Super Apps

In this post, I’ll touch upon briefly the definition of a Super App, give a few examples and talk about the business implications of these apps.

The term Super Apps is generally credited to Mike Lazaridi, the founder of Blackberry, who defined it as “a closed ecosystem of many apps that people would use every day because they offer such a seamless, integrated, contextualized and efficient experience”. In laymen’s terms, a Super App is an application that offers various services on one interface. While the mix of services offered by Super Apps varies from one to another, the common denominators of these apps are 1/ they are all two-sided networks popular with both merchants and consumers and 2/ they all began their journey by being excellent in one function before branching out to others. Merchants need to have access to a lot of consumers to join a network while consumers only find the network useful when there is a lot of utility, namely plenty of merchants. The chicken and egg problem of a two-sided network is hard. Therefore, the singular focus on a vertical in the beginning makes sense as start-ups can’t afford to solve this issue in multiple verticals. No-one can build a Super App right from the get-go. Once an app excels and makes a name for itself in a vertical, why not leveraging existing traffic and offering users more reasons to stick around longer?

Examples of Super Apps

WeChat

WeChat started out as a messenger app. An engineer named Allen Zhang alerted his employer Tencent on a threat of other competitors taking away its market share and app engagement. To stay competitive, WeChat transformed itself into an app on which users could do everyday things on a single interface including payments, social media, e-commerce, doctor appointments, hotel reservation or ride-hailing. The pivot was a hit as the new services surpassed even the apps that inspired WeChat in the first place. 

Facebook

Facebook and its founding story need little introduction. Over the years, Facebook has added several services to make itself stickier as a platform. Nowadays, users can shop on a marketplace or Facebook-native stores; create new connections with Facebook’s own Tinder version; make payments with Facebook Pay or consume exclusive content from creators. With its ambition and virtually limitless resources, it won’t be a surprise that Facebook or Meta will expand its offerings in the future.  

Grab

The title of grab.com reads “Grab: The Everyday Everything App”. Its status as one of the biggest Super Apps in Southeast Asia is so different from its humble beginning. Grab was founded as a taxi-hailing business in Malaysia in 2012 by two Harvard graduates. The company gradually expanded into other areas, such as other modes of ride-hailing, food delivery & nonfood delivery, travel bookings, bill payment and financial services. In Vietnam, almost everyone in big cities uses Grab for daily tasks from food delivery, ride-sharing or bill payments.

What Grab mobile app looks like in Vietnam
Figure 1 – What Grab mobile app looks like in Vietnam

Uber

Uber was founded in 2009 by Travis Kalanick and Garrett Camp as a ride-hailing alternative to taxies. The company’s meteoric rise saw it become a global phenomenon, but the company today is more than just a ride-hailing app. In 2014, Uber launched a food delivery service called Uber Eats, which was later rebranded under Delivery. While Covid-19 decimated the Mobility segment (ride-sharing) as riders were restricted by stay-at-home orders, the pandemic was a catalyst for the transformation of Uber as a whole. Delivery has been growing substantially due to consumers ordering food and grocery deliveries. Its gross bookings have repeatedly surpassed Mobility’s and now reaches Mobility’s pre-pandemic level. Second, the company has made strategic acquisitions to expand beyond food delivery. In June 2020, Uber acquired Cornership, a popular grocery delivery service in Latin America. A few months after, it added Postmates, which is very competitive in coastal cities and offers delivery-as-a-service for non-food items. In October 2021, Uber took over an alcohol delivery startup called Drizly. The company has been tinkering with marijuana delivery in Canada and waiting for the green light from the federal government before launching it in the U.S. Powered by the new capabilities, nonfood categories make up around 5-6% of Uber’s overall gross bookings and are expected to grow more in the future. Uber’s ambition is very simple: be the go-to app when consumers have a transportation need. 

PayPal

PayPal first made a name for itself by being a secure digital wallet and online payment system, especially as the primary checkout option on eBay. Since its spin-off from eBay in 2014, the company has added plenty of services to its mobile app and become a formidable two-sided network, due to relentless acquisitions and product development. End users can access various services on the current PayPal app, including paycheck deposit, high-interest savings, bill payment, remittance, credit cards, debit cards, in-store & online payment, BNPL, PayPal Credit, P2P payment, shopping deals and investing. PayPal’s end goal is to be the go-to Financial app for its users.

PayPal's offerings to consumers and merchants
Figure 2 – PayPal’s offerings to consumers and merchants. Source: PayPal

Cash App

Cash App started out as a P2P payment app in which users could transfer funds to anybody in the U.S. Nowadays, users can pay for purchases in stores and online with Cash App debit card and Cash App Pay; invest in stocks and cryptocurrency; or make deposits into checking accounts. In November 2020, Square bought the tax filing division of Credit Karma and subsequently added to its flagship app the ability to file taxes and receive tax refunds. In August 2021, Square paid $29 billion for Afterpay, one of the major BNPL players in Australia and in the U.S. It’s just a matter of time before Cash App turns on BNPL for its users and merchants. Cash App’s ambition is similar to PayPal’s; which makes it interesting to see how the two compete in the future.

Pros and Cons of partnering with Super Apps

Merchants stand to gain an additional payment option as well as more sales from Super Apps, but the story isn’t all rosy. Too much reliance on Super Apps means that merchants’d risk ceding the control of direct customer relationships. In business, few things are more valuable than that. Take Apple and Amazon for instance. Apple’s customer base is so loyal and attached to their brand that almost all developers or other brands take the back seat in negotiations . Amazon’s scale and iron grip on the valuable Prime base allows them to dictate terms over merchants. When you buy from a merchant on Amazon, do you feel more related to the former or the latter?

For banks, Super Apps can have adverse impact in a couple of ways. First, services such as PayPal in 4, Afterpay, PayPal Credit or PayPal/Venmo credit cards can reduce issuers’ credit card spend and subsequently balance as well as revenue. Secondly, it’s in their interest to have users maintain an in-app balance and keep funds away from banks’ checking accounts. Think about it this way: would you feel more poised to use PayPal when your PayPal balance was $20 or $0? That’s why Venmo credits dormant users $10 for downloading and logging into the app again or why Square wants users to keep tax refunds in Cash App balance. The reduction in deposits can raise banks’ cost of funds as well as threaten to cut off the most fundamental relationship with customers. 

On the other hand, Super Apps present a battleground for financial institutions vying for wallet share. Once the connection between checking accounts or debit/credit cards and these Super Apps is established, users often don’t want to go through the inconvenience of updating their default payment method. Hence, every financial institution wants to be the primary source of funds for consumers on these Super Apps to have a leg up over the competition. In this sense, Super Apps offer a business opportunity.

In summary, as you can see above, there are multiple paths towards the Super App status, whether an app’s starting point is to be in messaging, digital wallets or ride-sharing. I think all successful consumer-facing apps have ambition to gain the Super App status. If not, they’d do something wrong. It’ll be interesting to see how these Super Apps compete for mindshare as feature parity is established (meaning they all offer similar features). For merchants, working with Super Apps can be a double-edged sword. While the benefits these apps bring are very tempting, merchants need to keep in mind the risk of losing customer relationships. Like people usually say: don’t miss the forest for the trees.

Review of my 2021

Here is the scorecard for my 2021.

Investing

The last couple of months wasn’t nice to my portfolio, but overall I made money in the whole year. My portfolio’s total return went from 4% in 2019 to 23% in 2020, to 40% in 2021. It’s not much, but it’s honest work and I can’t say I am too disappointed. Can it be better? Absolutely.

