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514 International Journal of Management Vol. 21 No.

4 December 2004

An Analysis of the Impact of the Internet on Competition
in the Banking Industry, using Porter's Five Forces Model
Irene Siaw
The Open University of Hong Kong, Hong Kong
Cisco Systems (HK) Ltd, Hong Kong

The emergence of the Intemet has created both threats and opportunities for banking
executives. Those who are able to leverage competitive benefits from the Intemet are
confronted with significant business potential. The Internet has fundamentally changed
traditional relationships and services within the banking industry. It shifts the overall
competitive landscape, the technical and standards infrastructure, and the requirements
of individuals and business users. The impact of the Intemet on the banking industry
and Internet banking as a source of competitive advantage have become challenging
issues for both business managers and academics. This article uses the theoretical
framework of Michael Porter's Industry 5-Force Competitive Model as the theoretical
framework to analyze the ways that the Intemet is affecting the competitive dynamics
of the banking industry.
The Internet's compelling effect on the commercial world is its ability to pull enormous
infonnation from virtually every comer of the globe (Engelman, 1996). Today every
business model is evolving to adapt to the growing acceptance of the Intemet and E-
commerce. Banking is no exception. E-commerce fundamentally changes the existing
business models, shifting the balance of power fi-om the bank to the individual customer
(Brennand, 1999). The impact of the Intemet on the banking industry is often under-
valued by executives. The primary problem is that Intemet banking is often confused
with the traditional Personal Computer (PC) Remote Home Banking, which has been
available for more than 20 years. Despite its innovations, this form of banking did not
live up to its predicted level of success.
Many banks have experienced problems with home banking. The Chemical Bank in
the United States introduced Pronto Home Banking and Pronto Business Banker for
small businesses in the early 1980s. Pronto failed to attract enough customers to break
even and was abandoned in 1989 along with Citicorp's Direct Access and Chase
Manhattan's Spectrum home banking. The fundamental questions facing most executives
are whether Intemet banking will face the same situation and whether customers will
adopt this service. Their concems are understandable considering that the Security First
Network Bank, recognized as the first virtual bank in the world, and other Intemet
banks are still struggling for profits.
However, things are changing. Netbank, launched in 1996 as Atlanta Intemet bank,
reported $4.5 million in net income for 1998, versus a $5.6 million loss the year before.

with Intemet banking. using the theoretical framework of Porter's Industry 5-Forces Competitive Model.International Journal of Management Vol. Since then. In most home banking ventures. Impact on the Competitive Landscape in the Banking Industry Many research studies cu-gue that Intemet banking will be the predominant trend in the future of the banking industry (Birch & Young. "While FSI (Financial Services Institutions) executives cite many reasons for undertaking initiatives. The issue of whether Intemet banking can satisfy what customers want remains an unanswered question for most executives. 1998. By contrast. 1999. In view of these issues. 1997. the bank provides the customer with an application software program (or PFM by customer) that operates on a customer's designated PC. potential customers already have the software they need to do their banking services as application software resides on the bank's server in the form of the home page. Intemet banking refers to the use of the Intemet as a channel in the delivery of banking products and services (Starita. according to the Online Banking Report: The Tme US Intemet Batiks (www. 1999). This paper analyzes ways in which the Intemet impacts on the competitive dynamics of the banking industry. business partners. The Security First Network Bank (SFNB) in the United States inaugurated the world's first transactional Web site on October 18. 1999). or of how the Intemet can be leveraged to act as a competitive weapon in businesses. et. The real value of E-Commerce comes from enhancing communication and transactions with customers. Brennand. The FS Intemet Value Creation Study conducted by Emst & Young (1999b) suggested. Franco & Klein. Crede. Internet Banking: A New Paradigm Today. the Intemet has evolved into a commercial technology usable by a broad spectmm of business people involved in E-Commerce. 21 No. govemment regulators and the public at large and ultimately moving towards an electronic marketplace where goods and services are transacted over the Intemet (Watson." The root problem is that most of the banking executives fail to recognize the real impact of the Intemet on the industry. this study aimed to examine how the emergence of the Intemet is likely to affect the competitive landscape of the banking industry. the United States alone saw over 200 new Web-based start-ups and/or spin-offs from existing conventional banks.onlinebankingreport. . In 1999. al 2000). most are not developing business cases to quantify their investment. The difficulty may be inadequate understanding of the competitive aspects of the Intemet in the industry as a whole. 4 December 2004 515 demonstrating that the words "Intemet banking" and "profitability" are not mutually Humphreys. Cisco. Intemet banking and traditional PC banking differ with respect to the application software resident on the user's computer and hence the requirement for ongoing software upgrades and distributions. suppliers. the number of Intemet banks has increased significantly each year. which is to be analyzed in detail below. 1999. 1995. 1998.

