Fintech 🧠 Food - 19th Sep 2021 - Square launches Cash App Pay, China forces Ant to break up lending & Why everything is BNPL

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Weekly Rant 📣

Everything is BNPL

In the past month, everything has been BNPL. Goldman acquired Greensky, Square acquired Afterpay, Amazon partnered with Affirm, and digital like Monzo launched their own "pay later" product.

Afterpay sold for $29bn, Affirm currently valued at $31bn, and Klarna was valued at $46bn at its last raise. For a niche type of lending, these valuations are massive.  These companies are between Deutsche Bank and BBVA in market value even though they deliver far less revenue.  

So is this a temporary thing? Will all these BNPL players get acquired? Surely they're a feature, not a product?

Well. Let's see.

What is Buy Now Pay Later? 💰

In general, BNPL is when a merchant offers a consumer the ability to "buy" a product at an e-commerce checkout but split the payment over 3 or 4 monthly installments. Typically this is provided for 0% if the consumer makes all of their payments on time.

It bears more than a passing resemblance to the point of sale lending ("POS lending") that has existed for decades, but there are some crucial differences.

In the analog world, POS lending was a merchant-led process.  If you're buying home furnishings like a new bed or sofa, the shop assistant might ask you if you'd like to finance that item. Heck, in the UK, it's common for kitchens and home furnishings to be offered at 0% (and has been for decades), but this isn't BNPL.  

The merchant would historically fill in some paperwork or sit with you at a screen as they slowly, laboriously enter a number of your personal details and run a full credit check on you. The whole process takes about 10 minutes, and then you arrange delivery/installation of your new home furnishings. The consumer has no relationship with the lender and no loyalty to the merchant they bought the item from. But, the merchant did get a sale. 

In the digital world, BNPL is a consumer-led process.  When you buy a Peleton or electronics at the e-commerce checkout, there is no shop assistant. Instead, BNPL is offered as an alternative payment plan to paying in full. 

BNPL is context-specific.  If you go as far as checkout, chances are you have some purchase intent for that item. But what if you can't afford that item this month?   

By placing the BNPL offer in context, BNPL also becomes much more engaging than traditional finance.  Getting to an e-commerce checkout is much lower friction than in a brick-and-mortar store. BNPL providers have designed the process to take seconds. Consumers don't have long forms to fill in, which not only makes their lives easier, it makes them much more likely to convert and complete the purchase. 

BNPL uses data in new ways.  When integrating with an e-commerce platform, the BNPL provider has access to much more than the information completed in a lending form. The BNPL provider can profile users based on their browsing history and behavior to identify users who would increase their order value or be more likely to purchase if given a BNPL offer. Additionally, because BNPL providers see so many shoppers worldwide, they can identify patterns in user behavior that impact credit risk (e.g., users who buy Peleton's tend to have a high likelihood of repaying on time).

Why do Merchants love BNPL? ♥

Higher conversion at checkout.  Klarna claims that its merchant customers see a 20% higher conversion rate. Put another way, that's like having 20% more customers who decided to buy from you by putting a new button at the checkout. 

Higher average order value.  Affirm claims its customers are seeing up to 85% higher order values, as customers are less concerned about add ons, upgrades, or taking a bundle of products. 

Repeat purchases.  Affirm's marketing claims they're able to drive a 20% repeat purchase rate through its platform. Having one-off customers is good; having customers that come back often is better.  

A network of buyers to activate.  Most BNPL providers have a mobile app and email marketing suite that provides offers and even direct shopping portals to their consumer users. Unlike POS lending, which was one-and-done, BNPL providers go out of their way to present their customers offers from merchants in their network. 

So, BNPL providers bring a network of new customers who make repeat purchases at a higher conversion rate and order value than other payment types. As Marc Ruby pointed out in a teardown of one of the BNPL providers, "they're selling revenue, which is the easiest sale in the world."  

Why wouldn't a merchant want BNPL? 

Well, it is more expensive than a card payment. But:

It's not much more expensive than cards.  Accepting card payments online can cost anywhere up to 2.9% + $0.30. BNPL providers will charge a merchant between 4 to 6% (on average) to fund the consumer's risk of not fully repaying. 