I made some stupid mistakes with my portfolio. The first was to sell Costco. I love the business, but I was in need of some capital to invest in companies which, to me, had more potential for growth than Costco. I paid the price dearly as the stock went from $370 when I sold it back in April 2021 to $550 today. The second miss was Upstart. A good friend recommended to me when the stock was trading at $88 in January 2021. I didn’t jump on it for reasons that I still don’t fully understand. At the peak, the stock hit $390 or something and even though there was a big pull-back, I would have still made a healthy return. The third mistake is that I didn’t save enough cash on hand when the market dipped and presented great opportunity to buy.

I wrote about how Investing is hard. It really is. I am sure I will continue to make mistakes. I can’t promise that I won’t repeat the ones I made this year. What I do hope is to take my return to a new height. The good news is that I have compounding on my side.

Grade: 6/10

Books I reviewed

I read in total 15 books this year. Not bad, but not a lot either. I’ll strive to read more in 2022. Below are some of my reviews:

Richer, Wiser, Happier: How The World’s Greatest Investors Win In Markets And Life. This is the best book I read in 2021.

Obviously Awesome

Junk To Gold

Amazon Unbound

Think Again: The Power Of Knowing What You Don’t Know

The Spotify Play

Exercised: Why Something We Never Evolved To Do Is Healthy And Rewarding

Grade: 7/10

My Blog

I blogged less this year than I did in 2020. There were weeks when I only had one post, excluding the weekly reading series I always do on Saturdays, or when I didn’t write anything at all. One of the goals I have for 2022 is to increase the posting frequency while keeping the same level of quality. I am not saying that I am a good writer at all, but truth be told, what I wrote this year or in 2020 makes me cringe less than what I put out three years ago. So I’ll take that as progress and continue to work on myself as a writer. I wrote some time back about why I blog. It rang true then and it does ring true now. It helps me become a better person, a better professional and I still do enjoy the process. If you ever came across this little blog of mine and became a subscriber or left a like, you have my thanks.

My top 5 blog posts, besides the homepage:

My experience with Amazon Shopper Panel

Naval Ravikant’s take on death

Create a hover effect on Mapbox

Circadian rhythm, Melatonin, Adenosine, Caffeine and Sleep

My thoughts on Walmart Plus

Grade: 7/10

Work

2021 has been a very busy year for me at work. The pandemic has turned the team upside down with folks relocating to other cities or leaving for better opportunities. Though we tried to backfill the ones that left, the new arrivals have to take some time to acclimate to the team and the overall business. Meanwhile, the work just keeps coming. Existing business-as-usuals and new initiatives. Hence, I have had to shoulder more responsibilities and spent more time working outside the business hours more than I’d like to. But it’s not all bad news. I got promoted and had a chance to mentor interns and new teammates; which is one of the areas I really love to improve next year and beyond.

There are two main things that I want to do better in the future. The first is to sell better, whether it’s myself or my work. This year, several occasions showed me that while the work I did might be good, it didn’t come across as convincing to others as I was a lousy salesman. My self-assessment was echoed by a senior leader in the company, who was gracious enough to share his thought candidly. To be able to move up the ladder, I need to be more confident and communicate my ideas more effectively and better.

The second goal is to have a team to manage and more ownership of an entire project. I managed folks before, albeit briefly, and have been mentoring some people at work. Nonetheless, my goal in the first 2 or 3 years to have a team of my own so I can manage and lead. In addition, I don’t want just ownership of a project’s aspect. I want the ownership of an entire project that can help my company meaningfully.

Grade: 8/10

Weekly reading – 25th December 2021

This is the last post of the Weekly reading series in 2021. Hope you have enjoyed it!

What I wrote last week

I wrote about VRIO, a business strategy framework that can help analyze a company’s competitive advantages

Get to know Affirm

Business

Spider-Man: No Way Home’ Swoops In With a Pandemic-Record Opening. The global gross of $257 million during opening weekend is the 3rd highest of all time. Remember that this is the 27th movie in the Marvel Universe Cinematic and it’s achieved during a global pandemic. Disney’s ability to draw viewers and make great content consistently is just extraordinary. However, it creates a conundrum for the company. Putting content in theaters will haul in a truckload of money and boost the top and bottom line. That also means Disney+, the flagship streamer, will have to wait for at least a certain amount of time to feature the hottest movies, diminishing its power to attract subscribers. Unfortunately for the iconic company, Wall Streets cares a lot about Disney+ subscriber count. Hence, the management team will have their hands full in the next year or two finding the right balance in terms of content distribution

Amazon’s grocery battle isn’t what you think. As an Amazon shareholder, I’d prefer the company owning the software powering stores to operating physical grocery shops. The reason is simple. Grocery is a low-margin business and the competition is fierce. Even if Amazon manages to operate cashier-less stores, chances are that they won’t reach the scale of Costco or Walmart to compete in unit economics. Owning the software powering other stores; however, is profitable. A few retailers already tested out Amazon Go technology. Now, Amazon just needs to prove their worth and scale it to make this another great and profitable business

Bob Iger Makes His Disney Exit as a Titan of Transformation. Bob Iger will go down in history as one of the best CEOs ever. His work transformed Disney and put it in the position that it is now. I like his book The Ride of a Lifetime too.

How Shopify Outfoxed Amazon to Become the Everywhere Store. “In late 2015, in one of Bezos’ periodic purges of underachieving businesses, he agreed to close Webstore. Then, in a rare strategic mistake that’s likely to go down in the annals of corporate blunders, Amazon sent its customers to Shopify and proclaimed publicly that the Canadian company was its preferred partner for the Webstore diaspora. In exchange, Shopify agreed to offer Amazon Pay to its merchants and let them easily list their products on Amazon’s marketplace. Shopify also paid Amazon $1 million—a financial arrangement that’s never been previously reported. Bezos and his colleagues believed that supporting small retailers and their online shops was never going to be a large, profitable business. They were wrong—small online retailers generated about $153 billion in sales in 2020, according to AMI Partners. “Shopify made us look like fools,” says the former Amazon executive.”

6th Annual Grocery Tech Trends Study. “74% of grocers report that the tight labor market is a major obstacle that will drive their retail technology investment over the next 18 months. More than half (54%) of grocers are increasing their year-over-year tech spend, with a focus on advancing digital and mobile capabilities, analytics-driven decision-making, personalized marketing, and click-and-collect.”

A great profile of the CEO of Automattic, the company that runs WordPress.com. “After we hung up our first Zoom call, Mullenweg sent me an email with the subject line “Freedom is central.” The body was a quote from Albert Camus, which worked as an explanation for just about everything Mullenweg believes in, fights for and plans to spend the rest of his life working on: “The only way to deal with an unfree world is to become so absolutely free that your very existence is an act of rebellion.”

The global semiconductor value chain. Today, I started my research into the world of semi-conductor and this is an excellent resource.

Stuff that I found interesting

Himalayan Glaciers Are Melting at Furious Rate, New Study Shows. “Glaciers across the Himalayas are melting at an extraordinary rate, with new research showing that the vast ice sheets there shrank 10 times faster in the past 40 years than during the previous seven centuries.”

Hospital Prices Are Unpredictable. One Type of Health Coverage Often Gets the Worst Rates. I said it before and I’ll say it again, the way that we have to live in fear of getting healthcare in this country is a disgrace

TikTok is the most visited domain in 2021, even more than Google.com. That’s impressive

Stats

YouTube TV is alleged to have more than 4 million subscribers

0.01% of bitcoin holders controls 27% of the currency in circulation

ACH made up 20% of non-cash payments in the U.S in 2020

Image
Source: Michael Batnick

Get to know Affirm

Want to understand Affirm, what it does and how it makes money? Read on as I am discussing one of the most popular BNPL names below. My goal is 1/ to give you a better understanding of the company than a normal article on the news and 2/ not to overwhelm you with a 20-page essay with a lot of details. Ready? Let’s do it.

