EDI and Electronic Commerce in Banking:
Extract (2): Financial Industry Issues
Extract's Table of Contents:
Introduction
Since the mid-1980s, banks have made significant investments in EDI programmes. Often, in the name of corporate
 strategy, these banks in fact were behaving quite tactically - without a long-term vision or commitment to the future. Generally these activities related to transactional-based services development, and were largely focused on payments applications.
This is no longer a viable approach from a profitability standpoint and a new set of requirements is needed to support the continued direction of service development in the financial services industry. It is not enough to be simply an electronic transaction provider and experiences since the mid-1980s reaffirm this point.
The most significant EDI activity that banks have been involved in has been the implementation of a technology infrastructure. Much of this has focused on payments applications and the related technologies needed to facilitate these. Some investment has also been made in conducting promotional and educational programmes to market their services. Although these activities have created significant market awareness, EDI business has not met expectations established in the mid to late 1980s. Why was such optimism defeated by sluggish response?
Numerous research studies have been conducted, primarily in the North American market, which indicate that there is considerable interest in EDI by business and government
agencies.¹ However, EDI payments and related financial applications have not been high-priority items and have tended to be the last implemented. Global corporations have very advanced EDI programmes in place for their purchasing function, but are only now experimenting with EDI payments.
Furthermore, research carried out by the EDI Group, Illinois, since the late 1980s, indicates that EDI payments represent less than 5 percent of the total potential EDI transaction business. Banks are, therefore, missing out on major revenue producing opportunities by offering "payments only" services. In fact, if this is so and there is significant uptake on financial applications of EDI in the near future, there is still such a limited market for EDI as to make the question of developing it as a profitable stand-alone application quite questionable.
Lastly, from a purely financial perspective, existing payment instruments have been meeting customer needs. There has not been significant pressure on banks to reduce the cost of payment instruments - especially when large values have been involved and need to be moved with speed and security. Wire payments have operated with satisfactory results and at what has appeared to be an acceptable cost.
¹ Most of the studies have been conducted by two groups, Gartner Group of Stanford, Connecticut and the EDI Group, Oak Park Illinois. See also, Working Group for EDI's report on healthcare which conservatively identified potential administrative savings in the US of over $ 1 billion (WEDI, New York 1993).
But, as payments can be netted among trading partners in some industries, in the long-term, banks are in danger of being disintermediated. This will significantly impact the corporate fee revenue from current account services and will place non-traditional competitors at banks' doorsteps. Broader thinking is needed and the concept of marketing a more substantial product than just EDI payments needs to be considered. The growing expectation of the business market is that it requires an electronic payment tool that meets its performance and cost expectations - as its administrative overheads in procurement, logistics and production have already been reduced.
There are, however, distinct differences between the financial and information intermediation business that require different strategies, marketing, and support skills and organisations. Information intermediation introduces a new set of customer criteria and relationship issues that need to be clearly addressed by banks (see Chapter 8). For instance, the best customers for credit are not necessary the best prospects for EDI. On the other hand, any organisation not preparing itself to be EDI capable could be a considerable credit risk in the future.
Business Opportunities
EDI is about information exchange between trading partners. There are two basic categories of EDI users:
-
Hubs - usually large organisations that act as the central buyers and stimuli for EDI programmes; and
-
Spokes - often smaller organisations that are the suppliers to the hubs.
In highly information intensive industries, EDI can provide significant benefits for hub organisations. The benefits for spokes can appear to be much less. The major problem facing most hubs is how to convince all their spokes to use EDI. Unless the majority of spokes become EDI capable, the hubs will have to operate a manual and an EDI process in parallel. This dual operation has consistently proven to be a significant factor in the continued support of EDI programmes. Unless an organisation can successfully convert the vast majority of its activities to electronic processes - usually within two years - then it will have difficulty sustaining the programme due to an unsuccessful cost/benefit analysis.
There is a major business opportunity for banks to become electronic information conduits between hub organisations and their spokes. A bank could simply provide a mailbox and a translation facility for EDI transactions as a basic commodity service. Or, more proactively, it could promote the usage of EDI by acting as an electronic interface between the EDI-capable hub organisations and non-EDI-capable spokes. Banks could use their data capturing and processing capabilities to capture any paper-based documents and convert them to EDI before transmitting them to the hubs. This would enable hubs to derive benefits from EDI much more quickly.
