Friend or Foe?

TIMES STAFF WRITER

When Microsoft Corp. Chairman Bill Gates was quoted in a magazine four years ago calling banks "dinosaurs" and suggested that his company should "bypass" them in its push into home banking, he set off warning bells throughout the financial industry.

But there was a flaw in Gates' vision. Banks are among Microsoft's biggest customers for business software and key players in the Redmond, Wash., firm's bid to capture the enterprise computing market.

Microsoft executives have been busy mending fences ever since, insisting that Gates was denigrating the banks' computer systems rather than the banks themselves.

As Microsoft pushes its way into new online services, from travel to real estate to car sales, it is increasingly finding itself on a collision course with its largest corporate customers. And while these new Internet services for the most part continue to lose money, Microsoft's biggest profit growth comes from selling its Windows NT operating system to those very customers.

It's a Catch-22 that demonstrates that Microsoft's apparently relentless drive into new markets may not be easy.

Not wanting to alienate its big banking clients and risk losing them to competitors such as IBM Corp. and Oracle Corp., Microsoft is shifting its strategy in the financial services industry, positioning itself more as a technology partner than a competitor.

But cognizant of Microsoft's take-no-prisoners reputation, financial services companies are watching the firm closely even as they join with it in partnerships.

When Microsoft last fall announced a joint venture called MSFDC with Hackensack, N.J.-based First Data Corp. to offer a service allowing consumers to receive and pay bills electronically, banks cast a wary eye.

Paraphrasing Intel Corp. Chairman Andy Grove on the importance of identifying a key rival, Bank of America Chief Executive David Coulter recently suggested that if he had one silver bullet, he would use it for Microsoft.

"There are areas we would consider a traditional banking role. In these cases, we look at them [Microsoft] as a competitor," BofA Executive Vice President Michael DeVico said, a little more diplomatically.

Bankers say they fear Microsoft is trying to deal directly with consumers, thereby undermining the banks' critical relationship with its customers.

Microsoft dismisses such worries, saying it is far more interested in gaining a bigger chunk of the billions of dollars a year banks spend on computer technology. The software giant wants to put Windows NT into everything from banks' ATM machines to Web sites and eventually into the banks' back-office operations, where typically computers running the competing Unix operating system handle billions of transactions a day.

"We already do $1 billion in business with financial institutions every year," said Charles Stevens, a Microsoft vice president who works with large customers such as banks. "We would be on a suicide mission if we were to compete with them."

So Microsoft is now placing a higher priority on selling its new Internet technology to corporate customers. This summer Microsoft will begin offering banks and brokerage houses the technology behind Investor, the company's popular investment Web site (http://investor.msn.com). And Stevens has encouraged his colleagues at MSFDC to include banks as shareholders in the joint venture.

Are banks buying into the kinder, gentler Microsoft? Not exactly. Nearly half the 50 financial institutions that responded to a recent survey by Cambridge, Mass.-based market research firm Forrester Research saw Microsoft as a threat.

One test case for Bank of America and many other banks will be how Microsoft handles the MSFDC "bill presentment" service later this year.

Americans spend on average about two hours a month paying the 18.2 billion bills a year sent to them, according to Tower Group, a Newton, Mass.-based market research company.

"If we can cut that time in half," said Jessica Ostrow, vice president at MSFDC, "more people will use their computers to get these things done."

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Although many banks offer online banking today, it's a clumsy system that requires CheckFree, a Norcross, Ga., company, to take computer checks, convert them to printed checks and mail them to merchants. The system ends up costing billers more money than the paper system because the checks have to be manually matched with bill stubs.

"When you talk to billers, they actually dislike online bill payment because there are often delays," said Lewis Levin, vice president of Microsoft's desktop finance division.

Analysts agree that a truly automated system would save billers, banks and consumers tens of billions of dollars. But to be useful, the system requires bringing together tens of millions of households with thousands of banks and businesses.

With MSFDC, Microsoft plans to offer a system that would allow consumers to go to their bank's Web site to view their bills and pay them directly from their bank accounts. For the system to work, Microsoft needs to work closely with bankers. So the company is bending over backward to satisfy their concerns.

When MSFDC was announced, Microsoft said it would charge banks for every transaction the company handled for a bank customer. When the banks scoffed, it agreed to drop the fee--then offered to share a portion of the roughly 30-cent fee it plans to charge billers such as Southern California Edison for each bill sent through the system. For billers, that's still a deal because the current paper process costs them about 50 cents to 80 cents a bill.

After initially trying to establish MSFDC as the key brand consumers would see when paying bills, Microsoft later agreed to bank demands to prominently display the bank's brand on the payment screens.

