The Wal-Mart model: mortgage lenders could learn a lot from the king of retail efficiency--Wal-Mart.
In the lending industry, scale allows for more sales channels (loan officers, call center, wholesale, correspondent, joint ventures and so on) and a greater variety of product offerings (prime, alternative-A, subprime, home-equity lines of credit, construction, etc.). Large lenders are able to distribute fixed investment costs over larger transaction volumes, and, in theory, scale should also drive operational cost advantages. Yet most struggle to realize their potential economies of scale because of the inherent limitations of legacy processes and technological infrastructures (or lack thereof).
Whether it is brittle legacy infrastructure due to prior merger-and-aqusition (M & A) activity, outdated point-of-sale (POS) and loan origination systems (LOSes), or lingering channel and organizational conflict, many lenders are actually burdened by their size.
The irony is that developing a unified POS system for a full range of products and channels isn't any more expensive for a megalender than it is for a midsized lender, although potential return on investment could be greater by orders of magnitude.
Far from being burdened by its size, Wal-Mart has put systems and processes in place that have enabled it to take its scale advantages to the next level to achieve unprecedented success. This is the second factor--the one to which lenders should pay attention.
Mortgage lending as a manufacturing process
For the lender, the supply chain reaches from lead generation and the point of sale to fulfillment and the sale of loans in the secondary market. If the activities that take place at the POS don't integrate with fulfillment, workflow efficiency is lost (and service suffers). If workflow does not involve suppliers systemically, an opportunity to improve efficiency is wasted.
Wal-Mart excels at business process efficiency. It is specifically acknowledged for innovation in the supply-chain arena, which shares many process concepts with manufacturing.
A study by New York-based McKinsey & Company determined that Wal-Mart was singularly responsible for about 12 percent of all productivity gains during the last half of the 1990s. This is an utterly astounding statistic, given the massive size of the U.S. economy. Wal-Mart has achieved these gains using what is analogous to activity-based cost modeling. Bankers often do not have sufficient information about a particular product or process to manage its cost. Wal-Mart does--to the fraction of a penny.
Should a lender centralize processing for Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) loans, or train every processing group to handle all product lines? Is it worth the investment to automate a function that happens manually on 1 percent of the bank's mortgage lending transactions? Are products that have unique processes driven by state-level regulation profitable at the given volumes?
Ask most lenders how much it costs to fulfill a loan, and they take their total known costs and divide them by the number of loans. When Wal-Mart gets into lending, it will know how much it costs to do initial underwriting of cash-out refis in Orange County, California, and, more important, it will know that it will cost 3.5 percent less next year.
In a lesson learned from U.S. efficiency expert W. Edwards Deming and applied with devastating effectiveness by leading Japanese manufacturers, Wal-Mart focuses on continuous incremental improvement, driving out costs a few pennies at a time over an extended period. In lending, this may be as simple as replacing a fax with a document delivered electronically. In and of itself, the savings in time and money is barely perceptible; but multiply it by millions of transactions, and pretty soon you're talking about real money. The Japanese didn't design in efficiency with one big systems release; they designed a continually improving process and focused on executing the process over time. Measure, adjust, repeat.
An adjunct to this is profitability-driven behavior. Is the new product you want to introduce going to drive profits in line with your business plan? How can you know, if you don't have a good picture of what it will cost to originate? Banks may launch a new loan program without a good idea of what it will cost. Wal-Mart would never roll out a new product without understanding how it will impact costs throughout the organization.
The supplier-retailer relationship
Wal-Mart is notorious for leaning on its suppliers to drive down prices, but this process is not just about saving money. Simply shifting execution costs to a supplier will not drive the long-term improvements in banking that the big retailer gets. One of the most forward-thinking behaviors at Wal-Mart is its willingness to invest proprietary knowledge and processes into its supplier base to improve quality and drive costs out of the business.
A well-documented example is the relationship between The Procter & Gamble Co. (P & G), Cincinnati, and Wal-Mart (as outlined in the report, Supply-Chain Integration Through Information Sharing: Channel Partnership Between Wal-Mart and P & G, by The Procter & Gamble Distributing Co. and the University of Illinois at Urbana-Champaign). It warrants a closer look.
P & G and Wal-Mart didn't start out working well together. In fact, Wal-Mart considered P & G one of its worst suppliers. The relationship was both adversarial and tactically oriented.
P & G's organization and processes were far too complicated for Wal-Mart's efficiency-oriented culture. P & G operations focused on delivering day-to-day results--strategic planning was not part of its account plan. In addition, P & G didn't leverage systems that could support a relationship as large and broad as was warranted by a distribution giant like Wal-Mart.
The keys to transforming their relationship and unlocking value on both sides were first to recognize the opportunity, and second, to begin the process of enabling interoperation between the companies' systems. Research in inter-operational information systems has identified three distinct levels: transactional, operational and strategic. Over time, the P & G/Wal-Mart relationship evolved through all three phases and has yielded tremendous value to both companies.
Their mutual business has grown more than tenfold since 1988, with increasing profitability for both. The companies even went so far as to develop a joint mission statement: "The mission of the Wal-Mart/P & G business team is to achieve the long-term business objectives of both companies by building a total system partnership that leads our respective companies and industries to better serve our mutual customer--the consumer."
Some key successes resulting from their joint operations were:
* Improved billing efficiency, going from 15 percent to 95 percent accuracy. Inaccurate invoices had been costing the companies $50 per invoice.
