Welcome to Quration - stand-out stories of technological disruption.
In today's edition, I throw my hands up in the air over the Buy Now Pay Later industry!
Buy Now, Pay Later
If I asked you to list the breakthrough innovations of 2020, you might say blockchain, crypto or 5G. If you’re a real nerd, you’d reference quantum computing, neural interfaces or new battery chemistry. I doubt you’d mention Buy Now Pay Later (BNPL) financial services. However, 2020 was a yuuuuge year for BNPL - perhaps a breakthrough year. But, despite getting a ton of press, BNPL isn’t new. In fact, it’s very old.
Originally known as factoring, the practice whereby a business sells its accounts receivable to a third party at a discount, began with the Mesopotamians over 6,000 years ago.
Here’s a general example that roughly applies to most modern-day BNPL services, using the biggest player in the pond - Afterpay:
Simon downloads the Afterpay app to his phone.
When he buys a $1,000 TV at Big W, he scans the barcode on his Afterpay app at the register.
Simon’s payment is split into 4 equal amounts of $250 that are due every 2 weeks until the amount is fully paid.
The next day, Afterpay pays Big W for the TV less a small fee for taking on the repayment risk. For example: $1,000 - $40 risk fee = $960 payment.
Afterpay then [hopefully] receives the full $1,000 from the customer, over 8 weeks.
There is no interest charged to the customer. There are small penalty charges if the customer does not make fortnightly payments. And the customer’s line of credit with Afterpay is put on hold until all payments have been made.
The customer gets immediate access to the products, and doesn’t risk mounting interest charges.
The retailer gets immediate payment [cashflow], and passes the risk of bad debt to a third party for a small fee.
Afterpay gets a high return on each small investment.
$40 return on $960 investment = 4.17% over 8 weeks
With an 8-week turnaround, the velocity of money is 6.5 per year, providing an effective interest rate of 27.1% per annum
Late fees increase the return. Bad debts are limited.
Once again, convenience wins the day, and delayed gratification wins the prize.
What’s the big deal?
“[W]hat is clear is that 19.9% [Annual Percentage Rate] on a credit card that never talks to you when you’re about to miss a payment and logs huge interest rate fees is not a good outcome for consumers,”
“The younger millennials are flat out rejecting that.”
I like Dan Peters. I know him from his days at Google, and always found him to be super-bright. And, in this instance, he appears to be super right.
Younger people are walking away from credit cards. They’re relying on debit transactions, and using BNPL services as a supplementary finance option.
Afterpay’s founder, Nick Molnar, agrees:
In, you know, five years time, Millennials will earn half of all disposable income in the economy. And as such, we're moving from a credit economy to a debit economy. 90% of Afterpay’s customers use a debit card, not a credit card. If you look at Visa’s latest numbers in May, credit card spend was down negative 21% year on year growth, but debit card spend was up positive 12% year on year growth. This is a systemic change now, beyond the millennial and Gen Z cohort, moving from a credit economy to a debit economy.
Traditionally, credit card providers make their money when a customer doesn’t pay out their debts and becomes a “revolver” - someone who pays the interest each month on a debt that takes a long time to pay down.
The more reputable BNPL providers flip that model. They get paid a fee by the retailer. The consumer may be liable for a late payment fee (e.g., between $10 and $68), but their account is suspended until the payment has been completed. It’s in the BNPL’s interests to keep the cycle flowing, and the debts paid on time. Nick Molnar suggests that Afterpay’s upside is aligned to the consumer’s benefit.
Investor alignment has been strong too. Afterpay’s market cap has soared to $31.7B this year, with its share price moving from $30 in January to $120 in December. Like a lot of other ecommerce-focused operators, pandemic lockdowns have been good for business.
Why here, why now?
Australia seems to be a breeding ground for BNPL innovation. Afterpay, Zip, Split-it, Sezzle, Zebit - all listed on the Australian Stock Exchange (ASX), and more innovators (like Limepay) are soon to join them. Why here, and why now?
Why now is simple: prevailing mobile app culture + shift to debit card economy + uncapped consumerism.
Why here is interesting too. Australia has a shrinking middle class, and a growing population of lower-income earners. Millennials are over-represented in the lower-income group, exacerbating the shift to a debit economy, and the need for low-cost finance options.
Australians also have super high levels of personal debt. Second highest in the world and just pipped at the post by the Swiss.
Oh, did I mention the legal loophole?
