Take-aways From CFPB’s Report On Buy Now Pay Later

CFPB just released a report on Buy Now Pay Later (BNPL) which I think is pretty comprehensive. The report covers a lot of ground using data between 2019 and 2021 from five surveyed lenders. If you are interested in consumer financial products or BNPL in particular, you should have a read. Below are some of my takeways

BNPL grew furiously in 2020 and 2021

According to the report, the number of loan originations from BNPL lenders in the US grew by 227% per year, from almost 17 million in 2019 to 180 million in 2021. The amount of BNPL loans grew even faster, by 245% per year, from $2 billion in 2019 to $24.2 billion in 2021. In the same period, the average loan size increased from $121 to $135. I suspect that this is due to the popularity of Peloton in 2020 and early 2021 at the height of Covid and the urge to go back to travel late 2021. The growth in average loan size is exactly what the lenders will sell to merchants: come to us, pay us the merchant fees and we will bring you more business.

BNPL Loan Origination Volume
BNPL Loan Volume By Merchant Vertical

BNPL usage rate and the number of BNPL super fans continuously rose

Per CFPB:

The quarterly usage rate has steadily increased over the past three years, reaching a high of 2.8 loans per unique borrower in Q4 ’21. In Q4 ’21, four of the five lenders surveyed had a usage rate between 2.9 and 3.2 per quarter, while the fifth had a usage rate below 2

In short, the last three years saw an increase in quarterly usage to about one loan per month per average user. This increase was slower than that seen in the upper ends of the spectrum. Specifically, the share of users with at least 5 or 10 loans per quarter reached 15.5% and 4% at the end of 2021 respectively. It’s quite surprising yet interesting to me that 4% of BNPL users used the product more than 3 times a month. I am suspecting that these high-usage users concentrate more in the young generations. With BNPL, users must be underwritten on a transaction basis. The fact that some ignore the inconvenience of filling an application 3 times a month instead of getting a credit card indicates that they cannot get a credit card. On the other hand, a debit card is always available, even to these thin-file consumers. Hence, it is a little worrying to see this kind of behavior, when there is a debt-free alternative out there.

Share of Unique Quarterly BNPL Borrowers With 5+ and 10+ Loans

Young consumers like BNPL and they tend to default

The surveyed lenders’ demographics data backs up my suspicion above over the credit-trapped young consumers. BNPL skews heavily towards younger generations. Even though we see more older and presumably wealthier consumers over 40 years of age, almost 50% of BNPL users are 33 years old or younger. Compared to the 2020 Census Bureau data, these young consumers are over-indexed.

Worryingly, it is consumers aged 33 or younger where we found default or charge-off most frequently. According to the surveyed lenders, 5.7% of BNPL users aged 18-24 had at least one default or charge-off in 2021 while 4.8% of users aged 25-33 had a derogatory BNPL trade. No other age group had higher than 4%. These data points show that any credit issuer wanting to underwrite thin-file consumers need to do their homework carefully in order to manage risks. This population is too big and valuable to ignore, but they are very risky!

Share Of Unique Borrowers By Age Cohort With 1+ Default Or Charge-Off

One in ten borrowers was charged a late fee in 2021

We can deduce the amount of overextension from borrowers by looking at late fees. According to the report, the borrower-level late fee rate in 2021 was 10.5%. That’s surprisingly high to me given that all BNPL lenders enforce autopay and Affirm doesn’t charge late fees. Because autopay is virtually required on every loan and 89% of all payments in 2021 came from debit cards or checking accounts, the fact that one in ten borrowers got penalized shows that many users didn’t have sufficient funds for their purchases in the first place.

BNPL Late Fees

Weekly reading – 2nd July 2022

What I wrote last week

How does credit card direct mail process work?

Business

A great podcast episode on Don Valentine and Sequoia Capital. I guarantee that this is way better than Don Valentine’s profile on Wikipedia.

