Wednesday 07 Jun 2023
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This article first appeared in The Edge Malaysia Weekly on January 25, 2021 - January 31, 2021

IN the early 1990s, 18-year-old Maksymilian Levchin, a Ukrainian-American student at the University of Illinois and a Chernobyl nuclear disaster survivor, maxed out on his credit card, co-signed by his immigrant parents with a mere US$200 spending limit. Upon graduation, he went on co-found a successful payments firm with a bunch of friends, many of whom are now among the wealthiest people on earth. Yet, just as their firm was readying its IPO in 2000 he wanted to celebrate by buying a new car. To his horror, he found that while he was incredibly wealthy on paper, he was not considered creditworthy enough to buy the car even with a hefty down payment. So, he paid cash.

Last week, another fintech firm that Levchin co-founded, consumer credit provider Affirm Holdings Inc, went public, making him a billionaire many times over. He and his former colleagues, including Tesla Inc CEO Elon Musk, Palantir Technologies Inc co-founder Peter Thiel and LinkedIn founder Reid Hoffman, co-founded the pio­neering payment giant PayPal, which is now the world’s 27th-largest company, with a market value of more than US$290 billion (RM1.2 trillion). Only one bank in the world, JPMorgan Chase with a market value of US$415 billion, is bigger.

Affirm’s direct listing on Jan 13, with a more than 100% first day pop in its shares, came just as the broader fintech segment — tech companies playing in the financial services arena — is on fire. (Singapore’s GIC Pte Ltd, which has a small stake in Affirm, was a key beneficiary of the IPO pop.) Listed fintech firms such as PayPal, Square (market value of US$104 billion) and Amsterdam-based Adyen have seen their stocks surge in recent years. PayPal shares were up 110% last year, having surged nearly 700% over the past five years. Square shares were up 250% last year, having surged 2,200% over the same period as investors chased fast-growing fintech players. Payment is where the rubber meets the road when it comes to changing consumer behaviour in the post-Covid world. People are no longer comfortable paying cash or zipping out their debit or credit cards from their wallet to swipe when they show up at the cashier. They are increasingly using apps on their smartphones such as ApplePay, PayPal’s Venmo or Square’s CashApp to pay for things.

That addresses only the debit portion of the payments process. You need money in your wallet or in the bank to use your app to pay for stuff, although ApplePay and GooglePay allow you to link your credit card as well. Now, a new breed of fintech firms is tackling the credit part directly. Because of Levchin’s terrible first-time experience with consumer credit, Affirm is out to disrupt thecredit card business. Like other “buy now, pay later” firms such as Sweden’s Klarna AB, a payment provider for online shoppers, and Sydney-listed Afterpay Ltd, an instalment credit provider, Affirm is trying to change the way young people shop, pay and use credit. It provides loans for purchases from 6,500 merchants, including Walmart, stationary fitness bike maker Peloton and other online direct-to-consumer firms such as furniture retailer Wayfair and mattress maker Casper Sleep Inc.

Feeling the fintech threat

Not surprisingly, banks are sitting up and taking notice of the rise and rise of fintechs as well as the huge market valuations they now command. Jamie Dimon, CEO of JPMorgan Chase, made no secret of his apprehensions about the threat from fast-growing fintechs last week at the bank’s earnings conference call for investors. “Absolutely, we should be scared s—less,” Dimon said about the looming threat of fintechs. “We have plenty of resources, a lot of very smart people. We’ve just got to get quicker, better, faster.” The CEOs of three other large US banks also mentioned the fintech threat last week. Clearly, bank CEOs are trying to send a message to global investors: We hear you about the fintech threat and we are taking steps to mitigate the onslaught of the fintechs.

To be sure, “shop now, pay later” is different from anything you believe it might resemble. Unlike credit cards, which have exorbitant interest rates of around 24% or more, plus even more exorbitant late payment fees, many of the purchases on the platforms of these consumer finance fintechs have a zero annual percentage rate (APR) and, indeed, no late fees.

The way Levchin sees it, the financial product called the credit card is deeply flawed. “It’s a power tool that has no manual and no safety features,” he says. The problem is that, unlike power tools, it comes with no warning label. “When I was in college, I had no idea how a credit card worked and, before I knew it, I had run up US$200 debts,” Levchin was quoted as saying in a recent interview. “If you are financially savvy and you know exactly how it works, a credit card can be a wonderful tool.” He argues that banks and credit card firms are making a ton of money by using all sorts of gimmicks to make people who do not really understand it use it. “Three decades ago, banks could get away with it,” he says. “Customers these days want clarity and are no longer willing to allow banks to blatantly take advantage of them.”

