How Does Direct Mail Credit Card Process Work?

Have you ever wondered how banks or credit unions can mail credit cards offers to you at your current address? How does the process work behind the scene? What impacts a campaign? Why do you receive the same offers from the same issuers but in different envelops? If you have such questions, I am here to pull back the curtain a bit by talking about the Direct Mail (DM) process in general, what impacts the success of a DM campaign and some less known details.

Direct Mail Process

Let’s go backwards from the moment you tear up a mail from an issuer. Whenever an issuer, whether it’s a bank or a credit union, sends you an offer, it must contain information on the offer as well as credit terms and conditions, as mandated by regulations. Inside a mail piece, some issuers include a postage-free envelop that customers can use to send back a filled paper application. Since each piece of paper is an expense, some elect not to send a paper application to save costs, especially during the times of supply chain constraints and inflation. In that case, customers can go directly to the issuer’s website, either by inputing the address manually on a browser or by scanning a QR code. They can also call customer care and apply on the phone.

Each mail piece carries an access code and a reservation code. These codes will be used to identify which offer is attached to an application. Normally, an issuer assigns a unique identifier to an offer for easy and transparent tracking. More on this later.

How do issuers know who you are and where you live? The answer is by working with credit bureaus. Credit bureaus like Experian, Equifax or Trans Union collect a lot of data on Americans. They have your latest address, your social security number, how many trades (mortgage, loans, credit cards…) that you have, how many with a balance that you own, so on and so forth. Issuers can work with these bureaus to pull the names of prospects for DM campaigns. The caveat is that in addition to a fee per name, issuers need to commit that they will send an offer to the names that they pull. Said another way, issuers can’t just call bureaus out of a blue and say: hey, I want to pull sensitive information of these people, but I don’t send them any offer.

Because of this requirement and the fact that each credit card is an unsecured loan that carries risks of losses, issuers must have a plan as to whom they want to send what. To answer these questions, issuers rely on their Credit Risk department, Marketing team and historical data. Credit Risk determines the risk parameters in which new acquisitions must fall. For instance, some banks are more comfortable with people who have little credit history than other banks. Some want to acquire folks with FICO less than 660 than others.

After Credit Risk defines the broad risk parameters, Marketing will work on the specific criteria and offers for a campaign. Each year, Marketing will conjure a campaign calendar that details how many pieces will be sent, when a campaign starts, which offers will be sent, how many applications and accounts can be expected. These details are determined with the help of historical data. Hence, the longer an issuer has been around, the more data it has to make informed decisions regarding DM campaigns.

What Impacts A Direct Mail Campaign?

The biggest factor is whether an issuer sends the right offer to the right audience. People have different preferences. Some don’t like complex rewards structures while others love to maximize rewards points. Some want to transfer balance to a card with a much lower interest rate while others just want to get a cash bonus for their activity. Issuers need to figure out who likes what and sends an appropriate offer. There is a big caveat. Credit cards are highly regulated in the US. Issuers can’t be caught being discriminatory towards any portion of the population. They can use certain behavioral traits as targeting attributes. What they can’t do is to use demographic elements. For instance, income, age, marital status, occupation or place of residence, just to name a few, are strictly forbidden.

Indicators from the bureaus such as how many trades a person has, the age of the oldest/latest trade, the total balance or how many delinquencies a person has can be used in a campaign. Issuers and bureaus themselves also try to use machine learning to build predictive models based on these legal attributes to gain an edge. The better the models are, the more efficient DM campaigns become.

Of course, offers with numerous benefits will excite prospects. As credit card is a fragmented business with a lot of competition, issuers cannot afford to come to prospects with bare bone offers. However, they must also think about their bottom line as rich products tend to be money-losers. Would you apply for a credit card with zero interest on balance transfer and purchase for 20 months, 2% cash back on everything and $400 bonus offer after spending $1,000 in the first 3 months? You likely would, but I can almost guarantee that the issuer of that card would not make a cent of profit. Hence, it’s all about finding that sweet spot between profitability and acquisition efficiency.

Additionally, mail design, paper quality, paper color and copywriting can contribute to the success of a campaign. I am sure you can recall seeing the same offer from the same company, but in different mail designs with different types of paper. Issuers conduct a lot of tests to see which paper or design can generate an extra basis point or two. Furthermore, the use of QR code can also help. USPS currently has a deal in which they will lower the postage expense if issuers use their Informed Delivery service. This is a numbers game. It’s all about finding those extra basis points in response rates.

Behind-The-Scene Details

Let’s start with promo/campaign codes. These codes are usually invisible to credit applicants. They are what issuers use internally to identify offers. In fact, each offer can have two promo codes: the parent code and the child code. The child promo code represents applicants that are upgraded or downgraded, depending on the setup of each campaign. For instance, anybody who applies for a Visa credit card and is awarded a credit line of more than $5,000 will receive a Signature card, instead of a Classic card. Signature cards carry more benefits and give more interchange revenue to issuers. The child promo codes for Visa campaigns are usually assigned to these “upgrades”. For Mastercard, the parent promo codes are given to the higher tier and the child codes are given to the “downgrades”.

What happens between bureaus and issuers? After an issuer finalizes a campaign’s strategy using criteria from a chosen bureau, the issuer will send the bureau such criteria and get back at least three files. The first file will go to the printing house and have some necessary information such as name, address, promo code or a unique identifier tagged to a mail piece called Solicitation ID. The file will not have people’s social security numbers. Nor will it have all the attributes that the bureau has at its disposal because the printing house doesn’t need to have such information.

The second file will go to the issuer and it has fields such as Solicitation ID, promo code and all the targeting attributes that the issuer and the bureau already agreed upon beforehand. These attributes will enable the issuer to analyze campaigns and see what can be the most predictive of success. Almost every issuer usually tasks its Machine Learning team to use multiple bureau attributes to come up with a predictive model so that it can use to generate more applications in future campaigns. Like the first, this second file will not have Social Security Numbers as Marketing or Machine Learning team does not need that kind of data.

The third file will also go to the issuer and be integrated into its decisioning engine. This file will have Social Security Number as Credit Risk and Operations will use it to make underwriting decisions. Of course, these teams don’t need all the targeting attributes as they are less relevant to them than to Marketing.

How do issuers deploy custom models? The answer is that issuers don’t “deploy” the models themselves. Credit bureaus do. After finalizing a model, an issuer will send the “formula” to its chosen credit bureau and the bureau will calculate the score based on such “formula”. The score will be appended to the appropriate files mentioned above and sent back to the issuer every campaign. The issuer will use the real performance data to validate the model and adjust, if necessary.

Every issuer must make sure that all models are in compliance with all lending regulations. Annually, the Office of the Comptroller of the Currency (OCC) conducts an audit to see if financial institutions comply with the regulations. Hence, every model must get approval from an issuer’s Compliance before deployment.

That’s all I have for today’s entry. I hope you find it useful. Drop me a line if you do or if you have questions.

Weekly reading 25th June 2022

What I wrote last week

Books on Payments

Supreme Court overturned Roe v Wade and took away abortion rights

Business

Inside the Reinvention of Albertsons Cos. The over-arching theme of Albertsons’ plan moving forward is to use technology and data to make decisions so that efficiency can improve and so does customer engagement. Grocery is a hard business. Margin is low and competition is fierce. Albertsons said their goal was to have shoppers complete grocery shopping at their stores without visiting rivals’ footprint while offering local assortments. It means that the selection has to be broad, but the stores at the same time cannot expand in size forever. They also need to keep a close eye on costs and margin as well. That would require a lot of data analytics, coordination in the case of omni-channel shopping and great execution.

