Special report -- Towards a brighter future

Sugary drinks were declining in popularity while healthier options and high energy drinks with new and unique labels were taking off.

Coca-Cola’s plan was to develop a diversified competitive strategy to maintain the strength of its flagship Coke product while at the same time introduce a new range of beverages and brands aimed at a more health conscious market.

The strategy paid off – and the company’s multi-branded portfolio is holding steady against those of its rival, without profits or market share having been sacrificed.

The mortgage sector is at a similar cross road. With the increased cost of funding, RBA interest rate hikes as well as slowing customer confidence contributing to a decline in residential loans volumes, now is the time for lenders to review their product and service offerings and look to new ways of generating revenue to safeguard their futures.

Challenging times

The Australian lending landscape has been set on a course of gradual change as mortgage businesses look to add value to the services and skills they offer.

For mortgage manager Resi, the slowdown in residential lending has prompted a review of its business strategy with a view to safeguarding revenue – and profits.

Lisa Montgomery, head of marketing and consumer advocacy at Resi, says the lender has been analysing new market opportunities and exploring different services and relationships to help strengthen its existing portfolio.

“Resi is going through a conceptual thought process phase, looking at existing products and services that we can expand or move into comfortably,” says Ms Montgomery.

Diversification has proven to be a strong risk management tool for the non-bank sector in the past. So in the current climate it is arguably a safe umbrella under which lenders can seek shelter as the credit crisis continues. It’s also a way of maintaining a competitive edge against the banks.

“Past successes of the non-bank sector have related to its nimbleness and ability to compete strongly with the banks,” says Phil Naylor, CEO of the Mortgage Finance Association of Australia (MFAA).

Back to their roots

From the time the first non-bank lenders burst onto the scene, they have shown a remarkable ability to adapt to change.

The sector has indeed rapidly evolved since its early days – so much so that the mortgage industry’s own association, the MFAA, was forced to re-invent itself to better reflect the needs of its members.

The MFAA now has a pool of members that service areas outside mortgage lending, such as equipment finance. Moreover, current members that once specialised solely on residential mortgage lending are expected to start looking beyond the segment to remain competitive, especially during times of tighter funding and market liquidity.

“Residential mortgages still comprise 70 per cent of all mortgage business so there will always be a strong market there, but clearly where there is customer support, some businesses will choose to diversify into other types of finance,” says Mr Naylor.

Leading University of New South Wales (UNSW) academic Vic Edwards says new streams of business can have a smoothing effect as declining revenues in some areas are replaced by new.

By reducing a business’ exposure to market cycles, diversification is a much safer strategy than specialisation for boosting revenues. But it’s important that businesses take a cautious approach to diversification based on a sound business analysis.

“We tend to be a bit seduced by size – but diversification in the current climate should be about quality and risk management,” says Mr Edwards.

Diversify: how?

Choosing the right diversification model will be the key to balancing risk and profit profiles in the current market – and lenders have two main choices.

Like Coca-Cola, the first is to introduce entirely new revenue streams to help grow the business and at the same time reduce the risk of damaging its core product offering.

Such a model has a name: conglomerate diversification. It’s a model which industry leaders such as Aussie Home Loans have adopted.

Aussie has recently moved into low rate credit cards – as well as personal and car loans – transforming the business from a mono-product/service model into one with varied income streams.

For Aussie, employing a conglomerate diversification strategy has had two key outcomes for the business.

“Because it expanded the breadth of products we offer in the market by providing a stronger business, it’s proven to very helpful in today’s climate – lessening our exposure to money markets,” says Aussie Home Loans chairman John Symonds.

The move has also broadened Aussie’s target market as well as created new opportunities to strengthen its existing customer base.

But there can be a downside. Introducing new products is often labour and capital intensive, distracting the business from the main game.

For this reason, Symonds says it’s important to take a cautious approach to diversification. “You can lose sight of the core customer proposition and profit drivers if you diversify too widely,” warns Symonds.

Concentric growth is a more organic diversification strategy by which lenders look to maximise the opportunities their current products and services offer.

For mortgage manager Australian First Mortgage, its distribution channel has been the driver of its diversification strategy.