lack of money has acted as a barrier to entry into any particular market ( does is something totally different from traditional brick-and-mortar practice and this change has resulted in operating costs so low that they can easily undercut the discounts offered by large conventional bookstores. its past track record. 1999a). despite the fact that the volume Amazon processes may be significantly less than the competition. From Capital Requirements to Knowledge Requirements Traditionally. In addition. . Today. This has been especially tme in the banking sector. Investors recognize that an organization's key asset is not its economies of scale. economies of scale count for nothing in this new virtual environment. Intemet banking. For example. 4 December 2004 From Economies of Scale to Altering the Rules of Competition As a result of the advent of Intemet technology. other banks have had to respond in kind (playing by SFNB's rule rather than their own). larger banks no longer gain an advantage based on the economies of scale that they were able to achieve in the past. 1979). raising finance is perhaps the least difficult task facing an organization. In today's banking environment. With Intemet banking. a large labor force.or any of the other trump cards traditionally held by the incumbents in a market. by setting up their own Web-based outlets. The market is likely to see more new small banks emerge that will use the Intemet to compete with the large-scale multinational financial giants. Historically. Physical size and bureaucratic organizational structure can mean high operating costs. 21 No. because banks have emphasized personal direct contact with customers and have require complex hierarchical organizational stmctures that function to deliver the personal level of contact traditionally required by customers. What investors are interested in and expect is the organization's knowledge. 1998). Such a shift has substantially lowered the traditional barrier to entry. online technology is said to be able to deliver services far more economically than pre-existing methods (Emst & Young. where physical processes are replaced by infonnation via the Intemet. and a large branch network may seem to have become less important. Economies of scale are relevant only in markets where all the participants are playing by the same set of mles (Czemiawska & Potter. mortar and physical networks are no longer required. its brand . Not surprisingly. Financial muscle.516 International Journal of Management Vol. the processing of large physical branch networks is perhaps no longer a serious competitive advantage or a primary consideration for customers selecting a bank. large branch networks that require substantial capital outlay have been established. can be leveraged to set one's own mles of competition. In this case. if executed correctly. Today. Similarly SFNB is a classic example of an innovator in the banking field. The end result is that Intemet banking shifts the competitive mles by leveling the playingfieldamong large and small banks and reduces the importance of issues such as physical distance and location. The question is whether you want to set your own agenda or you want your competitors to do it for you. bricks. what Amazon. as well as inefficient and limited degrees of flexibility. information via the Intemet enables smaller companies to seize the advantage and to set a new competitive agenda.