($) Retailers’ Inventories Pile Up as Lead Times Grow. On top of the ever-changing consumer behavior and sky-high inflation, retailers now have to deal with long lead times in production which make it even more difficult to match demand with supply while keeping costs in check. Hold a lot of the wrong inventory to avoid supply chain and production issues, and you will be punished like Walmart or Target. Be nimble with inventory and you don’t have well-stocked shelves to woo customers. Hard times ahead.

Consumer watchdog eyes crackdown on credit card late fees as inflation threatens to increase them. If CFPB introduces regulations on late fees, it will affect how issuers generate revenue from credit cards. Late fee is a significant source of revenue by itself, but it also encourages consumers to pay off balance to avoid further penalty. If late fees are further capped or even outright banned, such an incentive will go away and consumers may carry more balance. It will increase risks and reduce revenue for issuers. It’ll be interesting to see how this develops.

($) Canada to Compel YouTube, TikTok and Streamers to Boost Domestic Content. I am generally supportive of having the right kind of regulations in place to help businesses. Hence, I would be in favor of the Canadian government giving these streamers incentives to promote Canadian creators’ work. I am not; however, ok with a government mandating a preference of local content.

($) GM and Ford, Driving to Beat Tesla, Turn on Each Other. An interesting read on how two iconic American car manufacturers are going at each other for market shares in the EV area.

($) How Singapore Got Its Manufacturing Mojo Back. “In courting factories like this, Singapore has become a rare wealthy country to reverse its manufacturing downturn. The city-state had faced industrial decline, with World Bank figures showing manufacturing falling to 18% of gross domestic product in 2013, from 27% in 2005. Then manufacturing made a comeback in Singapore, rising to 21% of GDP in 2020, according to the World Bank’s latest figures. Singapore has aggressively wooed highly automated factories with tax breaks, research partnerships, subsidized worker training and grants to local manufacturers to upgrade operations to better support multinational companies, among other enticements. There’s a caveat: Singapore’s success has come by automating away many jobs. It has more factory robots per employee than any country other than South Korea. Business executives say Singapore has succeeded because it has a welcoming, low-tax government and a strong base of English-speaking science, engineering and mathematics graduates and manufacturing managers. Relatively loose immigration laws make it easy to hire foreign engineers.  Executives also say they trust intellectual-property protection laws in Singapore, unlike in places like China where they sometimes worry their partners will copy their products.”

Source: Twitter

Other stuff I find interesting

Japan to subsidize TSMC’s Kumamoto plant by up to $3.5bn. Semiconductor companies get handsome subsidies from governments from all over the world. Japan will give TSMC $3.5 billion while Europe hands Intel billions of euros to build a plant there. That goes to show how countries value the strategic importance of semiconductor going forward

Why America Will Lose Semiconductors. A good run-down of problems that America faces in semiconductor. It’s a nice complementary read to the previous link

Friendly fungi help forests fight climate change. “A 2016 study led by researchers from Imperial College London revealed that one particular type – ectomycorrhizal fungi – enables certain trees to absorb CO2 faster (and therefore grow faster) than others. This is known as the “CO2 fertilisation effect”. These fungi live in the root system of a host tree. In a symbiotic relationship, fungi help the tree to absorb more water, carbon and other nutrients. In exchange, the tree provides food for the fungi by photosynthesising. Ectomycorrhizal fungi have also been found to slow down the process of rotting; decomposition breaks down all that locked-away carbon and releases it into the atmosphere. So the fungi, in effect, have two methods of fighting global warming.”

The most dangerous place on Earth. “Nestled on Lithuania’s southeastern border, Druskininkai opens onto a narrow notch of strategic territory known as the Suwałki Gap. Stretching about 100 kilometers along the Lithuanian-Polish frontier, between Belarus in the east and the Russian exclave of Kaliningrad to the west, Western military planners warn the area would likely be one of the Russian president’s first targets were he ever to choose to escalate the war in Ukraine into a kinetic confrontation with NATO.”

($) Erdogan Is Hung Up on the Power One Kurdish Woman Has in Sweden. “Amineh Kakabaveh’s journey from Peshmerga fighter to Kurdish refugee and then Swedish lawmaker has thrust her into her adopted homeland’s standoff with Turkey. Turkish President Recep Tayyip Erdogan is holding up Sweden’s application to join the NATO alliance, saying it harbors “terrorists” — his catch-all label for those with links to Kurdish militancy — and he’s hinted at Kakabaveh’s influence as a particular problem.”. Just an amazing story by Amineh

Stats

Edmunds reported that the average price of an EV exceeded $60,000

Since November 2021, more than $2 trillion in cryptocurrency value has evaporated

Covid vaccines saved 20 million lives in the first year

TikTok had $4 billion in revenue in 2021. Its US-based users spent on average 29 hours on the platform, compared to 16 hours on Facebook and 8 on Instagram

Source: IMF

Supreme Court overturned Roe v Wade and took away rights to abortion

Today, the Supreme Court overturned a long-standing precedent in Roe v Wade and outlawed abortion. The Court’s opinions were leaked a while ago, but when the news broke, it’s still as devastating.

When I was younger, I used to mistakenly think that the Founders were so brilliant that the Constitution stood the test of time with few changes. “How could they think THAT far ahead?”, I naively thought. The truth is that the more time I spend in the US, the more I realize that they did NOT think that far ahead. They did what they could and it’s nobody’s fault that they couldn’t foresee what happens almost 250 years later. How could they foresee the radicalization in ideologies that plague our society nowadays? How could they foresee a society where it’s more of a hobby to own a gun than a necessity and where guns kill children far too often than anyone could imagine? How could they foresee a society where women are NOT second-class citizens and they have rights to their bodies?

I understand that opinions on gun control and abortion vary significantly across the US. But in a democracy, the policies should reflect the will of the majority. The fact of the matter is that the majority of Americans support abortion and think it should be legal, at least to some extent. By declaring that the Constitution doesn’t automatically give citizens the rights to abortion, the Court allows states with draconian policies to dictate what women CANNOT do in any circumstances. How can we call this a democracy when the will of the majority is cruelly ignored?

A few days ago, the Supreme Court allowed open carry in the state of New York, citing the 2nd Amendment. Here is what the 2nd Amendment says

A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.

Since we tend to scrutinize every word in the Constitution, let’s look at the two key phrases: well regulated Militia and the right. America is the lone outlier among developed countries when it comes to gun homicide. And not for a good reason. It’s unthinkable how many mass shootings we have in the country. It’s even less fathomable to imagine teenagers that are not old enough to drink yet are old enough to buy military grade and kill kids at school. Does that sound like well regulated to you? Furthermore, if the Amendment itself includes the word “regulate”, more regulations on gun control do NOT mean the infringement of the rights. We have the right to express ourselves, yet we have a bunch of laws that dictate what we can or cannot do. Then how is it that we are more gung-ho on this gun control issue more than we are on others? Nobody ever proposed that we don’t have the right to bear arms. It’s just that we have the responsibility to make sure arms are in the right hands.

Why do I mention gun control? To demonstrate the head-spinning reality in the US. We allow open carry in public, discarding the risk to human life, yet we outlaw abortion because we want to protect fetus. It doesn’t sound logical to me. It doesn’t sound like a society well-run by the rule of law and common sense. It sure doesn’t sound like something worthy of the Greatest Country status.

As disappointed as I am today, I am more fearful for what is coming next. Appointments to the highest Court in the land are life-time. These judges are here to stay. Their ideologies are here to stay. For citizens to moot this kind of opinions from the Court, there must be codified laws. Unfortunately, Congress is as broken as they come. Given that Republicans are all but guaranteed to win back the House, the Senate and likely the White House as well, chances of new meaningful and reasonable laws to protect citizens’ rights and safety are as slim as none.

