ING Direct (www.ingdirect.com) a pioneer in the direct retail banking business.

* Pressure on Spreads [High] - "In 2006, as rising interest rates took a toll on lending revenues, as well as on credit quality among the biggest consumer credit card and mortgage lenders, the US banking sector was struggling to maintain strong earnings" [3]. Economic slowdown in the country and high interest rate proposed by the Federal bank has put enormous pressure on the banks to maintain their margins. The overall challenges faced by the banks to generate profit have resulted in intense competition among the banks to acquire more business from the customers.

* Homogeneous Product Offering [High] - The banking products are homogenized which limits the differentiation that can be brought in by a bank in its offering. Superior technologies, better service, higher savings rates, lower lending rates are some of the ways in which banks try to differentiate themselves.

* High Exit Costs [High] - As the industry is based on a high level of trust, exit from the industry is highly regulated (legal barriers) and extremely damaging to the brand.

Threat of Entry [High]

* Regulatory Barriers [High] - The banking industry is one of the pillars of the macroeconomic policy formulated by governments hence the regulations in this industry are comparatively tighter and more complex. Some regulations include - minimum reserves (a bank must hold with the Central Bank to the tune of 10% of the transaction deposits), capital requirements that are more risk-sensitive and regulations which are exceptionally damaging for U.S. banking organizations that are subsidiaries of foreign bank. These subsidiaries are required to hold more capital than their foreign counterparts.

* Brand Identity [High] - Banking is a trust based industry. The brand image is the key to attracting customers and is the vehicle for the salability of the financial instruments developed by the institution. This can be concluded from the fact that the industry is highly consolidated with acquisitions taking place across the board. A new entrant would have to possess credibility supported by reputed foreign banking institutions or subsidiary businesses of existing banking houses, to be successful.

* Learning Curve and Experience Effects [High] - one of the key differentiating factors in this industry is lower service charges. Hence the ability to come down the learning curve faster and become cost effective provides a significant competitive advantage. Experience leads to the efficient usage of capital which in turn is used to provide better deals to the customers in a profitable way.

* Access to distribution [Moderate to High] - The Minimum Economic Scale (MES) of the banking industry is typically achieved by having a wide customer base and the key to achieving this scale is through a huge distribution network which could include Banks, ATMs, Advisory Services, and Mortgage etc. Setting up such large infrastructure is a capital intensive process and serves as a huge barrier to entry.

* Experienced Retaliation [Moderate to High] - Banking is one of the oldest and mature industry. The industry is dominated by a few big players. Any new entrant will be stifled by large and extremely cash rich competition who have diversified product portfolio and have entrenched themselves across almost every service quadrant in the industry.

Threat of Substitutes [Moderate]

For the banking industry, substitutes are alternative means for storing and investing wealth, sources of credit and means of payment systems.

* Investment substitutes [High] - Investment substitutes include real estate, equity, mutual funds etc. These options vary in risk-return-liquidity parameters.

* Credit alternatives [Moderate] - Alternatives for mortgages, loans and other credits are available mainly from product and services companies. These companies have started their own finance companies to finance the sale of their products and services at attractive rates e.g. Ford Credit.

* Payment alternatives [High] - Recent technology developments have brought many payment systems that compete with the payment solutions of the banks such as cash, credit and debit cards. Some of the most popular services like PayPal and the Google checkout are becoming de-facto standards in online transactions.

Though the price-performance-risk trade-off between substitutes and banking products varies, the cost to switch to a substitute is minimal. Therefore given a substitute, with better price-performance-risk, the buyer's inclination to substitute is also high. Overall the threat of substitutes is high.

Bargaining Power of Supplier [Moderate]

* Labour [Moderate] - The banking (financial) industry is one of the most attractive industries in the US that employs a significant number of skilled available labour in various positions from customer facing teller roles to highly skilled professional investment consultation[6] (Exhibit 6). Though the requirement of the banks in terms of skilled labour is very high, the attractiveness of the industry in terms of working environment and pay has ensured that there is more than adequate supply of qualified professionals. Also "Very few workers in the banking industry are unionized-only 2 percent are union members or are covered by union contracts, compared with 14 percent of workers throughout private industry"[7].

* Information Technology Providers [Moderate] - The banking industry in highly dependent on technology. Technology plays a significant role in various phases of banking processes. Front office interplay between customers and technology includes ATMs, online transactions, online payments, credit card acceptance. In the back office technology enables ACH, Wire transfers, Positive Payment and other business critical processes. Many banks have outsourced this function of the bank to derive efficiency and economy. Though IT companies wield formidable power, intense competition among the IT service providers and rapid globalization has ensured that their powers over the banks are limited.

