PDD#17: FICO Deep Dive
Jasginder Singh
Product Manager, Problem solver, Generalist | Mastercard, ex-Amex, ex-Adobe
Preface
The last article in this series focused on payment risk management, and how decision making models like that of FICO were having an impact on payment landscape. Since then few people reached out to talk about FICO vs. Credit bureaus, and how VantagePoint fits in. Some had queries on private players launching their own custom scoring models.
Given the interest, I thought I would do a deep dive into Fair Isaac Corporation (FICO) itself. This article will explain FICO's business model, how it fits in the financial ecosystem, and the economic forces that have shaped its growth. Follow along, and let uncover the story of a company that has quietly but profoundly impacted how credit is granted and managed in not just United States but across many other places in the world.
Disclaimer: The information provided in this article is for general informational purposes only and should not be considered as professional advice. The content is based on my knowledge and research, and I have endeavored to ensure its accuracy. However, please note that information can change over time, and I cannot guarantee the accuracy, completeness, or relevance of the content at all times. The views expressed in this article are solely my own and do not necessarily reflect the views of any organizations I am affiliated with.
FICO (NYSE: FICO) is a leading analytics software company, helping businesses in 90+ countries make better decisions that drive higher levels of growth, profitability and customer satisfaction. - FICO in it's own words
Despite its low profile, FICO’s credit scoring system is a cornerstone of consumer finance, influencing decisions that affect billions of dollars in lending each year. Not only is it core to the financial fabric of the United States, it has also been one of the highest-quality business models in the world. Lets dive into its journey:
Pre FICO
Back in old days of 1950s, if someone went to banks for financing needs, the banks would ask for information on the income and current obligations. That information was of course neither standardized nor readily available. So the loan decision was based on trust and familiarity with the bank manager plus the collateral value - and hence highly subjective. Bank's decision itself was Yes - No kind, and had a standard interest rate that bank would charge.
The Genesis and Evolution of FICO
Founded in 1956 at Stanford Research Institute by engineer William R. Fair and mathematician Earl J. Isaac, FICO was established to create a more reliable and objective method of assessing credit risk. FICO’s inception was grounded in a simple yet revolutionary idea: utilizing mathematical algorithms to predict a borrower’s likelihood of repaying loans. The development of the FICO score catapulted the company into a pivotal position within the financial sector. This score became a universal benchmark for evaluating creditworthiness.
FICO Scoring System
Fair Isaac sold its first computer-derived credit scoring system in 1958. The system was rudimentary, and used 50+ variables that borrowers had to provide which the borrowers did not have patience to provide. But once that data was made available, the scoring models would allow lenders to play around tightening and loosening the parameters and also compare the performance of various segments. Lenders were now able to charge variable rates, based on risk profile which also led lenders to tap into subprime lending market.
Equal Credit Opportunity Act (ECOA)
In 1974, the Equal Credit Opportunity Act was passed, making it illegal to discriminate on factors like race, color, religion, national origin, sex, marital status, age, or because loan applicant already received public assistance. It also required the credit reporting bureaus to open their files to the public and delete negative information after a specified period of time.
Lenders now had to ensure that their models used objective, credit-related data rather than subjective or potentially discriminatory criteria. Through series of mergers and acquisitions in the '70s and '80s, the three main credit bureaus emerged that we still have today, Equifax, TransUnion and Experian. These bureaus developed the first standardized credit bureaus risk score PreScore which was released in 1981.
How is FICO Score calculated
The FICO scores use the information found in individual consumers' credit reports to calculate credit scores for them. These scores are then used by lenders to gauge each consumer's creditworthiness and determine whether to approve their applications for loans, credit cards, and other borrowing.?The percentages in the chart below reflect how important each of the categories is in determining how the FICO Scores are calculated. The importance of these categories may vary from one person to another. Also, the more recent a positive or negative signal is on the credit report, the more weight it carries.
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Due to the structure of scoring process, while you might see your score drop when you open a new credit card account (signaling you looking for debt, i.e. you are in need of money), the score comes not just back but goes higher once you start making payments on time for that card (as it signals that lender felt you are credit worthy to get that card, and then another signal that payment was made on time).
?? FICO scores range between 300 to 850. It is said that the 100 to 300 range was left for another scoring product, and that 0 to 99 was meant for special posts to identify incomplete data. That leaves us with an odd starting value of 300
How does FICO make money?
FICO has a capital-light business model that revolves around the development and licensing of its credit scoring algorithms. The revenue is split evenly across its Software and Scoring business segments, but scores provides over 75% of the operating income of the company because that side of the business has much higher margins.
Scores business helps lenders asses credit risk for consumer loans (such as mortgages, autos, credit cards). FICO scores are a common language used by the various industry participants to talk about the credit quality of a loan or a consumer. The company delivers over 15 billion scores every year and 100 billion FICO? Scores have been sold to date making FICO the most used credit score in the world. And scores are inexpensive, generally less than $1 each (not to be confused with the final reports that are priced higher). FICO scores are used in over 90% of the credit lending decisions and at over 99% of credit securitizations. And not just lenders, the scores are also used by 400+ retailers and general merchandisers, including one-third of the top 100 U.S. retailers.
The software portion of the business delivers data analytics for things like loan originations, fraud detection, customer management, customer communications. The software is provided either as On-Premises offering or as a SaaS offering (cloud based). 75% of the largest 100 global banks use FICO software in some form. (Source of statistics: www.fico.com)
A small portion of revenue comes from consulting services that FICO provides to help organizations implement and maximize the value of its analytical solutions.
Cost of revenue is around 21% of its annual revenue, while R&D expenses (including personnel and related overhead costs incurred in the development of new products and services) was at 11% of its Total Revenue.
Position in the Value Chain
FICO is strategically positioned within the financial value chain, functioning as an essential intermediary between credit bureaus and lenders:
No doubt, FICO has reported 33.07% Annual EPS growth in the past 5 years (data as of May 2024). The company has reported 30% Net Profit Margin and almost 80% Gross Margin. As of this date (May 25, 2025) the stock has already given returns of 80.95% in past one year. Am noting these latest financial and stock performance to note the strong moat this company has been able to create which is reflecting in the stock price.
Conclusion
FICO’s influence on the financial industry is profound and enduring. Through its innovative scoring models and strategic business model, FICO has fundamentally reshaped the way credit is assessed and managed. Plus, it is positioned as a crucial intermediary in the financial value chain, an envious position in the age where lending as an industry is growing. It is in a dominant market position, wields tremendous pricing power (which has even caught the eye of CFPB director), provides great value for the price of its product, has an operating leverage and doesn't see the value eroding anytime soon. This was a business that can mostly be augmented by new players but will be very hard to replace.
That is a wrap up for now. Your comments, opinions, and corrections are all much welcomed. If you enjoyed this article and think others will too, give this article a like below and share it. Thanks!