Focus: Does egg have Net banking cracked?

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The Independent Online

EVER SINCE the Prudential hatched its egg subsidiary last October, the Internet-based financial services start-up has acted as a lightning rod for two great City debates: which of the new Internet banks will succeed, and which will fail; and how realistic are the outrageous valuations placed on Internet businesses? These questions are even more pertinent given Halifax's launch of its own stand-alone Internet bank, announced yesterday.

EVER SINCE the Prudential hatched its egg subsidiary last October, the Internet-based financial services start-up has acted as a lightning rod for two great City debates: which of the new Internet banks will succeed, and which will fail; and how realistic are the outrageous valuations placed on Internet businesses? These questions are even more pertinent given Halifax's launch of its own stand-alone Internet bank, announced yesterday.

Mike Harris, chief executive of egg, is convinced he has the right model. "After all, egg was one of the most exhaustively researched personal finance launches ever," he says. But talk of Internet valuations, floats and the like sends him scuttling for cover. Which is not unreasonable. "We haven't even decided whether to float or not yet. We're still building a customer base, building the brand."

They've certainly piled on the customers. egg launched its flagship savings account by promising it would keep its interest rate at half a per cent above base rate for the first year, and at base rate after 2000. The effect was dramatic. egg has more than £6.7bn in deposits and 600,000-plus customers. Yet the speed with which it attracted such customers set its City critics' tongues wagging. Wouldn't the "hot money" attracted by unsustainably high rates flow straight back out when these rates fell, as they must?

Firstly, says Mr Harris, "the deposit account is going to be our one and only loss leader. Everything else we do will be expected to make a profit, measured on a conventional basis". Secondly, he agrees that the customer attracted to such an account will be by definition, sophisticated, and more likely to shift their money to the highest rate.

When they were researching the market before launching egg, he says, they discovered "a tranche of customers that won't trust anyone anymore. They just want to be supplied with more information and then be allowed to make up their own minds. They want the whole process demystified. We're aiming at that sort of [customer]."

And keeping these customers should not be as difficult as critics claim, because the Internet keeps costs below those of branch-based banks. egg can survive with margins on its savings products of half a per cent, he says, as opposed to the 2 to 3 per cent common in the UK savings industry. "That's what's happened in the US already. No one pays more than half a per cent over base in the States," he says.

The critics then accuse egg of suffering "brand stretch".While egg may have attracted savers with a high rate, it is quite another thing to cross sell other types of financial products to them, they say. "Bancassurance" - the idea of trying to combine traditional retail banking with selling financial services - was tried in the 1980s and failed to catch on. People prefer to shop around for the best deal on mortgages, life and general assurance and the like. Why should anyone buy a complicated product like a mortgage, say, on the Web?

Mr Harris says egg will not be selling any Pru products, only specially tailored egg products. Furthermore, all these products, such as the credit card which egg launched in the past fortnight, will be "sustainably priced on conventional terms. That goes for mortgages and personal loans", he says.

And even those customers who are "hyper rate sensitive", he says, like egg's guarantees on how long it will keep its savings rate above base. "People like Northern Rock and Bristol & West have come in with some really high savings rates, like 6.5 per cent. But customers like our guarantees," he says.

egg's next launch will be an investment "supermarket" enabling customers to choose from the best savings products from all suppliers in the market. This will be coupled with lower prices than those available through Independent Financial Advisers (IFAs), he says.

So we come on to the $64,000 question: When will the Pru float egg? And will it reach the valuations of more than £3bn being bandied around the City?

As to whether egg will be floated, Mr Harris says: "To be honest that's speculation." He admits it may be floated "eventually. But we have made no decision at all." The aim is simply to break even by 2001. He will not comment on City advisers. It is known, however, that Goldman Sachs has been appointed by the Pru to look at ways of obtaining the best value from its creation, while the Pru's broker Warburg Dillon Read will have a role in whatever transpires. As for a £3bn-£4bn price tag? "Who knows?" he says. "Our target is two million customers over the next five years."

And this is where the Internet comes in. He says the "first-mover advantage is important in this business. If we can build a critical mass of customers [using this technology] then the company will be enormously valuable". Mr Harris says the initial vision of egg was a combination of telephone and Internet services, supplying a mix of products and information. "We never imagined it would grow so fast", he says. The idea is to build a base of customers on the Net as quickly as possible. "That's the battlefield today," he insists.

Some analysts have tried to build valuations of egg by arguing that each Barclays customer is worth £6,000 to the bank, or that each Freeserve customer is worth £2,500 to the Internet service. Critics counter that Barclays customers often stay with the bank for life, in contrast to egg's "fly-by-nights", and, therefore, there can be no comparison. And, they point out, Freeserve is hardly a happy example, with the company struggling to show it can create any kind of customer loyalty.

Mr Harris compares egg's strategy to that of Internet-based share dealing services in the US such as E*Trade and Schwab. "They are not dissimilar to us in the business sense, and they have the highest valuation per customer [of Net-based companies]", he says. Customers use these services to manage their affairs. It is therefore not a trivial decision to switch firms, he says. Customer loyalty can exist on the Web.

Yet another cry from the egg bashers is that the company balance sheet doesn't balance. It has attracted lots of savings without building a lending side to utilise these funds. "This doesn't bother us in the least. A matched balance sheet is irrelevant to us," he declares. egg uses securitisation to keep the balance sheet in place. "We worry about customer profitability. We don't manage spreads across a balance sheet - that's the old bank model."

Another problem with the Internet is that it is just as easy for other companies to enter the market. Standard Life has launched its own stand- alone Internet bank, and the Co-op is about to follow suit with "smile".

"This is a fairly direct competitive response", Mr Harris admits. "It will get harder and more expensive to acquire customers. That's why first- mover advantage is so important." Still, he says, these rivals do at least indicate that egg has got its business model right: "Imitation is the sincerest form of flattery."

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