My good friend Sharon Lu seeded an idea into my mind and now it is time to discuss!
Regardless of your views of Amazon, as a company it has caused some momentous shifts across multiple industries. I am calling these shifts an Amazon Moment and believe the same thing will happen to the Australian mortgage broking industry. Although Amazon hasn’t fully arrived in Australia, across the world it has changed many things:
- It forced many retail shops to close or change their business models
- It revolutionized online retail along with a small select group of firms
- It made books cheaper for the everyday consumer
- It allows people to buy thousands of items online with next or same day delivery from the comfort of their own home
The major problem with retail in the modern day is that there are natural mismatches that lead to obvious inefficiency:
- A large physical store where the consumer is only interested in a small selection of products (size, colour, use, brand are just some of the factors)
- A poor matching of supply and demand (shops open in the day, people’s free time is generally in the evenings) and seasonality.
- An inventory and working capital problem. People want to buy from a physical store if it is in stock, otherwise they see no advantage against ordering online (so physical stores need to hold more stock).
The overall result is that physical stores represent a form of sales and marketing but have limitations in that they are expensive and inefficient. The result is that a consumer will pay more to visit a physical store when they don’t know what they want to buy (spur of the moment), need deeper inspection (quality control) or want the product immediately (coffee).
Amazon did well as it identified a few things:
- People might have an idea of what book they want to buy: the latest trends (Harry Potter), the top ranked, the life-related (I’m currently reading about fatherhood)
- Physical quality inspection for books isn’t required in most cases: they are paperback (or were, digital is now here)
- They are not needed immediately (except the airport purchases). You can’t read a book in a day, so you can buy ahead of time in many cases.
The result was that a market for online or automated sales of books was there and consumers would buy it. Amazon won. Once it was able to achieve scale, the ability to cross into other areas made sense by reinvesting the money saved on physical stores into improving the supply chain: Faster delivery and better stock management.
The overall result: Traditional bookshops who were unable to add value where Amazon played soon lost out. Not every bookshop closed but they had to offer more – better spur of the moment locations and products, better research into what is a good read (quality advice) and older or rarer books (need physical inspection). This is creative destruction: a better service is offered by a new entrant and existing players also need to improve to keep up.
So how does this translate into an Amazon Moment for Mortgage Brokers?
Firstly, some basic facts about mortgage brokers:
- They sell a widely viewed commoditised product (although this is questionable for reasons below)
- They have a high cost of use at 1.3% on average of the loan balance (relatively high sales and marketing cost)
- Supply doesn’t match demand: it suffers from seasonality as well as poor conversion rates
- High salary/cash commission costs
So what would happen if the 1.3% cash commission (which is a sales cost similar to the physical store above) is used for something else: a better credit supply chain in the same way Amazon changed the physical product supply chain.
Supply chains in finance are less obvious. In the most simplistic form, someone somewhere usually has some cash. They invest it (buy shares) or save it (deposits). This feeds through the financial system into a bank and then gets loaned in the form of a residential mortgage.
The bank can make a few choices here. What a deposit holder wants is 100% certainty of their money back, whilst the home loan borrower has some risk: they may default. The bank equity usually holds the difference (is a risk bearer). However a number of other risks also exist and are simply not managed by the expert (the bank): interest rates change when a central bank alters rates or market sentiment changes them. These fluctuations are extra risks and are shoved onto the borrower, who doesn’t have the capability to manage the complex risk.
So what happens in Australia with these extra risks?
Australian loans are either variable rate or fixed for a period. There are very small but hugely significant differences in these loans to the rest of the world:
- Variable loans in Australia allow a bank to re-price loans at their discretion. Recent examples of new capital charges to banks leading to price increases straight away. Consumers get a bad deal.
- Fixed loans in Australia have only a limited fixed period (mostly up to 5 years). They also have high break costs if a borrower wants to repay early and interest rates have dropped (and banks won’t reward people who repay earlier if rates go up, so this is unfair!). Overall, borrowers face interest rate risk: they either get stuck in mortgage, have to pay to get out and the fixed period isn’t long enough to protect them for the life of the loan, say 20 years, if interest rates increase over the long term..
Both of these loans are then pretty risky to a borrower if something harsh was to happen to the economy: banks would shovel costs onto borrowers or their fixed periods would lapse (and you can’t lock-in rates before the expiry of old fixed periods as you would need to pay extra costs!).
The simple solutions: make loans better by redesigning the supply chain and adding in extra features that make these above risks disappear. The loans themselves aren’t a new invention either:
- A Tracker loan, which is defined as the central bank cash rate plus a fixed margin is a better floating rate loan for the borrower. Tracker loans exist in the UK.
- Longer fixed periods without break fees. 25-year fixed loans without prepayment fees exist in the United States and Japan.
So how is Huffle going to create the Amazon Moment for Mortgage Brokers?
We are looking to take that 1.3% cash commission and use it to creatively bring new, customer-centric mortgages to the Australian market.
We hope that the end result is not dissimilar to Amazon and traditional bookshops – with a more customer-focused and cost effective alternative that drives the traditional brokers to adapt and enhance their service for the benefit of all Australians.