From a spoke's perspective, EDI represents a major business challenge. It must be able to use EDI with an increasing number of companies, including banks, however, it generally has neither the technical capability nor the resources to do so effectively. Such organisations represent a different kind of business opportunity for banks. They need a wider variety of interconnection as well as implementation and consulting support.
There is increasing demand for spokes to become EDI capable from their large customers and governments. For example, many payroll deduction remittances and reporting can be filed more effectively via EDI. In fact, this process is to become the requirement in the majority of States in the US and federally in Canada. Smaller businesses will need assistance and more cost-effective methods to satisfy these requirements.
Working within payments systems will increase the demand for financial EDI products but it will still be limited to businesses that have sophisticated payment strategies in place already. Companies that lack such strategies may need non-EDI front-end applications - using traditional means - for cost-effective EDI payments to be a reality.
Financial EDI is also a very low priority for organisations implementing EDI. In general, for each payment there are about 20 invoices and for each invoice, five purchase orders. Furthermore, payments can be netted whereas it is more difficult to net other types of transactions.
Nevertheless, EDI payments provide a powerful leverage and a competitive advantage for banks to compete with VANs. This represents a major opportunity since it is more difficult for a non-bank to control or participate in the financial component of a transaction than it is for a bank to participate in the information exchange business. From the banks' perspective, they will have to broaden their services to address more than just the payments aspect of EDI.
Strategic Implications
EDI and electronic commerce are changing industry structures and the way in which business is conducted. Since the implementation of just-in-time (JIT) inventory management, the use of electronic processes has become increasingly popular as the best way to complete business transactions.
EDI provides a cost-effective alternative to paper-based information in the following ways:
-
Changing the total cost of doing business and giving EDI-capable organisations a cost advantage;
-
Reducing the time needed to respond to customer requests;
-
Pushing inventory up the value chain with JIT manufacturing causing structural changes in industries;
-
Closer customer-supplier relationships leading to a smaller number of suppliers for each major purchaser; and
-
Bypassing certain intermediaries in industry value chains.
All of these changes focus on the way business is managed in an overall context and reduce or eliminate the non-value-added elements in the process. From the perspective of financial institutions, EDI has the potential of displacing a significant amount of current account fee revenue, especially in the corporate marketplace. This will not happen overnight but is expected to take place over the next five to ten years. If looked at as simply cannibalisation of one service fee structure by another, there is significant risk. There is, however, a substantial amount of evidence to show that by taking an active role in managing the transition and process, banks can create revenue opportunities that are greater than those lost.
Therefore, completely new business opportunities for banks will arise from EDI and preparation for these opportunities means having the right strategy in place and the capacity to change. It is not simply a matter of having the right technology. In the US, for example, a $70 billion lending opportunity has been created by tax preparation companies using EDI as a means of remitting returns to the Internal Revenue Service (IRS). What other opportunities may be on the horizon?
From a Financial Institution's Perspective
To take advantage of the new opportunities, banks must become more responsive to market demands. Internal procedures that have effectively supported banks' existing business functions may not be adequate to meet the demands of EDI business. The new windows of opportunity are considerably smaller both in terms of their total profitability and the time it takes to bring them to market. Banks need to design and deliver products for niche markets much more swiftly than they have in the past.
However, the ironic truth seems to be that the lead time to develop new technology solutions is becoming longer due to the complexity of most banks' systems and the technology development needed. This is largely due to the historical issues of control and security within a money-management business and the rigours of systems audit and control processes. Chapters 3 and 9 provide some insight into how some of these approaches can be streamlined and improved, but the most important element is to separate the control processes that are prudent and necessary for the management of "value" processing from those of product creation and "information" processing and management.
This is not to say that information needs less control and management than value, but appropriate controls and evaluation of information in the context of the risks associated with it is a key requirement. Moreover, banks must compete with non-traditional competitors. For example, multilateral netting of payments can be processed by VANs such as GEIS, and then passed on to any bank that offers the lowest-priced services. This is the essence of disintermediation being relegated to passing a single financial transaction for the settlement of hundreds or even thousands of high-value information exchanges.
