Weekly reading – 17th September 2022

What I wrote last week

Relocation from Vietnam to the US with a cat

Business

JPMorgan Chase acquires payments fintech Renovite to help it battle Stripe and Block. Incumbent financial institutions are sparing no coins to invest in their technology stacks. Capital One has always touted itself as a technology company. JPMorgan Chase has plowed so much money into fintech that the long-time CEO Jamie Dimon is under pressure to justify the investments. But that’s the name of the game. Any company that wants to compete in finance in the future will need to put money where its mouth is

Goldman’s Apple Card business has a surprising subprime problem. Given the lack of disclosure from either Goldman Sachs and Apple on earnings calls, it’s helpful to finally to see some performance metrics of the Apple Card portfolio. The headlines are that more than 25% of the overall outstandings is from folks with FICO lower than 660 and the loss rates are among the highest in the industry. The article did well to note that Apple Card is a young business; therefore, its loss rates may not be fully comparable to other fully established ones. I’d also love to learn about the share of balance from Apple purchases. My theory is that since a lot of people use the Apple Card to break their payment into installments, the lower FICO crowd is responsible for the bulk of such payment plans’ balance. Is that necessarily a good thing? I don’t know. But if these “bad apples” are barred from holding an Apple Card ever again, whoever is left will be good loyal customers.

Apple’s Next Big Thing: A Business Model Change. Apple’s executive team doesn’t get enough credit for their long-term vision, the ability to pivot & execute and their relentless patience.

($) How a CEO Rescued a Big Bet on Big Oil; ‘There Were a Lot of Doubters’. Vicki Hollub sounds quite a businesswoman, an operator and an executive!

How to blow $85 million in 11 months: The inside story of Airlift’s crash. Another one on a long list of examples of how companies collapse due to the “move fast and break things” mantra.

($) Instagram Stumbles in Push to Mimic TikTok, Internal Documents Show. If I were Meta investors, I would be worried. The company commits huge investments, HUGEEEEEEE, to the Metaverse, a concept championed by the CEO which, in my opinion, is very very far from reality and of course, monetization. Its business model built upon surveillance tracking is under pressure from Apple’s privacy-centric, though controversial, policies. Meanwhile, Reels, which is one of the highest priorities, is no match against TikTok. According to the Chief Operating Officer of Instagram, Reel’s differentiation comes from the ease of sharing content. I mean, that’s a very weak point. “Instagram users cumulatively are spending 17.6 million hours a day watching Reels, less than one-tenth of the 197.8 million hours TikTok users spend each day on that platform, according to a document reviewed by The Wall Street Journal that summarizes internal Meta research. The internal document showed that nearly one-third of Reels videos are created on another platform, usually TikTok, and include a watermark or border identifying them as such. Meta said it “downranks” these videos, meaning it shows them to smaller audiences to reduce the incentives for those that post them, but they continue to proliferate. For Reels users, the result is that often they are shown videos recycled from another, more popular platform. The portion of Instagram users who think the company “cares about” them fell from nearly 70% in 2019 to roughly 20% earlier this summer. On the question of whether the product was “good for the world,” the score fell from more than 60% in 2019 to slightly over 45%.”

Other stuff I find interesting

Good enough. On Twitter and business websites, you see all kinds of people trying to predict the performance of a stock or a business. Some do it with a breath-taking degree of condescension and over-confidence. At work, the phrase “data-driven” which refers to the practice of using historical data to back up a course of action is just overused and bores me to death. Instead, I like what Morgan proposed. Make all the predicting and forecasting good enough and then spend the unused bandwidth on something else. I don’t know, like understanding the industry, the customers or what is holding the company back and fixing it.

Three Big Things: The Most Important Forces Shaping the World. A great perspective by Morgan Housel

Shanghai emerges as China’s semiconductor highland. “In total, the market size of Shanghai’s semiconductor industry reached 250 billion yuan (US$36.95 billion) in 2021, or about a quarter of China’s total, according to Wu. The city has attracted over one thousand key industry players and over 40 per cent of the country’s chip talent, Wu added. Shanghai’s relative success in cultivating a big local semiconductor industry has been partly helped by the city’s preferential policies. To attract semiconductor businesses, talent and investors to the city, the Shanghai authority has rolled out a series of preferential measures, from government subsidies to tax breaks. Even during the city’s draconian lockdown in April and May, the local authority gave priority to semiconductor businesses to resume their production and operations as soon as possible.”

The Oldest Restaurant in Kabul: Where Tradition Trumps Rockets. “During the four decades of war that Afghanistan has been through, the Broot family never left the country. They kept their restaurant open and continued serving chainakito the hungry people of Kabul as rockets rained on their neighborhood, bombs exploded, and regimes changed.

Discipline is Destiny: 25 Habits That Will Guarantee You Success

Stats

Indonesia, Brazil, Ghana and Suriname accounted for 80% of tropical forest loss due to industrial mining between 2000 and 2019

Top-Ranked US Colleges All Cost More Than $55,000 a Year. BEFORE room and board.

U.S. mortgage interest rates top 6% for first time since 2008

Source: Twitter

Weekly reading – 20th November 2021

What I wrote last week

My thoughts on Apple Business Essentials

What I think about Apple Pay & Apple Card

Good reads on Business

HelloFresh: Delivering on Process Power. This episode goes deep into the operational aspect of Hello Fresh. I certainly under-estimated it and its operational complexity.

Macy’s CEO, a department store veteran, fights to fit in the Amazon future of retail. Macy is an interesting case study in which its online presence is so valuable that activist investors want it to be publicly traded alone, separate from the physical stores. “Of the company’s 5 million new customers that came in over the second quarter, more than 40% came to Macy’s digitally, Gennette said on the earnings call. In an effort to capitalize on its most valuable customers — those who shop at Macy’s both in-person and online tend to spend three times more than those who only shop at one or the other — Macy’s has invested in data analytics so it can follow when and what they shop, then tailor incentive programs and product messaging to them.”

Breaking Down the Payment for Order Flow Debate. A good read on the payment for order flow debate and why orders on trading apps like Robinhood are halted when there is too much volatility.

Apple is sticking taxpayers with part of the bill for rollout of tech giant’s digital ID card. As an Apple shareholder, it is good to see the power that Apple wields against even the states. As a tax payer, I am quite concerned that the few participating states so far seem to give that much ground to a private company.

The end of “click to subscribe, call to cancel”? One of the news industry’s favorite retention tactics is illegal, FTC says. I am really glad that the FTC intervened to protect consumers. If you want an example of how governments can help citizens, this case is exhibit A.

Airlines Are Rewriting the Rules on Frequent-Flier Programs—Again. “The airline will make it possible to earn elite status without taking a single flight starting in March. Credit-card miles will count more toward status than ever before. Those who are true frequent fliers will get some added benefits, and business travelers who aren’t taking as many trips will be able to boost their status with their spending. Small-business owners and others who use their credit cards a lot now can be a top dog at American before they ever lift the buckle on a seat belt. Delta says it will automatically roll over status that SkyMiles customers have this year to 2022. In addition, it will pool qualifying miles earned this year and next together toward 2023 status requirements. Delta is also offering bonuses to qualify for elite-status tiers faster and is counting the flying that members do on award tickets toward status levels.” Another change that was encouraged by the pandemic. What doesn’t kill you makes you stronger, I guess.