($) Spotify’s Billion-Dollar Bet on Podcasting Has Yet to Pay Off. “Over the next four years, Ostroff spent more than $1 billion on the business, licensing shows, buying production studios, and signing exclusive deals with celebrities, including the Obamas, Kim Kardashian, and Prince Harry and Meghan Markle. Last year, Ostroff’s research and data team asked a question that many at Spotify already knew the answer to: Had any of this spending yielded a major new hit? The team produced a report that basically said no, according to five current and former employees who didn’t want to be named discussing internal business.” A very interesting story on the development of podcasts at Spotify. They used to like Netflix making a lot of shows and movies without anything concrete in return. The new internal structure is now in place to help Spotify better at making shows. I think they may be better off by following the model of HBO and Apple. But as a company that is never actually profitable, Spotify doesn’t have the luxury that Apple or Warner Bros has.

($) The Surprising Reason Your Amazon Searches Are Returning More Confusing Results than Ever. “The problems Amazon took on once it opened up its marketplace to sellers in China have become more evident in recent years. My Wall Street Journal colleagues in 2019 uncovered thousands of banned, unsafe or mislabeled products in Amazon’s catalog, most of which came from China-based sellers. It also became apparent that Amazon sellers were gaming Amazon’s algorithms to get goods listed as high in its search results as possible, and even going so far as to bribe Amazon employees in China to help boost items’ rank. The Amazon spokeswoman says the company spent more than $900 million last year to combat counterfeiting, fraud and other abuse—an effort she says involved 12,000 people. The company stopped more than 2.5 million fraudulent attempts to create new seller accounts, she added, down from over six million the prior year.”

‘Wallets and eyeballs’: how eBay turned the internet into a marketplace. This article is actually an excerpt for an upcoming book calling for the de-privatization of the Internet. It basically calls for another version of the Internet where people would be less motivated to create their own content because capitalism and competition wouldn’t work. I haven’t read the book, so I don’t know how good it is, but it’s still cool to read up on the birth of one of the most important marketplaces we have ever had.

Lessons from an investing legend. Anyone interested in investing should have a read. Everything Peter says is similar to what I have read from some of the greatest investors

($) Inside Didi’s $60 Billion Crash That Changed China Tech Forever. It further solidifies my stance that as long as the current regime stands and it surely looks that way for years to come, I won’t buy Chinese stocks. Didi at its peak was worth $100 billion. Now it’s a shell of its former self because of actions from the government. Worse, the leaders at Didi, all Chinese and with resources to spare, didn’t understand why the government acted the way it did. Then, how could a foreign investor hundreds of miles away?

($) Draymond Green, Podcast Star, Turns an Unsparing Mic on Himself. I listened to Draymond’s podcast a few times and while it does carry a sense of disruption and fresh air, compared to the likes of First Take or Undisputed, I still want to hear more basketball analyses from Draymond. He is an intelligent player and a 4-time champion. He surely is capable of producing basketball breakdowns for casual fans like Kobe once did with Detail. I’d love to hear more about the preparation before games or during off-season. I’d love to hear about the mental struggle of players during injury rehabilitation. Dray has much to offer and I hope he will bring it instead of cat fights and trash talk against the incumbent media. On a side note, after the liquor industry, athletes are marching into the media space. With their fame, connections and insider knowledge, they are greatly positioned to make a splash in this industry.

Other stuff I find interesting

Nigerians are learning to buy now and pay later. “In a country where only 2% of the 106 million adult population have access to bank credit, credit cards are also conspicuously absent, as banks shy away from consumer lending. BNPL is becoming a rising alternative and is set for further growth, as Nigerians embrace digital credit. BNPL thrives in markets with integrated identity systems, consumer credit culture, and decent consumerism, where people are able to pay for not just essential items like food and fuel but are also willing to buy nonessential items like cars and gadgets. However, the Nigerian market struggles with efficient identity systems, over 100 million Nigerians, or a little less than half the population do not have any form of recognized ID. And following the economic slump over the last eight years, many households are barely clinging to whatever funds they have after spending on rent, food, and other necessities. A June 2021 report showed 61% of the country’s adult population suffered “severe financial distress” over the previous 12 months, forcing many to cut down on expenses.”

