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Fair Isaac: Regulatory tailwinds and channel distribution innovation

The most successful companies in vertical markets pair product innovation with go-to-market disruption. In this series we explore that marriage, how companies many have never heard of came to dominate their markets, and how they scaled with distinct tactics. These history lessons inform what we look for when investing in vertical markets at Scale Venture Partners, and hopefully provide blueprints for the next generation of vertical market winners.

Company name: Fair Isaac (ticker:  FICO)

Founders: Bill Fair, Earl Isaac

Year founded: 1956

Company vertical: Banking Software and Information Services

Market dominance: Consumer credit scoring

What do they actually do:  Fair Isaac provides the near ubiquitous FICO consumer credit score to financial institutions to help them effectively underwrite all types of loans. The company also sells underwriting and fraud management software to that same customer base. The FICO score is so important that consumers purchase services that help manage and monitor their own score, and this direct-to- consumer business is 15% of Fair Isaac’s total revenues.

Product innovation: In the 1950s, credit underwriting was a judgment-based process that relied on the experience of the underwriter and their subjective assessment of the applicant, focusing on employment, assets, reputation, etc.  Fair Isaac implemented a paper-based objective scorecard which assigned points to each aspect of the applicant’s history to develop a risk-based score. They demonstrated to financial institutions that this method achieved better outcomes with lower variance, and they were willing to customize the scorecard for each institution. Their next big innovation occurred in the 1970s, when they started to incorporate credit bureau data (from Experian, Equifax, and TransUnion) into their scores. Prior to that time, credit bureau data had been used by some retailers to offer consumers credit “on account” but financial institutions tended not to incorporate it, in part because the data quality was spotty. Fair Isaac was able to incorporate the bureau data into scores both because data quality improved and because their analysis was robust enough to handle some data inaccuracies. At the time, bureau data was shared with financial institutions via magnetic tape on a periodic basis.

Scaling magic moment: From 1956 to 1984 the company grew slowly and steadily, reaching $9M in revenues. In the late 1980s, the company decided to switch from just being a user of credit bureau data to partnering with the bureaus to distribute the FICO score. By 1989 the three major bureaus had each integrated a FICO score based on their own data, and were reselling it profitably. This materially increased Fair Isaac’s growth, to $80M in revenues in 1994.  And this trajectory was extended when Fannie Mae and Freddie Mac (organizations which guarantee most mortgages in the US) mandated that the FICO score be used for mortgage origination.

Fair Isaac grew quickly after that until 2003, when they acquired HNC software, which boosted revenues from $390M to $630M. HNC, which owned the market leading Falcon credit card fraud management system, became the basis for their underwriting and fraud management software business.

What’s interesting about Fair Isaac is that it had two scaling magic moments, and while neither was originally in the business plan, both were the result of steady execution that allowed opportunistic “magic.” They co-opted data suppliers (the bureaus) to be well compensated distribution partners and thereby became the industry standard. This was further reinforced when Fannie and Freddie mandated the use of FICO for mortgage underwriting – something the bureaus were very ready to support as it grew their revenues as well. This is a unique and impressive case of crafting a product for excellence in channel sales.  Later in their history, the existing brand and awareness with financial services customers allowed them to pursue a transformative acquisition in HNC Software, further accelerating their growth trajectory.

Where are they now:  Fair Isaac is the clear market leader in credit scoring, with the FICO score used in 90% of US consumer credit lending decisions today. They distribute their scores through the major credit bureaus who then add a markup and sell them to banks (and in some cases directly to consumers). They have $1.7 billion in revenues, with about half coming from scores and half from underwriting and risk management software. 

Three fun facts illustrate their market power:

  1. The major competitor to the FICO score is the Vantage Score, which is a joint venture of the three major credit bureaus – the very bureaus who distribute the FICO score and account for the majority of Fair Isaacs scores revenue. Yet the FICO score remains dominant.
  2. To originate a mortgage, banks typically pull credit scores twice (early in the process and before final signing) and they pull scores from each of the major credit bureaus. So, the FICO score is pulled 6 times… and Fair Isaac is paid each time. Recently when origination volumes went down, Fair Isaac responded by dramatically increasing their mortgage score price (by some estimates, they more than doubled the price in one year), minimizing the revenue decline because their market share of mortgage originations did not change after the price increase.
  3. While their software business was originally on-prem license, they have successfully built a $200M+ revenue cloud/SaaS offering that is growing at 30% YoY, delivering underwriting and fraud management functions. Admittedly they have  a big advantage because of their existing installed base, but it is impressive that a 70 year old company could so effectively transition to a new platform, as they did previously going from paper to offline computers to online connected computers.
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