Finovate Blog

Eliminating bill payment fees is the simplest way to make customers happy.
However, there may be less expensive alternatives that position you better
for the long term.

First, let’s look at how consumers choose a bill payment service
provider. It’s not so much about the price. What they want is to have their
bills paid in a timely manner with the least amount of effort and maximum
amount of control. Other factors play a role as well:

• overall complexity of household finances
• technological sophistication and outlook
• financial experience and behavior
• risk tolerance

Table 9, right, lists 43 attributes related to the consumer’s bill
payment purchase decision.

So, rather than offering it fee-free, perhaps you could improve your
value-proposition in other ways to provide a similar adoption lift without
losing the fee income altogether.  Following are five alternative
approaches.

1. Conditional (on another purchase)

·      Free if you do add something that improves revenues, such as
adding an account

·      Free if you do something that lowers costs such as switch to
estatements*

·      Free with minimum balance levels

·      Free as part of an overall relationship account

2. Crippled (reduced features and benefits)

·      Free with usage limited to electronic merchants only

·      Free with reduced or pay-per-incident customer service

·      Free with reduced functionality

·      Free with reduced usage

*Two top-50 banks are using this approach,
First Tennessee and
National Commerce Financial

Table 9

Factors Used by Consumers When Selecting a Bill Payment Provider

• security
• customer service availability
• quality of customer service
• timeliness of payments
• turnaround time of the payment
• payment scheduling requirements
• guarantees in the event of late/lost payments
• usability
• tracking of payments in process
• stop-payment capabilities
• merchant list
• process to add a merchant
• ability to review the billing statement
• confirmation numbers
• confirmation messages
• ability to schedule recurring payments
• how long it takes to complete a bill payment session
• how easy is to make a mistake
• session logs
• payment limits
• look and feel
• integration with other online banking activities
• built-in credit to handle shortfalls
• ability to pay from multiple accounts
• archives of payment transactions
• reporting
• automation options
• positive word of mouth
• customer service wait times
• online FAQs
• online instant messaging support
• telephone support
• learning curve
• SMS/IM confirmations
• ability to schedule via telephone
• integrated email to payees
• budgeting/planning tools
• search capabilities for prior transactions
• expedited transactions
• control
• privacy
• trust
• perceived record keeping improvements

Source: Online Banking Report, 8/04

3. Substitute other lower-cost FREE services

·      Free paper check and statement archives

·      Free account aggregation with online bill manager (see
www.LowerMyBills.com
)

·      Free 24/7 customer service

·      Free interbank transfers

·      Free credit report information

·      Free account alerts

·      Free companion air fare or other non-banking incentive

4. Provide overall relationship incentives

·      Higher rates or lower fees on checking or other deposit accounts

·      Lower rates and/or higher lines of credit

·      Higher service levels and better guarantees

5. FREE as part of plain-vanilla, reduced-benefit online banking
package

·      Actively upsell advanced fee-based packages with numerous
additional features and benefits (see Table 10 below)

·      Limit the life of the plain-vanilla package; enact forced
conversion after several years into fee-based product

Table 10

Bill Payment Product Differentiation

Source: Online Banking Report, 8/04

The real question: Does subsidizing bill payment improve profits more than
spending that money in other ways, e.g., better service, better branches, better
website, and so on? Only individual financial institutions can answer the
question, factoring all the alternative uses of capital. However, we caution
against blindly jumping on the fee-less bandwagon. Think of free bill pay as
just one more strategic choice, not a mandate from the marketplace.