What is Affirm? What does it do?

Affirm was founded by Max Levchin, a co-founder of PayPal, in 2012 with the purpose of reinventing the payment experience for consumers and merchants. With Affirm, consumers can spread out a purchase over multiple payments over time without deferred interest, penalties or late fees. There are generally two types of transactions processed on Affirm platform: with or without interest. 0% APR transactions guarantee consumers a payment plan with no interest, fee or additional costs. Interest-bearing transactions carry an interest rate that never compounds. For instance, if a $100 purchase comes with an APR of 10%, $110 is the absolute maximum amount that a shopper will ever pay. The unpaid balance will not compound. All of the benefits give shoppers more purchase flexibility, especially those who are tight financially.

For merchants, Affirm helps increase sales through a bigger ticket size, more leads and more options at the checkout for consumers. When consumers can pay off a big purchase in installments, they are more incentivized to take on more expensive items. What merchants don’t want to sell their pricier products or services? In addition, as one of the most popular technology names out there, Affirm can bring hundreds of new leads – new businesses, to merchants. In exchange for all of these value propositions, Affirm charges participating merchants a fee on every transaction.

How does it originate loans?

When Affirm authorizes a transaction on its platform to a shopper, it is essentially giving out an unsecured loan. Even though Affirm itself doesn’t have a banking license to do that, it works with Cross River Bank and Celtic Bank, which help the fintech firm originate loans and comply with regulations at state and federal levels. Affirm is obligated to purchase the loans processed on its platform and originated by the partner banks. Such an obligation is backed by a cash deposit that Affirm has at these banks. The purchase price of a loan is the combination of its outstanding principal balance, a small fee for the banks’ trouble and any incurred interest. As a result, Affirm incurs an expense for every 0% APR transaction because they have to purchase the loan at a value higher than the fair market value of the loan. This expense is called “Loss on loan purchase commitment”.

Because the banks originate the loans themselves, they have the ultimate power to either approve or decline such loans and Affirm needs to underwrite within the risk parameters that the banks set. You may ask why banks need Affirm in this whole process after all. The answer is that Affirm brings in the ability to sign up merchants, the marketing expertise to appeal to shoppers and the capability to use machine learning to process data that can help better underwrite loans.

How Affirm originates loans
Figure 1 – How Affirm originates loans. Source: Affirm

How does Affirm make money?

Affirm has multiple revenue streams. The first is Merchant Network Revenue, which consists of transaction-based fees. Every time Affirm processes a transaction on its platform, it takes a percentage cut from the purchase amount, coming out of the merchant’s pocket. The amount varies depending on a specific arrangement between Affirm and the merchant in question. Typically, Affirm earns larger Merchant Network fees on 0% APR transactions. Similarly, the firm earns a higher commission rate on higher value purchases. In some cases, in order to grow its user base by working with a giant partner, Affirm may not generate positive revenue and the loss is recorded as Sales and Marketing expense.

The second revenue stream is Virtual Card Network. This revenue stream essentially is comprised of interchange fees earned by Affirm for transactions on its platform. Apart from paying the Merchant Network above, merchants also have to pay another on every sale smaller fee called interchange. A portion of that fee, or I would say, the lion share of that fee will go to Affirm. Based on the aforementioned descriptions, it’s obvious that how much money Affirm can make in Network Revenue (Merchant Network + Virtual Card Network) in general hinges on how much transaction volume (GMV) it processes. Barring some caveats that I will explain later, GMV is a good indicator of Affirm’s health.

In addition to Network Revenue, Affirm also makes money from the interest on non-0% APR loans to consumers (Interest Income). These interest-bearing loans typically result in lower Merchant Network fees than 0% APR loans, but fill in the gap with interest. In Q1 FY2022 ending September 30, 2021, 57% of Affirm loans were bearing interest and the rest were interest-free. During the fiscal years 2019, 2020 and 2021, 45%, 37% and 37% of Affirm’s revenue came from this revenue stream.

The company can also leverage its outstanding loans for more income. It can sell part of its outstanding balance to any interested party and record Gain/loss on Sale. While keeping a balance on balance sheet can lead to more interest income, it comes with a charge-off (consumers don’t pay off) risk and additional expenses (cost of funds). By selling some of the balance, Affirm can recognize, usually, gain on sale and reduce its risk exposure. Moreover, loan owners can solicit Affirm’s expertise to manage the loans in exchange for a monthly fee or what the company calls: Service Inc

Affirm's revenue breakdown in FY2021
Figure 2 – Affirm’s revenue breakdown in FY2021

What are Affirm’s competitive advantages?

Affirm’s competitive advantages come down to two things: its two-sided network and underwriting capability. Let me expand on that.

While difficult to build at first, a two-sided network provides a real strong competitive advantage. More shoppers entice more merchants that make the whole ecosystem more appeal to new shoppers. To maintain and grow its two-sided network, Affirm needs not only consumers, but also merchants. So far, the company has done a good job at this by partnering with some of the biggest names in the U.S such as Target, Peloton, Shopify, Walmart and Amazon. By locking in popular retailers, Affirm becomes more popular among shoppers which, in turn, help it acquire more merchants and negotiate more favorable terms. By working with Shopify, Affirm can onboard a lot of merchants right away and appeal back to shoppers. I suspect that some of these partnerships (Walmart, Shopify and Amazon) come at a cost for Affirm as the company must make major concessions, but in the long run, it’s a smart move by its management. Who else can make the same claim that they are the BNPL provider for these brands?

Affirm may have to subsidize some partnerships
Figure 3 – Affirm may have to subsidize some partnerships. Source: Affirm

The second advantage is its ability to use data analytics for underwriting. Underwriting unsecured loans is a tricky business. Quite often, the riskier customers are the more profitable as they pay interest income yet they can also default on the loans. The art of underwriting is to find a sweet spot between profitability and risk. If Affirm only had reliable borrowers, they could still make money with their business model. However, they would leave out folks who need POS-lending the most, you know, the folks with FICO less than 700 or bad credit history. This population is significant, but it can result in losses. This is a challenge for not only Affirm, but all the companies that are offering unsecured loans. With a lot of transaction data, Affirm can fine-tune their underwriting model to limit losses while expanding the customer universe.

It is an interesting and fairly complex business

It’s not straightforward to understand Affirm’s performance from one quarter to another. The first issue is the nature of the company’s partnership with strategic brands. The partnership with Peloton, while fruitful and successful in the beginning, gave the POS lending tech firm some headaches, such as its recall of products (it reduced the merchant network revenue by more than $5 million in FY2021), 0% APR loans that are more expensive to originate and the delay in loan recognition as well as revenue booking. In FY2021, Affirm facilitated $66.3 million more transaction volume than what was captured and reported by Peloton.

Even though GMV, at first glance, can be a good indicator of Affirm’s business health, how the company generates GMV affects its revenue streams heavily. A high concentration of low-value or interest-free transactions negatively affects the company’s top and bottom lines, as explained earlier, despite an excellent growth in merchant and shopper counts. Case in point, the number of active merchants increased from 29,000 in Q4 FY2021 (ending June 30) to 102,000 in Q1 FY2022 (ending September 30). while the number of active customers rose from 7.1 million to 8.7 million in the same period. However, revenue only increased by 3%, from $262 to $269 million. One of the main reasons is that the average order value decreased from $495 to $402 and the concentration of 0% APR loans went up from 38% to 43%. As the partnerships with Amazon, Walmart and Shopify ramp up, I expect the trend of a bigger ecosystem, lower AOV and modest increase in revenue will persist. But who knows? If Peloton roars back and brings more high-value loans or if Affirm signs a similar partner, the situation will certainly change. This makes it a bit tricky to analyze this business as it has more than meets the eyes.

