Blockbuster has been on death watch for a while now, while their nemesis Netflix has been making huge inroads. There is clearly no doubt that digital distribution of content is here to stay, but the question is - could Blockbuster have done anything different? I think that Blockbuster came close to getting the formula right, but then threw it away.
The moment Netflix entered the market in the late 90s, it was clear that they had structurally lower costs compared to Blockbuster's video store model. Blockbuster struggled for a few years to respond to this threat, while the upstart took market share from the incumbent. They launched their online rental offering in 2004, but could not match the online selection that Netflix provided, and the service lagged Netflix by a wide margin.
However, around 2006, Blockbuster came up with a very smart idea of in-store exchanges. This married the ease of use for ordering movies regularly online with the convenience of "picking up a movie for the weekend" from the store. I signed up with Blockbuster because of this feature, and loved it. So did 3 million others!
Then, in 2007, they decided to throw it all away. Between 2007 and 2009, they did a number of flip-flops on their in-store exchange policy - they removed it, they added it with extra fees, they added weird limits - every time you went into the store, there were new rules. The whole idea of a convenient in-store exchange was replaced by the pain of showing up in the store and being surprised by a new fee.
So, what does this have to do with financial services? Banking is a digital good, and increasingly banking services are distributed online (including mobile devices). But, if you have a branch network, you can take advantage of this if you can offer services that take advantage of the unique strengths of both the web and the branch. There are not a lot of banks and credit unions that do this well - the experience between online and the branch is still disjointed, and that presents an opportunity to a resourceful player.
Jan 19, 2010
The problem with Lending
Felix Salmon quotes Mark Gimein's story about Prosper.com's default rates. For people familiar with peer-to-peer lending, this is old news. I have more than a passing interest in this - I was at Zopa, which runs a peer-to-peer lending operation in the UK and ran a different business model in the US, through 2007-08.
Mark makes this insightful comment about Prosper:
Lending is in a select club of business activities (along with insurance) where you have to turn away a large fraction of customers that you have spent money selling to. If you make too few loans, you will not get an adequate return on your marketing dollars. If you lend too much, you will lose your shirt with defaults. Lenders make 2-4% of the loan principal. But, when a loan defaults, they lose 100% of the principal. So, one bad loan wipes out the returns from 25 to 50 good loans.
Effective underwriting is so difficult because you have to walk this tight-rope. Moreover, you have to make individual decisions that estimates the credit-worthiness of the borrower over the course of the loan, a time measured in years (or decades in the case of mortgages).
This is also the reason why the allure of automated underwriting is so powerful. Underwriting that relies completely on scorecards or models provide an illusion of predictability that is misplaced. Most lending models rely on information present on credit reports to make a lending decision.
No doubt, credit reports serve a useful purpose in credit underwriting, but they have severe limitations. First, they are backward looking, and the abiding mantra in everything financial is that past performance is not an indicator of future performance. Second, there is usually a lag of a few weeks to a few months before adverse information makes its way to credit reports, a fact that is exploited by borrowers intent on not repaying their loans. Third, credit reports present only the liability side of the financial picture of an individual and has no information about income - models that have automated decisions rely on income that is stated by the borrower.
Good credit underwriting requires synthesizing information from a lot of sources - credit history, current income and future income potential, potential for fraud - that requires a degree of skill that humans currently do much better at than computers. Technology has not yet advanced to a point where this kind of fuzzy decision making can be fully automated.
So, does this mean automation and models are useless in making loan decisions, and we have to go back to the dark ages where everyone shuffles paper? Definitely not.
Manual underwriting is expensive and you have to turn away a lot of borrowers. Using models and automation to turn away unqualified borrowers earlier in the process is an efficient use of your skilled underwriters. It is also a non-confrontational way for borrowers to be turned down for a loan (better for a borrower's self-esteem than being told by a person that they do not qualify for a loan). Models are also very useful in setting loan interest rates, so you have consistency in pricing.
The goal of automated credit models must not be to eliminate skilled underwriters but to allow them to spend more time evaluating the loans that will get made.