Below are some of the notes I took from reading the opinion of the dissenting Justices

The lone rationale for what the majority does today is that the right to elect an abortion is not “deeply rooted in history”: Not until Roe, the majority argues, did people think abortion fell within the Constitution’s guarantee of liberty. The same could be said, though, of most of the rights the majority claims it is not tampering with. The majority could write just as long an opinion showing, for example, that until the mid-20th century, “there was no support in American law for a constitutional right to obtain [contraceptives].” So one of two things must be true. Either the majority does not really believe in its own reasoning. Or if it does, all rights that have no history stretching back to the mid- 19th century are insecure. Either the mass of the majority’s opinion is hypocrisy, or additional constitutional rights are under threat. It is one or the other.

Source: https://www.supremecourt.gov/opinions/21pdf/19-1392_6j37.pdf

The Court knew that Americans hold profoundly different views about the “moral[ity]” of “terminating a pregnancy, even in its earliest stage.” And the Court recognized that “the State has legitimate interests from the outset of the preg- nancy in protecting” the “life of the fetus that may become a child.” So the Court struck a balance, as it often does when values and goals compete. It held that the State could prohibit abortions after fetal viability, so long as the ban contained exceptions to safeguard a woman’s life or health. It held that even before viability, the State could regulate the abortion procedure in multiple and meaningful ways. But until the viability line was crossed, the Court held, a State could not impose a “substantial obstacle” on a woman’s “right to elect the procedure” as she (not the government) thought proper, in light of all the circumstances and complexities of her own life.

Today, the Court discards that balance. It says that from the very moment of fertilization, a woman has no rights to speak of. A State can force her to bring a pregnancy to term, even at the steepest personal and familial costs. Some States have enacted laws extending to all forms of abortion procedure, including taking medication in one’s own home. They have passed laws without any exceptions for when the woman is the victim of rape or incest. Under those laws, a woman will have to bear her rapist’s child or a young girl her father’s—no matter if doing so will destroy her life.

Source: https://www.supremecourt.gov/opinions/21pdf/19-1392_6j37.pdf

The majority’s core legal postulate, then, is that we in the 21st century must read the Fourteenth Amendment just as its ratifiers did. And that is indeed what the majority emphasizes over and over again. If the ratifiers did not understand something as central to freedom, then neither can we. Or said more particularly: If those people did not understand reproductive rights as part of the guarantee of liberty conferred in the Fourteenth Amendment, then those rights do not exist.

As an initial matter, note a mistake in the just preceding sentence. We referred there to the “people” who ratified the Fourteenth Amendment: What rights did those “people” have in their heads at the time? But, of course, “people” did not ratify the Fourteenth Amendment. Men did. So it is perhaps not so surprising that the ratifiers were not perfectly attuned to the importance of reproductive rights for women’s liberty, or for their capacity to participate as equal members of our Nation. Indeed, the ratifiers—both in 1868 and when the original Constitution was approved in 1788 did not understand women as full members of the community embraced by the phrase “We the People.” In 1868, the first wave of American feminists were explicitly told—of course by men—that it was not their time to seek constitutional protections. (Women would not get even the vote for another half-century.) To be sure, most women in 1868 also had a foreshortened view of their rights: If most men could not then imagine giving women control over their bodies, most women could not imagine having that kind of auton- omy. But that takes away nothing from the core point. Those responsible for the original Constitution, including the Fourteenth Amendment, did not perceive women as equals, and did not recognize women’s rights. When the majority says that we must read our foundational charter as viewed at the time of ratification (except that we may also check it against the Dark Ages), it consigns women to second-class citizenship.

Source: https://www.supremecourt.gov/opinions/21pdf/19-1392_6j37.pdf

Stare decisis also “contributes to the integrity of our constitutional system of government” by ensuring that decisions “are founded in the law rather than in the proclivities of individuals.” As Hamilton wrote: It “avoid[s] an arbitrary discretion in the courts.” And as Blackstone said before him: It “keep[s] the scale of justice even and steady, and not liable to waver with every new judge’s opinion.”

So how does that approach prevent the “scale of justice” from “waver[ing] with every new judge’s opinion”? It does not. It makes radical change too easy and too fast, based on nothing more than the new views of new judges. The majority has overruled Roe and Casey for one and only one reason: because it has always despised them, and now it has the votes to discard them. The majority thereby substitutes a rule by judges for the rule of law.

Books on Payments

The payments industry is one of the most complex and interesting out there to me. A lot happen behind the scenes whenever we send out a rent payment through a checking account or buy a coffee with a swipe of our credit card. As consumers, we don’t know much about such complexities. Plenty of innovation over the years has gone into providing optionality as well as a smooth experience to consumers while helping out merchants and financial institutions achieve their business goals. It can be daunting and difficult to start learning about an industry as complex as payments, especially when there are numerous abstract concepts and jargon. But if you are really interested, I’d recommend these three books. They touch upon the general concepts, operational details of each payment method and more importantly, these books are written for laypeople like you and myself

The Anatomy of The Swipe

This book is focused more on credit and debit cards. You’ll learn about key concepts such as interchange, settlement, authorization, chargebacks, Know-Your-Customers (KYC), the parties involved in a card transaction and so on. You’ll learn about how money moves in a card transaction and how a merchant gets paid ultimately. The author did a great job explaining abstract concepts in an easy-to-understand manner. In fact, I gave this book to our intern who had had zero knowledge on payments as a crash course to our industry. He loved it. Hence, I think you too can learn a lot about card payments from this book. Check out my review here.

The Field Guide To The Global Payments

Launched earlier this month, The Field Guide to Global Payments covers more payment methods than just cards and it touches up on other countries than just the US. Because of the number of topics that it tries to cover, in my opinion, I don’t think it has the same depth as the other two books. Nonetheless, there are very interesting facts, stats and concepts covered that will trigger more research and investigation.

One of the earliest noted uses of the term “credit card” dates all the way back to 1887. In his utopian novel Looking Backward, Edward Bellamy described the concept of using a card for purchases; he used the term “credit card” eleven times in the novel. In 1946 the first bank card, Charg-It, was introduced by Brooklyn- based banker John Biggins. A user’s bill was forwarded to Flatbush National Bank, and the bank settled the amount with the merchant directly and collected the funds from the user’s bank account. Only a small number of merchants were supported by the program – those in a specific two-square-block radius – and the card could only be used by those who banked with FNB.

On the checkout page, the shopper fills in their payment details. Typically these are the PAN (payment account number, the sixteen digits on their card), the expiry of their card, the CVV (the three or four-digit security code), and their billing address. Pro tip: if you don’t send the AVS data (billing address information) in the authorization, you may get an interchange downgrade, which means, in short, that the transaction will cost you more as a merchant.

Taking on PCI compliance is a large decision – there are more than 1,800 pages of documentation and more than three hundred security controls, alongside yearly audits. There are four levels of PCI, which each have their own requirements that apply to different use cases. Partnering with a gateway, PSP, or standalone vendor to outsource PCI scope is the decision many merchants make because of this.

Merchants do, however, have a lot of agency in improving decline rates. Overall, in-store (POS) transactions tend to have very low decline rates, while ecommerce transactions can have 5 to 10 percent decline rates. Note that the prevalence of declines goes up for recurring transactions, like a subscription payment, or for cross-border transactions. High-risk merchants, like gambling or escort services (what many dating apps are considered by the card networks!), have even lower benchmark auth rates.

Visa’s excessive chargeback program is called the VDMP – Visa Dispute Monitoring Program. They divide the previous month’s chargebacks by that month’s total Visa transactions. If a merchant has 100 chargebacks and a chargeback ratio of at least 0.9 percent they are added to the program to be monitored. Mastercard has the ECP – Excessive Chargeback Program. The ECP divides the number of chargebacks in a single month by the total number of transactions in the previous month over Mastercard. Their threshold for entering the program is one hundred chargebacks and a ratio above 1.5 percent. In the event that a merchant hits these thresholds, they are notified by their acquirer who may also help them to get fraud levels below the threshold.