To keep banks in the loop, Microsoft invited leading financial institutions such as Bank of America onto a special advisory board, and the company is expected to make the unusual move of inviting banks to take equity positions in MSFDC.

And again and again, Microsoft has had to remind banks it isn't interested in their basic business.

"We don't do banking transactions and customer relations. We won't manage deposits," vice president Stevens said. "We've had to explain that in the last few months."

The strategy has begun to work. Wells Fargo, Key Bank, Banc One, Norwest and Merrill Lynch are among the institutions using the service on a pilot basis.

It's rare to see Microsoft eating humble pie. But don't assume the company's famous arrogance is gone. Banking is one of the areas in which Microsoft is the underdog fighting well-entrenched rivals such as Intuit Inc.

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Three years ago, Microsoft had a plan to finesse the problem. It proposed paying $2.5 billion for Intuit, which sells the popular Quicken personal finance software. When antitrust regulators killed the deal, Microsoft took a second look at the business, putting new focus on online services to exploit the rapidly growing Internet.

"We asked ourselves what is done with high frequency by real people. It kind of comes down to stock quotes and paying bills," Levin said.

But meanwhile, Microsoft had lost valuable time.

The nation's largest banks, reacting to the threat from Microsoft, established Integrion, a venture with IBM to develop software that would take banking into the age of electronic commerce.

Fortunately for Microsoft, Integrion has been slow to come out with products, and it has already lost some key battles. A personal finance package created by the consortium was never widely adopted. And its Gold Standard, a system designed to tie together banks' various information systems, has also had slow acceptance because it was not based on Internet standards.

"Banks have to decide, 'Are you going to deal with the devil?' " said Jim Bruene, editor and publisher of Online Banking Report. "Most people will do it if it's going to increase shareholder value by being first to tie with MSFDC. So what if it hurts the rest of the industry?"

Wells Fargo, for one, is convinced it is dealing with a new Microsoft.

"For a while, there was concern that they wanted to get into the financial services industry," said Dudley Nigg, executive vice president at Wells Fargo. "Now we see them as an attractive partner. They are wedded to the content, but they are not offering it themselves."

And many banks now like the idea of Microsoft stirring things up.

"One of the beauties of Microsoft is that their entry galvanizes everything," Nigg said. "Everyone now has to pay attention. And that is good. You have to get the bandwagon rolling."

CheckFree, which was dragging its feet in coming out with an automated bill payment system, has recently begun testing a system to rival MSFDC. And AT&T; Corp. announced last week that it will launch a similar service in partnership with Intuit.

Microsoft is looking forward to a steady stream of revenue from bill presentment, and Ostrow of MSFDC says the company sees great potential for offering new services, such as handling electronic payments between businesses.

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But the biggest payoff in the short term could come from selling the software used to operate the online banking systems.

If Microsoft is successful with MSFDC, thousands of billers will use computers running Windows NT to configure their bills before sending them to MSFDC. And thousands of banks and credit unions will have to use NT to connect with MSFDC to present bills to their customers.

Microsoft is also wooing banks with software that makes it easy for consumers to get information about their accounts using personal finance software such as Quicken or Microsoft Money. Wells Fargo, where 450,000 customers already bank online, says it uses the software, code-named "Marble," rather than spending large sums to develop software itself. That's another foothold for Windows NT at a major bank.

Critics say banks shouldn't be misled by Microsoft's apparent change of heart. "Banks are basically data-processing companies," said Gary Reback, an attorney who represents several Microsoft rivals. "They should be careful about letting Microsoft control the [information] pipes."

But Microsoft's new partners say they are going into their relationships with eyes wide open. "You just have to be realistic about how you create the business relationship," said Bruce Luecke, president of interactive delivery services at Banc One Corp. "You make sure you protect yourself."

Bill Burnham of Minneapolis-based brokerage house Piper Jaffray agrees it's up to the banks to protect their flanks as they move into cyberspace. "If the cookie jar is open and nobody is looking," he said, Microsoft "will grab the cookie."

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Banking on the Net

As a growing number of households use the Internet to deal with bill payment and other financial needs, banks are investing heavily to build the necessary infrastructure (all figures are projections, in millions).

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1998 1999 2000 2001 U.S. households with personal computers 42 46 50 54 Homes using the Internet for banking services 0.3 1.6 2.9 5.9 Spending by banks for online banking $336 $566 $798 $863

2002 U.S. households with personal computers 58 Homes using the Internet for banking services 8.8 Spending by banks for online banking $927

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Source: The Tower Group

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