Disclosure & Shameless plug: oFlows provides tools that makes the lives of underwriters easier.
Mark makes this insightful comment about Prosper:
To look at the results of Prosper's loan marketplace, though, is to see not a solution to the credit crisis, but a microcosm of it.He follows it up in an email exchange with Felix:
Because ultimately a paradox of lending is that the people who are more likely to repay are those who *don’t need the money*. And Prosper attracts those who do need it.I agree with all of this, but I would like to make a broader point about lending in general.
Lending is in a select club of business activities (along with insurance) where you have to turn away a large fraction of customers that you have spent money selling to. If you make too few loans, you will not get an adequate return on your marketing dollars. If you lend too much, you will lose your shirt with defaults. Lenders make 2-4% of the loan principal. But, when a loan defaults, they lose 100% of the principal. So, one bad loan wipes out the returns from 25 to 50 good loans.
Effective underwriting is so difficult because you have to walk this tight-rope. Moreover, you have to make individual decisions that estimates the credit-worthiness of the borrower over the course of the loan, a time measured in years (or decades in the case of mortgages).
This is also the reason why the allure of automated underwriting is so powerful. Underwriting that relies completely on scorecards or models provide an illusion of predictability that is misplaced. Most lending models rely on information present on credit reports to make a lending decision.
No doubt, credit reports serve a useful purpose in credit underwriting, but they have severe limitations. First, they are backward looking, and the abiding mantra in everything financial is that past performance is not an indicator of future performance. Second, there is usually a lag of a few weeks to a few months before adverse information makes its way to credit reports, a fact that is exploited by borrowers intent on not repaying their loans. Third, credit reports present only the liability side of the financial picture of an individual and has no information about income - models that have automated decisions rely on income that is stated by the borrower.
Good credit underwriting requires synthesizing information from a lot of sources - credit history, current income and future income potential, potential for fraud - that requires a degree of skill that humans currently do much better at than computers. Technology has not yet advanced to a point where this kind of fuzzy decision making can be fully automated.
So, does this mean automation and models are useless in making loan decisions, and we have to go back to the dark ages where everyone shuffles paper? Definitely not.
Manual underwriting is expensive and you have to turn away a lot of borrowers. Using models and automation to turn away unqualified borrowers earlier in the process is an efficient use of your skilled underwriters. It is also a non-confrontational way for borrowers to be turned down for a loan (better for a borrower's self-esteem than being told by a person that they do not qualify for a loan). Models are also very useful in setting loan interest rates, so you have consistency in pricing.
The goal of automated credit models must not be to eliminate skilled underwriters but to allow them to spend more time evaluating the loans that will get made.
Disclosure & Shameless plug: oFlows provides tools that makes the lives of underwriters easier.
Oct 22, 2009
I like your product. Now what?
So, your credit union or community bank has weathered the storm of the past year. Your loans have performed well, you are well capitalized, and you have a good reputation in your community. You are feeling pretty good about your institution and you want to expand.
Your products are clearly better than those of the big banks - loans are cheaper, deposits have better interest rate, and you don't nickel and dime your customers with hidden fees on every turn. So, you get your head of marketing to put together a great marketing campaign to get the word out. She puts together this killer online and email ad campaign, that gets people to your website at a real attractive cost. Clearly people like your offering - and who wouldn't like an loan that has a 2% lower interest rate!
I see this email, come to your website, click on "Apply for a loan" link, and fill out my personal information. 9 times out of 10, I receive a message that says someone will be in touch with me soon.
Meanwhile, someone at the institution took the online application I filled out, printed it, put it in a manila folder, and called it my loan file.
A day or three later, someone calls me and leaves me a voicemail, telling me that I need to mail or fax a copy of my pay check and my driver's license. I, of course, promptly forget - you see, applying for a loan or a bank account is not fun for me. It is a necessity and I would like to spend as little time as possible doing it.
A few days go by, and I fax in the documents. Now, I am not sure if the fax has gotten to the right place. So, I call the customer service number and the nice lady tracks down my fax and tells me that they have what they need and they will give me a decision in a couple of days.