Banks will also lose customer control because the information being exchanged relates to inventory status, accounts payable and receivable updates, and other data which would enable a bank to be in a better position to evaluate the ongoing status of the corporate customer.
For financial institutions, the major implications of EDI are:
-
Control over the payments system and fee-based services;
-
EDI enables multilateral netting outside of the banking sector;
-
The possible relinquishing of control of the EDI payments system to VANs-banks can be relegated to handling netted corporate-to-corporate electronic funds transfer (EFT);
-
Impact on the usage of cheques and EFT for corporate-to-corporate payments, and pre-authorised payments and direct deposits services in the corporate-to-retail market;
-
Control over customer relationship - not being able to expand the scope of business;
-
Control over the distribution channel for future information products and services;
-
Risk of losing access to certain valuable transaction information;
-
Establishing a conduit for new electronic products and services;
-
Becoming the custodian of valuable information between trading partners; and
-
Leveraging existing technology infrastructure and capability.
All of these components are risks that can be mitigated by leveraging skills and capability already in place in banking organisations today.
Transaction Versus Settlement Systems
One of the key factors that has emerged as a challenge in the establishment of EDI as a business is the differentiation of the EDI transaction from the settlement activities and the underlying methodologies that require change to meet this factor. This question first emerged in the application of realtime payments processing in the ATM shared networks where, when the customer of one bank removed cash from the ATM of another bank and left the area, there was no recourse should a dispute arise. In other words, there cannot be an electronic NSF because the transaction is as complete as it ever will be when the cash is removed.
The implications of this have been seen in payments systems worldwide, where rules have had to be modified to take account of the fact that a transaction needs to be settled at the same time as it is being processed - there can be no reversal.
This creates a key business issue for banks and banking systems that process EDI payments. Should there be the EDI equivalent of a stop payment? Further, if so, does that relegate the financial EDI transaction to nothing more than a messaging system, managed by the banks? This is a key issue in looking at the future of electronic intermediation and value-added developments by banks. The key component is that EDI payment transactions must be linked to, and supported by, the settlement infrastructure or else they can be processed outside the banking system with equal value and success. Banks that perceive their role as purely financial intermediaries will see the application of netting outside the banking system become a serious competitive threat.
What Are the Alternatives?
User Perspective
From the user's perspective, EDI is neither a product nor a service but an infrastructure. It is the equivalent of railway tracks. Market demands will be driven by innovative solutions that utilise the tracks to solve customers' business problems. The use of the "EDI track" will be purely incidental.
Furthermore, for most organisations real tangible benefits do not accrue until at least 80 percent of their transactions are in EDI - very few organisations had reached this level by the mid-1990s. Until such volume is reached, a parallel paper-based system has to be maintained. EDI has not yet reached critical mass, and growth has been slower and more difficult than was originally anticipated. Some of the difficulties include:
-
Real benefits can only be achieved after business process reengineering and not until a critical mass has been reached within a trading group or industry;
-
Significant internal resistance to change - threat to status quo;
-
Internal systems integration has proven to be more difficult and time consuming to implement - more so than the application of EDI technology itself;
-
Managing and co-ordinating trading partner relationships is a major issue and requires skilled handling; and
-
There has not yet emerged a single "total solutions supplier". This has increased the complexity in testing, negotiation and co-ordination of a variety of players in the market-not all of whom are on friendly terms with each other.
There is no doubt that there is a large pending demand. In the recently published "World Bank Technical Paper Number 317 - Information Technology and National Trade Facilitation Guide to Best Practice [November 1995]", only 100,000 organisations in about 50 countries were using any form of EDI as of the end of 1995 and over half of these were in North America. However, the number of users is increasing at the rate of 25 percent compound each year - and the volume of transactions and new applications is increasing at an even higher rate. Therefore, the market for EDI is just beginning to grow and saturation will not be reached in the near future.
|
|
N/A Order
from: |
N/A
Order
from:
 |
|