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
AlecYu
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.
Introduction
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.
International Journal of Management Vol. 21 No. 4 December 2004 515

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

From Economies of Scale to Altering the Rules of Competition

As a result of the advent of Intemet technology, larger banks no longer gain an advantage
based on the economies of scale that they were able to achieve in the past. Physical size
and bureaucratic organizational structure can mean high operating costs, as well as
inefficient and limited degrees of flexibility.
Today, information via the Intemet enables smaller companies to seize the advantage
and to set a new competitive agenda. Economies of scale are relevant only in markets
where all the participants are playing by the same set of mles (Czemiawska & Potter,
1998). For example, what Amazon.com 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,
despite the fact that the volume Amazon processes may be significantly less than the
competition. Similarly SFNB is a classic example of an innovator in the banking field.
In this case, economies of scale count for nothing in this new virtual environment,
where physical processes are replaced by infonnation via the Intemet. Not surprisingly,
other banks have had to respond in kind (playing by SFNB's rule rather than their own),
by setting up their own Web-based outlets. Intemet banking, if executed correctly, can
be leveraged to set one's own mles of competition. The question is whether you want to
set your own agenda or you want your competitors to do it for you.
From Capital Requirements to Knowledge Requirements
Traditionally, lack of money has acted as a barrier to entry into any particular market
(Porter, 1979). This has been especially tme in the banking sector. Historically, large
branch networks that require substantial capital outlay have been established, 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. Today, raising finance is perhaps the least difficult
task facing an organization. Investors recognize that an organization's key asset is not
its economies of scale, its past track record, its brand - or any of the other trump cards
traditionally held by the incumbents in a market. What investors are interested in and
expect is the organization's knowledge. Financial muscle, a large labor force, and a
large branch network may seem to have become less important.
With Intemet banking, bricks, mortar and physical networks are no longer required.
Such a shift has substantially lowered the traditional barrier to entry. In addition, online
technology is said to be able to deliver services far more economically than pre-existing
methods (Emst & Young, 1999a). 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. In today's banking
environment, the processing of large physical branch networks is perhaps no longer a
serious competitive advantage or a primary consideration for customers selecting a
bank. 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.
International Journal of Management Vol. 21 No. 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, thus allowing service providers,
banks for instance, to create awareness for the purpose of customer loyalty (Czemiawska
& Potter, 1998). As a result, millions of dollars were spent on brand development.
Brand building is particularly important for commodity products and for those products,
such as banking services, that are essentially undifferentiated (Porter, 1998). What is
the difference between deposit services offered by two banks, if they have the same
interest rates? Unfortunately, brands and "information availability" do not mix well.
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, as everything can be found
on the Web. Already on the Intemet, there are companies acting as "informers" or
advisers, who help potential purchasers make the best choices. The Intemet, by providing
customers with better information, effectively changes the balance of power from the
bank in favor of the individual customer.

Customer Segmentation: It has been claimed that 20% of a bank's customers often
account for 150% of its profits (Sheshunoff, 1999). Therefore financial institutions
attempt to maximize their profits by focusing more resources on those valuable customer
segments. However, as Intemet banking becomes an effective channel for reaching that
20%, it allows competing banks to target those same customers with their own Intemet
services. 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,
1999; Brennand, 1999). Intemet banking customers have higher deposits, more banking
products, lower attrition and a lower service cost than traditional banking customers
with similar demographics; they are also more affluent and more educated (Cisco
Systems, 1999; Brennand, 1999). So the profitability of banks now depends on
developing a lucrative market segment, identifying the potentially most profitable
Intemet batiking customers, and targeting them. The danger is, that if you don't do it,
your competitors will.

