Online banks scramble for customers

Meet your online branch manager...

As UK internet bank Egg floats on the London stock market, a raft of rivals that is joining the costly fight for a share of the online banking market.

When UK insurer Prudential launched its telephone and internet banking subsidiary Egg in October 1998, many thought it a folly - a costly attempt to boost the firm's image, following the industry-wide pensions misselling scandal.

But Egg's achievements are impressive. In less than two years the bank has attracted:

Over 1 million customers.

More than £9bn in assets.

250,000 credit card accounts (in just nine months).

Online shopping zone with 160 retailers.

The five-year target, 500,000 customers, was achieved within six months.

In fact, Egg has been so successful that it had to slow down its growth, paradoxically by turning to the web. The internet is now the only place where new customers can apply.

Costly growth

Call centres are cheaper than bank branches, but doing everything on the web improves profit margins even more

The rapid growth has come at a cost, both for Egg's reputation and its bottom line.

A string of security lapses at its web site brought the bank unwelcome publicity in 1999, although Egg moved quick to contain the damage.

The financial losses, however, are more serious.

At one point, Egg was offering savers interest rates above the Bank of England's base rate. This did wonders for customer acquisition, but plunged Egg deep into the red, to the tune of about £150m.

The company insists that it can "break even in the latter part of 2001". Some analysts are more cautious, predicting solid profits by 2003.

But to succeed, Egg must offer more than attractive savings rates.

The magic formula is called "cross-selling" - the holy grail of banking and the reason for many recent financial mergers.

Banks hope to attract customers with one highly competitive, albeit not profitable product, and then try to sell them other products with better profit margins too.

Egg is already branching out. Savings accounts were joined by mortgages, followed by "internet credit cards", an on-line investment supermarket and a web shopping zone.

The company predicts that the "benefits of the customer base and cross-buying" will come through soon .

Customers abandon High Street

Some online banks promise new customers a free Wap phone to do their wireless web banking

Egg's rivals on the country's High Streets have been slow to react. They made a bet on the notorious inertia of bank customers, who are more likely to change their partner than their bank account.

But the better rates offered by telephone and online banks like Egg and First Direct are slowly changing that.

High Street banks and insurers are now fighting back, and suddenly Egg finds itself under attack from three directions:

• Internet 'pure-plays' - web-only banks like First-e (a firm that is the vehicle for the European expansion of French bank Banque d'Escompte);
• stand-alone internet banks that are owned by high street banks like Lloyds TSB and Abbey National, but have their own branding, and
• traditional banks like Barclays that offer their customers the opportuniytdo their banking online.

Quirky branding...

The strategies may be different, but most online banks have one thing in common - a quirky name.

Smile (Co-op), IF (Halifax), Cahoot (Abbey National), Open Plan (Woolwich), Evolvebank.com (Lloyds TSB) all vie to rival the Egg brand, which was derided at first and is now praised as a product of true marketing genius.

... and innovative products

Good branding is supplemented by innovative ways of banking.

Egg, for example, offers its customers two levels of service. Clients have the option to talk to a real person on the phone if they have a query.

But if customers select internet-only banking, which is cheaper for Egg, the bank rewards them with higher interest rates - and more than two-thirds of customers are taking up this offer.

Lloyds TSB's Evolvebank.com - due for launch early in 2001 - is taking this to the extreme. It will be a pure internet bank. Without costly call centres, Evolvebank.com hopes to reach break-even point with only 200,000 customers.

Compare this to Egg, were 1m customers are not enough to get out of the red.

Others try to attract clients with new financial products.

Halifax's IF - which stands for Intelligent Finance and launches in July - promises customers to offset their accounts against each other, maximising the interest income they can make.

If the current account is £200 in the red, but the savings account holds £500, IF will pay interest on the £300 balance.

Other banks would both charge high interest rates for the current account in the red, and pay much lower interest on the savings account - so the customer loses out.

Cannibals

All this is very innovative, and will help customers - if they manage to find their way through the jungle of differing charges, service levels and interest rates.

Investors, however, and especially those planning to buy Egg shares, will have to worry whether such costly methods of customer acquisition can be sustained.

Traditional banks, meanwhile, must worry whether their snazzy but loss-making online banks will not eat into their own market share.

Experts call it "cannibalisation", where an online bank snatches the customers of its High Street parent.

After all, there are only that many bank customers to go around.

Some banks, and many investors, are set to lose out.