Signature debit cards get their name from the fact that a customer must sign the receipt during an in-store payment, and a merchant must subsequently authenticate that the signature on the receipt matches the signature on the back of the card. Signature debit transactions clear funds from the cardholder’s checking account same-day and are usually processed over Visa or MasterCard’s networks. PIN debit cards, however, are authenticated when the cardholder enters their PIN number on a point-of-sale device. Though the funds are also pulled from the cardholder’s checking account, they don’t always clear the same day. These transactions are also eligible for cashback. When you buy groceries and ask for $20 cash back, that transaction will be processed as a PIN debit transaction. There are many more PIN debit networks than the signature networks.

Payments Systems in The US

This book provides an overview of payments systems in the US with great details. First, it talks about payments and payments systems in the US in general. Then, it discusses each core system in details, ranging from the history of the system to what happens behind the curtain and what it is like today. The systems discussed in this book include checking, cards, ACH, wire transfer and cash. Then, it also provides the perspective of consumers as well as the banks before closing out with thoughts on payments innovation. It’s quite a long book, but if you are nerdy about payments, I’d recommend it.

In a net settlement system, the net obligations of participating intermediaries are calculated by the payment system on a periodic basis—most typically daily. At the end of the day, a participating intermediary is given a net settlement total and instructed either (a) to fund a settlement account with that amount, should it be in a net debit position, or (b) that there are funds available to draw on in its settlement account, should it be in a net credit position. Checking, card payments systems, and the ACH are all net settlement systems in the United States.

In a gross settlement system, each transaction settles as it is processed. With the Fedwire system, for example, a transaction is effected when the sending bank’s account at a Federal Reserve Bank is debited and the receiving bank’s account at a Federal Reserve Bank system is credited. No end-of-day settlement process is necessary in a gross settlement system.

Signature debit card interchange is lower than credit card interchange, and PIN debit interchange is even lower for unregulated debit card issuers. Larger debit card issuers (with over $10 billion in assets) receive regulated interchange rates that do not distinguish between signature or PIN debit usage.

Debit card authorization is more challenging than credit card authorization, as the bank must check against an ever-changing account balance. In the early days of debit, banks would authorize transactions (or have a processor authorize them) against a “shadow file” that could be hours or even days out of date. Now, however, most large banks handle authorizations dynamically against the “real” balance in the checking account.

Some payments networks are heavily resourced (i.e. have lots of money), enabling network-level investment in product definition, brand, risk management, and exception processing requirements. Visa, Mastercard, American Express and PayPal are all examples of what we call “thick model” networks. Other networks are thinly resourced, and manage only minimal interoperability issues, leaving functions such as product definition and brand to intermediaries. Check clearing houses, the ACH, and PIN debit networks are all examples of this “thin model.”

Closed loop networks, such as American Express, have card issuance policies similar to some provisions of the open-loop card network rules, so as to ensure interoperability for merchants and other users of the payments system. Merchant agreements, for similar reasons, are much like those of open-loop card networks. But a closed loop network is free to change such policies and agreements without the involved processes used by open-loop networks.

Closed loop systems have the advantage of simplicity. As one entity sets all of the rules and has a direct relationship with the end parties, it can act more quickly and more flexibly than the distributed open loop systems, which must propagate change throughout the system’s intermediary layers. The disadvantage of closed loop systems is that they are more difficult to grow than open loop systems; the payments system must sign up each end party individually.

Weekly reading 18th June 2022

What I wrote last week

Interchange and what influences it

Apple and Major League Soccer

Business

($) What Do Chinese Consumers Want? Walmart Can’t Figure It Out. Almost 30 years in the country and decades of experience in this industry, Walmart seems to lose grip in China. The stores aren’t an appeal that they once were. Walmart doesn’t seem to be able to offer what consumers want. Competitors are fierce. For good measure, the tension between America and China shows no signs of abating. Trouble is awaiting the largest retailer in the world in China.

Elon Musk’s regulatory woes mount as U.S. moves closer to recalling Tesla’s self-driving software. I admire Tesla, Musk and everything they have achieved. But I think it’s dangerous to create marketing materials touting full self-driving abilities when the vehicles are nowhere near that capabilities.

($) FanDuel CEO Amy Howe Wants to Help the Sports-Betting Business Grow Up. An interesting read into the market leader of sports betting. TIL, FanDuel had 70% of all sports betting platforms’ revenue generated in the state of Michigan in 2022 through April. Typically, it’s only about 5% of the amount wagered.

Maybe Bob Chapek Was Right. The tumult at Disney continues with the recent departure of Rice, a senior executive. Outsiders may not know the full story of what went down. Perhaps, Bob Chapek was right. Perhaps, it was just another example of how difficult life at the top is for him. Nonetheless, it really doesn’t matter how fair or unfair the criticisms on him are. The fact is that he is the CEO and the stock went down by almost 50%. Right or wrong, it’s on him and his record. I look forward to seeing whether they will adjust their subscriber target in the long run now that they no longer have the rights to the cricket league in India. Some said that Disney might lose 20 million subscribers in India. Others argue that it’s a blessing in disguise as a subscriber pays like 70 cents over there. Hence, losing a bunch of low-paying subscribers may boost ARPU and profitability, a premium in this market. The market’s reaction to a new target, if any, may influence Chapek’s tenure a lot.

($) Amazon CEO Andy Jassy’s First Year on the Job: Undoing Bezos-Led Overexpansion. A fascinating piece on Amazon that is unquestionably favorable to Andy Jassy and much less so to Jeff Bezos. I find it interesting that Amazon seems to shift the blame from Jassy onto Bezos for recent trouble with excessive fulfillment capacity. The founder and former CEO did make the decision to expand the capacity, but this sort of public admission while he is still the Executive Chairman definitely raised eyebrows.

($) One Grocer Wanted to Give Up Plastic. It Got Rotting Bananas. “When one of the best-known supermarket chains in the U.K. decided to remove plastic from its products, it hadn’t anticipated a spike in shoplifting. The zero-plastic drive also produced a series of unintended consequences that demonstrate how difficult it is for any company to shed plastic packaging entirely. When Iceland wrapped bananas in paper bands instead of plastic bags, the fruit rotted more quickly or snapped off. When it packed bread in opaque paper bags, sales fell as shoppers balked at buying something they couldn’t see. When it punched holes in paper bags filled with potatoes to make the contents more visible, the bags ripped. Bacon that isn’t wrapped in plastic quickly discolors, salad leaves wilt and unwrapped cucumbers rot more quickly.

Other stuff I find interesting

($) Biden Administration to Pursue Rule Requiring Less Nicotine in U.S. Cigarettes. FDA estimates that tobacco use costs the country $300 billion in direct healthcare expenses and lost productivity. A study published on the New England Journal of Medicine estimates that lower nicotine level will lead to 5 million additional adult smokers to quit smoking. If mandating a lower nicotine level in cigarettes results in fewer smokers and lower economic damages, FDA should press ahead and exercise their authority, knowing that the tobacco industry will take legal actions to protect their own interests

Downtown S.F. on the brink: It’s worse than it looks. The article goes into why remote work drives folks away from San Francisco and the downstream effects that such a migration can have on the city. I spent a few days in San Francisco last month. At no time did I ever feel safe due to the homeless folks on the streets. My team and I went around a bit by Uber and agreed that some areas were just too sketchy to live. Drivers there were just unbelievable. We had to report one Lyft driver because he literally scared us to death with his reckless driving. The living expense is so high there. One croissant and a small cup of coffee cost me $12, easily double what I’d pay in Omaha. It’s no wonder that white-collar workers moved away whenever they had a chance. When the engine that generates your city’s economy is leaving, it’s a serious challenge that demands different thinking.