Customer Relationship Management. Almost as quickly asfinancialfirmsdevelop new

products/services, other banks replicate them. The Intemet is also making it easier for
customers to shift from a current provider to a new one. What options do financial
services companies striving for profitability have? Perhaps, one way is to differentiate
themselves in the face of commoditization, thereby successfully managing the
relationships with banking customers. With the help of the Intemet, a bank is able to
deliver targeted marketing and product infomiation, personalized menus and Web pages,
and other data to customers as they browse a bank's Web site. In summary, the battlefield
is changing from competing by brand and/or product differentiation to targeting the
most lucrative customers, as well as maintaining optimal customer relationships for
long-term profitability.
518 International Joumal of Management Vol. 21 No. 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, 1998). Banks invested millions in building up their branch
networks and purchasing the best sites for outlets. Power lay in the hands of big banks
that could transport a product and deliver it to the customers. However, with the advent
of the Intemet such resources have become less relevant. It is more convenient to for
customers to direct debit from their bank account via Intemet batiking than to visit a
branch.
Mols (1998) argued that the trend of Intemet batiking customers is growing while the
trend of branch banking customers is declining. This development is predicted to change
dramatically the distribution channel stmcture in the retail-banking sector, and researchers
believe that the Intemet, in time, is likely to become the most important distribution
channel for financial services (Mols, 1998). The challenge now is not just planning
how to access customers but about knowing who they are. The value of the Intemet as
a distribution channel is its ability to enhance interactions between the bank and its
customers, as opposed to merely providing a means for touching base with customers.
The better a bank can identify its customers and know about them, the less it will
depend on traditional marketing channels.

From Regulated Govemment Policy to Unregulated Global Market

It is believed that regulatory and legal restrictions, other types of barrier to entry identified
by Porter (1979), are likely to be reduced as a result of the Intemet. For example, in the
United States, 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 - from accepting a deposit in any branch to combining
all of a consumer's banking products into one total relationship. The Interstate Banking
Bill permits banks to take thefinalsteps to become truly full-service financial providers
(Kalakota & Whinston, 1997). Clearly, 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 combination of the relaxation of govemment
regulations worldwide together with the embedded nature of the Intemet has resulted in
global and cross-industry competition.
Global competition: The erosion of boundaries due to the Intemet has accelerated the
trend towards global competition. Citibank has successfully entered the Japanese market
with a web-based solution. The Royal Bank of Canada has entered the US market by
acquiring the all-virtual web-based bank, SFNB. 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.
Cross-industry competitions: The Intemet gives people from other industry segments
opportunities to succeed in businesses where they had little or no presence before. These
International Journal of Management Vol. 21 No. 4 December 2004 519

new non-financial entrants, such as Microsoft, AOL Time Wamer, and Amazon.com,
are more threatening to traditional financial services companies than the new virtual
entrants, because these non-financial companies (which may be unknown as financial
service competitors) have established credibility, 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.
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. Such
proprietary standards tend to impose high switching costs to their existing customers to
prevent them from defecting to other competitors. The intent of the V Generation PC
Proprietary Remote Online Banking in the early 1980s partly evolved from this
competitive concept. Unfortunately, proprietary standards and the Intemet's open-system
architecture are contradictory in nature. 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.

From Gatekeeper to Gateway

A new model of 2P' century banking is expected to emerge. In the old 'gatekeeper'
model (Kalakota & Whinston, 1997) the bank functioned as an inhibiting supplier that
restricted the customer's product choices. In the new 'gateway' model, the bank functions
as a flexible intermediary that provides access to an entire spectmm of products and
delivery channels. Some of the products may not even originate from the batik but from
a third party provider, such as NetBank in the United States. In other words, the bank
acts as a gateway, and provides its customers with access to value-added service providers
anywhere in the world. Due to deregulation, financial institutions are likely to be able
to offer a wider variety of financial services. An all-Intemet bank could evolve into a
financial supermarket by teaming with other service partners in distribution and risk-
sharing arrangements (Kiesnoski, 1999). This new Intemet banking gateway business
model could expand a step further to associate with a "portal" provider that the bank
purchases, or ally a location on a portal site. 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.
In summary, the banking industry is rapidly undergoing a stmctural change due to the
emergence of the Intemet. It has changed collectively the battlefield as banking moves
from:
(1) Economies of Scale to Altering the Rules of Competition.
(2) Capital Requirements to Knowledge Requirements.
(3) Brand & Product Differentiation to Customer Segmentatioti/Relationships.
520 Intemational Joumal of Management Vol. 21 No. 4 December 2004

(4) Access to Distribution Channels to Access to Customers.

(5) Regulated Govemment Policy to Unregulated Global Market.
(6) Proprietary Standards to Eliminating Switching Costs.
(7) Gatekeeper to Gateway.