Another factor is how much the company estimates its provision for credit losses. The fancy term essentially means how much of the loan is expected to be lost. This estimate depends on not only the concentration of 0% APR loans or new product lines with higher expected losses but also macro economics factors. At the beginning of the pandemic, Affirm expected higher losses, but the expectation subsided over time before it was normalized to the pre-pandemic level. Because we are not out of the woods yet with Covid-19 (thanks Omicron!), it’s not practical to have a consistent estimated provision for credit losses.

Lastly, and this one is more for the future: the regulatory risks. As of now, the BNPL field is largely unregulated, yet there are signs that it’s about to change. The Consumer Financial Protection Bureau already opened an inquiry into BNPL products and ordered information from the main players, including Affirm. Whether there would be new regulations in place, what such regulations and what the ramifications would be remain to be seen. Personally, I think that the worst that could happen is Affirm will have to deal with the same regulations as banks do. But the same would also go for other BNPL firms. As long as the fundamentals of the company are strong and not prone to collapsing under more scrutiny, Affirm should be fine.

Credit losses increased at a much higher clip than revenue in Q1 FY2022
Figure 4 – Credit losses increased at a much higher clip than revenue in Q1 FY2022. Source: Affirm

In short, even though what Affirm does sounds simple on the surface, the inner workings behind the scenes and the numbers are not. I hope if you make it this far, you already have a better understanding of the company. Not too deep, but not too shallow either.

Disclaimer: I have Affirm stocks in my personal portfolio.

VRIO – A useful strategy framework to look at a business

If you are looking for a strategy framework to think about a business’ competitive advantages, I recommend VRIO.

The name is an abbreviation of Valuable, Rare, Inimitable and Organized. Essentially, if a firm’s capability or resource is Valuable, Rare and Inimitable, and the firm itself is Organized, it has a sustained competitive advantage. The more sustained competitive advantages a firm has, the more robust its business model is and the more likely it is to succeed. Let’s take a look at a few real-life examples to see how applicable this framework is:

Apple

Apple is arguably the best in the world in combining hardware and software to produce great consumer products. Such a capability is absolutely valuable and rare because we don’t often see that in the market. Samsung or Huawei can make good hardware, but they don’t put hardware and software to harmonious use like Apple does. Google owns Android and is excellent at software, but they aren’t known for their hardware prowess. The fact that some of the biggest companies in the world haven’t been able to copy Apple means that this capability is hard to imitate. Plus, Apple, since Steve Jobs return, has been well-organized to leverage this capability with one P&L to promote singular objectives, the sway that the Industrial Design has or the new multi-billion dollar campus to encourage creativity and collaboration. Lately, Apple has bolstered this competitive advantage further with its own chip M1 and the rumored initiative to design its own 5G cellular chip. It’s precisely the ability to combine humanity, hardware and software that makes Apple products astounding success and itself the most valuable company (as of this writing).

Another advantage that Apple possesses is its world-class supply chain. Not many companies can operate a complex supply network that spans the world and have bargaining power over even powerful players like Foxconn, TSMC or Intel. Imagine that you have to work with suppliers in different countries for different parts, navigate through local regulations, coordinate delivery and transportation, and negotiate pricing while protecting the confidentiality of products. It’s monumentally challenging, but on the other hand, it’s valuable, rare and hard to imitate. Any new rival will have to spend years to put up the same network, and even then, it likely doesn’t have the power of Apple. Additionally, is Apple organized to leverage this capability? Tim Cook, the current CEO, is a supply chain wizard. The company COO, Jeff Williams, is also an Operations guy. The company is one of a few from the West to have a productive relationship with China and its government, despite all the political tension between the U.S and China. This type of relationship can’t be replicated in a short amount of time, if it can be replicated at all. Hence, supply chain is another sustained competitive advantage that Apple has to offer.

Aldi

Aldi is a hard-discounter chain that originates from Germany and came to the U.S in 1976. The former CEO and President of Walmart, Greg Foran, labeled Aldi as “good and fierce”. What makes Aldi so? The discounter’s sustained competitive advantage lies in its long-standing culture and commitment to cut costs and pass on savings to shoppers. Here are a few practices that Aldi employs:

On average, an Aldi store’s size is about 12,000 square feet, compared to Walmart’s 178,000 and Costco’s 145,000 square feet. The smaller size helps drive down either leasing expense (if the land is leased) or depreciation (if the land is owned), as well as energy costs. Regarding SKUs, an Aldi store, on average, carries 1,400 items compared to 40,000 items by a traditional supermarket. The much smaller store size and more limited item selection lead to fewer staff required. An Aldi store usually has only 3-5 employees, a significantly smaller number compared to how many employees are present at a store like Walmart or Costco. The limited item selection enables Aldi to focus on its offerings and negotiate favorable deals with suppliers to keep costs and prices low. Another benefit is that a limited assortment doesn’t require complex marketing promotions, meaning that there will be no cost on marketing materials and labor.

Walking into an Aldi store, you won’t notice many decorations. It looks like an ordinary, no-fancy store and it’s by design to keep costs low. At Aldi stores, there is no free bag. Customers are encouraged to bring their own bags. Carts can only be used with a quarter coin. Customers retrieve the quarter upon returning a cart. This policy has long been part of Aldi’s signature operations. Additionally, customers have to bag their own groceries. A cashier will scan items and put them in a cart, but shoppers will have to take it from there. It speeds up the checkout process, increases efficiency and reduces the need for additional staff. As far as I know, there is no self-checkout.

About 90% of Aldi’s items are private labels. This private label centric approach allows Aldi total control over its selection and reduces the cost as well as complexity that comes with national brands. Private labels used to be unpopular among shoppers due to their cheap image. However, consumer preferences have changed. Astute shoppers, especially millennials, now have a much more favorable view on private labels because they are cheap and provide best value for money. According to Bain, 85% of American shoppers are open to buying private labels.

Source: Onepercentamonth

It’s certainly valuable to pass on savings to shoppers. While the practices themselves may not be rare, the commitment and the culture that enables consistent execution are. The frugal approach that empowers all the little things mentioned above has been nurtured and well-preserved since 1946 when the parent brand was founded in Germany. The only rival that has a similar mentality is Walmart. But the two chains differ in strategies. While Walmart has its hands in numerous cookie jars, Aldi’s bread and butter in the U.S is groceries in small stores with a small number of SKUs. In that segment of the market, I don’t see anyone with Aldi’s expertise and culture. As you can notice, it’s easy to copy a tangible element or an expertise of a business, but it’s much more difficult to replicate the intangibles like culture. Lastly, is Aldi organized? The brand is still one of the best, if not the best, hard discounters in various markets. In the U.S, it has been growing steadily since 1976 and becoming more popular among shoppers. So, I’ll say: yes, it’s organized!

Disney

Disney’s competitive advantage comes from its ability to consistently create excellent content loved by millions around the world. Any production studio can come up with a great movie or show once in a while. Disney is among a handful that can do it consistently. Take Spiderman: No Way Home as an example. It’s on track to net over $240 million in the first opening weekend while being the 27th Marvel movie since Iron Man in 2008. Over the last decade, Disney has dominated the list of highest grossing movies with hit after hit like Avengers: End Game, Captain Marvel, Infinitive War, Black Panther or Star Wars: The Force Awakens. While HBO is known for its quality outputs, even the famed studio isn’t as prolific as Disney. If you think about it, it’s all but nearly impossible to achieve what Disney has done, especially given that it owns the IPs such as Star Wars and Marvel franchise for eternity. Is it guaranteed to succeed long in the future? No. But Disney is more likely than any of its rivals to replicate its previous successes.