Exclusive: inside Apple’s iOS 16 remake of the iPhone’s iconic Lock Screen. One thing you’ll notice from this piece is that the road to this Lock Screen feature started a while ago with work on its neural engine, chip and personalization effort on the Home Screen in iOS14. That’s typical of Apple. Have a product roadmap, put the pieces together and release only the things that work.

Opening a Restaurant in Boston Takes 92 Steps, 22 Forms, 17 Office Visits, and $5,554 in 12 Fees. Why? “The American Dream is besaddled by byzantine regulations. As the report shows, for example, opening a restaurant in Boston is a 92-step process. In Detroit, it’s 77 steps. In Atlanta, it’s 76. The report goes into great detail. That 92-step process to open a restaurant in Boston requires that 22 forms be completed, 17 in-person visits be made to government offices, 12 fees be paid, and nine government agencies be involved, at a total cost in government fees of $5,554. Opening a restaurant in San Francisco requires that 17 government fees be paid at a total cost of $22,648.” Indeed, why?

Stats

There were 31 million cigarette smokers in the US in 2020

1.5 billion users watch YouTube’s TikTok clone every month

14% of the U.S. population lives within rural communities

Apple and Major League Soccer

Yesterday, Apple and Major League Soccer (MLS) announced a deal that would make the Apple TV app the home of all MLS games globally in the next 10 years, starting in 2023. Fans will be able to stream all MLS games, with no blackout dates, through a subscription service only available on the Apple TV App. The League has not yet announced the details of said subscription, but are expected to do so in the coming months. Apple said the subscription would also feature highlights, replays, analyses and other original programming. Furthermore, the partnership will also seek to enhance coverage of MLS teams in Apple News and fans can watch highlights right from the News App.

Subscribers of Apple TV+, which is Apple’s own streaming service, can watch a few games at no additional cost. A limited number of games will be available for free, even to non-subscribers of Apple TV+. MLS season ticket holders will automatically receive a complimentary subscription to the MLS streaming service as an additional perk.

The two parties didn’t disclose the value of this deal, but folks familiar with the matter said that it’s worth at least $2.5 billion in its entirety, approximately $250 million a year. The current deal with ESPN+ is worth $90 million and will expire after this year. It was reported that MLS was hoping to make $300 million in annual revenue due to increasing viewership and popularity. Apart from this deal with Apple, MLS is also talking to a few cable companies over the rights to broadcast some games on linear TV.

Below is what each party had to say about this partnership:

For the first time in the history of sports, fans will be able to access everything from a major professional sports league in one place. It’s a dream come true for MLS fans, soccer fans, and anyone who loves sports. No fragmentation, no frustration — just the flexibility to sign up for one convenient service that gives you everything MLS, anywhere and anytime you want to watch. We can’t wait to make it easy for even more people to fall in love with MLS and root for their favorite club.”

Eddy Cue, Apple’s senior vice president of Services

Apple is the perfect partner to further accelerate the growth of MLS and deepen the connection between our clubs and their fans. Given Apple’s ability to create a best-in-class user experience and to reach fans everywhere, it’ll be incredibly easy to enjoy MLS matches anywhere, whether you’re a super fan or casual viewer.”

Don Garber, MLS’s commissioner

Why MLS picked Apple?

In my opinion, it’s about reach and accessibility. A unique part of this deal is that Apple secured the streaming rights globally, not just within the US; which is very different from the usual practice of rights being given over select geographical areas. Apple is one of, if not, the most global and recognizable brands in the world. Its Apple TV app is available on many types of devices, not just those that run on Apple operating systems. By working with Apple, MLS has a partner that can bring the game to the global audience instantly. There is no need for MLS to set up its streaming service. It’s not an easy task, especially for a global audience. With this deal, MLS is responsible for generating content and Apple will take care of the distribution. Moreover, the Apple TV app is native on Apple devices and doesn’t require any more installation. Fans can just head to the app and subscribe to the MLS service; which the Commissioner already alluded to in his remark.

The second reason is reach. Everything Apple does is widely covered and followed. This blog entry is one example. Apple can use its massive following and Marketing expertise to increase the awareness of MLS and help the League become more global. I have no doubt that we’ll see more ads from Apple about this deal, more mentions during events & earning calls, as well as more articles from news outlets, fans and bloggers. From the League perspective, instead of running Marketing campaigns in each part of the world, either by itself or partnering with an agency, I imagine that leveraging Apple is easier and more effective.

Why Apple partnered with MLS?

I find this comment from Don Garber, the Commissioner of MLS, very interesting

This is a minimum guarantee. It’s not a rights fee,” Garber said of the non-traditional deal. “…So if we exceed the minimum guarantee, then we share in the upside in that guarantee. If we’re able to sell our linear rights for what we hope and expect to sell them for, then we would even exceed our expectations.

Source: Tennessean

The new MLS subscription service is only available through the Apple TV app. Hence, Apple will be the one collecting the subscription dollars upfront and grow its Services revenue, at least on the surface. Based on the comment from the Commissioner, I figure no matter how much revenue the MLS streaming service brings in, Apple will pay the League at least $250 million a year. Past that figure, the tech giant will be able to take a share of the upside. It’s clear that this arrangement will do two things: 1/ Apple has something exclusive to sell to its customers; 2/ MLS will have a partner incentivized to promote the League globally as much as possible. With a lot of cash and 73% in Services’ gross margin, I think Apple can afford the $250 million figure promised to MLS.

If an MLS subscription costs $100/year or less than $10/month, Apple will need at least 2.5 million subscribers around the world for it to actually make any money from selling the service itself. Given the current awareness of MLS, especially to countries outside the US, is 2.5 million subscribers an attainable threshold? Unlikely in my opinion, but over a long term, who knows? The financial success of this partnership for Apple hinges on the future popularity of MLS. There are a couple of factors that may come in handy:

The first is that the World Cup 2026 will be hosted by Canada, the US and Mexico. As the world’s biggest soccer event, the World Cup will undoubtedly raise the awareness of soccer as a sport and of MLS. Currently having 28 teams, the League will add one more next year and plan to eventually feature 32 teams in the near future. The more local teams there are, the more interest such teams will generate among communities.

The second factor is the arrival of superstars who make their names in Europe and have massive global following. We already saw household names join the MLS in the past, including David Beckham, Thierry Henry, Zlatan Ibrahimovic, Wayne Rooney, Frank Lampard, Steven Gerrard and David Villa. Recently, Giorgio Chiellini, a popular Italian veteran, signed a deal with LAFC. But MLS would rise to a whole new level if it could acquire superstars such as Messi or Suarez. These players did it all in Europe and are already rumored to play in the US soon due to the media & business landscape as well as the Latino fanbase in the country. The arrival of legends such as Messi would be an instant boost to the MLS and its streaming service.

Apple wants to keep existing customers loyal and appeal to new ones. Sports are a great way to consumers’ heart and Apple seems to agree. Before the partnership with MLS, it struck a deal with Major League Baseball to broadcast games on Friday nights. There were reports that claimed Apple already secured rights to NFL games on Sunday nights. All this sports content will enrich the Apple digital ecosystem and help the company make more money. Two possibilities that I can think of:

  • Apple TV+ is natively available on Apple devices through the Apple TV app. Android users can also access the streaming service, but only through browsers. That’s inconvenient. Great sports content on Apple TV+ can give a nudge to on-the-fence Android users to switch to Apple devices. Whatever money the company lost on this front can be made up by higher margin services (Apple Care, Ads, iCloud, payments, etc..) and slightly more expensive devices
  • At $4.99/month, Apple TV+ is one of the cheapest options on the market. With more games in the library now, Apple can make a case to raise the subscription price. Even a $1 increase could lead to millions more in revenue

From my perspective, this is a good partnership for both parties, more so for MLS than Apple, given its current level of popularity globally. But Apple is known for its patience and long-term planning. The company must have a plan in mind and I am curious to learn more about it.