When you look at the whole picture, yes, there's an increased cost to accepting BNPL, but the increased sales more than offsets any cost. It's a no-brainer for merchants. 

Why do consumers love BNPL? ♥

Try before you buy.  Many BNPL providers power services like "30 day free refunds" or even the "90-day free refund" you see with those fancy mattress companies. Savvy shoppers often use BNPL to buy more than they need (e.g., clothing) and return items they don't like.  

Instant gratification.  See something you want but can't afford it? BNPL means you can have that thing with less of a concern about the overall cost.

It can be a great way to manage costs.  Consumers who do manage to keep up with the BNPL payments pay the same price as consumers who paid in full at checkout.  

Find new things. Many shoppers actually value the discovery function some BNPL providers offer. On some level, it's halfway between how scarily good Instagram ads are at guessing what you might like to buy and a personal shopper. The discovery value offered to consumers by some BNPL providers is often under-discussed.

Create a sense of control.  Managing cash flow is consistently one of the top Jobs-to-be-Done that the market is failing at for consumers. With BNPL, the installments are offered in context, for the thing you want, in a way that helps you manage cash flow. Most BNPL providers also have an app/website that shows the status of installments (including items bought, payments remaining, and progress to date). The value of this sense of control to the user cannot be understated. A banker might see this as "nice UI"; a customer feels in control and trusts the BNPL provider more than their credit card provider. 

A credit card is an endless line of credit, often seen by younger consumers as bad for your financial health, so BNPL appears more balanced. A credit card doesn't allow you to manage your cash flow as easily or finances; it is hard to control, expensive, and often leads to debt. Many BNPL providers market themselves as the alternative to credit cards for this reason.

What makes them different from POS Lenders 😶

Partnerships. Klarna will actively partner with merchants to go deep into the consumer journey and optimize conversion pre-checkout, during, and after. This is why they often announce merchant "partnerships." POS lenders didn't typically partner with merchants to help them drive more sales and remove friction from their e-commerce and physical locations.  

Alternative underwiting. The highest friction part of POS lending was historically the credit check. The shop assistant had to capture a lot of detail before entering it into a system, and the process could take anywhere from 60 seconds to 10 days. That is an experience breaking length of time, especially in e-commerce, where every millisecond matters. 

BNPL providers solve this in two main ways.  

Firstly, they perform a "soft credit check" (or, in some cases, no check at all). Usually, a soft check is used to check your background and (and may return a score), but it doesn't involve submitting any data. This makes the experience much lower friction for the user.

Secondly, providers have built sophisticated alternative underwriting mechanisms. For example, in this blog post, Affirm details how it took traditional models to estimate if a customer would miss a payment and enhanced them with machine learning.  

Remember, for most BNPL providers, their credit risk (the risk that they won't get paid back) is actually with the merchant. They're making ~4 to 6% of each transaction that is successful. The most significant consumer risk to a BNPL provider is fraud. If the BNPL provider is confident the transaction isn't fraud, they're likely to approve it.

Can the banks get in on the act? 🏦

BNPL is now displacing credit cards as one of the most common types of consumer credit, forcing banks to react in several ways:

Credit cards with installments (lol).  Citi, Chase, and Amex all offer the ability to pay a specific purchase on the credit card in installments. For that given purchase, the user selects a term (e.g., 3 months) and pays a flat monthly fee (e.g., $2 per month) instead of paying interest. The bank marketing departments call this "buy now pay later," but, just, no.  

Remember, the Job-to-be-Done is to "help me feel in control of my money," these cards fail on that job because they're baked into the credit card. The credit card is designed as the ultimate slippery slope product, where the most profitable users are those who revolve their balance monthly (i.e., they don't pay off the total balance).

BNPL is also about context; the "Buy Now" part is crucial. BNPL providers have the best customer acquisition strategy because the offer is positioned during purchase consideration, not after the purchase. Lastly, credit cards that let you pay installments after the fact aren't funded by merchants, so the consumer isn't getting 0% on the purchase.