The simplest approach is a breakeven analysis
(see Table 8, right). In other words, will my current bill pay base, and
the new customers attracted to a free offering, bring in enough extra business
to cover the $50 to $75 annual subsidy?¹

On the deposit side, the case is pretty weak: to offset a $60 annual subsidy,
you’d need incremental balances of $3,000 at a 2% spread or $6,000 at a 1%
spread. On the loan side, the numbers work better. At a 4% spread, you only need
an extra $1,500 to break even. But is subsidized bill payment really the most
cost effective way to increase loan balances? If so, you should probably make a
more direct tie-in, such as waving bill pay fees for taking a new credit line (see
“Bill Pay Credit Lines,” OBR 81

Mini Business Case

A more precise measure of the balance levels needed to cover bill payment fee
waivers looks at the total cost of bill pay and the number of incremental
customers attracted. For this calculation, use the following assumptions:

·      $90 annual cost for each bill pay customer, including internal
servicing costs and outsourced processing

·      50% of bill pay customers would pay $5/mo

·      50% are incremental, drawn by the free offer

·      10,000 total users

So the total incremental cost is:

·      New users: 5,000 x $90 = $450,000

·      Forgone fees from existing users:
5,000 x $60 = $300,000

·      Total incremental costs: $750,000

Table 8

Breakeven Incremental Balances

Source: Online Banking Report, 8/04

Results

Even with a modest base of 5,000 bill pay customers currently paying $5/mo
for the service, you may need to attract $25 million or more in incremental
balances to make back the $750,000 in incremental costs. Even if you think
that’s possible, is that the best return on the $750,000 “investment.” Would
that money provide a better return if spent on service upgrades, marketing, or
employee education?

When deciding whether you can bring in enough offsetting balances, keep in
mind the demographic trend is moving in the wrong direction. Bank of America may
have been able to improve overall profit 30% after costs; however, that was
against an affluent, early adopter crowd. Going forward into the mass market,
will the same profit lift be seen in the 2005 to 2008 period? We doubt it. The
newest wave of users is less affluent overall, so it will be harder for them to
bring in the balances needed to offset the $50 to $100 subsidy.

¹ Assumes total out-of-pocket and internal costs of bill payment
are $6 to 8/mo.

One

We have no choice: to stay competitive, bill payment must
be free.

There is some truth to this. Twenty-two of the fifty largest U.S. banks now
offer bill payment free of charge to their entire online banking base. And the
big banks, especially Bank of America, are making a lot of noise about their
free bill payment services. And it does strike a chord with consumers who
naturally would prefer it be free, and tend to believe it should
be free, because of the incorrect assumption that it lowers the bank’s
processing costs.

However, online users are not naïve. They know there is a downside to free
services. It could be less privacy, inferior product quality, or distracting
advertisements.

Two

We’ll make up the lost fees
with improved retention.

There is no doubt that bill payment usage is correlated with higher
retention. But that’s the case with nearly every add-on service from savings
accounts, to credit cards, to safe deposit boxes, or Saturday branch hours.
Assuming customers like it, every account added increases retention.

It is true that electronic bill payment creates higher exit barriers (aka
“switching costs” or “customer lockin”) than a simple savings account. However,
it’s entirely possible that within a few years someone will invent a wizard that
automatically moves a user’s bill payment setup, merchant info, and history from
one bank to another.

Three

We’ll make up the lost fees with
 higher balances.

Again, we’ve seen the research and it points to a strong correlation
between bill payment use and customer profitability. As Bank of America and
others have demonstrated, the “extra” profits from the bill pay group vs. the
control more than make up for the extra costs. In Bank of America’s case, they
showed an overall profit lift of 30%, after netting out the 10% increase in cost
to service the account due to the bill pay subsidy .

This is the best argument for free bill pay, and it may even have been true in
the 2000 to 2003 period analyzed by BofA. Early adopter bill pay users were a
profitable group; they may have had a tendency to add accounts at the bank that
was providing them the latest and greatest services, including bill pay.
Complicating the analysis, however, is the fact that the banks offering free
bill pay, Citi and BofA, for example, also tended to have the best overall
online banking services. Was it the free bill pay or the killer website that
drove the incremental balance growth? Bank America made a billion dollar bet
that it was the bill pay.¹

Four

Eventually payment processing
costs will decline.