($) Norway Was a Pandemic Success. Then It Spent Two Years Studying Its Failures. “Norway’s government had the foresight during the first days of Covid-19 to appoint a panel called the Koronakommisjonen. Its mission was figuring out what the Norwegians did, what they could have done and what they should do. This crisis was barely under way when they began preparing for the next one. The next lesson from the Koronakommisjonen reports is the power of not pretending to know more than you do. Nobody really knew anything early in the pandemic. Anybody claiming otherwise should have known better.”

Mediterranean Diet Reduces Depression In Young Men, Study Says. One of the things I want to try till the end of the year is to try Mediterranean diet

Behind the scenes of Waymo’s worst automated truck crash. I have always believed that we are still a long way from having automated vehicles on the streets. Nothing has made me changed that belief, not even a little bit.

Stats

“Ground beef prices are up 36% from a year ago, while chicken breasts gained by a third”

Klarna is reportedly valued at $6.5 billion, down from $45 billion in 2021. Talk about a new definition of a down round

Source: Self.inc

Weekly reading – 4th December 2021

What I wrote last week

I shared my research on real-time payments

Good reads on Business

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

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

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

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

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

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

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

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

Stuff that I found interesting

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

Stats

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

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

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

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

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

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

Weekly reading – 30th October 2021

What I wrote last week

My own thoughts and commentary from several companies on App Tracking Transparency

Good reads on business

Intel slipped—and its future now depends on making everyone else’s chips. If the future of Intel depends on making chips for everybody else, then it’s a bleak future. They fall so far behind others, especially TSMC, in this game.

L1 Capital International Fund Q3 Shareholder Letter. It discusses Texas Instruments. So if you are looking for a new idea for your portfolio, it may be an interesting read

Buy Now, Pay Later & Payment Ramifications. If you are looking for a primer on BNPL, this one should do. Follow the author too for payments and fintech content

China is pushing to develop its own chips — but the country can’t do without foreign tech. One thing that I have learned so far is: never underestimate the Chinese. They may be behind in chip design and production, but they have every intention of integrating Taiwan, the hometown of TSMC, into the mainland and they have the will and resources to catch up and surpass the Western world

Mastercard Partners With Bakkt to Bring Cryptocurrency Payments to the Masses. This will definitely increase the usability of Bitcoin in ordinary circumstances. The problem, I think, is who will convince the masses that it’s ok to pay in Bitcoin. The cryptocurrency’s price has gone up by $20,000 in the last 30 days. This fluctuation makes me wonder why I should pay with something that can be 50% more valuable in 30 days.

Image
Source: Simon Moores

Stuff I find interesting

The Unlikely Outsiders Who Won the Race for a Covid-19 Vaccine. The two companies that helped the world get out of the once-in-a-lifetime pandemic were close to financial ruins. Just think about that for a second. On a side note, while I appreciate the dedication of BionTech’s founder, I wouldn’t want to be as extreme as he is.

Lewis Hamilton’s Plan to Revolutionize Formula 1. “The final report, published in July, confirmed what Hamilton had felt in his bones: Less than 1 percent of people working in Formula 1 are Black. The reasons, laid out across 184 pages, ranged from teams’ hiring practices (which tap the same universities year after year) to major fault lines within British education, as Black students are funneled into the lowest-achieving tracks and expelled at much higher rates. That began to change inside his own garage. Mercedes committed to making sure that 25 percent of new hires come from underrepresented backgrounds. The team, which has raced cars under the nickname Silver Arrows since the 1930s, also made a radical statement in paint. For the first time in its F1 history, the team changed its livery from silver to black last summer. The cars haven’t returned to the old colors. Not only did Hamilton’s latest contract, signed during the 2021 season, include stipulations for increasing diversity within the team—Hamilton also spoke directly with the team’s sponsors asking them to do the same. “Where are you guys at?” he remembers asking the CEO of the Monster energy drink company, which has backed him since 2013. “How are you guys holding yourself accountable? How can we work together?”