What Went Wrong With Zillow? A Real-Estate Algorithm Derailed Its Big Bet. When you are in a business of risk management and become reckless and carried away by the pandemic, the consequences can be dire.

Stuff I found interesting

Japanese Philosophies That’ll Help You Spend Money Consciously. “Chisoku talks about being content with what you already have. Wabi Sabi talks about finding beauty in imperfection. As things age and decay, they become more beautiful. Mitate teaches us that every object has more than one purpose.”

New Zealand’s 180-million-year-old forest. “While most petrified forests are far removed from the modern forests that grow near them, Curio Bay’s petrified forest, which is a representation of an ancient Gondwana forest of cycads, gingkos, conifers and ferns, still has its descendants in the present-day forests found here. About 80% of New Zealand’s trees, ferns and flowering plants are native having evolved in isolation for millions of years.”

One of the World’s Poorest Countries Found a Better Way to Do Stimulus. “In Togo, a nation of about 8 million people where the average income is below $2 a day, it took the government less than two weeks to design and launch an all-digital system for delivering monthly payments to about a quarter of the adult population. People such as Bamaze, with no tax or payroll records, were identified as in need, enrolled in the program, and paid without any in-person contact.”

Stats

The state’s venture capital share has jumped from $300 million in 2016, to almost $3.1 billion in 2020 — 866%– according to Crunchbase. That makes it the state with the fastest growing venture capital rate.”

Drug overdose deaths exceeded 100,000 in the U.S in the 12 months ending April 2021

Out of 100 children born prematurely in Vietnam every year, 17 die in the first 28 days. My country has a long way to go in terms of public health.

Image
Source: Dave Ambrose

Thoughts on Apple Pay and Apple Card

In this post, I want to discuss Apple Pay & Apple Card

Apple Pay

Natively available on almost every Apple device out there, Apple Pay is one of the most popular mobile wallets on the market. In 2020, 92% of mobile wallet transactions funded by debit cards in the U.S were through Apple Pay. This level of popularity can mean a windfall for Apple because for every Apple Pay transaction, the company is reported to earn 0.15% of the volume. In Q1 FY2020, Tim Cook revealed that the annualized Apple Pay volume was at $15 billion. At 0.15% take rate, Apple earns around $22.5 million in extra revenue for, what I would imagine, a very high margin service. Even with that advantage, I believe that Apple Pay still has plenty of potential to realize.

First, the wallet feature is still absent in many countries in Africa, Asia and South America, where a large portion of the world’s population resides. As the adoption of Apple Pay ramps up, it should increase the total transaction volume and consequently some additional revenue for the company. The second lever lies in how Apple Pay is and can be used. As of now, it is most used in online mobile transactions. In-store mobile transactions just don’t gain enough traction as there are only 6 out 100 shoppers that use the service in stores, even 7 years after launch. I don’t expect the in-store trend to change in the future. Where I do see growth opportunities for Apple Pay, though, is in online web transactions. As more customers upgrade from old Macbooks and iPads to more modern versions equipped with Touch ID and Face ID, it will make Apple Pay for web transactions an easier and more seamless experience. Finally, Buy Now Pay Later (BNPL). The whole market is red-hot and Apple is rumored to be working on its own BNPL solution. The big advantage for Apple here is that the feature comes in the Wallet app, which comes natively on every single device. Users don’t need to download any other app to apply. As the concept of BNPL becomes more common due to the popularity of apps like PayPal, Affirm, Klarna or Afterpay, Apple will just ride the coattail and won’t have to spend much money and time educating shoppers on the service.

Of course, I’d be remiss if I didn’t mention that there are also headwinds to Apple Pay. Companies such as Shopify, PayPal, Square, Affirm and Klarna all want to be the go-to app & checkout options for shopping transactions. These companies are well-known in the U.S and many international markets, as well as have enough resources to truly compete with Apple on this front. Hence, it won’t be all rosy roads for Apple Pay, but I do expect it to continue to grow in the future. If PayPal can process over $1.2 trillion in annual payment volume, it’s possible that Apple Pay could rise to $100 billion in volume, meaning $225 million in revenue and almost pure profit for the company. Since there are 1.65 billion installed devices in the wild, $100 billion in volume would translate to less than $100 per device a year. It seems doable to me.

Apple Card

Apple Card is a co-branded credit card issued by Goldman Sachs. The mega bank is about to close the GM portfolio purchase in the next quarter or two. Hence, their credit card balance is mostly, if not entirely, from Apple Card. According to the latest quarter result, Apple Card balance was $6 billion as of September 2021, up from $3 billion just a year ago. In other words, the Apple Card portfolio doubled its outstanding balance in 12 months’ time. The size of a co-brand portfolio is often a private matter, but I managed to find a few as a reference for Apple Card

A portfolio’s outstanding balance changes from day to day. Therefore, these numbers may be very different from now. Plus, these companies have a different business model, brand name and card offering than Apple. Nonetheless, I do think growing a credit card portfolio to $6 billion in loans in two years is not a small feat.

Apple Card’s loans were $6 billion as of Sep 30, 2021. Source: Goldman Sachs

According to Experian and ValuePenguin, the average credit card balance in the U.S has been a tad more than $6,000 between 2019 and 2021. If we apply that number to the Apple Card portfolio, it means that the portfolio has a bit less than 1 million accounts. However, given that Apple Card doesn’t have a big signing bonus or intro offer and it can only earn 2% cash back when used with Apple Pay, I think that the average revolving balance is lower than $6,000. In fact, I think it’s very common that people just get an Apple Card because 1/ they want a nice-looking metal card and 2/ they want to put their big Apple purchase on installments. In the latter case, an Apple purchase should range from $1,000 to $3,000 in most cases. As a result I’d think that Apple Card’s average card balance likely ranges from $2,500 to $4,000.

Average Revolving Balance Per Account# of Accounts (in millions)
$2,5002.4
$3,0002
$4,0001.5
$4,5001.3
$5,0001.2
$6,0001

The number of accounts can determine how much money Apple can get from this arrangement with Goldman Sachs. In the cobrand credit card world, the issuer has to compensate its partner for leveraging its brand. The compensation includes a finder’s fee (a certain amount for a new account opened) and a profit sharing agreement which may be based on interest income or purchase volume, for instance. I have seen smaller brands command $60 per a new account. Hence, it won’t surprise me one bit if Apple can demand a three-digit finder’s fee from Goldman Sachs, given that Apple shoulders all the marketing efforts. At $100 per a new account, 1 million accounts brings in $100 million in revenue for Apple. Even if we factor in the marketing and reward expenses that Apple might incur, it’s possible that Apple can bring in more than the $100 million figure since we know nothing about the profit sharing part between them and Goldman Sachs.