Clearly, end-to-end electronic processing has lower transaction costs than
paper. However, electronic bill payment comes with an implicit customer service
component absent from paper checks. When a paper check fails to reach the payee,
no one expects the bank to track down the problem and make it right.

With electronic payments, the banks, and its processor, are required to
troubleshoot and fix problems, even when the error was outside their control. As
quality and volume increase, these costs will decline. But it will be difficult,
if not impossible, for electronic transactions to have lower marginal costs if
customer service expenses are factored in.

¹ Bank of America’s stake $400 million stake in CheckFree gave it
extra incentive to promote free bill payment.

In the U.S. market, the industry standard pricing model has been free online
banking access combined with fee-based bill payment. However, during the
past three years, the fees for bill payment have gradually gone away to the
point where the most major U.S. banks advertise free bill payment, though it
may not apply to all account types or balance levels.

In July, we surveyed the top 50 U.S. banks and found only two that still
charged a monthly fee to all bill payment customers. Nearly half, 22 of 50,
offered bill payment free to everyone. Three banks did not offer bill
payment and the remaining 23 offered it free for certain accounts and/or
balance levels. In total, 45 of the 47 (96%) largest banks with bill payment
offered a free option . For those charging a fee, the average listed price
is $5.63/mo.

Last fall, TowerGroup found 33 of the 50 (66%) largest U.S. banks
providing bill payment free of charge to all or part of their customer base.
Furthermore, Tower found that bill pay penetration increased from 22% of
online banking customers prior to going free, to 38% after the change. This
70% lift was significantly more than what would have been expected without
the price change.

History of Free Bill Payment

Although BofA is largely credited with starting the free bill pay
movement, Citibank was actually the first to go free. In a major branding
campaign in the summer of 1997, the bank hit the streets of Manhattan
touting its no-fee electronic banking message (the fee-free policy also
applied to ATM transactions and other electronic banking transactions).

But until Bank of America’s high-profile move, most major banks held to
a $5 to $7 monthly charge, which not coincidentally covered their monthly
bill to CheckFree. Citibank handled payment processing in-house, which may
have contributed to their willingness to offer it fee-free.

Fees began to crumble in the fall of 2002 when BofA launched a
multi-million dollar television advertising campaign promoting free bill
payment. The campaign proved so popular with viewers that it continues to
this day. At the time, BofA said it was their most-remembered campaign of
all time. In the months and years since, most major U.S. banks have followed
suit. The most recent major to go free was U.S. bank earlier this year (see
Table 1, below).

One notable holdout is Wells Fargo, which last year said that 40%
of its base still paid a monthly fee.¹ Assuming 2 million bill
pay accounts, with 750,000 paying monthly fees of $6.95, Wells Fargo is
bringing in more than $5 million per month in bill payment fees. While it
may lose a few customers to its pricing strategy, the $60 mil/yr can be
reinvested into better services, more marketing, or shareholder dividends.

¹ American Banker, Wednesday, June 11, 2003

Table 1

Free Bill Pay Timeline

Source: Online Banking Report, 7/04

Table 2
Summary of Consumer Bill Pay Fees at Top 50 U.S. Banks

Source: Online Banking Report, 7/04

(1)       Free of monthly fees; in a minority of cases, fees apply for
excess usage and/or account inactivity

(2)       Excludes Comerica, whose pricing is not disclosed, and MBNA
which charges by the transaction

(3)       Average fixed monthly fee, excludes transaction fees for excess
usage

Table 3
Consumer Bill Pay Fees at US Top-10 Banks

Source: Online Banking Report, 7/04

¹In June 2003, Wells Fargo
reported that 40% of its customers received it free-of-charge.

²Wachovia is the other top-10 holdout; it has said that 70% of
customers get it free-of-charge.