Female African Elephants Are Evolving Without Tusks Due to Ivory Poaching. The thing about this trophy hunting that bugs me a lot is that it’s not critical to our survival. We just do it for fun, for ego and because we can. These elephants do us no harm. They just mind their own business and we are the thugs that come in, hurt and kill them for what doesn’t belong to us. Some people say that outrage for trophy hunting is hypocritical because we kill chickens and fish and other animals too. Well, there is a big distinction here. We and our societies have evolved in a way that we look to these animals for protein and survival. I mean we could have been eating grass for dinner too if our ancestors had done it millions of years ago. But here we are through no fault of our own. Why do we commit more sins for absolutely no necessary reasons?

The $3.50 go-anywhere ticket to fight climate change. I am no expert, but I really believe that the U.S has to significantly upgrade its public transportation infrastructure to catch up with other countries and contribute to the climate change fight.

Stats

There were more than 500,000 U.S sellers on Amazon between 1st September 2020 and 31 August 2021. Almost 4,000 sellers surpassed $1 million in sales for the first time

There were 203.7 billion cigarettes sold in the U.S in 2020. A mind-blowing figure

Source: Fox

Weekly reading – 25th September 2021

What I wrote last week

Is BNPL replacing credit cards?

My thoughts on Visa’s new benefits for U.S Signature/Infinite cardholders

Articles on Business

When to Buy Now, Pay Later, and When to Just Pay Now. “Affirm doesn’t report payments on its four biweekly payment zero-interest loans, it said, or when consumers are offered a three-month payment option with no interest. Afterpay doesn’t work with credit bureaus at all. Sezzle Up explicitly informs users that it will report on-time payments to Equifax and TransUnion. Affirm doesn’t charge late fees, but late or partial payments can hurt your credit score, and may prevent you from using the service in the future. Sezzle Up also reports delinquencies. Klarna and Afterpay revoke access to their platform until payment is made. Both companies also charge late fees, tacked onto your next payment. Afterpay charges $8, or 25%, of the purchase, whichever is less, while Klarna charges a maximum $7, or no more than 25%, of the past due amount. Klarna said it will contact users to collect payment before charging a late fee.

This delivery app went above and beyond for its workers. Then Uber took over. Cornershop’s original operating model was more beneficial and friendly towards workers. After the acquisition, life became more challenging for drivers. It remains to be seen whether the regulation in Chile will allow workers to unionize and force Uber to recognize drivers as full-time employees. This is a classic case of conflicting interests between gig companies and drivers as well as of the important role that governments play in this conversation.

Why the University of Florida gets a ~$20m cut of Gatorade profits every year. A fascinating story on a wildly popular drink.

The Most Important iPhone Ever. “What makes the iPhone and perhaps Apple special is that it seems to deliver things that nobody asks for but then everybody wants while eschewing overshooting a performance dimension that a few demand but most won’t use. The tragedy of overservice and disruption is that if you don’t shift the definition of performance eventually you run out of demand at the top of the performance curve. That opens you up to “good enough” competition from below. Instead you need to re-define the notion of performance: compete on a new basis, reset expectations. That the iPhone can find new dimensions of performance and hence demand is effectively a solution to the innovator’s dilemma.”

PayPal Introduces Customers to the Next Digital Payments Era with the New PayPal App. “The new PayPal app will introduce new features including PayPal Savings, a new high yield savings account provided by Synchrony Bank, alongside new in-app shopping tools that will enable customers to earn rewards redeemable for cash back or PayPal shopping credit and uncover deals with hundreds of merchants. Additionally, the new app offers PayPal customers a single place to manage their bill payments, get paid up to two days earlier with the new Direct Deposit feature provided through one of our bank partners, earn rewards and manage gift cards, send and receive money to friends, family and businesses, pay with QR codes for purchases and redeem rewards in-store, access and manage credit, Buy Now, Pay Later services, buy, hold and sell crypto, as well as support causes and charities they care about.”

