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defi_solutionsWith our recent purchase of a competitor who was one of the last hold-outs in the origination software industry not pricing per transaction, I am often asked to explain why transaction-based pricing makes sense for lenders and why SaaS is the right technology model for an origination technology provider. So here we go, my take on the subject.

SaaS vendors and Lenders are Not So Different…
As a lender you have profitability targets for each deal, the hurdles you have to make on each loan so that the portfolio performs and the business thrives. So do your SaaS vendors. You are covering losses, operating costs and cost of funds but SaaS vendors have to cover these areas to remain viable:

1. Infrastructure. The cost of infrastructure ranges from 30-40% of transaction-based pricing and is directly tied to volume. When volume goes up, your vendor is having to scale architecture. It would be great to think this is a fixed cost, but it’s very much driven by transactions. Isn’t it comforting to know that you can grow as much as you want and all the burden is on your vendor to make sure this scales with you?

2. Support and Maintenance. It would be ideal to think that these were fixed costs as well, that whether you do 1,000 apps a month or 100,000 it doesn’t cost the vendor anymore to support you, but that is not the case. It’s like hoping a subprime customer takes the same amount of servicing as a prime customer. With hosted technology as your volume goes up, so do the number of questions, issues and support needs.

3. R&D. Here is where you might find the largest variance in providers.

• Progressive technology providers are constantly updating and adding to the platform in the form of reinvesting in new features, integrations and performance enhancements. Other less progressive vendors starve R&D to maximize profit and maintain the status quo. One of these strategies is good for lenders and the other not so good….Technology is ever changing, if your vendor isn’t out there working for you, keeping up with the changes, making sure your technology is relevant, you will pay the price at some point – you can only push it off so far…….

  • Remember the “good” days of subvented rates and an abundance of new car incentives? Car buyers were buying more often, money was flowing – but it wasn’t sustainable. Cheap pricing may feel good in the moment, but it’s not sustainable. Instead of looking for cheap, look for value.
  • As Steve Job’s so eloquently put it “If you keep your eye on the profit, you’re going to skimp on the product. But if you focus on making really great products, then the profits will follow.”

You Get What You Pay For…..
My dad always said “you get what you pay for”. I thought he was crazy and just wanting to buy the cool stuff. But indeed it is often the case. However, as with most things the truth lies somewhere in the middle. The saying is a great rule of thumb, but you still need to be a savvy buyer. Total cost of ownership is the most effective way to evaluate your options and determine the true value of what you are getting.
When I was young, I was incredibly attached to my money, so I always wanted to go cheap – clothes, electronics, or furniture – it didn’t matter, cheapest won – cheap “felt” like the best deal.

For instance, I would have rather paid $500 for a desktop computer rather than the $675 for the laptop. But that desktop needed a monitor, cables, a keyboard and mouse plus a larger desk to store it all on. After all was said and done the desktop cost $615 total but when I went away to college I could not take it along since the space I had would not fit the desktop. So I ended up buying a laptop in 24 months for the then lower price of $625. Total cost of laptop $675 vs. total cost of desktop choice $1,240.

So how do you decipher the total cost of ownership (TCO) to determine if transaction-based pricing is really providing freedom or only more cost? With transaction-based pricing, the idea is not for you to pay more but to pay for what you use. Some of the strategic benefits of pay per use include:

1. Lower fixed costs, which is good for cyclical industries, anyone remember 2008? With SaaS you only pay for applications you get, not for servers, network people, DBAs and others to keep the system on every day.

2. Lower enhancement costs. A progressive SaaS vendor will continue to enhance the product to support multiple clients, which provides value for the entire network of customers. In the traditional install software model you install the software once, but then you pay for new features and integration services (these costs are typically billed hourly so the more time it takes the more you pay).

3. Reap additional operational efficiency rewards. If you find ways to book more loans with fewer applications (higher closure, better targeting) you save on technology costs in a SaaS model. With a traditional model the cost to license and run the system does not change with better operational efficiency.

Making Money benefits everyone….
Doesn’t it upset you when suppliers or regulators suggest you shouldn’t charge the rates you do and make profits? Profit margins for smart SaaS businesses can be good, no doubt, just like they can be good for a savvy lender. But it’s risky much like lending can be. We have to keep adding value, improving the network and serving customers. If your vendor isn’t constantly improving at being your tech provider it will catch up eventually, you will easily find another vendor (think loan charged off here) – the business model isn’t any more sustainable than a lender throwing a bunch of business on the books to hit volume targets with no thought for the inevitable losses.

A SaaS model inherently aligns profit motives of lenders and vendors. In the “one price regardless of volume” scenario, the vendor makes the same regardless of how you do. “One price” vendors are not incented to help you succeed and grow, only to maintain and stay in business. In the pay by the seat model, again, there is no direct alignment with seeing you succeed – the vendor makes more if you add seats even if you adding seats was not growth related. True you may add seats because you are growing, but you also add seats if you are inefficient. If you want your success tightly aligned with your key technology providers the SaaS model is the way to go.

Trade-offs not price drops…..
Much like rehashing a deal between the dealer and the lender, there are many ways to structure the deal so that it works for both lender and technology partner. So feel free to get creative, but remember, it is full structure you are negotiating with a long term impact, not just a lower price on a single transaction. When you are negotiating with the dealer and you have given a 15% rate which matches the risk and profitability target of the deal and the dealer comes back and needs 13%, what do you do? You don’t just say yes, you work to adjust the structure so it works for you and the dealer. You have the dealer put the buyer in a better car, or put more down, or adjust the discount. You also know you will need more business from the dealer in the future so you want a mutually beneficial deal that ensures the dealer makes profits to keep selling cars so you can keep lending.

Smart lenders don’t compete on price and the same is true for SaaS providers, they compete on value. If you are looking for a vendor who competes on price, you will have to accept the rock bottom value to go with it. Just like the dealers that are looking for the lenders that compete on price have to deal with the pitfalls that go with finding new lenders and learning new programs when that lender leaves the market.

Your call, Freedom or Frightening?
Yes we know new and different CAN be frightening, but those who can fight past the fear and look a little bit deeper are finding creative ways to partner with vendors to create new value, reduce risk and experience FREEDOM!! Think network power. The power of many with open access, crowd sourcing, and blogging has certainly changed the way we live by making information more free and made the knowledge field flatter. We think the same network and platform power will free lenders to focus on lending while savvy technology partners build a lending network of the future, free of high fixed costs, long vendor timelines and misaligned goals.

Stephanie Alsbrooks, Chief Freedom Fighter and CEO

As published in the July/August issue of Non-Prime Times.

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