personalized menus and Web pages. lower attrition and a lower service cost than traditional banking customers with similar demographics. thus allowing service providers. In summary. The Intemet. the battlefield is changing from competing by brand and/or product differentiation to targeting the most lucrative customers. they are also more affluent and more educated (Cisco Systems. and other data to customers as they browse a bank's Web site. Brennand. As a result. 1999. The danger is. Customer Segmentation: It has been claimed that 20% of a bank's customers often account for 150% of its profits (Sheshunoff. 1999. identifying the potentially most profitable Intemet batiking customers. by providing customers with better information. there are companies acting as "informers" or advisers. Brand building is particularly important for commodity products and for those products. banks for instance. . more banking products. Customer Relationship Management. Reseju-ch studies indicate that the Intemet banking customer provides from two to three times as much profit as the traditional banking customer (Cisco Systems. your competitors will. other banks replicate them. a bank is able to deliver targeted marketing and product infomiation. 1998). 4 December 2004 517 From Brand and Product Differentiation to Customer Segmentation/Relationships Brand Building: The last two decades were a period that saw a heavy emphasis on the development of brands as a means of differentiation. millions of dollars were spent on brand development. The Intemet allows batik customers to rely less on the high-level image created by a brand and to make far more informed purchase decisions. However. effectively changes the balance of power from the bank in favor of the individual customer. brands and "information availability" do not mix well. 21 No. such as banking services. 1999). Therefore financial institutions attempt to maximize their profits by focusing more resources on those valuable customer segments. and targeting them. Already on the Intemet. thereby successfully managing the relationships with banking customers. Almost as quickly asfinancialfirmsdevelop new products/services. Brennand. if they have the same interest rates? Unfortunately. as well as maintaining optimal customer relationships for long-term profitability. What is the difference between deposit services offered by two banks. that are essentially undifferentiated (Porter. 1999). What options do financial services companies striving for profitability have? Perhaps. that if you don't do it. With the help of the Intemet. as Intemet banking becomes an effective channel for reaching that 20%.International Journal of Management Vol. 1998). Intemet banking customers have higher deposits. So the profitability of banks now depends on developing a lucrative market segment. one way is to differentiate themselves in the face of commoditization. who help potential purchasers make the best choices. The Intemet is also making it easier for customers to shift from a current provider to a new one. 1999). as everything can be found on the Web. to create awareness for the purpose of customer loyalty (Czemiawska & Potter. it allows competing banks to target those same customers with their own Intemet services.

Citibank has successfully entered the Japanese market with a web-based solution. From Regulated Govemment Policy to Unregulated Global Market It is believed that regulatory and legal restrictions. 1998). The combination of the relaxation of govemment regulations worldwide together with the embedded nature of the Intemet has resulted in global and cross-industry competition. The Royal Bank of Canada has entered the US market by acquiring the all-virtual web-based bank. is likely to become the most important distribution channel for financial services (Mols. The challenge now is not just planning how to access customers but about knowing who they are. this change is both a threat and an opportunity since the restrictions that have stopped some from entering a market have also limited the geographic expansion of others. The Canadian Imperial Bank of Commerce has also entered the US market with a combined channel approach of Intemet banking and the supemiarket based ATM. This development is predicted to change dramatically the distribution channel stmcture in the retail-banking sector. with the advent of the Intemet such resources have become less relevant. These . Clearly. Power lay in the hands of big banks that could transport a product and deliver it to the customers. Cross-industry competitions: The Intemet gives people from other industry segments opportunities to succeed in businesses where they had little or no presence before. The value of the Intemet as a distribution channel is its ability to enhance interactions between the bank and its customers. The better a bank can identify its customers and know about them. SFNB. other types of barrier to entry identified by Porter (1979). 1998). are likely to be reduced as a result of the Intemet.from accepting a deposit in any branch to combining all of a consumer's banking products into one total relationship. 1997). in the United States. and researchers believe that the Intemet. in time. It is more convenient to for customers to direct debit from their bank account via Intemet batiking than to visit a branch. Global competition: The erosion of boundaries due to the Intemet has accelerated the trend towards global competition. Banks invested millions in building up their branch networks and purchasing the best sites for outlets. The Interstate Banking Bill permits banks to take thefinalsteps to become truly full-service financial providers (Kalakota & Whinston. 21 No.518 International Joumal of Management Vol. as opposed to merely providing a means for touching base with customers. Mols (1998) argued that the trend of Intemet batiking customers is growing while the trend of branch banking customers is declining. However. the passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Riegle-Neal Act) has created new opportunities for banks to serve customers across state lines . the less it will depend on traditional marketing channels. 4 December 2004 From Access to Distribution Channels to Access to Customers One of the key areas of competition in the 1980s and early 1990s was access to distribution channels to ensure that bank products/services could be brought to market (Czemiawska & Potter. For example.