In short, even though these two services have great potential and can bring in meaningful revenue and margin to Apple, given the size of the company, they won’t move the needle much. Instead, they are great value-added services that enhance user experience on Apple devices. With Apple Pay, transactions on every website or app that enable the service are so easy to process. With Apple Card, it’s likely the only product that come with no fees and installment plans every time you make a big Apple purchase. As long as Apple users remain loyal and attached to the company’s devices, these services will have the runway to grow. Remember that Apple Card so far is only available in the U.S.

Disclaimer: I have a position on Apple.

How do credit card issuers make money? What are the main types of credit cards? A quick look into the credit card world

Launching a credit card product is similar to putting together a jigsaw. There are many pieces: how to appeal to customers, which customers are an issuer’s likely target, what a good experience looks like, how an issuer can make money and how a card can compete with existing products on a market. In this post, I’ll go over my thoughts on the economics of a credit card, the main credit card types that I see on the market (excluding those debit cards that have credit card functions), the appeal of Apple Card and how different cards compare to one another.

Economics of a card

An issuer essentially generates revenue from three main sources with a credit card: interest payment when customers don’t pay off their balance, fees (late fee, annual fee, cash advance fee, balance transfer fee, foreign transaction fee and others) and interchange. Interchange is a small percentage of a transaction that a merchant pays to a card issuer whenever a customer uses a credit card to pay. The more spend is accrued, the more interchange issuers generate. Interchange rates are determined by networks such as Visa, Mastercard, Discover and American Express. The exact rates depend on a lot of factors: the industry or category that a merchant is in, what type of card (high end or normal) is being used, regulations (Europe imposes a limit on interchange rates, unlike the US) and how a customer uses the card to pay (swipe, chip, mobile wallet, online, phone..).

On average, some categories such as Airlines, Restaurants, Quick Restaurant Services, Hotels or Transportation have an interchange rate somewhere between 2% – 3%. Other categories such as Gas and Grocery, especially at Walmart, Target or Costco usually yield a very low interchange rate around 1% – 1.4%. Any credit card that offers higher than 3% in cash back in a category likely loses money on that category as the interchange cannot make up for the reward liabilities. Issuers are willing to offer 3-5% cash back, knowing that they lose money on that front, because they are banking on the assumption that the money that they make up from other sources will offset that loss. Specifically, they are likely to make money on categories with 1%. For instance, if you buy clothes or pay for a subscription online or buy something from a Shopify store, your card issuer is likely to make at least 1% in interchange, after they give you 1% in cash back. Additionally, issuers that offer a rich reward scheme usually impose an annual fee to offset the reward liabilities and the signing bonus that they use to acquire customers.

Hence, cards with no annual fee offer a cash back between 1.5 – 2%. They can’t afford to go higher than that because the maths would unlikely add up. Cards that have an annual fee often come with high rewards and a big bonus. While a big bonus can be an attractive tool to acquire customers, it incentivizes short-term purchase bursts and unintentionally attracts gamers, customers who receive the bonus, cash it out and either become a ghost, if they don’t have to pay an annual fee, or close out the card for good. There are a lot of gamers and gamers aren’t profitable to issuers. However, issuers still dole out a big bonus and attractive rewards because they think that there are customers that stay for a long term and can provide the interest income and fees that issuers need.

Three essential types of credit cards

I call the first type of cards the “Everyday Card”. Examples of this category include Blispay and Citi Double Cash Back. These cards offer a standard rewards rate on every purchase category (1.5% to 2%) with no annual fee. There is usually a 3% foreign transaction fee and there is no signing bonus. What makes Everyday Card appealing is that customers do not need to remember the complex rewards structure. They can just “set it and forget about it”. It earns them respectable rewards on every purchase, even at Walmart.

The second type of cards is the “No Annual Fee With Bonus”. Examples of this category are Discover It Cash Back, Freedom Unlimited or Freedom Flex. These cards’ highest reward rate is usually 5% on a certain pre-determined category that tends to yield a high interchange rate. In some cases, this 5% rate can rotate every quarter, keeping it interesting for customers and making them locked in if they want to activate a preferred category. There is a signing bonus for new customers. Some cards reward customers with a few hundred dollars in a statement credit if they spend a certain amount in the first 90 days. This mechanism is designed to make customers locked in early. The issuers bank on the assumption that once customers earn their signing bonus, they will stick around to keep those rewards points alive. However, it’s not uncommon for customers to cash out their rewards and become inactive afterwards. 

Discover’s signing bonus is designed to keep customers active during the first calendar year. They promise to match the cash back rewards at the end of the first year, but the bonus is a one-time occurrence and doesn’t repeat. This mechanism may keep customers active longer than what an outright statement credit does, but customers can always leave after the first year.

The last type of cards usually comes with an annual fee. Examples are Chase Sapphire Preferred or Bank of America Premium Rewards. Cards in this category come with a signing bonus after qualifying conditions are met and with a rich rewards structure. To offset expenses, issuers impose an annual fee. Customer acquisition may not be an issue with cards in this category, but will customers stay around after the signing bonus? Or are customers happy enough to pay a high annual fee every year? Also, these cards’ reward rate is high only in categories with higher interchange rate such as travel or dining. The rate is pretty light (1%) in other categories. While this approach appeals to a specific segment of customers, for customers that want “to set it and forget it”, does it still carry that same appeal though?

If you find credit cards complex and confusing, that’s normal because they are usually designed that way

Most credit cards can be pretty complex and confusing to customers. Let’s start with rewards. A tiered reward structure forces customers to mentally remember all the combinations of categories and rates. If customers have multiple cards in their wallet as they often do, it’s not an easy ask. Of course, there are folks that make a living in maximizing rewards, but that doesn’t work for the rest of us. In addition, it’s not always clear to customers how to categorize merchants. Merchants are categorized by Merchant Category Codes. These codes help issuers set up rewards and help networks determine interchange rates. MCCs are known in the banking industry, but to an ordinary customer, they don’t usually mean much. In some cases, issuers provide a list of qualifying merchants, but they can’t list all the available merchants and the practice is not ubiquitous.

Moreover, reward redemption can be a time-consuming process. Points or cash back earned in this cycle have to wait at least till the cycle ends before they are available for redemption. It can take longer in some cases, especially when it comes to signing bonuses. Here is a list of how long it takes for points to post at different issuers, compiled by Creditcards.com

 How long it takes to redeem the signing bonus?How long it takes to redeem spending rewards
Amex8-12 weeks after a customer hits the spending requirementWhen the current cycle ends
BofAAt the close of the billing cycle when the minimum spend is metWhen the current cycle ends
Capital OneWithin 2 cycles of when the spending requirement is metUp to 2 cycles
ChaseUp to 6-8 weeks after a customer hits the spending requirementWhen the current cycle ends
Citi8-10 weeks after a customer hits the spending requirementWhen the current cycle ends. With Citi Double Cash Back Card, it can take a bit longer if customers don’t pay in full
DiscoverWithin 2 cycles after a customer hits the spending requirementWhen the current cycle ends
US BankUp to 2 billing cycles after a customer hits the spending requirementWhen the current cycle ends
Wells FargoUp to 2 billing cycles after the qualifying period When the current cycle ends
Figure 1 – How long it takes issuers to let customers redeem rewards

The final point in rewards is that issuers tend to deceptively inflate the rewards by posting numbers in points, instead of dollars. Understandably, 100 points sounds much better than $1, even though they have the same value. Nonetheless, it creates an unnecessary level of complexity for customers to mentally convert points into cash, especially when the reward value is big.