In Australia, BNPL providers are not regulated by the National Credit Act in the same way as other credit or finance providers. In 2018, the Australian Securities and Investments Commission (ASIC) looked at six leading BNPL companies and found that they were not regulated under the act because either they did not technically charge consumers a fee on their debt, or because they charged upfront or periodic fees that were fixed, did not vary according to the amount of credit provided and were less than minimum specified amounts under the law. Loophole.
High entrepreneurship + early tech adoption + mobile app penetration + shrinking middle class + high household debt + legal loophole = a perfect intersection of unregulated supply and demand.
And so, this drought-stricken country, finds itself awash with a flood of BNPL options.
Afterpay is the current undisputed heavyweight, still fighting out of Australia but focused on taking on all-comers in the U.S. market.
Zip just announced that it has signed a deal with Facebook to allow small- and medium-sized companies to use its service to pay for advertising on the social media giant's platform. The push into the SMB market is an interesting move to differentiate from the hordes of consumer-focused BNPL providers, and wet their beak in the advertising rivers of gold.
Limepay is offering businesses their own branded version of a BNPL service. They argue that when a business sends their customer to a 3rd party BNPL app, they lose the engagement with customer, miss out on useful customer data, and expose their customers to offers from their competitors.
Split-it provides businesses with a BNPL option for customers that already have an existing Visa or Mastercard. No interest, application or fees. I guess that shows that the traditional credit companies understand that the debit economy is fast-approaching.
Whatever your taste, there’s a BNPL option designed just for you. Unless you’re already struggling for money.
Another way
I spoke with the Founder/CEO of Zebit, Marc Schneider, about his company’s efforts to provide an option for a market that is desperately underserved.
In the U.S., 47% of people don't qualify for traditional credit! That’s 120M people who won’t pass a standard credit check. So where do they turn? Payday lenders have been a regular option, but that model is crippling for people who are already struggling.
Payday lenders typically offer 2-week loans, with fees and penalties that compound into stratospheric Annual Percentage Rates (APR). Customers are usually desperate, so they don’t read the fine print and take what they can get. They find themselves in deals with rates that are so high that they have no choice by to take the “top up” loan option to help them make the fortnightly payments. That leads to a cycle where it’s not uncommon for the APR to reach 400%.
“Lease to own” vendors aren’t much better. A customer may not be able to buy an iPhone outright for $1,000, so they enter into a 3-year lease-to-own arrangement. After the first year, the $1,000 may have already been paid, but they continue to make payments for two more years before taking “ownership” of the now outdated phone. Very often, these arrangements will see a customer pay up to $4,000 for a device that retails for $1,000.
These finance models make it impossible for someone to get ahead. Especially someone who is already starting from behind.
Zebit has a mission to provide a “shopping line” to people who are unable to access traditional credit. Rather than lending money that can be used to make purchases anywhere, Zebit customers get up to $2,500 that can be used to shop thousands of products on zebit.com.
Zebit makes their money by factoring the purchases, and the customer enters a consumer-friendly agreement - 6 months to pay off the debt, no fees, no late charges, no interest.
The secret sauce is the Zebit algorithm, that uses non-traditional data to figure out how much to lend new customers, and how to build up the amount of debt that they are able to service.
Skeptics think that everyone using Zebit is poor, ill-educated and a guaranteed bad debt risk. In fact, the salary range across Zebit’s 1M users is $16,000 to $200,000, with an average income of $42,000. And the average default rate sits at around 2%.
As you would expect, Zebit customers are incredibly loyal - because they have nowhere else to go. But Marc believes that the mainstream market’s refusal to serve this market is likely to shift, and very soon.
After the middle-class saturation is complete, players like Amazon, Walmart and Target will realise that there’s a huge, untapped population of no-credit customers that are just waiting to be seen.
Also a recent entrant to the ASX, I imagine that Marc and team are positioning themselves for that moment: when Amazon or Walmart turn to address the unserved market, and decide that the fastest option is to buy Zebit.
Tech disruption?
Is any of this really the result of tech disruption? No doubt, all of the BNPL platforms rely on cloud infrastructure, and leverage Machine Learning to improve their debt-risk algorithms.
But I think its the general pervasiveness of tech that’s the real disruptor here. We, the consumer, have come to expect convenient options. Streaming content. Unlimited mobile data. Informative wearables. We even expect cheap autonomous vehicles to roll off the assembly line any minute now. And so it goes for finances.
Why shouldn’t we buy what we want [NOW], and pay when we want [LATER].
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