Source: Wikipedia

Another competitive advantage that this iconic brand has is its theme parks. Disney’s theme parks attract thousands of visitors around the world every year. As an important source of revenue and margin for the company, and a place for fans to connect with iconic movie figures, these theme parks are certainly valuable. However, they are not easy to create. Any company can pour millions of dollars into building and operating a park, but would they have the brand equity that Disney has with consumers around the world? Would they be able to lure enough visitors to make their park a financial success? To cultivate a brand or a cult like Disney does, a challenger needs to put out iconic content and characters year after year. That in and of itself is a monumental challenge that can’t be done in a few years’ time, if it can be done at all.

In short, VRIO is by no means the only framework to evaluate a business’ strength. We also have Porter’s Five Forces or Value Chain Analysis, just to name a couple. But VRIO is a very useful tool in analyzing a business’ competitive advantages and whether the business is great at anything it does. It’s one of my go-to tools when looking at a firm, as I demonstrated above. Hope this has been helpful for you.

Disclosure: I am long Apple and Disney’s shares.

Weekly reading – 18th December 2021

What I wrote last week

Is Menadione, a synthetic version of Vitamin K, safe for pets?

Good reads-0on Business

Netflix Cuts India Prices in Struggle for Biggest Foreign Market. The fact that Netflix slashed prices by 60% in India shows that the streamer feels very threatened by Disney+ and Amazon Prime. I have a lot of love for Netflix, but I don’t think the company is as invincible as many Netflix bulls make it out to be. If it were indeed invincible, then why would it cut prices that much? I often see Netflix bulls make fun of Disney+ ARPU because it has been growing its subscriber base by keeping the price low, especially in India. Now that Netflix lowers prices itself, I can’t imagine this will do the company’s own ARPU any good

U.S. appeals court denies motion to file amicus brief from Coalition for App Fairness. “U.S. courts–and especially appeals courts–normally have a permissive approach toward amicus briefs, above all in high-stakes high-profile cases like this one. It rarely happens that they tell stakeholders they are unwelcome to join a proceeding as “friends of the court” contributing potentially useful information. Here, however, a filing by the Coalition for App Fairness (whose three key members are Epic, Spotify, and Match Group, which is best known for Tinder) and four of its members (Match Group, Tile, Basecamp, and Knitrino) has been flatly rejected by the Ninth Circuit. As a result, the CAF now faces a credibility issue in any other App Store cases around the globe in which it may try to support Epic or even another one of its large members. Even if other courts ultimately allowed the CAF to join other cases, Apple would point to the Ninth Circuit decision, which at a minimum would diminish the credibility of anything the CAF would say on Epic’s behalf. The CAF has now been stigmatized as part of an Epic anti-Apple initiative designed to raise issues regardless of whether those were “organic or manufactured” as the evidence shows.” Even though I have shares of Match Group, Tinder’s owner, and Spotify, I don’t support their effort here. Yes, having to pay commission to Apple cuts their revenue and profit down, but that’s part of doing business on a platform you don’t own.

The DMV Is No Longer a Bureaucratic Purgatory, DMV Says. Information Technology is not just an item on a checklist. It’s the driver of innovation and business growth, even for a government agency known for its terrible services like DMV.

The Guardian has more than 1 million recurring supporters. I hope the likes of Business Insider can pay attention to this. The Guardian doesn’t have a paywall. It simply asks for donations from readers and relies on its journalism to woo subscribers. Putting content strictly behind a paywall doesn’t increase the likelihood of acquiring a subscriber. It actually creates some frustration and annoyance.

With $5 more every month, you can add Disney+ and ESPN+ to your Hulu Live TV+ subscription. An interesting move. I don’t believe that Disney double-counts its subscribers, meaning that a multi-service subscriber can only be counted once. However Disney counts it, I doubt that the move is purely about increasing the subscriber base for Disney+, its flagship streamer. I also don’t see how the new plan can increase Average Revenue Per User (ARPU). A standalone Disney+ already costs $7 a month, higher than the additional $5 that Hulu Live TV subscriber has to pay to get it. Hence, this move is perhaps to make Hulu Live TV+ more appealing and increase the overall revenue.

A good blog on Bill Foley, one of the best yet less famous investors in history

Other stuff I find interesting

A nice story on the new F1 world champion, Max Verstappen. If you want to know what it took to be the best F1 driver in the world, have a read. It requires talent for sure, but talent alone is definitely not enough.

52 things I learned in 2021

The Office Is an Efficiency Trap. “The setup of the Bürolandschaft was designed to follow the natural lines of communication, decrease inefficiencies, and, as an added bonus, cost less: No real hierarchies meant no expensively furnished offices for management. One huge room was far easier to heat, cool, light, and electrify. Yet the design, however well-meaning in theory, was a disaster in practice. In Germany, Scandinavia, and the Netherlands, the experience of working in an open office design was so miserable that in the 1970s local worker councils effectively mandated their removal. But not in the United States, where, as the architecture critic James S. Russell notes, Americans “characteristically reworked” the plan into “something cheaper and more ordered.” The “curvilinear informality” of the Schnelles’ design was formalized into workstations with shelves, cabinets, and dividing panels—what would eventually devolve into the cubicle.”

The World Wants Green Hydrogen. Namibia Says It Can Deliver.Now Namibia is positioning itself as a leader in the emerging market for another hot resource: green hydrogen, which is made using renewable electricity. With bright sunshine 300 days a year and vicious winds that rip along a nearly 1,000-mile coast, renewable experts and government officials say the southwest African nation has outsize potential for renewable energy production.” The next decades will see Africa rise in importance on the global scale with its young population and vast natural resources. China will surely be there to make strategic moves. The question is whether Western governments will do anything about it.

Stats

ETF inflows top $1 trillion

While NBA pays $2.5+ billion for the rights to stream Premier League, Major League Soccer brings in just $90 million a year from ESPN and Fox

In November 2021, 87% of all new vehicles sold in the U.S were sold at or above sticker price

Only 20% of the U.S energy in 2020 came from nuclear. A missed opportunity, I’d say

Between 2013 and December 2021, AirBnb has processed $336 billion in payments on their platform

U.S Online Grocery Sales hit $8.6 billion, $7 billion of which came from Delivery and Pickup

Is Menadione – Synthetic Vitamin K safe for your pets?

I have a 14-month-old cat that I love so much. He has been eating Purina Pro Plan Focus – Sensitive Skin & Stomach for over a year. Lately he has seemed to be fed up with the food so I looked for an alternative last weekend. That’s when I came across the controversy of Menadione and started to read upon it. I’d like to share what I have learned so far.

What is Menadione? It’s the synthetic version of Vitamin K, an essential vitamin for humans and animals. The natural version of Vitamin K (K1 and K2) are proven to be harmless, even with high doses. Menadione, on the other hand, can cause several health issues for humans, particularly liver toxicity. In fact, the FDA has long banned the use of Menadione as a supplement for humans, a decision echoed by several studies in Europe.

Although allergic reaction is possible, there is no known toxicity associated with high doses (dietary or supplemental) of the phylloquinone (vitamin K1) or menaquinone (vitamin K2) forms of vitamin K. The same is not true for synthetic menadione (vitamin K3) and its derivatives. Menadione can interfere with the function of glutathione, one of the body’s natural antioxidants, resulting in oxidative damage to cell membranes. Menadione given by injection has induced liver toxicity, jaundice, and hemolytic anemia (due to the rupture of red blood cells) in infants; therefore, menadione is no longer used for treatment of vitamin K deficiency. No tolerable upper intake level has been established for vitamin K.