Interchange and the major factors that can influence it

Have you ever wondered why some merchants enforce an additional fee when customers pay with credit cards? Or why do some merchants politely request customers to pay by cash when a purchase is less than $5? Or why can some fintech startups offer debit cards with rewards when big banks don’t seem to bother?

The answer is Interchange. Cash has been the medium of transactions for centuries. When a shopper hands cash to a merchant in exchange for goods or services, the merchant takes 100% the amount of such exchange and deals with taxes when the time comes. The problem with cash is that 1/ storing a large amount of cash requires a lot of effort for merchants and 2/ not many customers find it convenient to carry cash around, especially for large transactions. Card transactions bring convenience. Merchants get paid in the form of increased balance in a bank account while consumers can spend without carrying a thick purse or wallet. With credit cards, consumers can transact on the credit line extended by a financial institution. But as the old saying “there is no free lunch” goes, such convenience comes at a cost and that cost is Interchange.

Interchange is a small fee that merchants have to pay on every card transaction. The recipient of interchange is financial institutions (FIs) that issue debit or credit cards to shoppers. These FIs use this revenue stream to either pay for their operational expenses or fund rewards that are promised to consumers. Since doing business nowadays always involves card payments, interchange is one of the expenses that merchants can’t avoid.

How much do merchants have to pay on every transaction? The amount of interchange is determined by interchange rates mandated by networks such as Visa, Mastercard, Discover or American Express. There are a lot of factors that can influence these rates and below is a list of factors that I know (by no means, it’s an exhaustive list):

Merchant Category Code

Merchant Category Code (MCC) is a 4-digit code that represents the type of business area in which a merchant operates. For instance, 5411 refers to grocery stores while 5300 represents wholesale clubs. Some companies such as Walmart or Amazon can span across multiple MCCs because of the breadth of their offerings while others like mom-and-pop restaurants have only one MCC. In some industries, including airlines or hotels, a merchant can have its own code. For instance, 3000 and 3001 are assigned to United Airlines and American Airlines respectively.

High frequency categories such as Gas and Grocery carry low interchange rates while others such as Dining or Travel fetch higher rates. Whenever there is a push to promote a specific area, networks raise the interchange rates as an incentive for card issuers. Take Electric Vehicle Charging 5552 as an example. Its rate for consumer cards is 3%+ which is much higher than the average 1.7% across other categories.

Sometimes, it’s easy for consumers to guess MCCs of their purchases. However, it’s much trickier when it comes to big merchants such as Walmart or Amazon. The only way to know is to wait for the transaction to be posted.

Merchant

Giant merchants such as Costco, Walmart or Amazon command great bargaining power and can negotiate a special low rate with the networks. Think about it this way. The rates that I have seen for these companies are around 0.7%. At $500 billion in annual revenue that the likes of Amazon or Walmart generate, interchange expense amounts to $35 million a year. If they had to pay 1.4% in interchange, the expense would double to $70 million. Their retail business margin is not big enough for them to ignore that difference.

Card-Present or Card-Not-Present

A transaction is considered as “card present” only if a card is swiped or tapped or if an EMV chip is processed. A transaction by fax, Internet, mail or over the phone is considered “card not present”. Since card-not-present transactions do not require a cardholder or a physical card to be present at the time of the transactions, the risk of fraud is higher. Hence, issuers receive higher interchange rates on CNP transactions for taking on additional risks.

Networks

There are a few major networks such as Visa, Mastercard, Discover, American Express and JCB. Each has its own pricing schemes and that can affect the rates that merchants have to pay.

Plastic Type

The type of your card also influences interchange rates significantly. On the Visa Consumer side, there are usually three types of cards: Visa Classic, Visa Signature and its highest tier, Visa Signature Preferred. Visa Signature Preferred comes with much higher rates than Classic or Signature. Normally, if your credit limit is above $5,000, your card is qualified for Signature. To qualify for Signature Preferred, a cardholder typically needs to meet a certain spend threshold. To my knowledge, an issuer sends a list of cardholders that meet certain criteria to Visa so that they can flagged as Signature Preferred. If successful, the issuer can earn a decent amount of additional interchange revenue. On the Mastercard, there are also similar schemes and tiers.

Consumer or Commercial

The rule of thumb is that commercial credit cards have higher interchange rates than consumer cards.

Credit or Debit

Credit cards command higher interchange rates than debit cards, simply because credit cards are much riskier as a product than debit cards.

Purchase Volume

Sometimes, the size of a transaction can affect how much merchants have to pay. For instance, American Express has different rates for different ticket size tiers across key categories. Typically, the bigger a transaction, the higher the interchange rates.

Point of Entry

If you shop in store, whether you use an EMV chip, swipe your card, tap your plastic on the card reader or pay with a mobile wallet can affect the interchange rate of that transaction. To make it more complex, the type of mobile wallet that consumers use is also a factor. For instance, staged wallets (PayPal, Cash App) which break down a transaction into funding and payment stages command slightly higher rates than pass-through wallets (Apple Pay, Samsung Pay) that pass payment details directly to merchants. The alleged reason why there is such a difference is that staged wallet providers do not provide as much information regarding payments as the networks would like and that could make the verification task a tad more challenging.

Regulations

To help smaller banks compete, the US government allows debit card issuers with less than $10 billion in assets to charge significantly higher interchange rates than bigger issuers. That’s usually known as the Durbin Amendment. Fintech companies use this loophole to partner with small less known banks to offer debit cards with rewards. In many countries, including the European Union, interchange rates are capped by laws and much lower than what we see here in the US.

Weekly reading – 11th June 2022

What I wrote last week

Apple Pay Later

Business

Macy’s, Gap and Other Clothing Stores Are Stuck With the Wrong Items. An interesting report on how retailers got forecasting and inventory badly wrong. Macy’s, Walmart, Gap, Kohl’s, just to name a few, have a lot of inventory that they can’t sell at the moment or at least can’t sell fast enough. Remember that the executives at such companies are experienced and paid handsomely to nail down forecast. The fact that their calculations are so far off shows how unpredictable consumer behavior changes in this environment

Grocery’s Greatest Stories. Progressive Grocer has an interesting multi-part series on the history of grocers in the U.S, ranging from the start of Albersons or Walmart to the acquisition of Whole Foods by Amazon.

Axon Ditches Plans for Weaponized Taser Drones as Majority of Ethics Board Resigns. It’s a dangerous, revenue-driven and badly-conceived idea to develop drones to address mass-shootings. What are they trying to achieve with this kind of products? Who would fly these drones and could those drones even navigate through schools’ hallways? If a shooter knows about the drones, comes to a school, shoots people and leaves quickly before anyone could even fire up those expensive toys, what good would it be? More importantly, what if these drones fell into the wrong hands? I am happy that folks on Axon’s Ethics Board stood up for what they believed in and resigned in protest. As a shareholder of Axon, I am disappointed.

Charlie Munger: Full Transcript of Daily Journal’s 2022 Annual Meeting. It’s mind-blowing that Charlie Munger can be this clear in his thinking at 98. I am such a strong admirer of him.

Ferrari boss Mattia Binotto explains five-year journey back to top end of F1. It’s down to the people and the “no blame” culture, not the machinery. This issue is about the painful recovery of Ferrari. As the most famous and successful team in F1, Ferrari has disappointingly failed to win a title since 2008. 2020 was the worst year on record. The car was as slow as a tractor. However, Ferrari has bounced back amid the largest rule changes in the last few years. The Prancing Horse won the most poles this year, bagged two wins and are the two top teams of the paddock along with Red Bull.

