The question most asked by our clients is, "Where do you think we are going as an industry with the Internet?"

As we attend this year's MBA national convention, where the Internet will undoubtedly be the subject of choice, I would like to discuss the consensus views held by our clients, and touch on some longer-term issues.

In the near term, most see retail loan origination on the Internet falling into two categories: aggregation and lending. Aggregators serve as portals, funneling mortgage seekers to traditional lenders. Intuit is a good example. Internet lenders, on the other hand, take borrowers from application through closing with little or no human contact.

A general belief among our customers is that the aggregators add little value to the process and, as a result, will not be a major factor. If an aggregator is viewed as just another intermediary in an environment that supposedly acts to disintermediate, I would agree. However, these entities may add value in another way, as I will discuss later.

As for Internet lenders, a few, such as, have made significant investments to establish a brand presence. Reports of service problems aside, I believe those that have gotten out of the gate early have a good chance of long- term viability. A high portion of their business is presumed to be refinancings, which introduces earnings volatility, an issue that needs to be addressed.

Most of our clients believe the traditional lenders will eventually dominate the Internet by using their established brand identity to cut through the Web clutter, and leveraging their existing processing and closing infrastructures. Such structures, of course, have to be built or outsourced by the Internet lenders.

This "Revenge of the Dinosaurs" theory is supported by the fact that, while Internet companies have provided significant innovation, virtually none has figured out how to make real money. Many of the dinosaurs can and will heavily discount the same services to expand their core businesses, for instance, maintaining the customer relationship so they can cross-sell other financial products.

So far, so good. However, will this "alternate channel" view of the Internet be the final state or simply the first stage of a more fundamental evolution or revolution? I think the latter.

All business consists of a value chain held together by the glue of information. The nature of that chain depends on where the business is on the "richness/reach" curve. (I draw heavily in developing this framework from the work of Philip Evans of Boston Consulting Group.)

Richness and reach are opposite ways a business relates to its customers. A business that requires face-to-face dealings, with the ability to interact, react, and modify the relationship immediately is on the richness end of the scale. The practice of medicine might be an example.

At the other end of the spectrum is a business that relies on reaching as many customers as possible, but in a one-way mode - newspaper publishing, for example.

The prevalent wisdom today is that mortgage lending is on the rich end of the spectrum. Since obtaining a mortgage is relatively complex and occurs infrequently in the consumer's life, there is a need by the borrower for significant human interaction. That assumption is correct - today.

What must be considered, though, is that the Internet fundamentally and permanently changes the economics of information. Not only is information increasingly available to all, but the cost of search-and-switch is zero.

The effect of this on the richness-reach curve, which can be viewed as a line sloping downward with richness on the y-axis and reach on the x-axis, is profound - it moves the whole curve to the right. The Internet will allow lenders to have greater reach - worldwide for all practical purposes - while still maintaining the richness of the relationship through the ability of the Web to be interactive, to offer infinite financing alternatives, and to provide the borrower with a zero cost of search-and-switch.

In the final analysis, the borrower will be empowered and "pull" product and service from lenders, as opposed to lenders' "pushing" their products through the various channels such as retail, wholesale, and telemarketing.

We must view the Internet as not just another channel, but as a historical and significant shift in the way mortgage lending and all other financial services are delivered. This presumes, of course, that Internet-based costs of manufacturing and distributing a loan will be significantly less than the costs of today's existing, mature channels.

While this might be a difficult proposition to defend today, particularly in this age of consolidation and scale economies, I believe that continued advances in the ability of the Internet to support "mass customization" will drive Web-related costs down compared to the more traditional channels available to a lender.

As I discuss this with clients, I find that the factor inhibiting the short-term adoption of Internet lending is simple: conflict with existing production sources.

I do not presume to have the solution to this quandary, but it must be overcome, or the net income derived by new competitors using these new channels will ultimately exceed the potential loss to existing competitors resulting from channel disruption.

I mentioned earlier that Internet aggregators might have a significant role in the future. This role could be that they, as consumer navigators, serve as a partial solution to the channel conflict problem by sharing the economic benefits of Internet loan origination with those who are adversely impacted - in effect, giving them a piece of the action in the navigator product.

This presumes, of course, the brand identity of the lender is not undermined by the aggregator - an interesting point to consider for those forming aggregator offerings.

Many issues arise out of all this. What does the democratization of information mean in terms of the value delivered by the mortgage banker over the long run? What will the Internet do to business-to-business dynamics? How does all of this impact on the significant ownership position in the mortgage business that has been taken by commercial banks? What legal and regulatory issues will emerge?

These are topics you should address as you build your Internet strategy. For now, however, there are two imperatives. First, be sure you examine your Internet strategy in terms of the fundamentals of the flow of information. Second, ask yourself if you have looked far enough into the future. n

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