Viewpoints
Online banks are faltering. NetBank has fallen 75% from its July 1999 high, and WingspanBank is up for sale. The reason? They can't bring customers in quickly enough.

NetBank nets only around 15,000 new customers per quarter, while WingspanBank struggled to justify its acquisition costs—customers are estimated to have cost the company around $1,000 each. The difficulty in attracting new account holders isn't surprising mention the word "bank" and customers think "checking account"—a product they probably already have and are likely to buy from only a few companies in their lifetime.

When people do switch banks, it costs them dearly in time and patience. They're unlikely to launch the process on the basis of a few advertisements alone. Clearly banking is not the most effective proposition for acquiring online customers.

Online brokers, on the other hand, are attracting customers hand over fist, and at a reasonable cost. Total customer numbers for the top five competitors have risen 44% over the last year, with E-Trade gaining close to half a million customers in the first quarter of the year (excluding those it gained through its acquisition of Telebank).

These gains are made at an average cost of around $250 per customer. The effect is that online brokers are paying a fraction of the average market value of $3,000 per customer that the share price suggests.

This is an extraordinary way to create value for shareholders.

This difference between brokerages and banks creates an opportunity for " customer-acquisition arbitrage"—capitalizing on new customers by passing them on for a higher price than they cost to acquire. This phenomenon is the driving force behind a series of recent mergers and acquisitions in which brokers have allied with customer-hungry banks.

Consider the plight of online and traditional banks: If they are to avoid further pounding of their stock they need to:

Bring in many more customers and lower acquisition costs.

Dramatically increase the market value of current customers.

Some, like Fleet and Bank of Boston, have sought a solution in mergers that allow them to acquire customers at a discount and then spread reduced fixed costs over a larger customer base.

Others have developed "hooks"—products that attract a high volume of customers who may then buy additional products. A recent example is credit cards: some banks, such as Capital One and Providian, successfully boosted customer numbers by offering attractive rates on no-fee cards. Now, however, this source is drying up.

Today, online brokering has become useful bait. Charles Schwab and Merrill Lynch have become very effective at using their online brokerage businesses to drive customer growth. They complement this success by using the rest of their business system to sell more products to their customers, thus increasing the value of each relationship.

With their track record for swift customer acquisition, online brokers are becoming an attractive engine for customer growth in the banking business.

Toronto-Dominion Bank's majority-owned TD Waterhouse has shown how this can work. The second-largest online broker in terms of total accounts, it has built a profitable business through offering a full array of products and services to its brokerage customers, including banking products through its affiliation with TD Bank. TD Waterhouse's first-quarter earnings this year were almost double analysts' predictions.

A second example, Telebank, clearly saw the opportunity to acquire customers quickly when it sold itself to E-Trade. At 28,000 customers per quarter, its acquisition rate was less than a tenth of E-Trade's. Meanwhile, E-Trade saw an opportunity to increase the value that it extracts from each of its customers.

Whatever way you look at it, the deal makes sense. Of course, the value will be realized only if the new E-Trade Bank can cross-sell banking products to its stock-trading customers.

E-Trade certainly appears determined to eke the maximum value out of its precious customers. It is launching a door-to-door financial advice service and branching out into accounting and tax planning.

It's not just newer companies like Telebank that are using brokers to generate customer growth.

Think of blue-blooded U.S. Trust's sellout to Charles Schwab & Co. U.S. Trust was finding its customer-acquisition model increasingly expensive. It had grown by acquiring asset management companies, then adding a private banking practice to increase the depth of customer relationships—a tough proposition, given the rising price of asset managers.

For its part, Schwab was already selling profitable money market accounts to hold customers' cash between trades.

It needed an upscale brand and some additional services to help retain increasingly wealthy customers. The combined entity—a top-notch brand plus a high quality, fast growing customer base—has excellent prospects.

We have not seen the last deal driven by customer acquisition.

Other stalkers could include the likes of Cendant—a successful customer-acquisition machine that uses the all-important house purchase as the "hook" for customers, then sells a stream of related products to the new homeowners.

For their part, bricks-and-clicks banks must either increase the value of existing customers through further consolidation or spot other acquisition engines to buy. Specialist companies that can reel in the customers should keep an eye out for banks with which they can do a little arbitrage.

Contact: http://www.americanbanker.com