Rewards aren’t the only source of frustration for credit card customers. Credit cards are essentially loans on which you may or may not have to pay interest. However, issuers hope that customers will incur interest and fees (as long as they don’t charge off). How often are fees prominently and clearly marketed as rewards? How often do you see in advance the potential interest payment if you don’t pay off your balance? Here is a study by Experian on the concerns that consumers have about credit cards

Consumer concerns about having a credit card
Figure 2 – Consumer concerns about a credit card

Apple Card is designed to do something different

Apple launched Apple Card in August 2019 in collaboration with Goldman Sachs. Customers can apply for an Apple Card right from the Wallet app, which is pre-loaded on an Apple device. The preloading is a significant advantage as customers don’t need to either load another bank app or search for a website and apply for a card. As soon as an application is approved, customers can use their Apple Card immediately either by holding your device near an NFC-enabled reader or paying online. With Apple Card, cardholders earn 3% cash back on purchases at Apple and strategic partners such as Exxon, T-Mobile, Walgreens, or Nike, 2% cash back on others purchases using Apple Pay and 1% cash back using the titanium physical card. The 2% cash back on other purchases can be appealing, but not every offline or online merchant allows Apple Pay.

The biggest selling points of Apple Card are transparency and simplicity. Take their no-fee structure as an example. There is no fee involved with Apple Card. No annual fee, no foreign transaction fee, no over-the-limit fee and no late fee. While Apple remains coy on cash advance fees, their special clientele may not use the mainly virtual Apple Card for this specific reason much. 

The simplicity also goes into their daily cash back. Typically, cash back earned through a credit card can take weeks to be registered and redeemed. Points or cash back earned this cycle must wait at least till the cycle ends before they are available for redemption. With Apple Card, cash back is earned daily in Apple Cash. As long as transactions are posted, customers can see the earned amount reflected in their Apple Cash. In real money term not in points. This takes away an unnecessary step for customers to mentally convert points into cash. Furthermore, Apple Cash can be used at any time, either in a person-to-person transaction, in a deposit back to a checking account or to pay back the outstanding balance in Apple Card. 

In terms of transparency, Apple Card tells customers how much interest they are paying when making a payment. And their APR is on par with other issuers’. In the Wallet app, customers can determine how much of the outstanding balance they want to pay. Depending on the amount, Apple will let customers know in advance their interest so that they can make an informed decision. It is in contrast to what almost all other issuers do. 

Apple Card's flexible interest rate
Figure 3 – A simulation to show interests on Apple Card varies based on how much a cardholder can pay.
Source: Apple

Apple Card only works with iOS devices and Apple Pay can be a challenge for elderly or less tech-savvy customers. Nonetheless, no card is perfect for everybody and the transparency and simplicity can teach us a lesson on how to craft a good customer experience. Despite being available only in the US and all restrictions above, Apple Card’s portfolio balance grew from $2 billion in March 2020 to $3 billion in September 2020 and roughly $4 billion at the end of 2020. Not bad for a portfolio with one card that is restricted to iOS devices. 

Annual fee or no annual fee? Appealing and complex or straightforward and simple?

A good practice in positioning is to use a 2×2 matrix. In this case, I’ll look at Apple Card and the three main credit cards mentioned above through whether they are easy to use and whether they have an annual fee.

Credit card positioning
Figure 4 – A 2×2 positioning matrix for credit cards

Let’s look at the positioning chart above. On the top right corner, we have an ultra-luxury card such as The Platinum Card from Amex. This card’s annual fee runs up to $550 and while rewards rate can range from 1x to 10x, it is not easy to remember all the details or to redeem rewards. On its left side, we have cards such as Capital One Venture and Chase Sapphire Preferred. These cards’ annual fee is $95, lower than the Platinum Card’s. Similarly, the complexity of cards such as Chase Sapphire Preferred is still high. Capital One Venture has 2x rewards rate on every purchase, making it less complex to use for some users, but it’s still time-consuming to redeem cash back. 

Moving further left, there is Capital One Quicksilver. This card’s annual fee stands at $39 and it offers 1.5x on every purchase. It’s in the middle of the spectrums. On the “no annual fee” side, we have two groups. The first group features cards such as Freedom Flex and Discover It Cash Back. These cards offer a 5x reward rate, but it rotates every quarter and to some customers, that can add some complexity. The other group features cards such as Citi Double Cash Back and FNBO Evergreen. These cards have no annual fee and offer 2x on every purchase. Nonetheless, they still have a complex fee structure and a reward redemption process that can be improved.

The point here is that it’s very competitive on the top half of the chart. All these cards have their own unique selling points that appeal to different customer segments. What they do have in common is that their fees and reward redemption are pretty complex.

On the other side of the x-axis, there are Apple Card and Upgrade Card. Even though it’s straightforward to use Apple Card as there is no fee and cash back is earned daily, the use of Apple Card depends much on whether customers have an iPhone and whether merchants enable Apple Pay. 40% of mobile users in the US don’t own an iPhone and as discussed above, older and less tech-savvy customers may not find Apple Pay comfortable. Without Apple Pay, the titanium card itself earns customers a paltry 1% cash back. 

Upgrade Card is a credit card issued by Sutton Bank, a medium sized bank in Ohio with $500 million in assets, and marketed by Upgrade. There is no fee with Upgrade Card. Here is what the company claims on its website

Not all traditional credit cards charge fees. However, creditcards.com’s 2020 Credit Card Fee Survey found that the average number of fees per card is 4.5. For example, the 2019 U.S. News Consumer Credit Card Fee Study found that the average annual fee (including cards with no annual fee) is $35.23, the average late fee is $36.34 and the average returned payment fee is $34. 01. The Upgrade Card charges none of these fees. Over 90 percent of cards charge balance transfer fees and cash advance fees. The Upgrade Card enables you to transfer cash from your Personal Credit Line to your bank account with no fees.

Source: Upgrade

With Upgrade Card, customers earn 1.5% cash back on all purchases as soon as customers pay off balance. The 1.5% cash back rate is lower than what Apple Card customers earn using Apple Pay, but on the other hand, Upgrade Card is device-agnostic and doesn’t rely on any mobile wallets. Hence, it is more accessible. However, Apple Pay allows customers to earn and use rewards daily while Upgrade Card only allows customers to redeem rewards after they make full payments.

According to the book The Anatomy of The Swipe, medium sized banks are essentially unregulated and can charge a higher interchange rate than big regulated banks. Hence, it’s very likely that Upgrade Card’s interchange rates are higher than those of cards issued by the likes of Chase or Capital One. The higher interchange rates can help offset rewards liabilities and generate revenue.