Checking account with installments.  This week Monzo launched "Flex." Which they call "a much better way to pay later." Users apply in the app for a line of credit and are given an instant decision. Once complete, any transaction can be "paid later" by clicking on it and choosing "flex." It costs 0% over 3 months or 19% over 6 to 12 months. 

Monzo's execution here is much better than the credit card providers; it's clear they've understood the job is control (you can see that even on their marketing page, "more control, less stress"). Monzo has also called it a "pay later" product; smart. This feels like 2018 Monzo; it's so well done. It's the details that make it. The jury is out whether "pay later" will become a significant success for Monzo, but "pay later" is a different product that solves some of the same jobs as BNPL. 

(Fun fact: Monzo had this in their labs since 2018 but never took it out of beta. )

Partnering with white label SaaS providers of BNPL.  Amount has white-labeled "point of sale finance" and pays later and has customers like Regions Bank and Barclays. These platforms solve the banks having to build new R&D capabilities and speed up time-to-market but at the expense of vendor lock-in.  

Many banks have used platforms like this to focus on the consumer side (pay later), but few are going merchant side and fully BNPL for fear of cannibalizing their credit card revenue.

Is BNPL a feature or a product? 🤳

The Fintech twitter-sphere has concluded that because Square acquired AfterPay, and banks launching pay later products, BNPL is a feature, not a product.

I disagree.

BNPL is the ultimate wedge product 🧀

BNPL has a low-cost acquisition strategy. The merchant is bringing the BNPL provider customers. The product solves one of the most important pain points for the consumer, "feeling in control" while offering instant gratification. BNPL also aligns incentives between the merchant and lender in a way other products hadn't historically. The best BNPL providers drive sales for their merchants and become indispensable to those merchants. 

Whether BNPL is offered by Fintech super-apps like PayPal/Square or as a standalone, it can also create a flywheel into other products. For example, Klarna has a full banking license and could begin to offer its customers a suite of other banking products. 

What are the downsides to BNPL? 👎

BNPL can create debt problems.  In a recent study, 1/3rd of US consumers have fallen behind on repayments (and 72% of those consumers said their credit score had declined). In the UK, one in ten BNPL shoppers has been chased by a debt collection agency.

In fairness, all debt can create debt problems, but critics find it infuriating that BNPL isn't presented as a debt at all.

No credit checks, but late payments are reported.  If a consumer misses a payment, that does get reported to the credit agencies. Those missed payments will be on file and negatively impact your credit score.

Too easy to use.  The BNPL providers have done such an excellent job in reducing the friction of purchasing using BNPL that critics argue most consumers don't understand they're entering a debt. Given the possibility of debt collections and negative credit scores, regulators and consumer advocacy groups are concerned about how BNPL is advertised and offered.

Where does BNPL go from here? 🤔

If the market caps are anything to go by, BNPL is the hottest category in Fintech, so the sky is the limit.  

I think we'll see:

1. BNPL exist as giant standalone companies like Klarna and Affirm, who can begin to cross-sell.

2. Fintech super-apps use BNPL as the link between consumer and merchant ecosystems (this is Square's stated strategy)

3. More banks FOMO into installments in credit cards

4. Neobanks follow Monzo's lead with "pay later," which could be an exciting category in its own right

5. Some sort of regulatory response or action within the next 12 to 24 months.

BNPL feels like the perfect product for consumers and merchants when used right and the nightmare product when misused. My fear is that regulators typically solve problems by slowing everything down in red tape. Throwing complex finance jargon at consumers to make sure they "understand" they're buying a debt product won't solve the problem.

BNPL used right is already a fantastic product. For consumers who do get into debt trouble, what if we did something better instead of breaking the UX to manage risk?

I've said it before, but BNPL has to be the perfect use case for Open Banking (especially in Europe, where Open Banking can enable payments in addition to account data).  

