‘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.”
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.”
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.
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
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?
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.
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.
Google Pay team reportedly in major upheaval after botched app revamp. 92% of mobile wallet transactions in the U.S in 2020 were on Apple Pay. If I were an Executive at Google, I’d question why a firm with limitless resources, world-class engineering and ownership of Android couldn’t get Google Pay to be an equal competitor to Apple Pay. One can argue that Apple should have some credit with popularizing Apple Pay. If the driving force were the Cupertino-based company’s dominance and monopoly, why wouldn’t Google replicate that success with its own digital wallet?
How one woman helped build the #AppleToo movement at tech’s most secretive company. I never want to read about anybody being mistreated at their workplace. This #AppleToo movement is no exception. I am very disheartened to read about a group of folks being mistreated and disrespected, especially at a company that I long admire for other reasons.
PayPal is exploring a stock-trading platform for U.S. customers. It came as no surprise to me that PayPal is planning to launch a stock-trading feature. The ambition to be the Super App for consumers’ financial needs has been in full swing for a while. The company is putting the pieces of the puzzle together and this is one of them.
Why Marta Ortega Pérez Is the Secret to Zara’s Success. This is one of the more interesting points in the article: Every morning after dropping off her son at school, Ortega Pérez gathers with the company’s CFO, Miguel Díaz, and other top staff around an industrial table out on the open floor to review global rankings for such bestselling pieces as a minimalist black spaghetti-strap summer dress, or a rococo printed pajama-style blouse with matching shorts. Orders heading to stores are constantly adjusted, an anomaly in an industry that typically plans merchandise drops well in advance. (Zara’s operations are supported by an in-house technology product team that uses Netflix as a measuring stick for both consumer-facing and back-of-house innovations, including a mock fulfillment center floor set up to study the movements of a box-moving robot.)
To appease Japan Fair Trade Commission, Apple agreed to relax its anti-steering rules for Reader apps globally. What it means is that the likes of Spotify and Netflix should be able to sell digital goods to consumers without paying commission to Apple by adding a link to an outside webpage. Historically, Apple was vehemently against this, but the regulatory pressure has been piling up around the world so I guess this is Apple’s pre-emptive action to hopefully get some relief. I have seen some developers skeptical of how this change in policy will actually pan out. I mean, they have reasons to, but given the resources and clout at Apple’s disposal, this is a great step for developers. For consumers, this remains to be seen. One of the selling points of the App Store is that consumers feel safe whenever they make a purchase. Since Reader apps can now direct consumers to outside the App Store, it will depend on who will make the determination as to which app can qualify for the new policy. There remains a possibility that some developers with a harmful agenda can camouflage their app as a Reader App and commit fraud.
Apple Plans Blood-Pressure Measure, Wrist Thermometer in Apple Watch. Apple’s positioning of the Apple Watch is very smart. It’s not trying to compete with normal watches whose main function is to tell time or luxury watches whose main value is the bragging rights. By focusing on the watch wearers’ health, Apple sticks to its core value of providing hardware that is personal to consumers and its strengths, mainly the combination of hardware & software as well as its ecosystem.
How Disney and Scarlett Johansson Reached the Point of No Return. The legal debacle with Scarlett Johansson is unfortunate and worrying as it foreshadows what could be in store for Disney in the future if they didn’t learn from this lesson. According to the article, it could have been avoided, yet here we are. Plus, the pandemic, the interconnectedness of Marvel storylines, the pressure on the bottom line and the priority status imposed on Disney+ make release distribution a delicate matter. While Black Widow brought in $60 million in extra revenue and profit from the Premier Access, Kevin Feige, the Marvel boss, wasn’t happy about it. Putting “Black Widow” on Disney+ conflicted with Mr. Feige’s tiered approach—creating TV shows that complement movies on the big screen. He resisted plans for the movie’s simultaneous release, in part because he didn’t like the idea of having one of Marvel’s few female-driven movies demoted to the at-home streaming service, said people familiar with his thinking.