Table 4
Consumer and Small Business Bill Pay Fees at Top-50 US Banks
ranked by deposit size, 12/31/03

Source: Online Banking Report, 7/04

Bank of America landing page from Google ad
(8/25/04)

The Bank of America Story

Thanks to an unusual openness, motivated by the strategic importance¹
of its free bill payment policy, Bank of America’s internal research
results have been widely circulated in print. To recap, in a 2.5 year study
of bill pay users compared to a control group of similar customers, the bank
found a 30% profit lift (see Table 5 right). Despite conventional wisdom,
little of it came from increased retention: the main driver was increased
balances.

Normally, we don’t pay much attention to studies correlating bill payment
with higher profits. It’s a function of the early adopter demographics and
will gradually diminish as bill payment becomes a mainstream service.
However, Bank of America’s results deserve a second look because they used a
control group of similar non-bill payment customers to compare profit lift.

We have serious doubts that you will be able to recreate these results
within your own customer base. Here’s why:

• What really caused the profit lift? Was it the bill payment in
  isolation, or was it the entire online banking experience at BofA’s
  award-winning site.

·      Did households in the control group already have one foot out the
door? Perhaps the control group didn’t adopt bill payment at Bank of America
because they were already in the process of moving their balances to another
financial institution. If so, the control group was predestined to have
lower profits no matter what factor was evaluated.

·      Was the control group really that similar? Although, they may have
been in the same demographic segment, it seems to us that a household using
bill pay in 2001 was fundamentally different in their financial behavior
than one that didn’t use bill pay.

·      Would the same profit lift be seen with any new product geared to
affluent customers, e.g., a new diamond credit card? In other words, it may
not be that bill pay causes balances to grow; it’s merely that those
with growing balances tend to sign up for new upscale services regardless of
what they are.

·      Finally, even if you take the results at face value, does BofA’s
experience with early adopters during the past three years have any
correlation with what you might expect with mainstream users during 2005 to
2008?

¹ Besides the free publicity, the bank has an ulterior motive
for promoting free bill payment across the entire industry. The bank
took a 16% interest (10 million shares) in CheckFree in Q2 2000; the
deal was valued at $400 million at the time.

Table 5

Bank of America Results

index of profitability with 100 = to
profits prior to the household using electronic bill payment

Source: Bank of America, increase in customer profitability during a
31-month period ending in 2002, results of an analysis of 300,000
customers comparing profits from bill payment users vs. the profits of a
control group of similar households not using bill pay

Results from Online Resources

Online Resources, a major bill payment processor with more than 500
financial institution clients, found that bill pay penetration was 40% for free
vs. 28% for those with monthly fees of $5 or less
(see Table 6 below).

Table 6

Online Resources results
Aug 2003

Source: Online Resources, 7/04

(1) January 2004 data

(2) June 2004 data

That’s a 30% lift in conversion of online banking users to bill pay; and an
even more impressive 120% lift in total bill payment adoption across the bank’s
checking account base. However, it’s been achieved at a hefty cost. Not only are
the banks giving up the $5 to $6 monthly free from their existing bill pay
customers, they’re paying several dollars per month for a whole new group of
customers.

It’s also difficult to ascertain how much of the increase in online banking
adoption was accounted for by the free bill pay offer. Since the first to offer
free bill pay tended to be more aggressive in their overall marketing of online
banking, some of the lift is from better overall marketing, regardless of the
price.

Results from Compete Inc.

Ecommerce researcher Compete Inc., which has a financial services
practice run by Stephen Franco, a high-profile analyst at US Bancorp Piper
Jaffray during the height of the bank technology boom. He found that banks
offering free bill payment had a higher share of their customer’s electronic
bill payments. At major banks that charge for bill pay, 18% of their customers
used biller-direct payments. In comparison, those offering it free-of-charge had
a third fewer customers (13%) using biller direct services (see Table 7 below).

Table 7

Bank Bill Pay vs. Biller Direct
Feb 2004

Source: Compete, Inc. 5/04

LowerMyBills landing page from Google ad (8/25/04)