The Performance of Internet-based Business Models: Evidence from the Banking Industry

Abstract

This study introduces a general intuitive framework for analyzing start-up firms with Internet-based business plans, and estimates the framework for Internet-only banks and thrifts in the U.S. Internet-only banks historically have underperformed branching banks, leading some to conclude that this business model is not viable. But automated production technologies like the Internet are likely to exhibit substantial scale economies - so although Internet-only banks tend to grow fast, most are still relatively small operations, and thus may be operating below efficient scale. The empirical analysis demonstrates that profitability gaps do shrink as Internet-only banks get larger, and that (regardless of scale) the more successful Internet-only banks are the ones that practice basic cost control. The results offer a number of insights for e-commerce firms in general, and more specifically suggest that Internet-only banking models may be viable when executed efficiently.