In fact, I am surprise to find no product like Upgrade Card from big banks. I suspect it would take a huge investment in infrastructure by legacy banks to offer the Daily Cash feature that Apple Card has. But legacy banks can essentially waive all fees like Upgrade Card does. While the likes of Chase, Discover or Capital One have more expenses than a smaller platform like Upgrade, they also have more popular brand names than Upgrade; something that would help tremendously in customer acquisition.

In summary, the credit card world is highly competitive. If an issuer follows the conventional way of launching a credit card, it will surely have a lot of competition and little to differentiate itself from competitors. In the upper half of Figure 4 above, I do think all the concepts and variations of rewards and economics have been tried. To be different, an issuer has to think differently and appeal to customers more with a superior customer experience (easy and simple to use) and less with complex features.

Weekly reading – 28th November 2020

What I wrote last week

I wrote about why I think Apple Card would be a significant credit card as Apple Pay grows more popular

I wrote about Target, Salesforce’s acquisition talk with Slack and Uber vs Lyft

I reviewed President Barack Obama’s new memoir “A Promised Land

Business

The difference in the business model between Booking.com and Expedia

NYTimes and The Washington Post expanded their subscriber base substantially in the last two years

Black Friday’s online shopping exceeded $5 billion

Amazon is strengthening its advantages with delivery capabilities that can rival UBS’

TikTok used its biggest stars in its legal fight against the US government

Research shows that unique visitors to Microsoft Teams far outnumbered those to Slack in October 2020

Technology

There are 123 Fintech startups in Vietnam in 2020. Most of them operate in the Payments area

Users of the new Macs with M1 referred to the hardware as having “alien technology”, “wicked” or “sockery”

What I found interesting

Hanoi and Saigon/Ho Chi Minh City is the second busiest domestic flight route in the world

This piece tells a story about how Utah uses collaboration and human touch to create policies that help foster the state’s equality and economy. Two quotes stand out to me

Utahns seem strongly committed to charitable works, by gov­ernment, alongside government or outside government. What­ever tools used are infused with an ethic of self-reliance that helps prevent dependency . . . when there’s a conflict between that ethic and mercy, Utah institutions err on the side of mercy

Betty Tingey, after seeing the news coverage about the Utah Compact, wrote to the Deseret News, “I don’t know much about politics except the sick feeling I get inside when there is constant arguing. . . . I don’t know how to settle debates, but I know a peaceful heart when I have one. I felt it when I read the Utah Compact.”

Source: American Affairs Journal

This clip about an 86-year-old baking master in Greece gave me mixed feelings. On one hand, I admire his work ethics, but on the other, it can be a condemnation of a system that forces old people to work this late in their life

As contactless payments become more popular in the US, card issuers should beware of Apple Card

Costs and benefits of a credit card from an issuer perspective

Issuing a credit card is a business and hence, it comes with risks, expenses, revenue and hopefully profits. A credit card issuer’s revenue comes from three main sources: interchange, fees and finance charge. Finance charge is essentially interest income or the interest on outstanding balance that users have unpaid at the end of a cycle. Fees include late fees, cash advance fees or annual fees, just to name a few. Interchange is what an issuer receives from merchants on a transaction basis, according to a rate agreed in advance and usually dictated by networks such as Visa or Mastercard. There are a lot of factors that go into determining what an interchange rate should be, but for a consumer card, it should not be higher than 3% of a transaction’s value.

As an issuer thinks about which credit card product to issue, it needs to balance between the benefits of the card, the expenses and the profitability. For instance, nobody would be paying $100 in annual fee for a credit card that has a standard 1.5% cash back without any other special benefits. That product wouldn’t sell. Likewise, an issuer would flush money down the toilet if it issued a card with a lot of benefits such as a Chase Sapphire without a mechanism to make money on the other side, like an annual fee. The art of issuing a credit card is to make sure that there is something to hook the users with and a way to make money.

The dynamic between a brand and an issuer in a Cobranded credit card agreement

In addition to having cash back or rewards on generic categories such as Dining, Grocery or Gas, an issuer can appeal to a specific user segment by having a special benefit dedicated to a brand. That’s why you see a Co-branded credit card from Walmart, Southwest, Costco or Scheels. These brands work with an issuer to slap their brand on a credit card. What do the parties in this type of partnership get in return?

From the Brand perspective, it offers to an issuer Marketing Assistance and an exclusive feature to appeal to credit card users. To the fans of Costco, a Costco credit card with 5% cash back; which should be very unique, is an enticing product to consider. Why saying no to extra money when you already shop there every week without it already? Moreover, a Brand can also be responsible for rewards at or outside their properties. For instance, Costco can pay for rewards at Costco stores or on Costco website or purchase outside Costco or the combination of all. It varies from one agreement to another.

From the Issuer perspective, it has to compensate the Brand in the form of Finder Fee, which is a small fee whenever there is a new acquired account or a renewal, and a percentage of purchase volume; which you can consider it a tax. The issuer, of course, has to take care of all the operations related to a credit card such as issuing, marketing, customer service, security, regulatory compliance, fraud, you name it. In return, issuers have an exclusive benefit to appeal to credit card prospects. They will also receive all the revenue, net the compensation to the Brand, as I described in the first section. Therefore, the longer a customer stays with an issuer and the more he or she uses the card, preferably revolves as well, the more profitable it is for the issuer.

BrandIssuer
What to offer– Marketing Assistance & brand appeal
– Rewards
– Finder fee (a fixed fee for every new account and/or a lower fee for every renewal
– In some cases, issuers fund rewards as well
– All operational needs related to a credit card
– A percentage of purchase volume
What to gain– Finder fees
– A tactic to increase customer loyalty
– A percentage of purchase volume from the issuer
– An exclusive feature to appeal to credit card users
– Revenue, net all the compensation to the Brand

Typical credit cards

Based on my observations, there are three main credit card types on the market which I assign names for easier reference further in this article:

  • The Ordinary: cards that have no annual fees, but modest benefits such as 1% or 1.5% cash back on everything. These cards are usually unbranded
  • The Branded: these cards are Co-Branded credit cards that are issued by a bank, but carry a brand of a company. These cards can come with or without an annual fee, but they reward most generously for purchase at the company’s properties, such as 3-5x on every purchase. Then, there is another reward scheme for a generic category such as 2-3x on dining/gas/grocery/travel. Finally, there is a 1x on everything else
  • The Premier: these cards are often accompanied by a high annual fee. To make it worthwhile for users, the issuers of these Cards hand out generous benefits and/or signing bonus. For instance, a Chase Sapphire user can get 60,000 points after spending $4,000 the first 90 days.

All the three types usually work well with mobile wallets and have a delay on when rewards are posted (usually it takes a cycle). This delay isn’t particularly enticing to users because when it comes to benefits, who would want to wait?