Source: Oregon State University

Since Menadione is cheaper to produce, pet food manufacturers have every incentive to include this substance to make their products nutritionally complete (on the surface) and commercially cheaper. The question is whether it is legal to do so in the first place.

Here is what the FDA says on the matter, as recently as April 2021:

Although vitamin K is an important nutrient for animals and several sources are available, not all of those sources can or should be used in animal feed. Many have not been approved for use in the United States. 

Menadione dimethylpyrimidinol bisulfite and menadione nicotinamide bisulfite are vitamin K active substances that are regulated as food additives for use in animal feed. Federal regulation 21 CFR 573.620 lays out how menadione dimethylpyrimidinol bisulfite must be used in feed. Menadione dimethylpyrimidinol bisulfite is a nutritional supplement for the prevention of vitamin K deficiency in chicken and turkey feeds at a level not to exceed 2 g per ton of complete feed, and in the feed of growing and finishing swine at a level not to exceed 10 g per ton of complete feed.

Menadione nicotinamide bisulfite is also used as a nutritional supplement for both the prevention of vitamin K deficiency and as a source of supplemental niacin in poultry and swine. Federal regulation 21 CFR 573.625 states that this substance can be added to chicken and turkey feeds at a level not to exceed 2 g per ton of complete feed, and to growing and finishing swine feeds at a level not to exceed 10 g per ton of complete feed.

Before either menadione dimethylpyrimidinol bisulfite or menadione nicotinamide bisulfite could be used in a manner different from that specified in the appropriate regulation, a new food additive petition would need to be submitted and approved by the Food and Drug Administration.

According to NRC’s publication, Vitamin Tolerances of Animals (1987), based on the limited amount of available information, vitamin K did not result in toxicity when high amounts of phylloquinone, the natural form of vitamin K, are consumed. It is also noted that menadione, the synthetic vitamin K usually used in animal feed, can be added up to levels as high as 1,000 times the dietary requirement without seeing any adverse effects in animals, except in horses. Administration of these compounds by injection has produced adverse effects in horses, and it is not clear if these effects would also occur when vitamin K active substances are added to the diet. 

Source: FDA

The fine print clearly says that the FDA only allows the use of Menadione in chicken and turkey feeds. Any other use of the substance will have to be reviewed and sanctioned by the agency. The last time I checked, my cat is a cat, not a turkey or a chicken. Therefore, if a cat food label doesn’t clearly show that it’s approved by FDA, it’s safe to say that from the agency’s perspective, the product is not legal.

The lack of explicit approval from FDA doesn’t deter pet food manufacturers. These companies argue that Menadione is safe for pets because they follow guidelines from AAFCO and that the substance is used in amount that is so much smaller than what AAFCO recommends. Let’s analyze that. Firstly, AAFCO is an NGO that consists of state officials with responsibility for passing and enforcing state laws and regulations with regard to the safety of animal feeds. AAFCO sets the standards and guidelines that these officials often adopt, but the organization itself has no regulatory authority.

Second, when it comes to the role of AAFCO in this debate, it’s important to separate its opinion on Vitamin K from the one on Menadione. The organization does require that “Vitamin K does not need to be added unless the diet contains more than 25% fish on  a dry matter basis“. What this requirement means is that if a diet doesn’t contain fish at all, there is absolutely no reason to include Menadione. When I found out that my cat’s chicken paste from Purina contains Menadione, I was furious. They put a controversial substance in the food even when they don’t have to! And even though Vitamin K is mentioned, AAFCO doesn’t refer specifically to Menadione as an approved source. In fact, here is what the Pet Food Committee Chair of AAFCO had to say on the matter:

Nowhere in Dr Kashani’s response did he mention that Menadione is approved for use in pet food. He clearly relies on the FDA guidelines, which, as mentioned above, only regulate the use of natural Vitamin K sources K1 and K2. Like the FDA, AAFCO only approves Vitamin K3 for poultry feed, not for pet diets. Sadly, pet food manufacturers muddy the waters and use it as a blanket excuse for their inclusion of this supplement in commercial pet products. In a response to a customer’s question, the owner of Weruva said: “according to AAFCO, cat food that contains at least 25% seafood on a dry matter basis must contain a certain level of vitamin K, and according to AAFCO, the only approved source of vitamin k is menadione“. As you can see from the screenshot below, it’s not exactly what is in the rule book.

Among the items discussed in the AAFCO meeting in August 2021 was the use of Menadione. An expert panel commissioned by AAFCO concluded that this ingredient was safe for use in pet foods. Here is the catch. The panel came to this recommendation after reading a white paper written by Purina Pet Foods, which, you may guess, is a pet food manufacturer. The white paper is miraculously deemed confidential and not available to the public eyes. This blatantly flawed process is frustrating and calls into question the recommendation of this so-called expert panel. Without knowing the rational and evidence behind the conclusion, who can say that it’s thoroughly studied and scientifically proven?

I visited a Petsmart and Petco store last weekend. There are a lot of products with Menadione. Apparently, the ingredient has been used in pet food for decades, yet the exact legality of the practice has barely been questioned. Just because something is a long-standing practice without any regulatory approval doesn’t mean that it’s legally allowed. Rules are rules. And if that’s not enough, consider this. We don’t often change our pet diets without cause. The consistent consumption of food with Menadione, albeit with a tiny dose, every day may also accumulate over the long term. And who knows? It may cause serious health issues for our pets. I don’t know about you, but I am not, in good conscience, willing to do it to my beloved cat.

Weekly reading – 11th December 2021

Good reads on Business

What the Tech? The Apple Watch’s Straps Are More Than Just a Finishing Touch. “For us, the band is not at all about technology — each band expresses our love for materials, craft, and the process of making.” When we look at the Apple Watch, we may wonder how obvious the band looks. But I believe that a lot of research and technology went into bringing the band and Watch together into beings. We are used to having the tail of the band stick out on normal watches. On the other hand, the Apple Watch tucks the tail under the band itself. Even that little detail is worth commanding.

A couple of good posts on Visa here and here. If you aren’t familiar with what the company whose logo is on your debit or credit card does, have a read.

Web3 is Bullshit. The article is as provocative as the headline. I do; however, agree with some of the points the author made, regarding cryptocurrencies.

Ride-Hailing: Is It Sustainable? A good essay arguing that ride-hailing is a sustainable business and the likes of Uber and Lyft have untapped pricing power. I wrote quite a couple of pieces on Uber, you can check out here: Uber acquired Drizly and Postmates, Uber Q3 FY2021 earnings

Amazon is making its own containers and bypassing supply chain chaos with chartered ships and long-haul planes. “Who else would think of putting something going into an obscure port in Washington, and then trucking it down to L.A.? Most people are thinking, well, just bring the ship into L.A. But then you’re experiencing those two-week and three-weeks delay. So Amazon’s really taken advantage of some of the niche strategies I believe that the market needs to employ”

Kohl’s Urged to Consider Sale by Activist Investor. Engine Capital estimated that Kohl’s eCommerce business can be worth around $13 billion. My question concerns whether that estimate factors in the value of the physical stores. Walmart, Target and Best Buy know the importance of using stores to enhance customer experience and fulfill online orders. If Engine Capital or other activist investors want to separate the online business from physical stores, how do they think the online business alone would fare against the likes of Amazon?

Scaling to $100 Million. ARR and Margin. ARR and Margin.

