The Crash of Two Iconic Business Models — 1
How Fair Isaac and Arbitron let their customers down
January 2008 By Denny Hatch
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In the News
DEFAULT LINES: THE NEW MATH OF CREDIT SCORESFair Isaac’s Revamped FICO Aims to Forgive Small Slips, Punish Repeat Offenders.
The company that cooks up credit scores for millions of Americans is changing its recipe—and that could affect how easily you get credit in the future.
Fair Isaac Corp., maker of the popular FICO credit score used by most lenders, says its new scoring model will do a better job predicting the likelihood of a borrower defaulting on a loan. For one thing, the new model, dubbed FICO ’08, will be more forgiving of occasional slips by consumers, but will take a harder line on repeat offenders. Fair Isaac predicts its new system will help lenders reduce default rates on their consumer credit by between 5% and 15%.
—Jane J. Kim, The Wall Street Journal, December 19, 2007
What is less understood is the highly complex algorithm of scoring—taking all that bill-paying data on an individual and determining the chances that he or she will fail to pay a credit card charge or default on a loan. The dollar amount of credit extended and the Annual Percentage Rate (APR) charged are pinned to a consumer’s score.
The unquestioned master of scoring alchemy is Fair Isaac, on whom some of the blame for the sub-prime crash—and perhaps the coming recession—must fall.
And it turns out that the Arbitron radio ratings folks have been totally dishonest with the advertising community for years.
The reason: both business models were woefully out-of-date.
Today we examine Fair Isaac. Look for the Arbitron mess on Thursday.
By the way, how state-of-the-art is your business model?
Good Ole Hooper Holmes
As regular readers of this curious e-zine know, I came out of the book business—negative option clubs and continuity series—“Take the first book free and receive one book a month thereafter.”
The offers were always soft: “Send no money now, we’ll gladly bill you later.”
The big challenge was dealing with what consulting wizard Bob Doscher calls “premium bandits”—those folks who send for anything free with no intention of becoming a paying customer.
All the companies I worked for in those early days were members of a very early cooperative database, the Hooper Holmes Credit Index. Membership required us to share all our bad names—premium bandits and accounts suspended for non-payment—so that they could be added to the pot.
Whenever we would send out an acquisition mailing with a soft offer, the names and addresses of all our new customers would be data entered and immediately sent to Hooper Holmes. These names would be bumped up against the unique database of bad actors and the results would be returned to us in short order.
The Hooper Holmes printouts were eye-poppers. Some addresses contained 25 to 100 or more hits—a single address or P.O. Box where the same person with myriad bogus names had stiffed direct marketers by ordering products and failing to pay or return unwanted merchandise.
Sometimes a name would be on the list with just one hit, say from the local Shell station. Chances are this was the result of a dispute between a car owner and a mechanic over a poor repair job. This consumer would be welcomed as a new customer.
Takeaway Points to Consider:
* Do not ever let greed trump common sense.* The person who cannot afford a down payment is probably a lousy customer.
* In 1965, Intel co-founder Gordon Moore predicted that the number of transistors on a chip would double every 24 months. The Moore formula—coupled with the Internet—have made the amassing and synthesizing of data possible at warp speed.
* As a result, consumers and businesspeople have come to expect more information—and more accurate information—to be available virtually in real time.
* Is your organization’s data retrieval and processing able to keep up with these sweeping changes, enabling your people to make decisions quickly and accurately?
* In short, does your business model need tweaking? Or even a complete overhaul?
* Had Fair Isaac done some serious tweaking to its algorithm—and had some real-world (as opposed to ivory-tower) understanding of how consumers’ and investors’ minds work—the enormity of the sub-prime catastrophe might have been lessened.
* This coming Thursday’s edition of Business Common Sense will examine Arbitron, a company built on a 1950s business model that was obsolescent at the outset, proven useless today and still in operation.
Web Sites Related to Today's Edition:
Fair Isaac Changes Its Recipe—The Wall Street Journalhttp://tinyurl.com/2vy97b
Fair Isaac and Sub-Prime Blame—Forbes
http://tinyurl.com/39a9uw
Credit Bureaus Create a Single Rating—The Wall Street journal
http://tinyurl.com/32mfb8
Fair Isaac Web Site
http://www.fairisaac.com
How Bear Stearns Blew It—Business Week
http://tinyurl.com/288v2a
Fraud as a Sub-Prime Driver—The Wall Street Journal
http://tinyurl.com/2ayb7u
Lenders Lobbying Exacerbated Sub-prime Mess—The Wall Street Journal
http://tinyurl.com/ytpmyf
Timeline: Sub-Prime Losses—BBC News
http://tinyurl.com/ypdb65
Financial Bubbles in History
http://en.wikipedia.org/wiki/Economic_bubble#Examples
Sub-Prime Implode-o-Meter (Bankrupt Lenders)
http://ml-implode.com/
Credit Bureaus Create a Single Rating—The Wall Street journal
http://tinyurl.com/32mfb8
Experian
http://experian.com
Equifax
http://www.equifax.com
TransUnion
www.transunion.com
Glengarry Glen Ross
Film History: http://www.imdb.com/title/tt0104348/
DVD: http://tinyurl.com/2jja5c
Script: http://tinyurl.com/3azp92
Companies Mentioned:
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