* Non-Branch ATM Locations [Moderate] - While branches provide retail presence to the banks, physical locations in demand now relate to ATMs in the non bank locations including gas stations, stores. These ATMs provide customers with the flexibility of utilizing banking services and also offer potential to the banks to provide value added services during non banking hours. Banks either operate their own ATMs or utilize the services of third party established ATM vendors.

Bargaining Power of Customers [Moderate to High]

The following factors influence buyer power in the banking industry.

* Buyer power [Moderate] - Customers in the banking industry can be categorized as retail and commercial. The retail customers are large in number but fragmented and hence do not have much buyer power. The commercial accounts on the other hand are concentrated and wield a fair amount of power.

* Switching Costs [Moderate] - Most of the banking products have standardized features and customers can compare and contrast various offerings from different banks. If there is an established relationship between the customer and the bank, for instance if a customer has multiple accounts in and multiple loans from the same bank, the switching costs are high. For earning products like savings accounts for which the frequency of transactions is low, the switching costs are comparatively low. In monetary terms these costs might not be too high but changing bank accounts is normally looked upon as an inconvenience by the customer.

* Potential Buyer Power [High] - Potential buyer power is the willingness of the buyer to use that power if she is unhappy with product. In the banking industry the customer has a plethora of options to choose from and hence this potential power is very high in this industry.

Taking into account all the above points the threat posed by the buyer power on the banking industry is moderate to high.

3. Internal Analysis

Generic Strategy of ING Direct - Focused player

ING Direct followed a focused strategy addressing the banking need of Internet-friendly households. In implementing this ING Direct followed a balanced mix of differentiation and low cost strategies.

Strategy

Remarks

Target segment

Focused player

Targeted Internet-friendly households interested in tripling the amount earned on savings or money market accounts with no offsetting fees or minimum account balances.

Product Strategy

Balance between Differentiation & Low cost

Limited number of innovative banking products well suited for direct banking.

Employees

Differentiation

Highly Skilled, Flexible, were paid above market wages extremely high asset-to-employee ratio (as high as $42m per employee as against an industry average of $5m in 2005 [4]).

Marketing

Medium Cost

Customer acquisition: Internet presence. Selective niche marketing campaigns.

Distribution

Low Cost

Internet based

Culture

Direct banking being a relatively new concept in the US, ING Direct had to build relationships with its customers without face-to-face contact and convince them that it is a safe way to bank. To be successful with this new model ING Direct realized that it should have an organizational culture that attracts people with lot of energy and a zeal for doing the right thing both in terms of higher returns and better service for the customer. In addition they had to want to do things differently. The team that the ING Direct assembled to execute its concept in US comprised of "people who were entrepreneurial with strong operating skills; who either had little banking experience or had been uncomfortable working for larger, bureaucratic banks; and whose average age was in 30s"[1]. The culture that evolved within ING Direct ensured that each employee became great ambassadors for ING Direct.

Entry strategies employed by ING Direct to enter the US market

ING Direct uses "Click Call Face Retail Strategy" [5]. ING Direct's focus is on click (Internet) and calls (Telephone) entry plus cross selling strategy, gradually adding face. In mature markets the product focus is on wealth accumulation products. The ING's entry strategy provides economical alternative for (good will) acquisition. The following illustrates some specific entry strategies that ING used in the US market.

* Execute Flank Attack and avoid Experienced retaliation - During entry, the product offered by ING Direct was a simple savings bank account in which customers could deposit money and earn a very high rate of interest. The customers were neither required to maintain a minimum balance nor were they charged a service fee. ING Direct encouraged the customers to shift their money at no cost from their existing checking accounts with other banks to their savings account with ING Direct. It did not compete with the other banks by offering services like checking, face-to-face teller services and automatic teller machines (ATM). ING Direct started off as the customers "other bank". Because of a low threat signaling the existing banks did not consider ING Direct as a direct threat. This has helped ING Direct focus to excel in its strategic group.

* Reuse Learning Curve and Experience Effects - The initial product design was meant to attract customers with already existing banking relationship with other financial institutions and just park their saving with ING Direct at a much higher savings rate percentage. Using this, ING Direct was able to tap into a large customer base very quickly. In addition, leveraging the low cost structure and experience of the parent group (ING Groep) in managing financial assets, ING Direct was able to sustain the high savings rate provided to the customers and still generate profits.

