How Consumer Lenders Can Make Competitors Irrelevant

November 16, 2015

Preface: What is the Blue Ocean Strategy?

The blue ocean vs. red ocean is an analogy used in the book The Blue Ocean Strategy by Renee Mauborgne and W. Chad Kim. The red ocean is a saturated, competitive market where profit margins are decreasing, and businesses are forced to compete with lower prices and higher efficiency. This environment can accurately be described as a “race to the bottom.” The predictable results are a hyper-competitive landscape where margins gradually become smaller, and growth slows to a crawl. At the opposite end of the spectrum, there is an environment known as the “Blue Ocean.” In a blue ocean, there is little or no competition, margins are high, and companies have a much higher chance of growing and succeeding.

Compete by Not Competing: Redefine Your Customer Instead (Pivot).

The reason I bring up the Blue Ocean Strategy is that I believe the consumer lending industry can learn from it. All the companies featured in Mauborgne’s book shifted their focus and business model to make their blue ocean industry. This business model shift that redefines your market is also used by start-ups in Silicon Valley. This idea of pivoting, highlighted in the book The Lean Startup by Eric Ries. involves a change in the way you do business. This change in your business model changes the way you approach your market in a way that sets you part and allows you to fit your redefined-customers’ needs perfectly. For example, Yellow Tail, a relatively new wine company, competes in the mature and competitive (red ocean) wine industry by purposely making wine that is below the industry standard. Yellow Tail went after non-wine drinkers, so they don’t have to compete for wine drinkers with high standards and established habits. They can go for people who have no expectations. The result is that they quickly dominated the market they made. You can read more about what they did in this blog post.

In short, to create a blue ocean, the business must be significantly different from its competition instead of incrementally better. It must be different enough that its target customers change, its competitors change, and its business model and operational structure change.

Let us recap what we know about the consumer lending industry.

Before I go into my theory of the blue ocean for consumer lending, let me provide my assumptions:

Money is the ultimate commodity. – It is hard, if not impossible, to differentiate a competitive loan product from another because similar loan products are interchangeable in the borrower’s eyes. As such, it is extremely hard to compete by offering better rates.
Regulatory changes. Specifically, let us address the CFPB and the Dodd-Frank Act. I would argue that those regulations are a result of very aggressive lending practices. In some cases, lenders were eating their lunch into oblivion. They were churning through borrowers without regard to the long-term consequences The fed is also getting closer to regulating the peer lending based marketplaces, again, abuse by some lenders can have a detrimental effect on the entire industry.
Incremental improvements and the ‘me too’ strategy. – Examples of incremental improvements include: giving borrowers access to their account information, a response in minutes to a loan application, payment options that are tailored to the borrower’s preference, and even mobile apps. An example of the ‘me too’ strategy can be illustrated when one credit card company started offering their borrowers free access to their credit score, the others followed suit. It is the same thing with banks allowing check deposits via mobile applications. These improvements are great, except, they do not put a lender in a blue ocean – not by themselves anyway.
Loan products based on investor’s appetite for risk. – It is too often that we see consumer loan products based on investors and funding sources’ needs. This is great, if as an industry, it is difficult to secure funding capital, and you need to make the needs of funding sources a priority. However, I would argue that this is not the case for our current economy. U.S.-based lenders have very acceptable sources of capital.

Back to the original question: What would the blue ocean of consumer lending look like?

One idea that would enable a lender to move into a ‘blue ocean’ is to develop customer loyalty. If a consumer lender developed significant customer loyalty, tied in with competitive rates, and aligned its value proposition to the actual needs of the customer, they could get into a blue ocean. We can use examples of pursing customer loyalty as a competitive advantage in other industries as a proxy to test this theory. I might tackle that in a future blog post. For argument’s sake, let us say that customer loyalty is a good enough to put lenders in a blue ocean. Here is what I envision:

Customer loyalty is high. Your financial products practically sell themselves. At core, these consumer lenders would want customer satisfaction to be extremely high, customer attrition close to zero, and cross-product marketing would be easier because your customers love you and will choose any of your loan products over any competitor.
You create loan products customized to your customers’ needs. Most lenders stick to a customer segment, be it prime, near-prime or sub-prime. These lenders develop processes and tools that optimize for these segments, including originations, marketing, and collections. But what if you didn’t have to limit to a particular segment? What if you could create loan products that are for a sub-prime borrower but continue to to offer them loan products when they move into prime? You could develop a long-term relationship with said borrower, and you would have significantly more data about them than other lenders. You could use that data to lower defaults and tailor loan products accordingly. Customer acquisition costs would go down, and moving between multiple loan products would be seamless. The borrower would certainly get a loan from a lender that he already has a relationship with than one he does not.
Your processes are personalized to solve your borrowers’ pains. All those incremental improvements I discussed earlier help make your borrowers’ lives just a bit easier. They remove barriers. For example, it would be ideal to have an online application that collects just the right amount of information and is available on any device, as well as an auto-decisioning engine that gives the borrower an application response within minutes. Note that the purpose of these improvements are to remove barriers placed on the borrowers rather than following suit.
Cannibalize short-term gains for long-term competitive advantage and profit. When considering generating revenue from additional fees by nickel and diming borrowers, the gain would be heavily weighed against the long-term goal of building customer loyalty. The same can be said of hiring process and hiring wages, long-term plan vs short term execution.

Consumer lenders differ greatly in the type of borrowers they go after, the type of customer acquisition and origination that they do, etc. The only companies that seem to be getting closer to a comprehensive approach to lending are peer-to-peer (P2P) lenders and similar platforms. P2P lenders are starting to expand and iterate dramatically. Some are expanding to medical, student, and even auto loans. It is only a matter of time until P2P gets enough scale that consolidation begins. At that point, all the smaller lenders may be close to obsolete, drowning in their red ocean.

The Blue Ocean Strategy is a must read for any business person. Buy the book at Amazon.com.

How Consumer Lenders Can Make Competitors Irrelevant

Preface: What is the Blue Ocean Strategy?

Compete by Not Competing: Redefine Your Customer Instead (Pivot).

Let us recap what we know about the consumer lending industry.

Back to the original question: What would the blue ocean of consumer lending look like?

Recommended reading and helpful resouces.