Imagine if a consumer could authorize a bank account check and set up an installment plan with a single click. The user experience would look like it does today, except when they click the BNPL button, they'd have the option to "verify with their bank." The BNPL provider would have a better view of the consumer's affordability (can they afford the item / are they likely to make payments). An approach like this has to be better than a regulator insisting on hard credit checks or complex UX for a BNPL transaction of $30.

I'm sure there are countless more that can be done with data and UX.

One thing is for sure, BNPL is here to stay, and for the time being, everything is BNPL.

Even when it's not.

ST.

4 Fintech Companies 💸

1. Collective - The back office for the self-employed

• Collective manages company formation, tax compliance, accounting, and payroll for S Corps (self-employed) in the US. Collective has a tech + people approach that starts with a consultation and guides onboarding.  

• The onboarding approach collective takes reminds me of the email client Superhuman, where it can help engagement. The $199 a month isn't that far off what a local accountant might cost in some markets, but Collective has an attractive mix of scale, technology, and service.  This is precisely the type of service that would fit well in a financial super app for SMBs in time.  

2. A.ID - Identity platform for high-risk clients

• A.ID provides compliance as a service, including customer onboarding, customer due diligence, transaction monitoring, and compliance case management. A.ID can help Neobanks and even banks onboard more complex customers like businesses or individuals who operate in multiple countries. 

• Getting compliance wrong is one of the common pitfalls of Neobanks, and criminals often target Neobanks because they lack sophisticated compliance controls. Banks have also received massive fines in the past decade for AML failures.  Getting compliance right means finance can be more inclusive, and less criminal activity is possible. Big names like Alloy and Hummingbird have done well in this category.  I'm curious if A.ID's "being good at high-risk clients" angle will give them an edge.

3. Provide - Finance, Checking & Management for Practice owners

• Provide helps dentists or veterinarians identify a [ractice for sale and then get the financing to buy it.  This could be to expand beyond their first practice or simply purchase their first after qualifying. In addition to lending for the practice, Provide also helps with checking and insurance.

• This is more of a lending business leading with a niche than truly "embedded lending."  Provide is a registered lender in California, but their user experience and market positioning are interesting. Like Collective, they're blending human expertise with a modern digital platform.  These scaled niche plays are a big trend. The first wave of "lending businesses with a digital front end" hasn't done well as they hit IPO. This makes me wonder, is this a lifestyle business or a VC return model business?  

4. Scribe Pay - Subscription management App (UK)

• Scribe Pay is an app for tracking subscriptions.  In the past year, subscriptions to services like Netflix have been up by 17%, and increasingly we subscribe to everything. As those providers increase their prices, it can be hard to track those expenses, switch them off or even be aware of them.

• Scribe Pay seems early, but their execution is odd. They're asking users to manually input all of their existing subscriptions so that in the future, those subscriptions could be managed through a dedicated Scribe Pay debit card.  Why wouldn't you just pull this data from Open Banking? Also, many Neobanks now have the "subscription management" feature (through providers like Minna technologies).  Consumer anxiety about subscriptions is an attractive wedge, but I suspect Open Banking may be a better path forward here.

Things to know 👀

1. Square launches Cash App Pay

• Square will allow merchants to offer a QR code at checkout for customers to scan and pay. Cash App pay is free for the consumer and will be available to all US Square merchants.  This follows moves by Square to add loyalty between consumers and merchants into their ecosystem and the recent acquisition of BNPL provider AfterPay. 

• 🤔 Square is creating another payments network because it has both merchants and consumers. Square sellers can now offer rewards, BNPL, and even simple discounts, all via QR codes.  By removing the card rails from the equation, Square can materially improve their own unit economics and the unit economics of their merchant per transaction.

• 🤔 Square has the opportunity to do things with data the traditional rails struggle to do.  It's still way too hard to link purchase intent to purchase behavior. When you use a debit or credit card, the rails rely on ISO8583 messages. That messaging standard is not only old; it's implemented differently by almost everyone that uses it. And when you swipe, the data has to travel from the merchant to the merchant's bank (acquirer), the card network, and your bank. Everyone in that chain could drop valuable loyalty data in that process.  By building a closed-loop, Square can build data over time about what merchants Cash App users like and bring merchants new business and repeat business. 