Stuff that I found interesting

Flutter allows developers to build apps for mobile, web and desktop from a single code base

Climate change: Is ‘blue hydrogen’ Japan’s answer to coal? Any disaster that costs lives is tragic, but I can’t help thinking that the switch back from nuclear to coal is massively disappointing

Grapefruit Is One of the Weirdest Fruits on the Planet. An interesting article on grapefruit. “Because those base fruits are all native to Asia, the vast majority of hybrid citrus fruits are also from Asia. Grapefruit, however, is not. In fact, the grapefruit was first found a world away, in Barbados, probably in the mid-1600s. In 1664, a Dutch physician named Wouter Schouden visited Barbados and described the citrus he sampled there as “tasting like unripe grapes.” In 1814, John Lunan, a British plantation and slave owner from Jamaica, reported that this fruit was named “on account of its resemblance in flavour to the grape. A Frenchman named Odet Philippe is generally credited with bringing the grapefruit to the American mainland, in the 1820s. He was the first permanent European settler in Pinellas County, Florida, where modern-day St. Petersburg* lies.”

The Many Worlds of Enough. “Ambition is largely driven by self-actualization, or the desire to become a more capable person. And when this happens, it’s only natural that good outcomes arise. You’ll witness bumps in your reputation, be offered higher salaries, and so on. But these things happen as a byproduct of your ambition, and not because these outcomes were your primary desires. Greed, however, is when those outcomes become your primary desires. When prestige, praise, and power are the reasons why you are ambitious, that’s no longer driven by self-actualization. That’s when you lust for everything that is external to you. It’s rather difficult to know where this point is, as the boundary between ambition and greed can be blurry. But for the most part, you’ve entered the domain of greed when you no longer pursue an endeavor because you’re curious about it. It’s when the coldness of utility replaces the warmth of curiosity.”

The $11-billion Webb telescope aims to probe the early Universe. If everything goes as planned, the Webb telescope will be 1.5 million kilometers away from Earth. 1.5 MILLION kilometers. Science and technology are just amazing.

Why U.S. Infrastructure Costs So Much. “Mile for mile, studies show the U.S. spends more than all but five other countries in the world on public transit, and more on roads than any other country that discloses spending data. In 2013, Portland’s 7-mile Milwaukie light rail extension cost more than $200 million per mile, as much as a full subway system would cost in many European cities. The first phase of the Second Avenue Subway in Manhattan, the most expensive subway project in the world, cost $2.5 billion per mile, nearly five times the cost of a similar extension in Paris. Spending swelled across three problem areas: over-design, inefficient project management and misaligned politics”

Stats

Global Logistics and Supply Chain is a $11 trillion market

Lieferando has…99% of Germany’s food delivery market

YouTube removed 2.2 million videos that violated copyrights between January and June 2021

Consumers are expected to spend $133 billion on apps in 2021. The App Store continues to dominate Google Play

Remittances to Vietnam in 2021 are projected to hit $18.1 billion

Weekly reading – 4th December 2021

What I wrote last week

I shared my research on real-time payments

Good reads on Business

Glass bottle shortage leaves US distillers high and dry. The supply chain challenges still persist. While the demand for spirits and wines in the U.S continues to be strong, the task of finding glass bottles becomes more challenging and expensive. One glass supplier considers more than quadrupled the price of a container. That kind of price increase will make your next bottle fairly more pricey.

The new memo by Howard Marks: The Winds of Change. Howard touches on many topics from politics, regulations to macro economics. Have a read and if you have time, read his other memos too.

The Rising Tide of Semiconductor Cost. The technological advances we made in chip design and production are not going to make chips cheaper any time soon.

Amazon Builds Out Network to Speed Delivery, Handle Holiday Crunch. “As of mid-November, more than 98% of parcels that arrived at Amazon’s delivery centers, which typically are in close proximity to packages’ final destinations, were being delivered the next day, according to estimates from research firm ShipMatrix Inc. At the same time, some items like household products and sporting goods were showing delivery windows of a few days, ShipMatrix said, emphasizing Amazon’s message to shop early.” As Amazon continues to invest aggressively in its warehouse and delivery network, it’s more likely that the company will raise the bar, making the next day or same day delivery a norm. When that happens, other retailers will have a hard time catching up. Replicating the same recipe requires a lot of capital, time and expertise. I think the more Amazon succeeds in raising the bar, the better the market will be for delivery services like Instacart, Uber or DoorDash

Ghost Kitchens Are Proving to Be a Messy Business, as Reef Global Shows. “Since the summer, local officials in New York City, Houston, Detroit and Chicago have suspended operations at some or all of Reef’s fleets of trailers for violating regulations, totaling more than 25 closures. Many of the suspensions were for kitchens that were operating without permits, while others were for failing to tow the trailers to a central commissary every day, a requirement for food trucks in many cities. Utility hookups routinely take months longer than expected, requiring expensive generators and water deliveries, according to former Reef managers. Food waste is a consistent problem, as is a broader labor shortage in the food-service sector that has sent its cooks’ wages soaring.

Payments are eating the world. A very interesting report by JPMorgan Chase on the state of payments

Oct 2021: U.S. Online Grocery Sales Stabilize at $8.1 Billion. This study of online grocery sales in the U.S is interesting. It claims that 50% of U.S households bought groceries online. The average order placed by an active customer is 2.6 per month and the average value for order is $70. That’s almost $200 in online groceries, more than what I expected.

Amazon charges sellers fees that are high enough to offset losses from Prime, a new report says. Amazon can exert this much control over sellers because it can bring consumers to the table. Sellers may not be pleased with how Amazon squeezes them, but if they want to rely on the eCommerce platform for reach and sales, they have to deal with its shenanigans too.

Stuff that I found interesting

How the Ancient Romans Went to the Bathroom. “Despite the lack of toilet paper, toilet-goers did wipe. That’s what the mysterious shallow gutter was for. The Romans cleaned their behinds with sea sponges attached to a stick, and the gutter supplied clean flowing water to dip the sponges in. This soft, gentle tool was called a tersorium, which literally meant “a wiping thing.”

Stats

A new paper estimates that 67% – 76% of new Covid infections in Germany in October 2021 came from the unvaccinated

Shopify merchants around the world recorded $2.9 billion in Black Friday sales

Black Friday 2021 sales in the U.S dropped from $9 billion in 2020 to $8.9 billion this year

Cyber Monday online sales in the U.S hit $7.1 billion in 2021, down from $10.8 billion last year

More than 17 million UK customers have now used a buy now pay later 

The U.S generates 42 million metric ton in trash a year, more than all EU nations combined

Real-time Payments

I did a little bit of research on real-time payments and want to share here. It’s a big topic so I’ll likely add more in the next few weeks. In this post, I just cover why we need real-time payments, what it means and what it does. Let’s go!

ACH

Before we talk about real-time payments (RTP), we must first talk about ACH. Automated Clearing House (ACH) is a method that moves money digitally from one bank account to another in the U.S. Before ACH was born in the 1970s, consumers and businesses sent and received money using checks that required a lot of human input. As the number of checks increased, along with the payment volume, and payment preferences evolved, the banks realized that they needed a more efficient way to automate and speed up the sending and receiving of money. That’s how ACH came about.

What does ACH do exactly? It acts as a financial postal office that handles transactions between financial institutions. Every day, there are thousands of transactions initiated in the U.S. ACH operators sort these transactions, bundle by recipient and deliver them accordingly in several batches every day. Each of the batches includes instructions telling the recipient financial institution whether it is to make a debit or credit to accounts under its purview. At no point do any two banks exchange real money to settle transactions. Settlement is processed through the Federal Reserve.

There are two ACH operators: EPN and FedACH. The Electronic Payment Network (EPC) handles the fund transfer for the private sector while FedACH serves the same function for the federal government. The National Automated Clearing House Association (NACHA), a non-profit, serves as a trustee and a rule-making body of ACH. Collaborating with the government agencies, NACHA sets up rules that dictate how EPN and FedACH deliver messages.