Apple Card

Apple Card is a credit card issued by Goldman Sachs and marketed by Apple. The card has no fees whatsoever, but comes with some special features:

  • An expedited application process right from the Wallet app on iPhones
  • Instant cash back in Apple Cash – no delay
  • Native integration with Apple Pay
  • 3% cash back on all Apple purchases
  • 12-month 0% interest payment plan for select Apple products
  • 2% on non-Apple purchases through Apple Pay
  • 1% on non-Apple physical transactions through a chip reader or a swipe

Without the 2% cash back with Apply Pay, Apple Card would very much be for Apple purchases only. But because there is such a feature and Apple Pay is increasingly popular, I think Apple Card should be something that issuers need to beware. Let me explain why

With the increasing popularity of Apple Pay, Apple Card should not be taken light

Last month, the Department of Justice filed an anti-trust lawsuit against Google. Interestingly, the lawsuit said that 60% of mobile devices in the US were iPhones. That says much about how popular Apple’s flagship product is. With the easy application process and the native integration into iPhone and Apple Pay, Apple Card has a direct line to consumers. Once a consumer contemplates buying an Apple product, it’s impossible not to think about getting an Apple Card and reaping all the benefits that come with it. With the existing iPhone users, the extensive media coverage and the marketing prowess of Apple will surely make them aware of Apple Card. Therefore, other issuers are on a back foot when it comes to acquiring customers from iPhone user base. However, most people have multiple cards, so one can argue that this advantage may not mean much. To that, I’ll say: fair enough. Let’s look at other aspects.

If you compare Apple Card to the Ordinary above, Apple Card clearly has an advantage. In addition to the 3% cash back on Apple purchases, there is also 2% cash back on other purchases through Apple Pay, higher than the 1.5% offered by the Ordinary. Granted, Apple Pay’s presence is a requirement, but as more and more merchants and websites use Apple Pay, it’s no longer relevant. It almost becomes a given and this advantage Apple Card has becomes more permanent. Besides, Apple Card has no fees and can issue cash back immediately after transactions are approved, compared to a host of fees and a delay in rewards from the Ordinary.

Between Apple Card and the Branded, it’s harder to tell which has the advantage. It depends on the use cases. For on-partner purchase (purchase on the brand’s properties), Apple Card has no chance here as the reward rate from the Branded is much higher: 3-5x compared to 2x from Apple Card. However, things get trickier when it comes to non on-partner purchase. If a non-on-partner purchase warrants only 1x reward from the Branded, Apple Card has an advantage here as it can offer 2x rewards with Apple Pay. If a non-on-partner purchase warrants 2x reward from the Branded, the question of which card consumers should favor more rests on these factors:

  • How much do consumers care about receiving immediate cash back?
  • Can the transaction in question be paid via Apple Pay?
  • How much are consumers willing to go back and forth in their Apple Pay’s setting?

Between Apple Card and the Premier, the comparison depends on which time frame to look at. Within the first year on book, the Premier should have an advantage. No one should pay $95 for a card and does not have a purchase plan in mind to get the coveted signing bonus. In other words, savvy users should plan a big purchase within the first 90 days to receive thousands of points. In this particular use case, the Premier clearly is the better card. However, it gets trickier after the first year on book. Without a signing bonus, users now have to determine whether it’s worth paying an annual fee any more. The usual benefits from the Premier should be better than Apple Card’s, but the high annual fee and the delay in rewards may tip the cost-benefit analysis scale to a tie or a bit in favor of Apple Card.

Given my arguments above, you can see how Apple Card, provided that Apple Pay becomes mainstream, can become a formidable competitor to issuers. Apple Card may not affect the acquisition much, but it may very well affect the purchase volume and usage of other issuers’ cards, and by extension, profitability because, as I mentioned above, issuers’ revenue come partly from interchange. In other words, Apple Card should not be taken lightly as a gimmick or a toy feature at all.

How popular is Apple Pay?

In Q1 FY 2020, Tim Cook revealed that Apple Pay transactions doubled year over year and reached a run-rate of 15 billion transactions a year. Loup Venture estimated that 95% of the US top retailers and 85% of US retail locations adopted Apple Pay.

Source: Loup Ventures

According to a research by Pulse, in the US in 2019, there was around $1.3 billion worth of debit transactions through mobile wallet, $1.1 billion of which came through Apple Pay. This level of popularity will leave retailers and merchants with no choice, but to have Apple Pay-enabled readers; which in turn will gradually benefit Apple Card.

Image
Source: Pulse

Disclaimer: I own Apple stocks in my personal portfolio

Weekly readings – 24th October 2020

What I wrote last week

How Apple Card’s balance grew by 50% in 3 months and the implications

Amazon Shopper Panel

Business

EU is shooting for an ambitious “industrial cloud” plan to rival the US

DOJ filed an antitrust lawsuit against Google and the tech giant had a strong rebuke

Will you exchange privacy for some money every month? If yes, Amazon will pay you $10/month for 10 receipts of non-Amazon purchases through a service called Amazon Shopper Panel

Doordash is still the market leader in the meal delivery space with 49% market share in September 2020, according to SecondMeasure

A fascinating story on a guy who learned, worked and blogged his way to be an authority in the podcast space

DOJ’s lawsuit against Google, a very interesting read with a lot of great information

Boosted by better-than-expected consumer spending and write-offs, card companies are eyeing more customer acquisitions

How Apple is organized for success

Technology

Emerging Architectures for Modern Data Infrastructure

Adobe released a new feature to help creative folks get credit for their honest work and fight misinformation

a16z released an interesting blog post on the promise of Payroll API

What I found interesting

Japanese Butter Tableware. Ain’t they beautiful and interesting?

How Egypt is growing forests in middle of the desert

A damning account of the failed project between Foxconn, Trump and Wisconsin. The red flags have been there for a long time, yet I fear this isn’t the last time we hear something about it

Apple Card grew balance by $1 billion in 3 months, up 50% from June 2020

Apple Card’s balance grew by $1 billion (50%) in 3 months

Back in July, Goldman Sachs, the issuing bank for Apple Card, reported this in its Q2 earnings call:

Funded consumer loan balances remained stable at roughly $7 billion, of which approximately $5 billion were from Marcus loans and $2 billion from Apple Card

Source: Seeking Alpha

Three months later, the bank said this on its Q3 earnings call this month:

Funded consumer loan balances remained stable at $7 billion, of which approximately $4 billion were from Marcus loans and $3 billion from Apple Card.

Source: Seeking Alpha

My best guess is that the figures for Q2 and Q3 were likely as of the end of June and September. In the banking world, we call them month-end balance. Both Goldman Sachs and Apple have been very tight-lipped about Apple Card. There is very little information and data publicly revealed by either party. With that being said, I do think that it’s positive for Apple and Goldman Sachs to increase month-end balance in 3 months’ time.

There are two ways that this could possibly happen. 1/ The existing accounts in the portfolio saw more usage and a higher accrue of balance and 2/ the portfolio expanded with new accounts and its balance increased. Because we are still struggling in a once-in-a-lifetime pandemic, scenario #1 seems less likely to me. Even if the portfolio’s size stayed the same in September as it did in June, the increase in balance would be much lower than 50% as we see here. Hence, it’s my belief that Apple Card portfolio has expanded and as a result, so has the balance. It’s worth pointing out that since the number of accounts likely increased yet there is no official reporting on it, we don’t really know if the average balance per account really went up from June to September. Nonetheless, a higher balance means:

  • More accounts were opened
  • Accounts were used more, leading to an increase of balance
  • Customers are more likely to revolve, resulting in interest income for Goldman Sachs

Last year, Apple announced a payment plan for iPhones with 0% interest for 24 months. In June 2020, the payment plan expanded to include other product lines:

It’s not a stretch to see that these financing options contribute to the increase in balance of Apple Card portfolio. From Goldman Sachs and Apple’s perspective, they would prefer cardholders to make purchases outside Apple, but because there is little information officially revealed, there is no way to dissect how the portfolio is really performing.