the banking industry is rapidly undergoing a stmctural change due to the emergence of the Intemet. The intent of the V Generation PC Proprietary Remote Online Banking in the early 1980s partly evolved from this competitive concept. or ally a location on a portal site. (2) Capital Requirements to Knowledge Requirements. are more threatening to traditional financial services companies than the new virtual entrants. In the old 'gatekeeper' model (Kalakota & Whinston. the bank functions as a flexible intermediary that provides access to an entire spectmm of products and delivery channels. 1999). loyal customers and deep pockets. This phenomenon has already been apparent for some time in the United States and has recently become common in Europe and Asia. Some large banks have adopted the "portal" strategy as shown by the alliance between Citibank and Netscape as well as between Bank One and Excite. such as NetBank in the United States. AOL Time Wamer. the bank acts as a gateway. and provides its customers with access to value-added service providers anywhere in the world. Such proprietary standards tend to impose high switching costs to their existing customers to prevent them from defecting to other competitors. This new Intemet banking gateway business model could expand a step further to associate with a "portal" provider that the bank purchases. The investment that banks have made in developing their own proprietary software to manage the user interface is perhaps tuming from an asset to a liability as the Intemet becomes a universal channel for information access. In other words. Some of the products may not even originate from the batik but from a third party provider. 4 December 2004 519 new non-financial entrants. because these non-financial companies (which may be unknown as financial service competitors) have established credibility. In summary. such as Microsoft. and Amazon.International Journal of Management Vol. Due to deregulation. (3) Brand & Product Differentiation to Customer Segmentatioti/Relationships. An all-Intemet bank could evolve into a financial supermarket by teaming with other service partners in distribution and risk- sharing arrangements ( From Gatekeeper to Gateway A new model of 2P' century banking is expected to emerge. 1997) the bank functioned as an inhibiting supplier that restricted the customer's product choices. In the new 'gateway' model. It has changed collectively the battlefield as banking moves from: (1) Economies of Scale to Altering the Rules of Competition. proprietary standards and the Intemet's open-system architecture are contradictory in nature. Unfortunately. From Proprietary Standards to Eliminating Switching Costs Over the past several decades one of the most common tactics that organizations have adopted to sustain competitive advantage has been to establish a set of proprietary standards that keeps their customers from their suppliers and competitors. . 21 No. financial institutions are likely to be able to offer a wider variety of financial services.

This is evidenced by the fact that most Intemet banking services are now free of charge. Internet Banking and Porter's 5-Force Competitive Model In his Competitive Model Porter (1979) argued that the nature and degree of competition in an industry hinged onfiveforces: the threat of new entrants. Therefore. As more new comers are expected to enter the industry. the traditional economies of scale benefits are no longer applicable. The processing of a large branch network is no longer a sustainable advantage. banking customers are facing more altematives that increase their bargaining power. Banks are no longer gatekeepers but gateways to financial products. 21 No. Impact of Internet Banking on Bargaining Power of Buyers Indirectly. The Intemet is fundamentally changing the way banks conduct business. However. . and hence more power is yielded to buyers. Some of the products may not originate from the bank but from a third party provider. 4 December 2004 (4) Access to Distribution Channels to Access to Customers. the bargaining power of suppliers. In the new gateway model. Intemet banking also provides banks with a more economical altemative distribution channel. the bank functions as a flexible intermediary that provides access to an entire spectmm of products and delivery channels. The banking market is likely to see the emergence of new small banks that use the Intemet to compete on equal ground with the financial giants. He said the collective strength of these forces determines the ultimate profit potential of an industry. it increases the bargaining power of buyers. the lower the switching cost. the business model has changed dramatically. This section will examine the effects of the Intemet on the retail banking industry with respect to the five forces that Porter identified in his Industry 5-Forces Competitive Model.520 Intemational Joumal of Management Vol. the bargaining power of buyers. Porter (1998) theorized that the more products that become standardized or undifferentiated. (5) Regulated Govemment Policy to Unregulated Global Market. Impact of Intemet Banking on Threat of Entry Intemet banking enables the emergence of new mles of competition. the threat of substitute products and the jockeying among current contestants. (6) Proprietary Standards to Eliminating Switching Costs. Access to distribution is now less important. as the Intemet allows direct access to customers in a more convenient manner. (7) Gatekeeper to Gateway. in this new Intemet banking world. Impact of Internet Banking on Bargaining Power of Suppliers Banks have previously acted as suppliers.

