According to Pulitzer Prize winner and The New York Times columnist Thomas Friedman, the technology you use every day -- from computers to cell phones to Internet browsers -- has changed not only how you work, but also how businesses compete. It has certainly removed barriers to trade -- making it easier to sell digital cameras in India -- but it has also broken down the geographic and cultural barriers that previously kept countries like China and India from competing on the same level with western business. -The World Is Flat: A Brief History of the Twenty-first Century.
Last week Ken Verrett introduced the concept of brand and generic products in the market place. This week, Ken discusses how the lending industry has taken advantage of market opportunities to modify their businesses to better compete in today's Flat World.
Brand products are created as a result of a marketing campaign to distinguish the brand from their competitors. The perception must be created in the consumer's mind that there is a difference between Cambell's soup and the others on the shelf. Once that perception is achieved in the market, the higher price is justified by that perceived difference.
Generic products make no attempt to create such a perception. It is what it is. We can't conclude that generic is a poor or unacceptable product...there are certain standards that must be met for the product to be offered and accepted in the market place. But generic products didn't have the investment in marketing necessary to differentiate that product from the others on the shelf, so no price premium can be earned.
Part of the marketing campaign for the brand product is to suggest that there is such a difference by inference if nothing else. It's a perfectly legitimate marketing tactic as long as it is done by continuing to reinforce the positive attributes of the brand. It is not legitimate to accomplish the differentiation by attacking the generic product. That brings law suits.
We also discussed the evolution in the finance industry over the last few decades, how the changes shaped by technology created opportunities to change the fundamental way those institutions conducted business. The lending industry has taken advantage of those opportunities to modify their businesses to better compete in today's Flat World. Local and regional financial institutions sold out to money center conglomerates on the left and right coasts. Loans were modified to be grouped as inventory in packages (CMO's) to be sold in the secondary market.
The lending industry became more like the local retailer, with profits made from inventory turns, not as much from net interest margins as previously. The loans, now inventory items, had become commoditized; a generic product had been created. That is a truly fundamental change in the lending industry.
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Those changes resulted in a different competitive environment for individual institutions. No longer were relationships as important. A lender could not depend on past ties between the loan officer and the customer as a guarantee for the next lending opportunity. They couldn't simply sit back and wait for the customer to come to them. They had to aggressively, actively seek loan opportunities.
Since prior personal relationships didn't exist, the lender was competing on equal terms with other lenders. Remember the TV commercial with the couple seeking a home improvement loan? An interview being held with a lender at the borrowers dining room table. The borrower reviews the terms, asks for a better interest rate. The lender shoves the papers back across the table and imperiously says..."that's the deal"...The borrower thanks the lender for coming, but turns the loan down and calls out "Next" to the group of lenders waiting in the next room....That's actually the competitive environment lenders are in these days!
First and second mortgage lending on single family residential property has always been the largest single segment of the lending industry. It was so before the revolution. It is even more so today. The population grows. Families grow. Families move. And now, with so many competitive mortgage products available, families replace their current mortgage with a more competitive one. Before the Information Revolution, the average life of a 30 year fixed rate mortgage was roughly seven years. After the revolution is it less. Inventory is turning faster.
That competitive environment has resulted in different demands by the lenders to their service providers, one of which is the appraisal profession. They need appraisals quick, accurate, and at a low price. Sound familiar? Aren't those the demands you are seeing from your lender clients over the last ten years? Faster, accurate, and at a low price? Since the lender is competing with all the other lenders in waiting in the 'next room' they must improve their response times to close the deal. Any delays, lack of competitive pricing (both rate and closing costs) and the loan will likely be done by someone else. The lender is trying to compete in a new, Flat World. They demand their service providers support them in this new environment or like their customers, they'll go somewhere else.
In response to a series of events spanning three decades, the lending industry has rebuilt, restructured itself. Local financial institutions have been merged into east and west coast conglomerates. The Information Revolution has allowed the conglomerates to centralize management and control of the branch network that were formerly locally owned institutions. A major shift in the balance sheets of the lending industry was accomplished, with emphasis on local loans held long term assets as the primary earning asset being less important and a current asset, loans held and accumulated for eventual resale rising in importance. The income statement of the lending industry changed also, with net interest income declining in relative size and importance, and offset by the rise in fee income associated with the closing of loans and the profits made from the sale of CMOs to the secondary market.
The lending industry had changed from being a locally owned pillar of the community with emphasis in long term personal relationships into more of a local branch of a any other business providing a competitive service to the community....more like the local liquor store or other retailer than like the pillar of the community they were previously.
Fundamental changes such as those we've described usually demands major changes in the business itself, and in the vendors who support that business. The Appraisal Profession is a major vendor serving the lending industry. Shouldn't we expect major change in the Appraisal Profession as a result?
However, before we discuss those changes, it is useful, even important, to remember that the Appraisal Discipline is a relatively new kid on the block. Oh sure, it has it's roots in Adam Smith's Wealth of Nations, first published in 1776. One of my favorite books. The concepts defined by Smith were refined over the next century, culminating in Alfred Marshall's Principle of Economics in 1890. It was Marshall who established the basic theory of valuation and developed the three approaches to value which are still our foundation today. The 1920's and 1930's saw further refinement by K. Lee Hyder, Harry Atkinson, and George Schmutz to applying the economic concepts of value to the more practical problem of valuing assets, including real estate. Schmutz's work was the basis of appraisal techniques published in the first edition of The Appraisal of Real Estate in 1951.
Why spend time discussing history? Simply to make the point that Appraisal Theory, Appraisal Practice, the Appraisal Profession, the Business of Appraisal is less than 100 years old...a mere infant...and is naturally in a state of evolution and constant change. Some folks today, and for the last few decades have resisted changes to the profession. As if the profession has been around for centuries, as if every idea related to the theory and practice of appraisal has already been invented, and as if our job is to defend the discipline as it exists from any future evolution.
It just ain't so. The Appraisal Profession is a mere infant. Constant evolution is absolutely essential for it to continue to grow and improve, and even to maintain it toehold on being relevant. The world is changing. We must change with it and in fact we have!
Next week we'll try to discuss those changes and the dichotomy in the Appraisal Profession that has resulted.
The author is the owner of Acorn Appraisal Associates, a 20 year old firm offering a wide range of quality appraisal services to the Financial and Business Communities in the greater Houston SMSA
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