FRAMINGHAM (08/10/2000) - The road from paper to virtual money has been blocked at every turn by cultural and technological barriers. But a new spirit of both cooperation and competition between fast young start-ups and traditional financial institutions is beginning to push some of these barriers aside.
Within five years, the vast majority of business-to-business transactions is expected to be electronic, analysts say, leading to faster payments, lower costs and, potentially, less fraud as stringent identity authentication and credit risk-assessment procedures become easier and less expensive.
These savings, combined with faster collections, integration with back-end procurement and financial systems, and access to a larger supplier and customer base, could expand the U.S. economic boom to the rest of the world, analysts say.
"Money is always in search of the place where it gets the best return," says Thornton May, until recently a futurist at Cambridge Technology Partners Inc. in Cambridge, Mass., and an occasional Computerworld columnist.
The increased access to market information made possible by the Internet, along with the ease of making electronic payments, will make it possible for companies to change suppliers or distributors in real time on a global scale.
"You will be able to exit bad resource allocations more quickly, which is really what's driving much of the New Economy right now," he says. "It's almost real-time feedback: That didn't work; stop; try again."
While virtual transactions are gaining steam, the vast majority of payments are still made with checks.
According to Stamford, Conn.-based Gartner Group Inc., 14% of business-to-business payments are made electronically. But that figure is expected to grow to 50% by 2009, says Gartner analyst Avivah Litan.
The biggest reason for the resistance to virtual payments is security, according to May. Companies, particularly those making large transactions, are concerned about the integrity of financial information that travels over the Internet, he says.
"Companies are going to spend more on digital security \[than Y2k\]," says May.
"Probably one and a half times more."
The threat isn't only from hackers breaking into sensitive systems. Fraud is also a possibility: Persons or companies passing themselves off as someone or something else.
"There's very little done now to validate the identity of the person making an inquiry," says Elizabeth Achorn, an analyst at Newton, Mass.-based Meridien Research Inc.
But both banks and start-ups are beginning to address the problem. Digital Signature Trust Co., a subsidiary of Salt Lake City-based Zions Bancorp., serves as a digital signature clearinghouse for banks. Other companies, including start-ups like Mountain View, Calif.-based VeriSign Inc. and major credit-card companies, also offer online identity verification and digital certificates. And the American Bankers Association recently initiated its own digital signature program, called TrustID.
But the process of using a digital certificate is still cumbersome and unattractive to consumers, says Litan. Businesses are more likely than individuals to use digital signatures, she says, because they have more to lose from fraud.
Large corporations have been exchanging money electronically for decades with costly and complicated electronic data interchange (EDI) systems.
These systems carry not only financial transaction information, but also detailed data about the status of orders.
The advent of XML has recently allowed Web-based front ends to be installed on these systems, letting small suppliers compete on a more equal footing with the major players.
"The big buyers and big sellers want \[smaller companies\] to participate without having to send a paper purchase order," says Kevin Jones, an analyst at Jupiter Communications Inc.
American Express Co. recently invested in start-up EC Co. in Palo Alto, Calif., which uses the Internet to integrate off-the-shelf small business accounting tools such as Intuit Inc.'s QuickBooks with the heavy-duty EDI systems used by large corporations.
"These guys reach people who are hard to reach and bring them online," Jones says, adding that American Express also benefits from bringing small companies that use its credit card into EDI exchanges.
The Internet has brought about a new alternative to the EDI-based supply chain - the online business-to-business exchange.
By 2003, one-quarter of business-to-business purchases will be made online, according to The Boston Consulting Group. That growth is expected to flourish most via digital marketplaces, such as VerticalNet Inc., Chemdex Corp. and e-Steel Corp.
Gartner Group expects the number of online business-to-business exchanges to climb from current estimates of 1,350 to about 3,000 by 2002.
These exchanges - powered by companies such as Pleasanton, Calif.-based Commerce One Inc., Mountain View, Calif.-based Ariba Inc. and New York-based TradeWeb LLC - offer small and large businesses an opportunity to find one another.
Until recently, however, financial arrangements were an afterthought, with companies left on their own as far as payments were concerned.
But after a number of third-party financial service providers sprang in to close the gaps by providing online authentication and payment services, large banks also began to move into this potentially very lucrative sector.
"Citibank is in partnership with Commerce One; Bank of America is partnering with Ariba," says Meredith Hickman, an analyst at Cambridge, Mass.-based Celent Communications. "There are several partnerships forming out there. It's definitely a hot area, but right now we're still in the very early stages."
Banks Play Catch Up
North American banks spent a total of about $90 million on Internet corporate-banking applications last year, according to Needham, Mass.-based TowerGroup. That was a drop in the bucket compared with their other expenditures. According to Securities and Exchange Commission filings, Citibank alone spent $527 million running e-Citi, its Internet site for consumers in 1999.
But banks are expected to start to put more money into business-related Internet projects.
Investments in Internet-related corporate banking applications are expected to increase by 34% annually to reach $290 million in 2003, with huge outlays expected for both self-developed systems and acquired technology, according to TowerGroup analyst Rajeev Agarwal.
Just last week, Citigroup and Wells Fargo & Co. announced a partnership with three technology companies - Enron Broadband Services Inc. in Portland, Ore., i2 Technologies Inc. in Dallas and financial services software provider S1 Corp. in Atlanta - to create FinancialSettlementMatrix.com, a venture that will link buyers and sellers in electronic marketplaces with payment processing, credit and other services through participating banks.
"In our view, it's going to be important that the financial institutions don't see themselves as competitors, but co-facilitators," says Steve Ellis, executive vice president of Wells Fargo's Wholesale Internet Solutions Group.
"We're working on combining an infrastructure so we can hook to an exchange, and the exchange can hook with a variety of other financial institutions."
To make inroads in business-to-business e-commerce, many banks will "have to build the infrastructure first," Agarwal says. That could be expensive.
The Bank of New York Co. is in the process of rebuilding its global communication networks using Internet standards so as to enable corporate customers to move money quickly and easily around the planet.
This network is key to the bank's global success, says James King, vice president of international communications at The Bank of New York. As a result of its investment - which King refuses to quantify - the bank already handles back-office systems (that is, it keeps track of the money) for a number of Wall Street firms, including J. P. Morgan & Co.
Outsourcing those tasks to The Bank of New York saved J. P. Morgan the expense of having to invest in its own technology, says Chief Technology Officer Veronique Weill.
In effect, The Bank of New York reinvented itself as a tech-savvy service provider.
"For many, many years, we were a very conservatively oriented bank," King says.
"It didn't burst forth with any new technology applications. The conservatism kept us at bay. But we now have a very young and aggressive technology staff at the helm, developed over the last four or five years."
Race May Go to the Swift
With the ever-increasing rate of technological change, many question whether banks will be able to keep up the pace.
One of the doomsayers is recently retired Citigroup Chairman John Reed, who has been responsible for many of the bank's technological innovations.
"I believe that the advantage in this change lies with those who come from the future rather than those who come from the past," Reed told a recent meeting of financial industry executives in New York.
In particular, he stressed, money transfer is an area susceptible to "major revolution," and traditional banks aren't well placed to survive.
"It's very hard to move faster than the generations move," he said. "You're going to have to wait until you have people who are relatively young and relatively capable in this medium in positions where they can make things happen."