How Two Africans Overcame Bias To Build A Startup Worth Billions. A sneak peek into the fintech startup scene in Africa. Much as I admire the two men on the cover, I was abhorred by the fact that a VC firm wanted a discount because Chipper Cash is from Africa.

Engineer Who Fled Charges of Stealing Chip Technology in US Now Thrives in China. Semiconductor is so important that whatever country “owns” it will have outsized influence in the world. China wants global domination and definitely doesn’t want to be beholden to any country for chips. Yet, semiconductor is the one area that it still lags behind other advanced nations. Hence, it resorts to theft of intellectual property to close the gap. It deserves every condemnation there is.

Behind Apple’s Megadeal for Brad Pitt Formula One Racing Film From Joseph Kosinski. “The key to the deal is a theatrical distribution component. But instead of a token release in a small number of theaters or a day-and-date opening, the movie would have an exclusive — and global — run of at least 30 days (one source says it could even go as high as 60 days) before heading to the Apple TV+ platform. In another first, insiders say the theatrical component is structured in a way that would see Apple and the filmmakers split the take from the big-screen release 50-50. The unique deal, in essence, pays the creative team three ways: their upfront fees, their hefty buyout fees and the theatrical backend.”

Other stuff I find interesting

Cao Bang – a green pearl in northeastern mountains. Imposing, magnificent and beautiful Cao Bang in Vietnam

How to buy a chicken sandwich in Shenzhen. Fascinating read on the livestream e-commerce space in China. Total Addressable Market is estimated at $100 billion. In 2021, there were 461 million people who shopped on livestream in China.

The New LaGuardia Is Haunted by the Mistakes of its Past. An interesting read on the redesign of LaGuardia airport. I was there a few months ago and I had to say that I was surprised to see the modernity of the airport. I still held onto this notion that LaGuardia was this old place in a decaying condition. Landing in the new Terminal B from Omaha was an eye-opener. Hence, it’s great to read the context on why the airport went through such a transformation

Adult Children of Work-Visa Recipients Forced to Return to Parents’ Countries. It’s just terribly sad to read that children of Dreamers have to voluntarily leave the US because they cannot get a valid status. It is NOT their fault at all. The only thing that is wrong for them is to spend most of their lives in a country with a broken immigration system. Look at the biggest companies in the US and in the world. From which country are their CEOs? India! Then, how come do we need to make them wait for years and years to get a Green Card? It’s insanely infuriating.

The epic story behind the Ferrari and Lamborghini rivalry. A great story and reminder that you should not piss off your customers

Stats

Average Order Value at the top-performing quartile grocers is 46% higher than that of the other stores

Walmart is building 4 next-generation fulfillment centers in the next 3 years that can provide next-or-two-day shipping to 75% of the US population

Nearly 20 million people watched the Jan 6. hearing

Pokemon Go surpassed $6 billion in lifetime player spending

Food-at-home prices in May up 11.9% from a year ago

Apple Pay Later

WWDC is where Apple shows off its new software updates and sets the expectation for what is to come in the next year. It kicked off on Monday with a flurry of announcements on iOS16, MacOS Ventury, watchOS 9 and iPadOS 16. Among these announcements, I want to focus on one that is really interesting from a financial product standpoint and, to me, the next step forward towards making Apple not just a consumer brand. Per Apple on Monday:

Apple Pay Later provides users in the US with a seamless and secure way to split the cost of an Apple Pay purchase into four equal payments spread over six weeks, with zero interest and no fees of any kind.3 Built into Apple Wallet and designed with users’ financial health in mind, Apple Pay Later makes it easy to view, track, and repay Apple Pay Later payments within Wallet. Users can apply for Apple Pay Later when they are checking out with Apple Pay, or in Wallet. Apple Pay Later is available everywhere Apple Pay is accepted online or in-app, using the Mastercard network.4 Additionally, with Apple Pay Order Tracking, users can receive detailed receipts and order tracking information in Wallet for Apple Pay purchases with participating merchants.

When the news on the service broke on Monday, it triggered a lot of questions due to the lack of details. Until yesterday when Apple agreed to disclose more information. Per CNBC:

A wholly owned subsidiary of Apple will check user credit and extend short-term loans to users for Apple Pay Later, the tech giant said. Apple has partnered with Mastercard, which interacts with the vendors and offers a white label BNPL product called Installments, which Apple is using. Apple Card issuer Goldman Sachs also is involved as the technical issuer of the loans and is the official BIN sponsor, the company said. But Apple is not using Goldman’s credit decisions or its balance sheet for issuing the loans.

Apple will run a soft credit check to ensure that borrowers are capable of paying back the loans, which will likely be capped at around $1,000, the company said. If Apple Pay Later loans aren’t repaid, then Apple will no longer extend those users credit. But the company said it won’t report the missed payments to credit bureaus. Apple will initially launch Pay Later in the United States

Per Bloomberg:

A wholly owned subsidiary will oversee credit checks and make decisions on loans for the service, which is called Apple Pay Later. The business — Apple Financing LLC — has necessary state lending licenses to offer the feature, though it operates separately from the main Apple corporation, the company said in response to Bloomberg questions. 

Apple has been working to move many elements of its financial services in-house as part of a secret initiative dubbed “Breakout.” In addition to taking on lending, credit checks and decision-making, Apple is working on its own payment processing engine that may eventually replace CoreCard Corp., Bloomberg reported in March. It’s also working on new customer-service functions, fraud analysis, tools for calculating interest and rewards for other services.

The company is also working on a longer-term “buy now, pay later” program called Apple Pay Monthly Installments, Bloomberg has reported. While the shorter-term Apple Pay Later offering doesn’t use Goldman Sachs or other major partners, the longer-term plan is likely to rely on an array of other companies — including Goldman Sachs — that could offer different plans and interest rates. 

The new revelations shattered some of my original assumptions. At first, I thought users could turn on the payment plan after the fact, just like what Affirm Debit+, American Express or Chase offers. Now, it seems shoppers have to choose upfront whether to use an installment plan. Second, I didn’t expect Apple to go as far as securing state licenses in order to offer loans. The report from Bloomberg suggested that the company had a long-term and ambitious plan regarding financial services, a plan that is big enough for them to take on more compliance work, the underwriting itself and possibly the loan balance on its balance sheet. Nonetheless, because this is Apple, a company known for being a control freak over user experience and key capabilities, its desire to underwrite loans, process payments and battle fraud are totally on brand.

Even though the newly reported details are helpful, I still have some lingering questions that I’d love to understand more:

  • The transaction amount is currently capped at $1,000. Is there a minimum limit? Can I still go to a restaurant and put my dinner expense of $20 on a payment plan?
  • Apple Pay Later is slated to go live in the US later this year; which is not a surprise. If there is a plan to expand internationally, how long will that take? Apple Card went live almost three years ago and it’s still exclusively available in the US
  • Costco doesn’t accept Mastercard at its stores. Can I still use Apple Pay Later there? That seems like a significant use case for shoppers in the US
  • What does the application process look like? I can’t imagine that any cashier or customer would wait comfortably for a two-minute in-store Apple Pay Later transaction
  • iPhone is very popular among young folks who don’t have a lot of credit history. This type of financial product definitely resonates with them. How much risks would Apple tolerate from this population?
  • What is the unit economics of a transaction? How much would Apple charge merchants?

BNPL providers usually charge 2-6% of a transaction amount. These providers argue that they earn this cut because they raise the average order volume (AOV) as well as bring more leads to a business. While Apple Pay Later will also help merchants increase the AOV, what would Apple do to generate more leads at the top of the funnel? We already see promotional emails like this from Apple, but will Apple add a Deals tab somewhere in the Wallet?