Other stuff

The tangled history of mRNA vaccines

Stats that may interest you

“One in five consumers made a purchase using a “buy now, pay later” service within the last 12 months.

One in six consumers who made a buy now, pay later service purchase regret doing so, commonly citing high interest rates, a lack of options to build credit, or making unnecessary or unaffordable purchases.”

There have been 47 startup venture deals in Africa in 2021 so far with the average deal size of $21 million

CPC on Amazon ads is $1.27 in August 2021, up from 86 cents from a year ago, according to a survey

31% of online grocery shoppers use PayPal, according to a new study by ACI Worldwide and PYMNTS

Fuel Wasted Due to U.S. Traffic Congestion in 2020 Cut in Half from 2019 to 2020

14% of U.S consumers said they switched to an iPhone from another operating system in the last two years, a report said

Is BNPL replacing Credit Cards?

BNPL is a red-hot phenomenon now both in the financial and retail worlds. Because most BNPL transactions are funded using debit cards or checking accounts rather than credit cards, one of the main debates is whether it is replacing or will replace credit cards.

When asked about BNPL and its impact on credit card balance, the CFO of Discover, John Greene, had this to say:

What we’ve seen to date is consumer appeal has been on the lower credit quality folks. I think there will be a natural evolution that, that will come up the credit spectrum. We’ve also seen in terms of the firm, some higher credit quality customers actually electing to do a buy now pay later transaction, whether it’s paid in for or something else.

We haven’t seen any discernible impact whatsoever. So where I would likely see that is through new customer acquisition, and that’s — that activity has been very, very robust. The balance sheet on existing customers here, so loans, that’s been impacted by stimulus and kind of how they’ve allocated their dollars within their household. Nothing from the details we’ve looked at that would indicate that buy now pay later’s impacting the portfolio.

Discover Financial Services – Barclays Virtual Global Financial Services Conference

Echoing that sentiment, Brian Wenzel, CFO of Synchrony Bank, said there was no visible impact from BNPL on their credit card portfolio:

Yes. So first, we have studied buy now, pay later impact over the last couple of years as it really has grown, and we partnered with an outside firm to kind of do a deep analysis really on the — at the customer account level to kind of understand the behavior patterns it has. So when we see it and the data we’ve seen, I think, 75% of the buy now, pay later accounts are funded out of a debit account, right? So the view is that they are — you’re using cash and taking what would be a debit transaction through the buy now, pay later. We then looked — and really the impact of our business, and we looked at it and talked a little bit about it in Q&A last week about the impact on our business.

Are we seeing anything that says buy now, pay later is impacting credit? And so when you look at it versus a cohort population of our Mastercard as well as our Dual Cards, we see a low penetration, and we have not seen any changes certainly with how they use credit with us. In fact, they are more engaged with us than our average customer. They generate more revenue for us, but we have not seen any change. So as we look at it — when we look at applications come through, go over some of these products are offering, we have not seen any change, discernable changes.

So when you think about the impact to us in credit, we don’t really see it yet. We think that there is a shift that’s happening probably from cash as a tender type. And I think this is where the merchants and our partners are taking a step back. They are saying, “Yes, we understand your offer, consumers like it. But is this driving incrementality for us, true conversion?

Synchrony Financial – Barclays Virtual Global Financial Services Conference

One may argue that the main business of Discover and Synchrony is credit card so they had to put on a brave face. They might have. But since they are publicly traded companies; which often require them to be truthful to investors, I’ll give them the benefit of the doubt. More importantly, what they say seems to be in line with what Marqeta sees in their 2021 State of Credit report.