At $3 billion in balance as of September 2020, Apple Card portfolio has so much room to grow. Based on outstanding balance, it’s quite small, compared to other issuers, though it’s unclear whether these portfolios are strictly in the US only

  • Chase: $122 billion in balance for consumer credit card as of Q3 2020.
  • Capital One: $12 billion in balance for consumer credit card as of Q2 2020.
  • Discover: $70 billion in balance for consumer credit card as of Q2 2020
  • Wells Fargo: $36 billion in balance for consumer credit card as of Q3 2020

A persistent and lucrative clientele for Goldman Sachs

I wrote a bit about the partnership between Apple and Goldman Sachs on Apple Card here before. Now I want to add a couple of more points to the conversation.

Apple users are enduring and lucrative. Once a person becomes an Apple user, he or she likely stays in the ecosystem and buys more products and services, as proven by Apple’s financials and analyst estimates. As of Q3 2020, Apple’s Wearables made up 11% of Apple’s total revenue and was the fastest growing segment in FY2020. Apple reported over 550 million subscriptions, up by 130 million from a year ago. With the introduction of Apple One and Apple Fitness+, that figure will likely go up even higher in the near future. Once an iPhone-reliant company, Apple now finds a robust source of revenue from Services, which was responsible for 22% of the company’s top line in Q3 FY2020.

Moreover, Neil Cybart, a prominent Apple analyst and the owner of Above Avalon, reported that nearly half of Apple users owned only one device: iPhone. He also estimated that only 35% of iPhone users in the US wear an Apple Watch. These estimates indicate that more Apple users will buy addition products on top of their iPhones and become engaged at a higher level in the ecosystem.

There is no credit card that offers 3% cash back AND interest-free financing options for Apple products and services like Apple Card. Hence, Goldman Sachs has a unique access to a lucrative clientele that

  • Tends to be sticky and loyal to Apple
  • Buys new expensive Apple products regularly on a few-year basis
  • Uses their Apple Cards monthly with their service subscriptions. Working in the credit card world, I can tell you that having users engaged and actively use cards every month is one of the major concerns for issuers. With Apple subscriptions and an expanding base, albeit as small as $3 per month for iCloud, Goldman Sachs likely will get a good number of active accounts with consistent spending every month, without any acquisition expenses.

Future opportunities

At first, there were only exclusive deals with 3% cash back from Uber, Uber Eats, Walgreen, Duane Reader and T-Mobile. Since then, Apple Card has welcomed to the fold Nike in November 2019, Exxon Mobil in June 2020 and Panera in August 2020. Additionally, Apple began to have acquisition bonus campaigns for Apple Card this year. A few months ago, there was a $50 bonus for every new Apple Card user with a minimum $50 purchase at Walgreen. Just a few days ago, it was reported that there is now a $75 bonus for new Apple Card users with a qualifying purchase at Nike. The more exclusive deals like these are, the more likely consumers will use Apple Card outside of Apple. And there is no reason to believe that they won’t add new partners or have acquisition campaigns in the future.

Besides Apple Card, Apple has been consistently and regularly promoting the use of Apple Pay with ad-hoc deals such as 15% off with American Eagle in October 2020, 50% off with Snapfish in July 2020 or 30% off with Rayban in May 2020. There is no data on how many Apple Pay accounts are paired with Apple Cards. But given the fact that users can only earn 2% Apple Cash from every Apple Pay transaction by using Apple Card, I won’t surprise me that Apple Pay promotions indirectly benefit Apple Card and Goldman Sachs.

There are rumors of new Apple products in the works such as Air Tags, Airpods Studio or Apple AR glasses. The more products and resulting services there are, the better the future outlook will be for Apple Card.

Disclosure: I own Apple stocks in my personal portfolio.

Cobranded Credit Cards and Apple Card

In this post, I’ll try to deduce the reasons why Apple and Goldman Sachs decided to collaborate on Apple Card. What follows in this entry is my deduction from available information and based on my experience working in the credit card industry. First, I’ll touch on the concept of cobranded credit cards and what brands and issuers often get out of a partnership. Second, I’ll talk a bit about Apple Card. Last, I’ll give my thoughts on why Apple and Goldman Sachs may benefit from their relationship. These are my own thoughts only and if you have any thought or material that can contribute to the topic, I’ll appreciate it that you share with me.

Cobranded Credit Cards

You probably have seen a few cobranded credit cards before at popular stores or when you fly with domestic airlines

Source: Google Images

So, what exactly do brands and issuers get for working on cobranded credit cards?

Every brand wants to establish as close a relationship with consumers as possible. One of the popular methods is through a credit card with exclusive benefits. However, brands would be subject to a lot of regulations if they issued credit cards on their own. There would be also a lot of expenses that’d go into servicing accounts. No brand wants that extra burden in addition to running their own business. That’s why they need financial partners.

To compensate an issuer for bearing the risks and operational expenses, a brand usually takes care of the cost of exclusive brand-related benefits. For instance, shoppers receive 5% cash back at Target when they use Target credit cards. I don’t know the exact detail, but my guess is that Target will be responsible for most of the cash back, if not all. Additionally, brands can assist issuers with acquisition costs. Issuers spend thousands of dollars, if not much more, every year to acquire new customers. Brands have an already established relationship with their customers, brand awareness and financial resources that can help issuers in this regard.

On the other hand, issuers are responsible for dealing with financial regulations and servicing accounts. That’s why issuers try to sign as many partners as possible to leverage economies of scale. A small number of partners wouldn’t make operational expenses justified.

Issuers also have to compensate partners for leveraging their brand names. Agreements between issuers and partners vary on a case-by-case basis, but I wouldn’t be surprised if an agreement featured:

  • An issuer pays a partner for each new acquired account and a smaller fee for a renewal
  • An issuer pays a partner a fixed percentage on total purchase volume
  • An issuer pays a partner a fee when accounts make the first purchase outside partners’ locations

What do issuers get in return?

Issuers, of course, keep all financial charges and fees such as annual fees, cash advance fees or late fees. Besides, issuers can generate revenue from interchange fees. In every transaction, a merchant bank which works with a merchant has to pay an issuing bank which issues a credit card to the consumer who shops at the merchant a small fee for accepting credit cards as payment. Payment networks like Visa or Mastercard act as a middle man between a merchant bank and an issuing bank, and decide how big the fee, which is called interchange, should be. What I just describe is a gross simplification of what transpires behind the scenes in a couple of seconds or less in a transaction. There is a lot more to it. Essentially, for the sake of simplicity, just imagine that for every transaction, an issue bank receives 2% of the transaction volume in interchange fees. So if an issuing bank handles $1bn in transaction a month, that bank will get $20 million in interchange fees. Lastly, as mentioned above, issuers can also leverage partners in terms of acquisition costs.