The documents go into my loan file as well.
If I am lucky, a couple of days later, the loan officer calls me and tells me that I am approved for the loan and that I will receive the paperwork that I need to sign by mail. I receive my documents by mail, sign it and send it back. And then I receive a check in the mail.
Of course, if I took a few hours off work and went into the branch, things may go a little faster - that is if I have remembered to take my last three paychecks to the branch.
All that great marketing seems to the user to only be an invitation to an obstacle course.
Well, a few years ago, we did not really have a choice but to do it this way. But today, people expect that they can complete their transactions online - not just start the transaction online and make a couple of trips to the branch - and we must deliver on their expectations.
Your products are clearly better than those of the big banks - loans are cheaper, deposits have better interest rate, and you don't nickel and dime your customers with hidden fees on every turn. So, you get your head of marketing to put together a great marketing campaign to get the word out. She puts together this killer online and email ad campaign, that gets people to your website at a real attractive cost. Clearly people like your offering - and who wouldn't like an loan that has a 2% lower interest rate!
I see this email, come to your website, click on "Apply for a loan" link, and fill out my personal information. 9 times out of 10, I receive a message that says someone will be in touch with me soon.
Meanwhile, someone at the institution took the online application I filled out, printed it, put it in a manila folder, and called it my loan file.
A day or three later, someone calls me and leaves me a voicemail, telling me that I need to mail or fax a copy of my pay check and my driver's license. I, of course, promptly forget - you see, applying for a loan or a bank account is not fun for me. It is a necessity and I would like to spend as little time as possible doing it.
A few days go by, and I fax in the documents. Now, I am not sure if the fax has gotten to the right place. So, I call the customer service number and the nice lady tracks down my fax and tells me that they have what they need and they will give me a decision in a couple of days.
The documents go into my loan file as well.
If I am lucky, a couple of days later, the loan officer calls me and tells me that I am approved for the loan and that I will receive the paperwork that I need to sign by mail. I receive my documents by mail, sign it and send it back. And then I receive a check in the mail.
Of course, if I took a few hours off work and went into the branch, things may go a little faster - that is if I have remembered to take my last three paychecks to the branch.
All that great marketing seems to the user to only be an invitation to an obstacle course.
Well, a few years ago, we did not really have a choice but to do it this way. But today, people expect that they can complete their transactions online - not just start the transaction online and make a couple of trips to the branch - and we must deliver on their expectations.
Oct 20, 2009
oFlows - A new beginning
Financial services have been in the news a lot recently, mostly for the wrong reasons. Lay people got a rude lesson in the exotica of financial services - CDS, CDO, MBS, LIBOR, TED Spread and other ingredients of a decidedly unpalatable alphabet soup, that were at the center of a multi-trillion dollar near-collapse of the world economy. The personal consequences of the financial crisis and the ensuing recession have affected many, and I am no exception. My previous company shuttered its US operations. Instead of trying to find work in a hostile job market, I decided to take the plunge into entrepreneurship.
Though most of us cannot relate well to exotic Wall Street products, we are all consumers of financial services. We open bank accounts, apply for loans and credit cards, transfer money, pay our bills etc. Financial institutions have historically been extensive consumers of information technology, and they have used technology to automate operations and drive down cost. Since the advent of web, banks and other financial institutions have steadily brought a number of consumer facing functions online. We can check our balances, transfer money and manager our finances quite efficiently online. Generally, these activities can be started and finished in a single session with immediate online feedback and timely email reminders.
But, applying for a loan or opening an account is still a very inefficient process. oFlows takes aim at the origination process and makes it completely paperless.
In the next few posts, I will address these inefficiencies in the originations process in more detail, and how paper stops here with oFlows.
For a few months now I have been involved with oFlows, a company I co-founded, and where I am responsible for building some really cool technology.
But, applying for a loan or opening an account is still a very inefficient process. oFlows takes aim at the origination process and makes it completely paperless.
In the next few posts, I will address these inefficiencies in the originations process in more detail, and how paper stops here with oFlows.
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