Recently, Marqeta released a 2021 State of Credit Report with some interesting insights into how consumers in the U.S, the U.K and Australia use BNPL and credit cards. The report is based on a survey of 3,500 people across three countries. Here are my take-aways regarding consumer preferences in the U.S:

  • 78% of respondents in the U.S use credit cards while 25% actively use BNPL
  • 50% of U.S consumers use credit cards because of rewards, something that is still a weakness of BNPL providers but they are working on it
  • “60% of U.S. 18-25-year-olds said they made more than five purchases on their credit card online each week, compared with 19% of 50-65-year-olds”
  • “79% of consumers surveyed who use BNPL reported having three or less BNPL plans open at a given time, with 45% of people reporting their average BNPL purchase at less than $100.”
  • “Older consumers however, were decidedly against, with survey respondents 51-65 years old voting overwhelmingly (63%) in favor of the credit card-first status quo.”
  • “Americans were again slightly worse off, with 30% responding that they’d struggled to meet payments”

3 out of 4 U.S consumers use credit cards. 60% of the younger segment use their cards regularly every week while the older and wealthier crowd want to keep the status quo. That, to me, is the sign that the credit card business is still healthy and well, at least for now. By no means do I insist that BNPL doesn’t have a chance to overtake credit cards. More and more issuers such as Citi, Amex or Chase introduced the ability to put qualified transactions on installment plans (BNPL). All the major retailers in the country allow shoppers to have a payment plan. Even Apple is reportedly working on their own version of BNPL. Who knows what the future holds? But for now, all signs point to a healthy credit card industry holding their ground.

Why Square paid the big bucks for Afterpay

Last Sunday, Square announced that it was going to acquire Afterpay, the Buy Now Pay Later provider from Australia, in a $29 billion all-stock deal. A lot has been said about this merger and the one bear case that I have seen quite often is that people questioned whether Square could actually build its own BNPL in-house and is wasting $29 billion on this deal. Below is how I think about it.

Before we go further, let’s take a minute to talk about these two companies in general. Afterpay was founded in Australia in 2014 by Nick Mornar and Anthony Eisen. The company allows shoppers to break purchases into four interest-free installments paid every two weeks. Afterpay charges merchants 3-4 times interchange rate in exchange for customer leads and the underwriting of the loans. Merchant revenue constitutes the majority of Afterpay revenue while late fees make up around 9% of the top line. Currently available in Australia, New Zealand, the U.S, the UK and Canada, Afterpay is launching services in a few European countries such as France, Italy and Spain.

Originally started as a payment company with a little credit card reader, Square has grown leaps and bounds over the years to become a publicly traded financial company with over 30 different services, a banking license and over $126 billion in market cap as of this writing. Square’s revenue comes from different sources. Bitcoin makes up more than 50% of Square’s revenue, even though the gross margin is only around 2%. The company sells POS hardware at a cost to merchants and charges them for used services. If merchants and customers want to receive funds instantly, they must pay Square a small fee. Square also offers merchants loans from which it earns interests. Last but not least, there is interchange revenue from millions of transactions processed through Cash App.

Square used to have a BNPL option which was discontinued due to the effects of Covid-19. Then why the sudden change of heart and why wouldn’t Square reactivate Square Installments instead of paying an enormous sum for Afterpay? First of all, it’s about international expansion. While Square is available in some overseas markets, 85% of its GMV is from the domestic front. Meanwhile, more than 50% of Afterpay’s GMV originates from non-US markets. Acquiring Afterpay gives Square quick access to those international markets and reduces reliance on its home market. Plus, it’s not really easy to build up a BNPL service from scratch. In addition to having to acquire merchants and users, to be a BNPL provider, one has to deal with a lot of regulation hurdles. These are the things that currently Afterpay does better than Square in non-US markets. Hence, this purchase will help Square bypass all the trouble and acquire these skills quickly.

