Chicago’s Banc One wants to make waves in cyberspace. In November 1998 the banking giant, which has $235 billion in assets, announced a deal with Internet portal Excite to build a web-based financial services center. But while the bank is gung ho about the project’s potential, it should be careful—because bad investment-technology investment decisions are common in the financial industry. Why look far for examples? According to American Banker, a new strategic banking system that Banc One wanted to develop with Electronic Data Systems, an information services company in Plano, Texas, unravelled in 1997 after an estimated $175 million had been spent on it.

During the past decade, not all financial institutions’ forays into technology have been disastrous. Examples abound of institutions that have efficiently employed technology. For example, many banks have effectively hooked together phones and computers to transform their call centers. Still, the use of technology by financial institutions remains an uncertain exercise. While some firms have harnessed technology well and improved their performance, others’ attempts have flopped. This is increasingly not only an important issue for financial firms, but also an expensive one. A typical bank spends as much as 15% of its non-intererest expenses on information technology.

So what determines how a financial institution decides on and uses its technology? Lorin Hitt and Patrick Harker of the Wharton School and Frances Frei of Harvard explore that issue in a new study titled "How Financial Institutions Decide on Technology." Harker, who discussed this study at the Second Annual Wharton-Brookings Financial Conference last October, says that he and his colleagues set out to explore three issues. First, they looked at how banks evaluate and manage their investments in information technology. Second, they probed how the banks’ practices compare with the theory about the way technology should be managed. And finally, the researchers assessed the impact of technology management on the banks’ performance.

Hitt, Harker and Frei focused their investigation on decision processes about two information-technology projects: PC banking—which allows customers to access their accounts, transfer balances and pay bills by computer—and the development of corporate web sites. They found that banks are getting into PC banking for several reasons. These include the desire to lower costs, increase revenues and retain customers, among others. Their study shows that PC banking has not brought about any major cost savings for the banks, however. The major reason is a low customer penetration rate. In the researchers’ sample, only 1% to 5% of the customers used PC banking. As regards revenue enhancement, the study found that PC banking customers tended to maintain higher balances, on average, than other customers. These customers are potentially highly profitable for the banks, especially if they could be persuaded to buy more services. According to Harker, banks are not—yet—making more money as a result of PC banking; its primary value is that it helps the institution retain profitable customers.

In addition, the researchers found that all the banks in their sample had set up corporate web sites, seeing this as a basic competitive necessity. This Internet presence usually came about, however, outside the bank’s normal approval and development process. Only rarely was a formal business plan written for the web site, and little thought was given to how the bank’s web presence would support its business. Further, the banks lacked the skills to build their web sites. They hired outside contractors to do the job.

Hitt, Harker and Frei maintain that their resarch points to three key conclusions. First, PC banking has not added as many new customers as many banks had expected when they first introduced the technology. It has, however, played a role in helping banks retain high-value customers. Secondly, the researchers say that external vendors will continue to play an important role because financial institutions are not equipped to think technologically. Many banks do not even have formal R&D groups. The third conclusion points to the need for so-called organizational architects. Banks will need specialized managers, equally at home with both finance and technology, who will knit together coherent organizational structures built around new technology systems.

William Fenimore, CEO of Integrion, a consortium of banks that are working together on Internet-related issues for the banking industry, led the discussion on this study at the Wharton-Brookings conference. "I agree with most of what was said in this paper," he said. "We do a terrible job of figuring out how to apply technology." He pointed out that only 20% of the information technology budget of large banks is focused on strategic initiatives; the remaining 80% is used to maintain current systems and technology.

The future, though, may be different. Banks are already recognizing the challenges ahead, and they are recruiting executives from industries like cable to lead new technology initiatives. As this happens more and more, it should help financial institutions make better use of technology. With luck, it might even prevent foul-ups like the one at Banc One.