* Integration of POS information (actual demand) from Wal-Mart systems with P & G's consumer data on why products were selling, trends and analysis. These combined data were unique in the market, and provided insights that allowed both improved retailing and product-development decisions.
* P & G reduced product-ordering times by three to four days using cross-company systems integration--the so-called continuous replenishment process (CRP).
What is most interesting about this example is that both companies made investments in joint activities to increase profits. This kind of success is impossible in an adversarial vendor/buyer relationship in which suppliers are treated as disposable commodities.
The impact that technology had on their success was critical, but was secondary to that of aligning strategic vision and operating procedures, and of building trust. As a result, the technologies that were put in place were able to have a far greater impact on efficiency than they would have if the relationship had been less complementary.
The lessons here? Make volume commitments that warrant investment by both parties. Create transparency on both sides. Because no company can invest in an unlimited set of relationships, narrow the supplier base.
In lending, now that service-oriented architectures (SOAs) and MISMO[R] are becoming more widely adopted, the barriers to entry and exit for partner relationships are greatly lowered. The risk of obtaining all of your services from one provider goes down dramatically because the provider knows it must maintain its service levels or risk being replaced, quickly and cheaply.
Finally, negotiate aggressively with your mortgage lending process partners, but be willing to take responsibility for the economic success of the vendors you ultimately select.
Ability to adapt
A business' willingness to be flexible and adapt quickly to shifts in business conditions (a drop-off in originations, or the sudden popularity of a new product such as fixed-rate, interest-only loans) is ineffectual unless its infrastructure can allow change to be implemented quickly and with minimal cost. Wal-Mart invests in process technology with this in mind, and lenders should, too.
Wal-Mart makes technology investments that are informed by a holistic strategy emphasizing the integration of business processes across all facets of execution. Absent the ability to execute, notions like cost-based modeling and continuous improvement are just so much business-school jargon. Implementation requires investing in a platform and point technologies that can continuously adapt. Wal-Mart has done this in retailing, and now stands poised to bring that same approach to banking.
As a distributor, Wal-Mart must be effective at managing demand. Planning and responding to demand are a religion at Wal-Mart. During busy shopping seasons, Wal-Mart sales and operational executives meet daily to review performance data from the previous day. They actually collect, aggregate and analyze sales data from across their massive network of stores in less than 12 hours.
The outcomes of these meetings are immediate adjustments in pricing and product strategy. Their unified point-of-sale and supply-chain systems allow them to quickly react--not to expected market swings, but to actual customer and operational data.
For most lenders, core pricing for products is done in the back office, and demand-level pricing is done in the front office via marketing subsidies and the like. There is virtually no visibility of the front-office pipeline in the back office. In most cases, the first time the back office sees a loan is when it is locked.
Near-real-time, demand-based pricing is uncommon in today's lending operations. But what a tremendous competitive advantage it can be. Product-flow efficiency can increase profitability in a number of areas: sales expense, product margin, operations and hedging.
Because its vendors are integrated into its systems and have access to some of the same data, Wal-Mart's decisions to push one product or pull back on another are transparent to the vendor. This transparency drives operational efficiency for the vendor/supplier, and gives Wal-Mart great leverage during vendor negotiations.
Consider the possibilities of having this sort of relationship with your credit providers, title providers, appraisers and others. They can know and anticipate fluctuations in your volume and react with improved service-level agreements (SLAs), differentiated pricing or entirely new products. In lending, on-demand and network-based POS and LOS platforms are making this kind of lender/vendor transparency a reality.
Wal-Mart's move toward radio frequency identification (RFID) is big news these days. (RFID involves small tracking chips that essentially offer the same functionality as bar codes, but use wireless readers.) It originally perfected the use of bar codes to gather sales data. Wal-Mart is now requiring its top 100 vendors to use RFID technology. It expects to save more than $8 billion using RFID technology. Wal-Mart uses those savings to drive down prices, increase market share and scale, and continue to compound its operational advantages.
We have seen movement over the past couple of years toward eliminating much of the paper in the lending process. (I'm always amused when I answer security-related questions about our software, and then walk through the lender's building with stacks and stacks of mortgage documents lying out on every available flat surface.) Technologies like bar coding, imaging systems and data capture all have well-documented benefits. The data standards coming out of MISMO are only at the earliest stages of yielding real benefit. However, it is difficult to yield maximum value from these technologies when the overarching processes are managed disjointedly across islands of functionality.
Every major lender has invested heavily in an enterprise-level imaging platform. However, in many cases these systems are only deployed at the end of their process--after the loan is closed--simply because the systems at the POS or fulfillment stage are not capable of integrating effectively with outside systems. In these cases, documents and the associated data are rarely in the same system. Consequently, much of the value of the imaging system is not being realized.
How much time is lost in your lending process simply by moving documents among the originator, the processor and the underwriter, and then on to shipping? The opportunity cost associated with perpetuating these inefficiencies is rivaled only by the actual cost of doing business this way.
Wal-Mart does something I see rarely in lending--it develops and manages processes and systems together. Systems don't drive processes. And inefficient legacy processes aren't allowed to survive and be re-implemented in new systems.
Wal-Mart is the ultimate agile operation. Its scale allows it to constantly invest, driving incremental cost of out the system. Dr. Deming would be proud.
Dain Ehring is chief executive officer of Dorado Corporation. San Mateo, California. He can be reached at firstname.lastname@example.org.
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|Title Annotation:||Wal-Mart Stores Inc.|
|Date:||Oct 1, 2006|
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