Second, customer acquisition. Afterpay’s main clientele includes Enterprise merchants wanting to leverage its popularity with consumers. On the other hand, while Square’s fastest growing segment is merchants whose GMV is higher than $500,000 a year, I doubt they are big enough that we can call them Enterprise. Hence, this acquisition enables the acquirer to move up the ladder and into a new market. The U.S is responsible for 62% and 43% of Afterpay’s active customers and GMV respectively. However, I’d say that in terms of reach to U.S consumers, Square is the far better company in this equation and has multiple touchpoints that it can use to acquire new users (Credit Karma tax, Cash App P2P, Bitcoin trading). Therefore, Square can definitely assist Afterpay in user acquisition. On the other hand, Afterpay gives Square access to the former’s high income customer base in coastal cities where Square isn’t as competitive as in the South.

Third, merchant acquisition and retention. Merchants pay BNPL providers because of not only consumer preferences, but also the new business that these providers bring due to their marketing reach. For instance, Klarna reported 22 million customer lead referrals in the U.S December 2020 alone. This extra revenue is what merchants, especially smaller ones, crave and are willing to pay for. With the Discovery tool from Afterpay, Square can strengthen the relationship with merchants and keep them in the ecosystem. The more merchants they have, the more their Cash App can appeal to consumers and the healthier the whole ecosystem will be. As a result, the addition of the Discovery tool is strategically beneficial to Square.

Last but not least, this merger is about the competition. Square ‘s main challenger in the race to become the Super Financial App is PayPal. Formerly a P2P platform and a primary checkout option on eBay, PayPal has transformed itself into a financial service and a formidable eCommerce player. It provides both merchants and consumers with multiple different services to facilitate in-store and online transactions. With PayPal, shoppers can pay in stores and online with QR Code, tap-to-pay, mobile wallet, debit cards, credit cards and PayPal Credit. In the past few months, the company has ramped up significantly efforts in cryptocurrency trading, one of the selling points of Cash App. Additionally, PayPal recently launched Zettle, its card reader, in the US, a direct threat to Square’s bread and butter. PayPal’s own BNPL, PayPal in 4, has facilitated $3.5 billion in GMV in a few markets since its launch in August 2020, $1.5 of which came in the last 90 days alone. As mentioned above, Square no longer has an installment service.

Outside of the U.S, PayPal and Klarna, the global leader in BNPL, share a lot of market overlap with Square and Afterpay. This acquisition of Afterpay gives Square an instant counterweight to these competitors. Could Square build its own BNPL muscles? Absolutely, I have no doubt about it. But it will take a lot of time and resources for Square to play catch-up. By the time the company could form a respectable presence in the markets, PayPal and Klarna would already sign more merchants, gain more market share and establish a purchase habit as well as brand name with consumers. It would be incredibly tough to overcome these advantages. With Afterpay, Square won’t have to start from scratch and can compete right away with their rivals.

In summary, from my perspective, there are legitimate reasons why Square made such a big splash. Afterpay brings to the table what Square needs for its growth plan and more importantly, it does so instantly. Of course, M&A deals fail all the time. Synergies are often overstated. Cultural clashes tend to be overlooked. Execution doesn’t materialize as expected. Management teams butt heads. All kinds of trouble can happen to derail a partnership. This one isn’t immune to such risks. But I hope that one day we can look back at this deal as an important milestone and lever that propels Square to incredible heights.

Figure 1 – An example of regulatory hurdles that a BNPL provider has to deal with. Source: Afterpay
Figure 2 – Afterpay can help Square move up market. Source: Square + Afterpay
Figure 3 – Afterpay can expand to coastal cities in the U.S and acquire higher income clientele. Source: Square + Afterpay
Figure 3 – Integration of Afterpay into Cash App. Source: Square + Afterpay
Fincog Overview of BNPL Providers, Ranked by Size
Figure 5 – GMV of Global BNPL Providers. Source: Fintechnews
Figure 6 – Klarna’s footprint. Source: Klarna

Weekly reading – 20th march 2021

What I wrote last week

The economics of a credit card

Business

Hy-vee CEO shared how Covid shaped the company’s operations moving forward

Why Amazon Fresh stores will likely rock a few boats. As its competitors do more shipping from their own stores, Amazon can get on level terms in that sense with having more stores of their own in strategic locations. Plus, if they can get these cashierless stores to run properly, they will be able to cut back a significant line item on the Income Statement, paid employees!

