customer willing to be a betatester. Finding such a partner will allow you to deepen that particular relationship, andiron out integration kinks before taking the product out to a broader audience. Even thesearch for a corporate partner can be beneficial, as opening the partnership discussion,even if it doesn’t bear fruit, will likely be remembered when the time comes to actuallyimplement a system. Beta testing also offers an opportunity to collect metrics on return oninvestment. An actual case that proves the value of the technology will be the mostpersuasive tool for recruiting new customers.

While new payment vendors will pose a threat that will over time prod banks to offerincreased functionality around electronic payments, they pose but a minor threat to bankswho are vigilant about monitoring the market and offering these new servicesappropriately. In fact, these new offering present pockets of opportunity to introduce newvalues added services to the relationship. Examples include trust services, guaranteedpayments, finance at the point of sale, and trade finance. Ultimately, banks have theadvantage; it’s up to them not to squander it.


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About the Authors

Jennifer McKinley leads IBM's e-Strategy Executive Council, a forum of senior e-businessexecutives at Fortune 1000 companies. She specializes in helping these executives solvetheir cross-industry e-business issues and manages the Council's quarterly meetings.Jennifer can be reached at [email protected].

Dan Latimore is a Principal with IBM's Strategy & Change Financial Services practice andco-leads its retained services offering. His thought leadership focus provides clients withframeworks and insights for addressing their most pressing business strategy issues. Hecan be reached at [email protected].


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IBM Global Services eStrategy Report B2B Payments …€¦ · IBM Global Services eStrategy Report B2B Payments Are Coming; Banks Must Prepare By Jennifer Franklin, Dan Latimore Over