This issue keeps presenting itself time and again to me, most recently in a series of exchanges on this very blog this week in the comments area. I've discussed it many times in different venues. Maybe it's time to address it here.
In my view, the market for Appraisal Services is best viewed as generally split into two basic types, and results in two very different basic business models required to serve each of those markets. We in the appraisal profession often fail to understand that distinction. I'll try to explain the basic types of demand and how that demand results in different business models built to serve the differing needs of the Clients.
No, I'm not referring to commercial versus residential. I'm referring to brand products versus generic products. The product differentiation is a better, clearer way of looking at the profession and the markets we serve than any other perspective provides. The market for appraisal services clearly understands it better than we do!
I'm going to try to discuss these two variations of the profession, what differences those markets represent, and what affect they have on our businesses. Click below to read on . . .
Brand versus Generic Products
Brand products have two components of value to the consumer; the utility of the product itself, and the trust or quality implied which comes with the company who offers the product. The two are inseparable and combine to set the price the consumer is willing to pay for the product. Examples include Campbell's Soup, Bayer Aspirin, Crest Toothpaste, Gerber's Baby Food, Gucci Handbags, Calloway golf clubs.
Generic products have only one component of value to the consumer; the utility of the product itself. The quality issue is a given. There are many generic soups, toothpastes, baby food, handbags on the market. The product may have a "company name" but that name is of no importance to the consumer. The only interest the consumer has in a generic product is the utility of the product itself.
I'm a generic shopper of most products. My wife is a brand shopper. My reasoning is that for food products the FDA sets certain minimum standards of quality and content, and if I can't notice the difference I'm going for the lower price. Utility is my concern, quality is a given. My wife generally ignores the price and instead trusts the Brand Name to do right by the family for whom she is shopping. She is concerned about utility and quality. We are both rational consumers even though our needs are different. My generic products serve my needs. My wife's brand products serve our families needs and give her the additional assurance that she is providing quality to her family.
- Brand consumers seek quality implied by the brand name as well as the utility of the product. Price is a distant second concern.
- Generic consumers are price sensitive and convenience sensitive. Quality is a given.
Which type of consumer are you? You can actually be a little of both, choosing brand when you think it makes a difference, choosing generic when it doesn't. But you likely can classify yourself as one or the other. So which are you?
Brand versus Generic in the Lending Industry
Before the Information Revolution, before the personal computer, before the Internet, the lending industry was brand oriented. Local lenders, local decision makers, personal loan officers, loans booked in the institution for the life of the loan. We often saw our loan officer at the coffee shop, at the PTA meeting, at the little league fields on the weekend. The lender was woven into the fabric of the community. Lending institutions advertised their local ties to the community, their soundness, their service. It was not uncommon to see individual employees featured as part of a given marketing campaign. It was a far, far different world than exists today! When was the last time you saw your loan officer? Have you ever seen him or her face to face?
A revolution occurred in the decades of the 1980's and early 1990's. Local and even regional lending institutions disappeared, merged into money centers conglomerates located mostly on the left and right coasts, but also in a few other pockets around the country. There are still exceptions, but you get the sense that those are just waiting for the right price to sell out. It's inevitable; that's the feeling we have...right?
In Texas today we have one financial institution that is Texas owned who seems determined to stay that way. They ran a year long ad campaign last year with the theme "We're from here!" What a great theme, a great way to try to brand a Texas institution! Part of the reason the campaign was so effective is that it was so uniquely true. They, in essence, the only ones "from here". I'm betting your community is very similar to mine. The Revolution is for the most part complete.
While that revolution was going on, and actually a little before it, another equally important process was developing. Individual loans were being separated from the payment handling process, and managed by different groups, even by different entities! Mortgage servicing as an industry had been created. Firms that specialized in handling the receiving of loan payments, accumulating the various tax and insurance payments, and accounting for each principal and interest payment.
That was one lucrative business! Pretty simple really. All one needed was a very big computer and a staff to handle the paper. Did I mention the accumulating of the tax and insurance escrow? A financial institution had to account for those escrow payments separately...in effect, put them in a trust account. A mortgage servicing company was not a financial institution. All it had to do was have the cash on hand when the tax and insurance bill came due. During the course of a year those escrow deposits grew into a huge cash asset and could be used for investment or whatever, as long as the cash was there when the bills came due.
Where financial institutions were customer oriented, mortgage servicing companies didn't have to be, and weren't. They had a captive customer. The loan was going to stay there until it was paid off at maturity or the underlying asset sold. A customer didn't like the harsh late payment letters and high fees? Tough. To the servicing company the customer was just a loan number.
The servicing of mortgage loans became commoditized, the servicing became a generic product. Mortgage servicing portfolios began selling to different folks. The actual servicing might stay at the same computer, but the rights to the portfolio could be separated and sold off. More commodization.
If the servicing of a loan could be commoditized and separated from the loan itself, why couldn't the loan morph into something else? The 1980's saw that idea take shape, become accepted and a new financial instrument was born. Collaterized Mortgage Obligations; CMOs. Mortgages secured by real estate, at first single family residential mortgages, later any type, and sharing certain common characteristics...loan type, interest rate, maturity date, were packaged together and sold to investors. Later as the new market matured, innumerable variations of CMOs were created...specific geography of loans, specific maturities, specific pricing of the mortgage, etc.
The development of the CMO and the market acceptance of those instruments had profound effects on lending institutions. Before the lender could make loans to the extent of their deposit base would let them, the loans being held as an earning asset on their balance sheet until the loan was paid off. The lender made their income on the net interest margin, the spread between the interest rate earned on the loans they made, and the interest they paid to their depositors for the used of those funds. Now, they could package those loans in a CMO, sell them to the secondary market that had been created, and use the cash to make more loans.
The lender became a retailer. Like the local liquor store. A liquor store, like any retailer makes money on the turn of it's inventory. The more often inventory is turned, the more income the store makes. The cycle works like this. Use cash to buy liquor inventory. Sell the liquor to the customer. Use a portion of the cash received to buy replacement inventory. The cash left over represents the store's profit. The more times the store can "turn their inventory" the more profit they make.
The lender didn't sell liquor. They sold loans. But it's the same cycle, but sorta in reverse. Use customer deposits to make mortgage loans. Accumulate those loans into groups (CMOs) and sell those loans. Use the cash received from the sale to make more loans. Loans became the inventory to turn. The profit was made from the origination fees when the loan was granted. The more loans the lender made, the more origination fees were earned, the more profit the lender made. Lenders became retailers, just like the liquor store.
So we had two revolutions going on at the same time. Local lending institutions disappeared, replaced by branches of money center conglomerates. Loans, heretofore a very personal one on one experience, now became a commodity, capable of being bought and sold in different pieces to different folks.
The lending industry had created a generic product! Where before they sold personal relationships and local community involvement, now they sold loans that are never intended to remain on their books, but instead will be packaged and sold so they can make more loans. Their profit came from inventory turns, not customer relationships.
For that generic product to be successful, the various lending industry suppliers had to adapt to the new environment, the new lending business. Next week we'll talk about what those adaptations were, and the effect that had on the appraisal profession, creating the Dichotomy that exists today.
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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