* Circumvent Government Barriers - The deregulation of US banking industry in the later half of the 1990 opened up many new opportunities for existing and new entrants to the banking industry. Though there were other online-only banks that had started around the same time as ING DIRECT started, their growth was limited by their ability to come up with the required statutory capital requirements. The backing of the parent company, ING Groep NV, one of the largest financial services companies in the world ensured that ING DIRECT could meet the minimum reserves and other capital requirements mandated by the government regulations.

* Alternate access to distribution - ING Direct realized that the banking industry was a capital intensive industry and to overcome this barrier it chose to use the internet as its distribution channel. There were no physical branches and the company only setup cafes as a means for customers to interact with each other as well as get to know the bank better. This drastically reduced the costs incurred on the distribution channel and added to the cost savings that ING Direct could eventually pass on to customers.

Growth Strategies

ING Direct's growth strategy was to provide a face to their "Click Call" retail operations. This is achieved by increasing their product portfolio and effective cross selling of products offered by their parent company. They also ensured that their value proposition is not diluted in this process. The following illustrates some of the growth strategies

* Reduce Switching Costs - ING Direct chose to sell simple, no-frills products for which the switching costs were low. They typically targeted customers who had money that was earning low interest rates at other banks and made it easy by allowing inter-bank transfers free of cost. Added to that, the customers were not charged a service fee for opening a new account with ING Direct. In the service industry, switching costs are generally associated with convenience; the more inconvenient it is to change banks, the higher the switching costs. ING Direct's model ensured that convenience, speed and low costs brought the switching costs down to a minimum.

* Differentiation - ING Direct's differentiation strategy consisted of offering simple products at zero service charges to its customers (Exhibit 3). Online banking is a fairly new concept and ING Direct uses it to enhance its customers experience by supplementing the online product with a 24/7 telephone support service. Some of the ING Direct's products are basic and it didn't cater to customers with high demands. If the customer became too demanding, they terminated the account. They used this strategy as a means of controlling buyer power.

* Building Brand Identity - ING Direct leveraged the reputation of the ING Groep as a respected financial services house internationally and in the US as starting point for its brand building process. ING Direct then focused its brand building and marketing campaign on the aspect of "Bringing Americans back to Savings" (Exhibit 4) and tried to differentiate itself from all the existing brick and mortar services that typically focus on credit. ING Direct used a very active marketing campaign built on the color Orange and attaching this nomenclature to all their services (Exhibit 1). ING Direct used low cost, cleverly designed advertising campaign typically concentrated in each of the markets it targeted beginning with New York, Philadelphia, Boston and Los Angeles[8].

Financial Analysis - Key Performance Indicators

* Total Deposits - The total deposits at ING Direct have been increasing at 18% (year 05-06) and currently are about $45 billion (Exhibit 9). Though it holds only 0.7% of the total deposits of US, ING Direct has the biggest market share in the "Direct Banking Segment" (Exhibit 10).

* Efficiency Ratio - The ratio of cost to income defines the efficiency of operations of a bank. ING Direct has been consistently having lower efficiency ratio (indicating higher efficiency in operations) than the industry average of 58% (Exhibit 11).

* Net Income Growth - ING Direct has been showing consistent growth in their net operating income over the year (Exhibit 12).

* Account closure rate - The account closure rate at ING Direct is 3% which is lower than the industry average [8].

4. Sustainability of the Strategy

ING was able to navigate successfully across many of the barriers that existed in year 2000 to start its banking operations in the United States. The profits and growing customer base stand testimony to the viability of the ING Direct's business model. ING Direct's CEO Arkadi Kuhlmann was named "Innovator of the Year" by American Banker in 2006. But in the long run, the competitive advantage derived by this model may not be sustainable.

ING Direct can outperform its competition only if it can establish a difference that it can preserve. Our analysis reveals that ING Direct's sources of competitive advantage are not difficult to imitate, nor does it possess unique resources to sustain competitive advantage

Resource capability

Valuable

Rare/unique

Difficult-to-imitate

Low-cost online

Business model

Yes

Yes

No

Brand name

Yes

Yes

Yes

(But incumbents have equally well know brand, which they can leverage - e.g. CITI DIRECT, HSBC DIRECT, PayPal, Google Checkout to leverage)

Technology

Yes

No

No

Innovative product offering suited for direct banking

Yes

Yes

No

Service levels

Yes

Yes

Yes

* The threats to entry in the Banking industry are governed by external factors such as government regulations, statutory capital requirements. The Business model as practiced by ING has not erected entry barrier to thwart new entrants nor was it successful in preventing other banks from imitating its model. Firms with deep pockets who could meet the regulatory requirements in fact have started competing with ING Direct with offerings similar to that of ING Direct. This threat is substantiated by the decrease in the deposits growth rate of ING Direct (Exhibit 13).