IssuersPartner Brands
Responsibilities– Service accounts and handle regulatory compliance
– Bear risks of charge-off
– Compensation to partners 
– Additional rewards expenses as selling points to consumers
– Assistance in acquiring new accounts
Benefits– Financial charges and fees
– Interchange fees
– Marketing leverage from partners’ outreach
– Deepen relationships with customers
– Compensation from issuers
Table 1

Apple Card

Apple Card is an Apple-branded credit card issued by Goldman Sachs. You can only apply for an Apple Card via your wallet app on Apple-produced devices such as iPhone or iPads. The Card is so synonymous with Apple that you can barely hear about Goldman Sachs.

Apple reportedly will offer monthly payment plans for iPads and ...
Source: The Verge

Apple Pay’s selling points include:

  • No fees
  • Simple application process
  • Premium look and feel
  • Unlimited 2% cash back when you pay with Apple Card using your Apple Watch or iPhone
  • 3% cash back from select merchants such as Uber, T-Mobile, Nike, Walgreens, Duanereade and of course, Apple itself
  • Security as each transaction must be verified either by Touch or Face ID
  • Apple and Goldman Sachs promise not to sell consumer data with a 3rd party for marketing purposes

What’s in it for Apple and Goldman Sachs in launching this Apple Card?

Goldman Sachs isn’t know for consumer banking. It’s known for its investment banking business. Apple Card is the first attempt at consumer banking from the renowned company. As the issuer, Goldman Sachs (GS) will have to deal with all regulatory and security challenges while bearing the risk of charge-off. They will also take part in servicing accounts, but the work is shared with Apple as Apple Customer Service agents handle upfront communication with users. Since Apple Card has no fees whatsoever, what GS can benefit from this collaboration, I allege, include

  • Interchange fees
  • Insane marketing power from Apple and its global footprint in the form of millions of installed iphones
  • I imagine that if this collaboration succeeds, GS will want to sign more partners to achieve economies of scale, leveraging what they learn from operating Apple Card

Apple allegedly wants to launch Apple Card for two reasons: 1) to deepen relationship with users, to motivate them to buy their hardware more 2) to generate more service revenue. As a technology partner, I don’t imagine Apple will have to deal with fraud, regulatory or security concern. In exchange, Apple provides marketing outreach and technical assistance in incorporating Apple Card into its ecosystem. Additionally, from what I read, customers who need technical assistance will reach out to Apple Customer Service agents. Hence, that’s also what Apple brings to the table. Also, the company may allegedly be responsible for Apple-only rewards and interest free payment plans when customers buy Apple products. In terms of rewards with 3rd parties such as Nike or Uber, I can’t find any relevant information. If I have to guess, my money will be on Apple taking the bill for extra rewards as well.

Goldman SachsApple
Responsibilities– Service accounts and handle regulatory compliance
– Bear risks of charge-off
– Compensation to partners 
– Market Apple Card to users 
– Offer technology to make the card work with Apple Pay and its devices
– Help service accounts 3% cash back on Apple products and services
– Interest-free payment plan for customers when buying Apple products
Benefits– Interchange fees
– Leverage marketing power from Apple and its footprint
– Deepen relationships with customers
– Compensation from Goldman Sachs
Table 2

According to Apple, the number of transaction through Apple Pay has grown substantially since it was launched. As of Jan 2020, the annual run rate for Apple Pay reached 15 billion transactions. Not all Apple Pay transactions are through Apple Card. The card debuted only in August 2019. Since Apple doesn’t offer details on Apple Card transactions, let’s run some scenarios by assuming that the annualized transaction count for Apple Card is 500 million to 2 billion. If average ticket size (dollar amount per transaction) ranges from $20 to $60, the transaction volume will be as follows

 Annualized Apple Card Transactions
             500,000,000                         1,000,000,000                2,000,000,000 
$20$10,000,000,000$20,000,000,000$40,000,000,000
$40$20,000,000,000$40,000,000,000$80,000,000,000
$60$30,000,000,000$60,000,000,000$120,000,000,000
Table 3

Interchange fee rate varies depending on numerous factors. However, if we assume that the rate is 2% of purchase volume, based on the scenarios above in Table 3, GS would receive the following as interchange fees

Annualized Apple Card Transactions
             500,000,000                         1,000,000,000                2,000,000,000 
$20$200,000,000$400,000,000$800,000,000
$40$400,000,000$800,000,000$1,600,000,000
$60$600,000,000$1,200,000,000$2,400,000,000
Table 4

As you can see, the more Apple Card transactions, the bigger the interchange fees for GS. Given that Apple has legendary marketing prowess, an installed base of millions of devices and rising demand for contactless payments, the numbers may even grow bigger in the near future.

On Apple’s side, it is reported that Apple takes 0.17% cut on each Apple Pay transaction. In terms of Apple Card transactions, I think the cut will be even bigger, but won’t be bigger than GS’ interchange fee rate. Since we assume that GS receives 2% in interchange fee rate, let’s say Apple receives somewhere from 0.2% to 1% on purchase volume. How much would Apple receive, using the lowest purchase volume for each scenario of transaction count (first row respectively in Table 3)?

 Annualized Apple Card Transactions
             500,000,000                         1,000,000,000                2,000,000,000 
0.20%$20,000,000$40,000,000$80,000,000
0.50%$50,000,000$100,000,000$200,000,000
1%$100,000,000$200,000,000$400,000,000
Table 5

A few days ago, Apple and Walgreens announced that new Apple Card customers would receive $50 bonus in Apple Cash after spending at least $50 at Walgreens using the card. The promotion is valid till the end of June. It signals to me that 1) Apple wants to acquire more customers for Apple Card and 2) Apple may also receive a fee whenever a new customer comes on board. I don’t imagine $50 bonus would be paid for Walgreens or GS. Why would they do so when there is no sustainable benefit? If Apple shoulders the cost of the acquisition bonus, or at least most of it, it will likely not make financial sense to just rely on fees from card purchases to recoup the investment.

In sum, I hope that the information I shared and my thoughts are useful in helping you understand more about the credit card world that is complex yet fascinating. I spent quite some time thinking about the collaboration between Apple and Goldman Sachs as the presence of a tech giant and an investment bank in the consumer banking area is quite interesting. There isn’t much information out there so I would love to learn from whoever has useful information to contribute to the topic at hand.

Disclaimer: I own Apple stocks in my personal portfolio

Weekly readings – 4th Jan 2020

Issues with speed reading

Algorithmic Radicalization — The Making of a New York Times Myth. A primary issue I have with this piece is that I wish it were presented in a more understandable manner, as in the diagrams and charts should have been easier to understand

Nestle Faces New Coffee Rival as Vietnam Targets Instant Market

Focus is a huge competitive advantage

Good Enough is Good Enough

Vietnam only looks good on paper

Electric Cars Threaten the Heart of Germany’s Economy

A massive and expensive problem called returns for retailers in the holiday season