• 🤔 I'm still not sold on QR codes, but Square's execution is always so solid they could make me a believer.  The pandemic got us all a bit more used to QR codes, and they've been popular with the Chinese payment giants as an alternative to cards. They're low-cost to implement, but I can't escape the feeling that there has to be a better way. Square has the app; they have the terminal. Couldn't it issue a token and use the NFC capabilities they already need to support Apple Pay etc.? 🤷‍♂️

2. China forces Alipay to separate lending and payments business

• Under a plan reported by the FT, Alipay would turn over all lending and credit scoring decisions and data to a new entity, part-owned by the state. According to the report, Ant will not be the only online lender affected by this change.

• 🤔 China's approach to limiting big tech power is different from the US (which has been to have Anti-trust hearings and legal action).  If Big Tech has all of the Big Data, that could be a Big Problem if something goes wrong. China's solution here is to ensure they can see all of the data and that their state benefits from lending. 

• 🤔 It's tempting to view this one-dimensionally as the Chinese state leashing the big tech giants that miss nuances.  Until 2018 China didn't have a consumer credit rating agency, Baihang Credit received the first license. Earlier this year JD.com and Xiaomi built a joint venture with several state-owned enterprises to launch Pudao Credit.   If you wanted to ensure fair and consistent lending without building up a tech-driven debt bubble, having rating agencies is one way to drive consistent data usage and credit decisions.

• 🤔 It's also likely that in doing launching these agencies, the Chinese state can ensure it sees all of the credit data it wants. This could allow it to make sophisticated policy decisions and have deep insight into consumer behavior. It could (and likely also will) be a privacy nightmare. 

• 🤔 The re-introduction of state-owned enterprises (SOE's) into finance could be a long-term negative for China's innovation. China's private sector has powered growth in the past decade, freeing it from historically bureaucratic and corrupt SOEs. This could be a return to corrupt, state-run capitalism that stunted China’s growth for decades through the mid 20th century.

• 🤔 China is also launching its own CBDC to compete with the major payments networks the Big Tech companies have built. Payments are a critical piece of global infrastructure, controlling payments gives the ability to oversee (and manage) the entire economy and state. The US does this through laws and co-opting private sector innovation, where the Chinese appear to be actively trying to compete with the private sector. This feels like a move that may be beneficial in the short term, but negative for the state in the long term if it is designed to compete not complement the existing rails. It could also just be a much more efficient version of FedNow China.

Good Reads 📚

1. The next generation of Fintech product: Context

• In this blog post, Emily Mann from Redpoint Ventures points out that while the first wave of Fintech companies and Neobanks made better banking products, the next wave is going deeper in solving customers' problems in everyday financial lives. As banks got bigger, they became more general-purpose and further away from the customer.

• We now see Fintechs for particular contexts like landlords, immigrants, e-commerce, the logistics industry, families and couples, etc. These fintech companies get closer to the problem and can solve it more holistically. Emily points out that the emergence of B2B API providers in Fintech has lowered the CAC, and the brands getting closer to the customer context can drive strong organic growth and cross-sell in communities. 

• 🤔 The big banks have built "one size fits nobody" solutions and have digitized their paper process.  Banks took the paper statement, put it on a web page, and then put it on the mobile phone. Each time they did, the customer experience got worse, but the bank reduced its distribution cost. But the likes of Chime did more than make banking cheaper and digital. With "get paid early," they also solve a massive problem for the underbanked. 

• 🤔 The winners in D2C and D2B Fintech are those that get closer to the customer context. The scaled niche in Fintech has the potential for multiple billion-dollar businesses in the same category.

• 🤔 This post defines context to mean community or industry vertical. These are correct, but I think there's a third context that is more ephemeral.  Something that is event-based or at a point in time can also be a context. For example, e-commerce checkout is a context for Fintech that can be highly engaging if it solves friction (e.g., this is why BNPL works so well). Other events might be life stages (getting married, moving house). This third category still has oceans of opportunity for scaled niche fintech products.

Tweets of the week 🕊

That's all, folks. 👋

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