Keeping it simple

So, how does Affirm make money? For one thing, it collects a ton of data on you that gives it a big edge over just about every bank or financial firm willing to lend you money. Monetising that data can be a fairly profitable proposition. For another, Affirm uses artificial intelligence to determine whether its customers are who they say they are creditworthy. The thing Levchin learnt as he began building his consumer credit firm in the aftermath of the global financial crisis in 2009 was that, “if you treat your customers right and don’t try to profit from their mistakes, they will more often than not pay you back”.

Affirm also tries to keep it simple. Unlike a bank or credit card firms that go to great lengths to obfuscate what exactly they are charging you, fintechs such as Affirm tell you straightaway — if you buy, say, a Peloton bike for US$2,500 or a Peloton Treadmill for US$4,500 — just how long it will take you to pay it back if you can only afford an instalment of US$150 a month. Or, if you were paying back US$100 on the first of the month rather than on the sixth of every month, how much you can save or what your effective interest rate would be. Most of the credit fintechs are apps on your smartphone, with built-in calculators that tell you in real time what it is really costing you to pay off something that you bought on your last vacation in Hawaii or last trip to the neighbourhood mall.

Fintechs have learnt that if they keep things simple and transparent rather than convoluted in legalese and jargon like banks often do, because that is what their army of lawyers advise them to, they will probably have lower overall costs and far higher customer satisfaction. Passing the benefits of lower costs to customers and high satisfaction rates lead to higher retention rates, lower marketing costs and repeat business. Not only do fintechs leverage the data they collect and the technology they deploy, such as AI, they also do not have the legacy costs of old banks. Ask JPMorgan Chase, which employs 260,000 people, or Industrial and Commercial Bank of China (ICBC), which employs 450,000, about legacy costs and you will get the picture.

Affirm can waive interest payments because of its close ties with merchants such as home fitness bike maker Peloton. You could buy a Peloton bike on an American Express credit card or your local bank’s branded Visa or MasterCard and pay annual interest rates of between 24% and 26%, plus a hefty late payment fee if you were behind just one day, or you could have bought the same bike from Peloton with an instant loan from Affirm at a zero interest rate and no late payment fees. Now you see why Dimon and other bank CEOs are having sleepless nights worrying about what Affirm, Klarna, Square or PayPal might do next.

In the July-to-September quarter, 30% of Affirm’s total revenues came from lending to customers of one firm, Peloton, whose bikes were among the most popular items for affluent people in North America who could not go to a gym during the pandemic-induced lockdown.

Benefiting from partnerships

Detractors say that is a very high level of single-customer concentration even for a company as young as Affirm. Levchin and Peloton CEO John Foley say both their companies have benefited from forging a partnership.

Peloton could not have built a business as strong as it has without Affirm as a partner; and Affirm could not have built a consumer credit business as quickly without a product as hot as the iconic fitness bike and app firm. Affirm also has a partnership with Canadian e-commerce software and solutions provider, Shopify,  which has an 8% stake in Affirm, hosts a ton of small and medium businesses on its platform trying to sell goods and services worldwide.

Affirm’s goal is to be a viable alternative to credit cards. Levchin believes the traditional revolving credit offered by banks or credit card providers is not in the best interest of most borrowers, who end up paying far more than they should through no fault of their own. Moreover, the higher interest rates and late payment fees benefit only old-fashioned banks and card firms that use marketing tricks and gimmicks to maximise the use of the cards to boost their own bottom lines.

In the case of Affirm, close to half of the loans last year were actually interest-free and almost all of the loans it extended in 2020 carried no late payment charges. Levchin says merchants are embracing the late fee-free and low or no interest rate loans from Affirm because it ultimately allows them to sell more products or services. Because competition in online consumer finance is fierce, it is unlikely that perks such as interest-free or no late fees will be curtailed anytime soon.

The user-friendliness of consumer finance apps and their ability to save consumers money are leading to strong loyalty and repeat purchases, not just at Affirm but also at Klarna, Afterpay and a host of other “buy now, pay later” firms that are imitating their business model. The focus of the consumer finance firms is not only to get their loyal customers to buy again using their credit lines but to buy bigger-ticket items, allowing them to take the challenge to the banks’ doorstep. If you bought a US$450 designer handbag for the year-end holidays using Affirm or Klara, they want you try that Peloton treadmill, which is 10 times the price.

The reason Ant Group’s massive US$39 billion IPO was abruptly cancelled last November was not that founder Jack Ma made a scathing speech criticising Chinese regulators but because Beijing mandarins finally woke up to the realisation that fintechs such as Ant pose a clear and present danger to China’s state-owned banks. Hong Kong and, more recently, Singapore have given out licences for digital-only banks. Digital banks are expected to roll out in other Asian countries over the next two years. The real battle between challengers and the entrenched incumbents, at least initially, will not be over mortgages or loans to small enterprises but over lucrative credit cards and the unsecured credit market.


Assif Shameen is a technology and business writer based in North America



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