The physical size of the banks becomes less relevant. Banks that anticipate the power of the Intemet will be in control of events. Impact of Intemet Banking on Threat of New Competitors The Intemet fundamentally lowers the barriers to entry that allow more new competitors. Microsoft or AOL Time Wamer. such as Intuit. As it is believed that eventually there will only be a few gateways (suppliers) such as AOL Time Wamer and Microsoft. 4 December 2004 521 Another important shift from the old gatekeeper model is that competitors are now keen to get control of the gateways. The Intemet enables both existing players and new entrants to play by a new set of competitive mles that leads to an extremely volatile competition. this analysis can be used to guide a company in the process of formulating its competitive strategy. Firstly. for banks already in the industry this analysis can be used periodically to assess the stmctural changes that have occurred since the emergence of the Intemet. Once the bank is partnering with a gateway. but most importantly. The Intemet has far exceeded its apparent role as just a new distribution channel. Secondly. And lastly. It is equally important for managers to gain an understanding of how the Intemet affects the five contending forces identified by Porter. . A thorough analysis of the Intemet's actual impact is useful to managers who wish to gain the greatest value from Intemet banking. The Intemet enables extremely low switching costs to substitute providers. Impact of Intemet Banking on Rivalry The Intemet enables small banks to compete on equal ground with the large-scale multinationalfinancialgiants. It gives people from other industry segments opportunities to succeed in businesses where they had little or no presence before. managers of companies entering the field of Intemet banking can attain an understanding that will help them systematically assess likely profitability before entering. To be competitive in this Intemet economy banks need to hamess the power of the Intemet and use it as a competitive advantage. high switching costs may be imposed on the bank. The one who wins may not necessarily be a bank but a non-financial entity. The Intemet's universal standard eliminates costs involved in customers changing to a new provider.International Journal of Management Vol. because the traditional high-cost. the bargaining power of suppliers is now strong. Conversely. banks that do not respond will be forced to accept changes that others initiate and will effectively find themselves in a position of competitive disadvantage. The operations costs for Intemet banking are lower than those of the traditional distribution channels. Managerial Implications This paper has provided a systematic and holistic view of the overall impact of the Intemet on the banking industry. brick-and-mortar branch is not mandatory. 21 No. The potential power of the gateway as a supplier is strong.

Van Norstrand Reinhold. it changes the industry stmcture and. Humphreys. 1999b. in so doing. Firstly. FS Intemet Value Creation Study. 7(1997). 1998. Engelman. Van Norstrand Reinhold. Emst & Young. July. It is essential for them to comprehend how the marketplace is evolving. (Ed... pp.Exploiting Information for Competitive Advantage. MA. the Intemet has spawned the creation of new businesses that are beyond the traditional banking domain.findsvp.A. pp. Next Steps in Financial E-Services in Asia .522 Intemational Joumal of Management Vol. E-Commerce: Customer Relationship Management. Intemational Banking and the Intemet in Cronin. Whether it is a threat or an opportunity depends on two basic factors.J. No. Financial Services and the Intemet . 1999. Macmillan Business. & Whinston. New York. C . Brennand..). Czemiawska. 1999a.. First. Financial Services Summit Nov 1999. The Intemet is essentially affecting the competitive landscape of the banking industry in several ways. Intemet Business Solutions Group. NY. G. New York. Addison- Wesley Longman.. Cisco Systems Inc. M. 21 No. F. And finally. Business in a Virtual World . 271-305. the banking marketplace has become more dynamic and volatile. Second. L. http://www.2. The Banking Industry and the Intemet . 1998. M. 4 December 2004 Conclusion With the emergence of the Intemet. Banking and Finance on the Intemet. FIND/SVP (1997). 1996. Secondly.. 120-128. 75-105. References Birch. Banking and Finance on the Intemet. D & Young. Internet World Hong Kong. Crede.Security First Network Bank and the development of Virtual Financial Institutions in Cronin. Electronic Commerce -A Manager's Guide. it creates competitive advantages for banks by giving them new ways to outperform their rivals.. 1998. executives need to develop a strategic agenda that helps the bank deal with such changes.J. . Interacting on the Internet. Vol. Times Mirror Higher Education Group. Kalakota. Boston. executives need to understand thoroughly the impact of the Intemet on the banking industry as a whole. USA. Emst & Young.What Does Cyberspace Mean for the Financial Service Industry? Internet Research: Electronic Networking Applications and Policy. (Ed. & Potter. For some executives it poses a threat to existing businesses. M.A View of the Impact of Intemet Business Models on the Future of Banking. for others it represents great opportunities.Lessons from other Market.). pp. R. A. NY. Banking on the Web . 1997. Special Report on Technology in Financial Services. A. alters the mles of competition.

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