Even if this is the first time you have ever heard of ACH, you must have already used it. ACH is how employers deposit salary to employees’ accounts, a customer pays a service provider every month, a customer pays a credit card, a business makes a payment to a supplier or IRS deposits tax refund to a taxpayer’s account. Compared to credit cards or wire transfers, ACH has its strengths. Credit cards aren’t available to many consumers, especially those with a bad credit history. Meanwhile, it’s far easier to open a checking or saving account which one can use to initiate an ACH transaction. For businesses, credit cards can mean a few percentage points in revenue losses due to interchange fees. ACH, on the other hand, is significantly cheaper. Wire transfers can enable a big transaction safely and quickly; however, they are usually pricey at $15 per transaction. Because of its accessibility and cost-effectiveness, ACH is very popular with 27 billion payments worth about $62 trillion in the U.S in 2020.

But ACH isn’t perfect. Because it is batch-based, ACH can take several hours, if not days, to confirm and settle funds. The delay can have ramifications. For instance, small businesses can run into cash-flow problems with delay in fund availability. The pending transactions and, as a result, the uncertainty regarding balance can put some consumers at risk of overdrafts. Consumers that pay bills on the last day of the grace period may incur late fess or even face stoppage of services because their payments won’t be cleared fast enough.

Real-time Payments

According to the Payments Innovation Alliance, a real-time payment (RTP) is “an immediate, irrevocable, interbank account-to- account transfer that utilizes a real-time messaging system connected to every end-user through a financial institution, third party, or another real-time system. Funds are available for use by the receiver and real-time confirmation is provided to both the sender and receiver in seconds. While the requirement of immediate confirmation and fund availability is undebatable, there are conflicting opinions on whether settlement of RTP should be immediate. NACHA said that RTP settlement doesn’t need to take place real time. The majority of RTP systems today use a deferred net settlement method which offers a lower liquidity risk than a gross settlement method (settle transactions individually). On the contrary, The Clearing House claims that RTP network payments “clear and settle individually in real time with immediate finality”.

Essential characteristics of RTP include:

  • 24/7/365 availability
  • Authorization or rejection of payment is within seconds 
  • Fund posting and availability are within seconds
  • “Push” payments only
  • Use of ISO 20022 message standard. This will enable the transfer of richer data
  • Irrevocability. Funds are only transferred after sufficient funds are confirmed and when payments are sent, they are irrevocable
  • Availability of a proxy database that allows end users to send and receive payments without knowledge of the receiver’s bank account information 

RTP benefits consumers and businesses in several ways. The constant availability and the immediacy of funds increase consumers’ convenience and help them manage budgets better. Thanks to RTP, some consumers may no longer have to live in anxiety with last-minute bill payments not clearing fast enough. With a proxy database, RTP can allow consumers to receive and send money without offering bank account details, a practice that makes me nervous every single time. All they need is a phone number or an email.

For businesses, there are multiple benefits that RTP can bring. They can refund customers and pay off suppliers right away, rather than a few-day delay. Who doesn’t want to get their hard-earned cash faster? Hence, customers and suppliers will field fewer anxious calls and be ultimately happier. Happy customers and happy suppliers mean happy life, I guess. In some urgent circumstances, the value of RTP will be even more highlighted. For instance, sometimes businesses are required to make unexpected same-day payments to authorities. They can use ACH and hold their breath that their payment makes it to one of the earlier batches. Or RTP can solve that problem instantly and hence, reduce regulatory and compliance risks. As receivers, the finality and irrevocability of payments will be a boon to businesses. Once they receive payments through RTP, they don’t have to worry about whether the senders have enough funds or will recall transactions. Plus, payments are cleared and settled right away. These two factors will help improve their cash flow management tremendously.

Another benefit of RTP is the use of ISO 20022 payment messages. The new standard is an improve over the old ones in the amount of data it can transmit and its structure. With the old standards, businesses can’t extract insights from the messages. In some cases, that can send false positive compliance issues leading to delays and higher expenses. According to SWIFT, poor data results in 1 out of 10 international payments being held up. The ISO 20022 payment messaging standard enables parties involved to attach a richer and more structured data to a payment. Data can include details of the remittance, the purpose of the payment, the original source and other relevant information. With this new data that can be processed more easily, businesses can reduce fewer errors, avoid delays, decrease unwanted reconciliation expenses, and gain valuable insights. 

A practical example of ISO 20022
Source: SWIFT

What are the RTP or faster payment services in the U.S?

First, let’s talk about the RTP network. It is the first core infrastructure in the U.S in more than 40 years. It was built and launched in November 2017 by The Clearing House, whose owner banks include arguably the biggest in the country. The RTP network is available to all federally insured U.S depository institutions and already reaches 61% of U.S demand deposit accounts (DDA). 

Next is FedNow. It is owned by the Federal Reserve and is expected to launch in 2023. Once live, it will be available to all depository institutions in the U.S. The Federal Reserve said that FedNow will process messages and settle payments within 20 seconds. In the beginning, FedNow’s initial transaction limit will be $25,000, lower than the current limit imposed on the RTP network by The Clearing House. 

Clearing House's owner banks
Source: The Clearing House

Mastercard Send is Mastercard’s native method that enables instant payments between governments, businesses, and consumers. Mastercard Send supports disbursements – non P2P payments to consumers, domestic P2P payments and cross-border P2P transfers originating from the U.S. As of this writing, Mastercard Send is available in the U.S only and all domestic debit cards, including non-Mastercard cards. Interested issuers can tap into the Mastercard Send API to enable this capability. 

Visa Direct is Visa’s equivalent of Mastercard Send with two major differences. The first difference is that while Mastercard Send is currently available in the U.S only, Visa Direct can be used in more than 100 countries. Secondly, its requirement for fund availability varies from one financial institution to another. In the U.S, Visa Direct mandates that all participating issuers make funds available within 30 minutes, a more relaxed approach than Mastercard Send, which claims that funds are available and settled within seconds

Zelle is a mobile payment application developed by Early Warning Services, which is owned by Bank of America, Truist, Capital One, JPMorgan Chase, PNC Bank, U.S Bank and Wells Fargo. The application enables users to transfer funds from one to another without the need for account details. All it requires to initiate a transfer is an email address or phone number. Formerly confirming transactions within minutes, Early Warning Services announced in February 2021 that Zelle transactions can now be cleared and settled in real time, officially making it an RTP network. Zelle users need to note that several banks place restrictions in terms of the number of transactions and transfer volume that a user can initiate in a month. 

In December 2017, NACHA announced the launch of Same Day ACH, which enables the ACH payments to be processed faster and potentially settle in the same day, if a payment is submitted early enough. Despite this improvement, Same Day ACH isn’t an RTP method because transactions are still processed in batches and revocable. 

Wire Transfers offer instant payment confirmation and settlement. However, unlike RTP, Wire Transfers are more suited for low-volume high-ticket transactions, limiting its value and accessibility to consumers and businesses. Compared to a few cents per RTP transaction that The Clearing House charges, a wire transfer usually costs at least $15. 

Mobile payment apps such as CashApp, Venmo or PayPal allow instant transfers between users. Users can use their Venmo balance for purchases. What makes me unclear about whether these apps are RTP are 1/ they require users to use another payment rail to retrieve money. Customers who want instant transfers from these apps to their checking accounts will have to pay a small fee. 2/ will refunds go to bank accounts or Venmo accounts? If they go to bank accounts, how long will it take? 3/ Since not every merchant supports checkout with these apps, will it still be RTP?