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, the bargaining power of
buyers, the bargaining power of suppliers, the threat of substitute products and the
jockeying among current contestants. He said the collective strength of these forces
determines the ultimate profit potential of an industry. 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.

Impact of Intemet Banking on Threat of Entry

Intemet banking enables the emergence of new mles of competition. Therefore, the
traditional economies of scale benefits are no longer applicable. The Intemet is
fundamentally changing the way banks conduct business. The processing of a large
branch network is no longer a sustainable advantage. 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.
Access to distribution is now less important, as the Intemet allows direct access to
customers in a more convenient manner. Intemet banking also provides banks with a
more economical altemative distribution channel.

Impact of Internet Banking on Bargaining Power of Buyers

Indirectly, it increases the bargaining power of buyers. Porter (1998) theorized that the
more products that become standardized or undifferentiated, the lower the switching
cost, and hence more power is yielded to buyers. As more new comers are expected to
enter the industry, banking customers are facing more altematives that increase their
bargaining power. This is evidenced by the fact that most Intemet banking services are
now free of charge.

Impact of Internet Banking on Bargaining Power of Suppliers

Banks have previously acted as suppliers. However, in this new Intemet banking world,
the business model has changed dramatically. Banks are no longer gatekeepers but
gateways to financial products. In the new gateway model, the bank functions as a
flexible intermediary that provides access to an entire spectmm of products and delivery
channels. Some of the products may not originate from the bank but from a third party
provider.
International Journal of Management Vol. 21 No. 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 one who wins may not necessarily be a bank
but a non-financial entity, such as Intuit, Microsoft or AOL Time Wamer. As it is believed
that eventually there will only be a few gateways (suppliers) such as AOL Time Wamer
and Microsoft, the bargaining power of suppliers is now strong. The potential power of
the gateway as a supplier is strong. Once the bank is partnering with a gateway, high
switching costs may be imposed on the bank.

Impact of Intemet Banking on Threat of New Competitors

The Intemet fundamentally lowers the barriers to entry that allow more new competitors.
It gives people from other industry segments opportunities to succeed in businesses
where they had little or no presence before. The Intemet enables extremely low switching
costs to substitute providers. The operations costs for Intemet banking are lower than
those of the traditional distribution channels.

Impact of Intemet Banking on Rivalry

The Intemet enables small banks to compete on equal ground with the large-scale
multinationalfinancialgiants, because the traditional high-cost, brick-and-mortar branch
is not mandatory. The physical size of the banks becomes less relevant. The Intemet's
universal standard eliminates costs involved in customers changing to a new provider.
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.

Managerial Implications
This paper has provided a systematic and holistic view of the overall impact of the
Intemet on the banking industry. The Intemet has far exceeded its apparent role as just
a new distribution channel. A thorough analysis of the Intemet's actual impact is useful
to managers who wish to gain the greatest value from Intemet banking. It is equally
important for managers to gain an understanding of how the Intemet affects the five
contending forces identified by Porter. Firstly, managers of companies entering the
field of Intemet banking can attain an understanding that will help them systematically
assess likely profitability before entering. Secondly, 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. And lastly, but most importantly, this analysis can
be used to guide a company in the process of formulating its competitive strategy.

To be competitive in this Intemet economy banks need to hamess the power of the
Intemet and use it as a competitive advantage. Banks that anticipate the power of the
Intemet will be in control of events. 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.
522 Intemational Joumal of Management Vol. 21 No. 4 December 2004

Conclusion
With the emergence of the Intemet, the banking marketplace has become more dynamic
and volatile. For some executives it poses a threat to existing businesses; for others it
represents great opportunities. Whether it is a threat or an opportunity depends on two
basic factors. Firstly, executives need to understand thoroughly the impact of the Intemet
on the banking industry as a whole. It is essential for them to comprehend how the
marketplace is evolving. Secondly, executives need to develop a strategic agenda that
helps the bank deal with such changes.
The Intemet is essentially affecting the competitive landscape of the banking industry
in several ways. First, it changes the industry stmcture and, in so doing, alters the mles
of competition. Second, it creates competitive advantages for banks by giving them
new ways to outperform their rivals. And finally, the Intemet has spawned the creation
of new businesses that are beyond the traditional banking domain.

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Contact email address: isiaw@ouhk.edu.hk