How Trader Joe’s $2 wine became a best-seller

Telegram App Is Booming but Needs Advertisers—and $700 Million Soon 

The new Google Pay repeats all the same mistakes of Google Allo

Apple brand loyalty hits all-time high as Samsung loyalty dives

Austin Rief: How Morning Brew went from college newsletter to $75 million in 5 years

She Came to the US to Study With Only $300 in Her Pocket — Now She’s a NASA Director For the Mars Rover

What I found interesting

Does Atlantic Canada have a blueprint for rural revival in the post-pandemic era?

Facebook’s GDPR bypass reaches Austrian Supreme Court

Stats you may find interesting

BNPL grew by 215% year over year in Jan and Feb 2021. Total eCommerce spending reached $121 billion so far

As of February 2021, 45% of Square sellers accept online payments, up from 30% a year ago

56% of the people surveyed by AirBnb preferred domestic travel post-pandemic

Weekly reading – 6th March 2021

What I wrote last week

My take-aways from Berkshire Hathaway’s latest shareholder letter

A quick look at Buy Now Pay Later

Business

Demand for semi conductors exceeded supply by 30%

A look into Google’s failure to build games

A higher saving rate in American households is expected to boos the economy in the future

Macy’s, Gap, Neiman Marcus Will Let You Buy Now, Pay Later. The piece has some good information on the “Buy Now Pay Later” trend

WSJ profile of Roblox

A very nice post on Reddit’s history and its potential that has never been realized

The New Era of Social Media Isn’t About Feeds

A very interesting piece on payments in Vietnam. From my observation, it’s true that a lot of Vietnamese skip credit cards and go straight ahead to e-wallet.

Google is going to stop selling ads based on individualized tracking. As users are more conscious of their privacy and the topic becomes more scrutinized, I do think it’s in Google’s best interest to start looking at a new way to deliver effective ads. The macro environment is changing. The conditions are less favorable to their way of doing business. Why sticking to the old way? Google has enough talent and resources to pivot and innovate. If I were a Google shareholder, I would be happy about the news

Rolling Stones interview with Twitter and Square CEO Jack Dorsey

What I found interesting

Taking on the tech giants: the lawyer fighting the power of algorithmic systems

Africa’s biggest air polluter is now battling sewage flows into a major water source

SoundCloud announced changes to how they compensate artists. The move is said to help less popular creators, but how much exactly the help would be remains to be seen.

Using Apple Silicon (M1) as a cloud engineer, two months in

How to operate an airport in Antartica

Stats that you may find interesting

21% of Vietnam’s eCommerce spend was from Digital/Mobile Wallet

Instacart claims that they are serving 85% of US households

Kohl’s partnership with Amazon added 2 million customers in 2020

If the world adopted a plant-based diet we would reduce global agricultural land use from 4 to 1 billion hectares

A Look At “Buy Now Pay Later”

“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.

 InterestInstallment FrequencyFee to use BNPLLate fees
After Pay0%Every 2 weeksNoneYes
Affirm0% – 30%Monthly, up to 12 monthsNoneNone
Amex0%Every month% of each eligible plan’s total amount. Yes
Chase0%Every month between 3-18 months% of each eligible plan’s total amount.Yes
Klarna0% – 19.99%Every 2 weeks or in 30 days for 0%Every month up to 36 months with APRNoneYes
Paypal0%Every 2 weeksNoneYes
Quadpay0%Every 2 weeksNoneYes
 AmexChase
How many plans can an account have?10 active plans at a time10 active or pending plans at a time
Minimum purchase requirement$100$100
Penalties for paying off plans earlyNoNo
Rewards on BNPL purchasesYesYes
Are refunds/returns automatically applied to an account’s balance?No, customers must call the issuerNo, 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 planOnly 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.