Direct booking gains are definitely meaningful, though I have a feeling search/compare is happening on OTAs, just that people go direct to get better customer service/assurance in covid. pic.twitter.com/8nn4eeWRKm
“Buy Now Pay Later” (BNPL) lets consumers break down purchases into smaller installments, either for free or with a charge. Sounds familiar? BNPL isn’t a new concept. Your credit card is essentially the OG of BNPL. When you put a big purchase (like a mattress or a new smart TV) on your credit card, you can spread out the outstanding balance into smaller chunks over a few months. If you make prompt payments every cycle, there will be no finance charge or late fees. Otherwise, you’ll incur penalties which can be fairly expensive as credit cards’ APR is usually in the high teens or the 20s.
What is the difference between BNPL and credit cards then? While credit cards can be convenient, securing approval isn’t always easy, especially for low FICO customers. Even though possession of a credit card can boost one’s FICO in the long term, upon an application for a new card, consumers will likely receive a hard FICO pull which hurts their standing in the short term; the price that some customers are reluctant to pay. Furthermore, it can take a couple of weeks for consumers to receive their plastics. With BNPL, consumers can receive a decision from BNPL online in a few minutes and there is only a soft FICO pull that doesn’t hurt their credit standing in the short term. As Covid-19 forced businesses to move from brick-and-mortar to online and it placed significant financial constraints on consumers, it created a perfect environment for BNPL to thrive.
Who are the main players and what do they offer?
Afterpay is among the biggest BNPL lenders in the US. Hailing from Australia, the company only entered the US market in 2018. Remarkably, the US has quickly become the biggest contribution to the company’s revenue in only 3 years. Afterpay doesn’t charge interest. Consumers make the down payment at the time of the purchase and have to pay off balance in 6 weeks (a payment every 2 weeks) to avoid late fees.
Klarna is a Swedish startup that offers payment and financial services, including BNPL. It entered the US market in 2015. Klarna allows consumers to make interest-free installments within 30 days or 6 weeks. It also offers high-interest financing options that spread out payments in a longer term.
US consumers should be very familiar with Paypal. The company launched its BNPL offering last August. Paypal’s BNPL is similar to Afterpay’s, allowing consumers to break down purchases into 4 interest-free installments.
Affirm was founded by ex Paypal, Max Levchin in 2012. Its model is slightly different from other BNPL lenders’ in a sense that Affirm doesn’t charge consumers usage or late fees. Payment options include monthly interest-free installments in 3 months or installments with interest over a longer period.
These startups have played an important role in popularizing BNPL. Now, banks joined the party. Amex launched its BNPL a couple of years ago, but on a fairly limited basis. Since then, it has opened it up to more customers. Chase also introduced its own version called “My Chase Plan”. These banks let consumers make interest-free installments with a monthly fee equal to a percentage of the purchase’s amount. This gives borrowers incentive to pay off their balance as soon as possible, because the longer the plan is, the more fee they will have to pay. Amex even lets its customers combine multiple purchases into one BNPL plan. Unlike startup BNPL providers, these banks impose a minimum requirement of $100 per purchase, along with other criteria, to ensure that customers aren’t overextended.
Are refunds/returns automatically applied to an account’s balance?
No, customers must call the issuer
No, customers must call the issuer
Can authorized users set up plans?
Only card owners or Authorized Account Managers with Full Access can set up a plan
Only card owners can set up a plan
What do merchants and consumers get from BNPL?
For shoppers, BNPL lets them spread out a big purchase into smaller interest-free installments quickly and without a credit card. As mentioned above, the convenience and speed that BNPL brings are even more attractive during Covid-19, especially to younger shoppers who may not build their credit yet or may not have a credit card. Klarna and Afterpay claimed that 90% of their transactions were with debit cards, and 72% of those customers had enough balance on their checking account to cover 2-5x the purchase amount. To lock in customers, BNPL providers such as Klarna and Afterpay launched loyalty programs respectively with additional benefits for their most engaged customers. Klarna’s rewards program Vibe was launched first in the US in June 2020. The no-fee program allows customers to earn 1 point for every dollar spent. The points can be later redeemed for gift cards. Klarna reported that the program exceeded more than 1 million members. On the other hand, Afterpay’s loyalty program Pulse offers a different set of benefits. Registered members in the program can opt to pay nothing up front, choose to reschedule up to 6 payment dates and buy Afterpay gift cards. With Amex and Chase, shoppers accrue points to their bank rewards accounts and can be redeemed later.