“We wanted to see how we could best use our distribution arm to sell more loans,” says Australian First Mortgage director of sales and marketing Iain Forbes.

As part of its strategy, Australian First Mortgage has broadened its commercial product suite as well as introduced leasing finance options to give its brokers a better shot at success.

Mr Forbes says it is ‘value adding’ such as this that will make a difference in the current lending environment.

“Eighty per cent of our business is still focused on residential lending, but we’re launching products that have been adapted to the current market conditions to support our distribution chain,” says Mr Forbes.The group is still a new kid on the block where commercial products are concerned but broker adoption has been very encouraging to date.

“It’s not easy at the moment but so far the results have been very positive,” Mr Forbes says.

Creating a competitive advantage in the current lending environment requires businesses to look at the longer-term potential of their products, services and resources. But they also need to remember their roots.

“You have to understand your own strengths in this market – you can’t simply play follow the leader,” says UNSW’s Mr Edwards.

Lending institutions often mistake strength for growth, says Mr Edwards – but the current environment calls for strategic risk management and a prudent approach to sustainability. And businesses that are smart about diversifying are those that will be sustainable in the long-term.

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LOOK BEFORE YOU LEAP

Competition is likely to drive many brokerages to explore diversification this year – but it can be risky

While the non-bank sector has been gradually expanding its core offering, the broker channel has also been handed a golden opportunity to explore new business possibilities and consumer markets.

The heyday of residential borrowing between 2000 and 2005 saw broker ranks swell, and many were able to sustain healthy incomes. But increased competition is now driving many brokers towards diversifying their service capabilities and customer base as a logical and profitable solution to buttress revenue streams.

Choice Aggregation Services’ managing director Michael Russell says businesses with diversified revenue streams have continually been rewarded in the current economic climate.

“Many brokers have now come to realise why the banks in recent years have placed such a great emphasis in ‘share of wallet’,” says Mr Russell, adding that a faster uptake of diversification strategies may be needed to ensure brokers’ survival in the current market.

“For mortgage brokers, diversification should be seen as a tool to widen revenue streams and strengthen the business against potential market downturns in residential mortgages,” he says.

But for all businesses, whether small or large, diversification is not without risk.

Diversifying with caution

The challenge for brokers is to introduce new products and services without affecting their core residential service offering.

“Moving into an area where you lack expertise and focus can make a business vulnerable – especially if it distracts you from your core business,” says PLAN Australia’s CEO Ray Hair.

Sustainability should be the central concern for any business looking to expand. Key factors to consider are the capital the business can afford to inject, the resources it will require to support the expansion, and the potential impact on the business’ reputation.

Like PLAN Australia, Choice Aggregation Services has been actively encouraging its members to explore areas where they can use their expertise to effectively support new products or services.

Commercial mortgages, personal loans, asset finance and insurance are all logical areas for brokers to explore, provided they can adopt a business model that reflects their expertise and their relationships with their providers.

“Commercial mortgages and personal loans can be easily added to the armoury of most mortgage brokers who are willing to make an investment of their time in personal training and development,” says Choice Aggregation Services’ Mr Russell.

According to Mr Russell, most of the larger aggregators now have the necessary in-house resources to accommodate product diversification, with most also well resourced to offer relevant training in-house.

Strategic alliances and referral agreements are another way for brokers to grow their business, and arguably a less risky one.

“You don’t have to be all things to all people. By forming better relationships you can increase your value proposition without placing your business at risk,” says Mr Hair.

For the broker channel the immediate challenge diversification presents is reputational.

Mr Hair says brokers are only as good as their reputation and need to consider the impact diversification can have on the way their customers perceive them. But he is confident they will succeed in making diversification work for them.

“Brokers have established credibility as a business sector and will be able to leverage off their experience in the residential market to bolster consumer confidence,” says Mr Hair.

The biggest risk to brokers according to Mr Russell is in choosing not to diversify. He says brokers should enlist the help of both aggregators and lenders to find a strategic product fit for their business.

“Most risks can be mitigated with some good research and the right relationships,” says Mr Russell.