Implication for Apple’s future

For the argument sake, let’s assume Apple will earn in revenue 3% of all Apple Pay Later transaction amount, including the 0.15% cut it already has on every Apple Pay transaction. Affirm did $13 billion in loan volume in the US in the last 12 months. If Apple Pay Later had the same volume, a 3% cut means that the company would earn almost $400 million in revenue, before expenses. It’s not nothing, but it’s still essentially a rounding error for a machine that generated $365 billion in revenue last year.

The bulk of the value that Apple Pay Later brings is to increase the stickiness of the Apple ecosystem. Existing users have one more reason to stay locked in. Those on the fence have one more reason to lean towards Apple. Merchants will be more motivated to add Apple Pay to their checkout pages. Regarding merchants, I do think Apple has a big plan in place to become more than just a consumer brand.

Going back to the first announcement, buried inside the text and overshadowed by the installment product is the fact that consumers will soon be able to track orders from Wallet on Apple Pay purchases. For this to happen, Wallet will effectively become an ordering system where merchants can process orders and have the delivery status updated. Instead of having an iphone as a payment reader and another software as an ordering system, Wallet can function as both. All a merchant needs is an iPhone. Here is how I see it:

First, Apple launched Apple Business Essentials, a subscription program that helps small companies manage their Apple devices. Then, the company introduced Tap To Pay with iPhone, which allows merchants to use their iPhone as a payment terminal without any extra hardware. A few days ago, Block (Square) said that they would bring Tap To Pay with iPhone to Square sellers who can use their Square POS app on an iPhone to receive payments in stores. Next, Apple Pay Later offers another payment option to shoppers and all the benefits that BNPL can bring to sellers, including higher average ticket value and conversion rates. Last but not least, merchants can use Wallet as an ordering system. Can you see the picture now? Payment is an integral part of doing business nowadays. If Apple devices and services can become integral to companies’ payments, Apple will have a stronger case for Apple Business Essentials. Far-fetched? Perhaps, but I am curious to see if my prediction comes true.

Implications for other BNPL providers

CEOs of Klarna and Affirm already got on TV to appear defiant and confident in the outlook of their business. But I suspect that the last few days already triggered some serious discussions in the boardrooms. How could they not take this seriously? Apple has some advantages that none of these BNPL firms have. First, Apple is one of, if not the most, recognizable and talked about brands in the world. It doesn’t have the brand awareness debt that a newcomer in this space would have. Second, Wallet is a native app that lives on Apple devices by default and requires no further download. If shoppers don’t have BNPL apps downloaded beforehand, the only way these firms can process loans is through merchants’ checkout pages. Unfortunately for them, Apple Pay is at least as popular a checkout button as any. Plus, if Apple can manage to push Apple Pay Later to Apple Watch, I don’t see how Affirm or Klarna or PayPal can get there to compete. Third, some BNPL firms are required to pay interests and expenses on the loans they generate. Apple, on the other hand, has an otherworldly balance sheet and generates cash as well as any company in the world. That should give Apple advantage in terms of unit economics. For now, Apple only offers one flavor of BNPL, but as Bloomberg reported, there are more to come. Hence, whatever advantage on product offerings that the likes of Affirm or Klarna have over Apple may soon evaporate.

Do I believe that this is a winner-takes-all space? No. BNPL firms will still have their space with their loyal followers and non-iOS users. However, their growth will likely be capped with the introduction of Apple Pay Later. I expect that we’ll see moves from these providers in the near future as they will try to bolster their positions while Apple Pay Later gets its feet wet.

In short, as someone who is interested in payments and invested in the future health of Apple as a company, I am excited about Apple Pay Later. Not only the service, but also what Apple does to launch it the way they do, I believe, will have an impact on the business. Personally, I am curious to see if my prediction on Apple Business Essentials will ring true. I also want to see how the BNPL space will change with the arrival of Apple Pay Later. Some already cast demise on BNPL providers as they are now just a feature that Apple offers. But I am skeptical of that view. The space is big and just because you compete with Apple, it doesn’t mean you can’t survive or grow.

Weekly reading – 4th June 2022

What I wrote last week

Book Review: Trillion Dollar Triage

How Walmart Is Betting On Stores To Catch Amazon In E-Commerce

Business

Amazon Briefing: One year into Andy Jassy’s tenure, sellers see subtle strategic shifts. Under Bezos, Amazon was maniacal about being consumer-oriented. Using the iron grip on consumers, especially Prime members, Amazon managed to exert their bargaining power on merchants. According to the article, there are already subtle changes under Jassy regarding how to work with merchants. Merchants have more dialogue with senior folks from Amazon, but they are expected to spend more on ads and prove their unit economics value to Amazon. The push to grow ads revenue may have one important downstream effect: if shoppers are bombarded with sponsored items instead of what are best for them, there is no telling how that could damage Amazon and loosen their grip on prized Prime members

The first act of the streaming wars saga is over — Netflix’s fall from grace has ushered in the pivotal second act. The first phase is to establish presence. Now, all these streamers need to figure out some tough questions. First, how can they make money while spending a lot of money on content? Streaming is an arms race. You need great content all the time to acquire and retain subscribers. But investors’ patience is wearing thin. They want to see profits. Hence, streamers have a tough balancing act on hands. Secondly, ads or no ads? Disney+ and Netflix are planning to go live with ads-supported plans later this year. However, ads is not a trivial business. There is also a question of consumer experience. Additionally, expanding internationally or not expanding? An international expansion requires extra investments in marketing and content. If you go to India without local content at a dirt cheap price, you won’t win the battle. But this goes back to the first question. If a streamer spends too much on content and marketing, how can it turn profits? All in all, such an interesting space to keep an eye on

Facing Inflation-Weary Shoppers, Grocers Fight Price Increases. As inflation keeps rising, consumers turn to private labels instead of more expensive national brands. Private labels give grocers a higher margin, but the key here is to keep customers happy while resisting the pressure from vendors. Those who can make shoppers happy in tough times like this may get the permanent business in the long run. For me, Aldi has been my go-to grocer for a long time with their highly competitive grocery prices.

Bull Market Rhymes. “I don’t think investors are actually forgetful.  Rather, knowledge of history and the appropriateness of prudence sit on one side of the balance, and the dream of getting rich sits on the other.  The latter always wins.  Memory, prudence, realism, and risk aversion would only get in the way of that dream.  For this reason, reasonable concerns are regularly dismissed when bull markets get going. “

Spotify Podcasters Are Making $18,000 a Month With Nothing But White Noise. Who would have thought that white noise could be a lucrative podcast category?

Other stuff I find interesting

Sun-Starved Sweden Turns to Solar to Fill Power Void. It’s intriguing that Sweden shut down two nuclear plants and relies on solar power for electricity despite lacking sunlight for a long period of time in a year.

While Electric Vehicles Proliferate, Charging Stations Lag Behind. There are 93,000 public charging stations in the country, but it’s estimated that we need 1.2 million more. That’s how much we are lagging behind. The governments, local or federal, need to take a lead in this and perhaps losses too in the beginning to encourage more purchase and usage of electric vehicles.

90% of Women in India Are Shut Out of the Workforce. I have to say that this is an eye-opening yet disappointing read. I 100% support gender equality. To me, there is absolutely no reason why female can’t work or receive the same level of treatment as men do. Hence, it’s insane to think that only 10% of women in a country with 1.3 billion people in population are working. How much more productivity could be unlocked if women could work?

AC Milan’s ‘Mind Room’: The story behind an innovative psychology lab. Fascinating!

Here’s why you shouldn’t miss ‘bột chiên’ while in Ho Chi Minh City. It’s one of my all-time favorite dishes in Vietnam and Saigon. You don’t experience the local cuisine until you try it

Stats

Disney+ Hotstar Hits 5 Million Subscribers in Indonesia

App Store stopped nearly $1.5 billion in fraudulent transactions in 2021

Safari reached one billion worldwide users

Source: Federal Reserve Bank of San Francisco