However, there are risks for consumers when using BNPL services. A study found that many shoppers incurred late fees, not because they couldn’t make payments financially, but because they lost track of their payment schedule. While this prospect is real, BNPL providers are taking steps to make it easier for shoppers to pay on time. Klarna lets customers set up automatic payments and send out notifications. In the long term, it will be better for BNPL providers to rely too much on late fees. The second risk lies in the consumer protection or lack thereof and the difficulty when it comes to refunds/returns. Credit card issuers have to stop payments when they are disputed. With other BNPL providers, consumers first have to contact sellers, get credit and then proceed to the next steps with the lenders and the outcome is less guaranteed.
From a merchant’s perspective, BNPL brings more customers as the service providers spend a lot of money on marketing and user acquisition. Regardless of whether borrowers make payments on time, merchants get paid in full up front and they don’t have to bear the risk of chargebacks or fraud. In return, though, merchants have to relinquish a fee for each transaction to BNPL providers that can be multiple times higher than what they usually pay in interchange. Plus, merchants risk losing their relationship with customers. I wrote about the importance of owning your relation with your customers. If shoppers feel more attached to BNPL providers than merchants, in the same way shoppers feel more attached to Amazon than the sellers on Amazon’s website, merchants run a risk of losing bargaining power.
BNPL adoption
Because it brings flexibility in payments, BNPL became a hit with shoppers in 2020. Klarna reported that at the end of 2020, it had 14 million registered consumers, 3.5 million monthly active users and 60,000 downloads in December 2020 alone. As of Feb 2021, Affirm had about 4.5 million users that had at least one transaction in the last 12 months, up from 3 million users from one year prior, an increase of 50% YoY. Likewise, Afterpay had 8 million active users as of Feb 2021, up from 5.6 million in June 2020, and the US is now its biggest market. Paypal introduced its “Pay in 4” product in the US market in August 2020 and said that it was the company’s most successful launch ever.
The rise of BNPL also benefits merchants. In December 2020 alone, Klarna drove 22 million lead referrals to more than 6,000 US retailers. Reportedly, Sephora’s in-store and online orders through Klarna in the US saw an increase in average order value by 65% and 35% respectively. Additionally, Afterpay delivered 45 million lead referrals to its partners globally in December 2020. As the US is Afterpay’s biggest segment and the world’s biggest retail market, it likely made up more than half of those referrals. Over the last 12 months, Afterpay reported a 141% increase in the number of active merchants in the US, from 7,400 in Dec 2019 to almost 18,000 in Dec 2020. Furthermore, Affirmgrew its merchant network by 39% during the last 6 months of 2020, to almost 8,000.
According to the latest Global Payment Reports by FIS, BNPL will make up 4.5% of North America’s eCommerce in 2024, up from 1.6% in 2020.
How do BNPL providers make money?
For providers that have an option to charge interest up front like Affirm, interest income can be a significant source of revenue. In fact, it’s Affirm’s second biggest revenue stream. Late fees can be another stream, though, as I already mentioned, they should constitute a small percentage of a provider’s income. Afterpay’s late fee only makes up 7% of the company’s revenue. Most of these providers make money from a fee that merchants have to pay them on every transaction. This fee helps BNPL providers offset the cost of fund placed on the balance allocated to shoppers, the interchange fee that these providers later have to pay to card issuers when shoppers make payments and operating expenses. As BNPL lenders become more popular, I suspect they will eventually launch advertising services whose revenue is high margin, compared to their current margin structure. For banks such as Amex and Chase, a minimum purchase requirement of $100+ means a higher interchange revenue. Plus, they charge customers a monthly fee to use their BNPL service. On the other hand, banks have to incur more expenses as they are much more regulated.
In short, BNPL is a trend born out of unaddressed needs of consumers and accelerated by a special market environment (Covid-19). It’s similar to something that once you saw, you can’t unsee. Once consumers experience it and come to like it, as evidenced by the rapid growth of BNPL providers, I don’t see how it will go away in the future. It will be interesting to see 1/ how these providers work to be more efficient, grow their machine learning capabilities so that they can minimize their losses, and acquire users and 2/ how lawmakers catch up to what’s going on in the market and what ramifications potentially new laws would bring.
Minh Quang Duong 