* Loss of differentiation position due to imitation. Ease of access (internet) and quality of service had initially differentiated ING Direct's services. Coupled with simple design (Exhibit 7), no hidden charges and higher interest rates had allowed ING Direct to gain significant market share. But players like ETrade have started imitating the attributes that has made ING direct a huge success.

5. Threats facing ING Direct

* Threat from incumbent banks: Though many of the brick and mortar banks have started their own online version of their banking services, most of them soon realized that they cannot match the inherent cost advantage pertaining to online-only model practiced by ING Direct. Recently some of these incumbents have started to emulate the DIRECT model by floating online-only banking business units- CITI DIRECT and HSBC DIRECT being examples.

* Threats from financial solution providers: Among the other competitors, E*Trade which focused much of its efforts in developing brokerage business unit during the late 1990's have started competing with ING Direct with the direct banking model. Similarly, online payment system PayPal have recently started accepting deposits and giving interest rate returns matching and in some cases bettering those of ING Direct. Though ING Direct has an earlier mover advantage, our assessment is that ING Direct will find it growingly difficult to maintain its competitive advantage.

6. Recommendations

* Increase the depth of Cross Sell - ING Direct's core strategy of "Click Call -->Face" has to be implemented aggressively. Though ING Direct has secured a leadership position in the "Direct Banking Segment" it has not yet fully leveraged the "Cross Sell" opportunities provided by the presence of the ING in US. By increasing the cross sells, the company will start acquiring the "Face" quadrant of the customer interaction and can effectively counter the threat from pure direct banking imitators.

* Provide value added service in the internet channel - The internet banking strategy though is very effective still lacks the personal touch of an advisor. ING Direct should start providing value added services powered by technology (Web 2.0) that would increase the interaction of the customers with the web channel. Some tools like investment calculator (Exhibit 8), Savings advisor can be integrated into the internet channel that would not only increase the attractiveness of the channel but also provide value of the existing customer.

7. Conclusion

ING has perfected the online-only-direct banking model by developing simple products suited for online banking, targeting a niche market and executing a set of set of activities that not only reinforce each other, but also fits the ING Direct's stated positioning. But the success of the business model has attracted competitors, who have imitated the whole set of activities that have once given ING Direct its competitive advantage. Though there is room for more than one player in this market, ING Direct should take concrete steps to protect and enhance its competitive advantages.

References

[1] ING Direct - Harvard business School Case Study - Professor James L.Heskett.

[2] ING Groep N.V. - Company Profile - DATAMONITOR Business Information Center.

[3] The North America Banking Sectors - A Company and Industry Analysis. Mergent Report - Apr 2007.

[4] http://www.banktechnews.com/article.html?id=20051201D6IL5GB0

[5] ING Direct strategy - Hans Verkoren, Member EC Europe, Global Head ING Direct -12 April 2001.

[6] http://www.bls.gov/iag/financial.htm

[7] http://www.bls.gov/oco/cg/cgs027.htm#emply

[8] ING DIRECT, the nation's largest direct bank, is the recipient of two major awards for its innovative, strategic marketing campaigns. The American Advertising Federation (AAF) is honoring ING DIRECT with a 2007 Gold ADDY (r) Award in Advertising for its "MoveOutMoveUp.com - First Time Home Buyer" online campaign. ING DIRECT has also earned a "Marketer of the Year" Award in Experiential Marketing from the American Marketing Association's Philadelphia chapter for its "Chicago Cash Cow" consumer brand experience events. Source -http://home.ingdirect.com/about/about.asp?s=News#05302007.

[9] All bank data obtained from http://www.fdic.gov

Exhibits

Exhibit 1 - Products offered by ING Direct (Source www.ingdirect.com)

Exhibit 2 - Decline in the number of Saving Banks or Thrifts

Exhibit 3 - Core Tenets of Product Design by ING

Source - Branding in Retail Banking, Catholic University, Milan. Christian Miccoli, Sergio Rossi, Antoinette Leopold 8 June 2006

Exhibit 4 - Brand Promotions - Promoting Savings in US

Exhibit 5 - Non Interest Expense comparison

Exhibit 6 - Employment increase in financial sector

Source - U.S. Department of Labor Bureau of Labor Statistics

Exhibit 7 - Comparative complexity

Exhibit 8 - Value added tools - Source HSBC Direct

Exhibit 9 - Growth in Total Deposits if ING Direct

Exhibit 10 - Share of Deposits - Direct Banks

Exhibit 11 - Efficiency Ratio of ING Direct

Exhibit 12 - Net Income Growth - ING Direct

Exhibit 13 - Growth rate of Total Deposits - ING Direct