Business Breakdowns
· Fraser
[00:00:00] S1: It impacts the whole network. Merchants are happy because they're getting more sales — there's more consumers that browse the website that can actually transact. Consumers are happy because where maybe a credit card wasn't approving them for a limit, maybe a $100 loan for a very short repayment schedule can be approved by someone like Affirm. So they're also getting access to credit. And typically what we see when, again, Affirm is talking about their business is that frontier of: we can approve more of these people across more, let's call it, credit score bands and end up still with very, very strong repayment rates and very low delinquency levels, because they're optimizing the dollar amounts and the terms for each individual. I do want to highlight there is a big misconception that all of BNPL and all of these financial technology businesses that have credit aspects to them are generally lending to non-prime customer bases. Like the credit card industry and other traditional lending industries, it's the full spectrum. So yes, you get some players that are predominantly lending to subprime, but then someone like Affirm, as I mentioned — their average customer is actually generally prime, particularly when you look at the dollars they're lending rather than customer count. It's also just not young people. It actually skews perhaps older than you would think — ages 30 plus is the age bracket. And so the product isn't subprime lending to people that otherwise couldn't have access to credit. It's a much broader pool of the population. And I would re-highlight and double down on the statistic that half of US credit cardholders are sitting on revolving balances. And so there's this huge portion of the population that haven't necessarily been served by a great product best suited to them historically, and Affirm is targeting that part of the population. They're not targeting the American Express Platinum cardholder that wants points and airport lounges.
· S0
[00:00:00] S0: And maybe take a step back and set the stage on the actual business. So I want to spend some time on the economics and unit economics, because I think a lot of people, when they hear buy now, pay later, they may assume it's just that merchant discount rate where the merchant pays a fee, and that's the business, or you have these very simple no-interest, pay-in-X or pay-in-4 types of installments or options. But from reading and hearing more about the business, it's actually much more complicated and layered than that. And there are various products. I think there are four primary revenue streams for the business. So maybe you could walk us through the different sources of revenue, how they fit together, the volumes for each in terms of GMV.
· Fraser
[00:00:00] S1: It certainly is one of those businesses that can feel very complicated when you look at the P&L, but at its core, when you think about the biggest line items, it is reasonably simple. There are basically three types of offers that Affirm generates GMV from. So there's interest-bearing, the 0% loans, and then the Pay in X. And, let's call it in round numbers, 70% is in that interest-bearing category, and then the rest is evenly split between the 0% loans and the Pay in X. Pay in X and 0% loans look pretty similar from a P&L perspective, and then interest-bearing looks different. So I'll split it really into the two categories. So if you look at Pay in X, you're buying some jeans for $100 and you're agreeing to pay $25 over four installments. The primary way Affirm makes money there is on the MDR that we've talked about. So that's negotiated merchant by merchant. Big merchants get a smaller MDR; small merchants get a higher MDR. Interestingly, the MDRs on the Pay in X transactions are generally trending towards credit card rates over time and are almost there. The 0% loans — because the interest is being funded by the merchant, those MDRs are still very high. But that's typically where you see the big merchant revenue or network revenue coming from. The second pool of transactions, which is the 70% of GMV, is the interest-bearing loans. This is a different economic structure, because the MDRs are actually very small here, much smaller than the Pay in X or the 0% APR loans. The vast majority of the economics are coming through the interest income that the consumer is paying to Affirm. And so that's the way to think about the revenue. Pay in X is mostly coming through merchant revenue. Interest-bearing loans is mostly coming through interest income. And then the way to think about — well, how profitable are these products? And Affirm discloses this in their recent investor forum. Those Pay in X, those shorter-term, smaller-dollar-value loans, generate RLTC margins, or gross profit margins, of about 1 to 3% of GMV, whereas the interest-bearing loans generate a gross profit margin of 4 to 6% of GMV. So you can see the smaller ones, 1 to 3%; interest-bearing, larger value, 4 to 6% of GMV.
· Fraser
Which is why when you look at Affirm's P&L, it's actually very healthy, particularly when you compare it to other businesses in this landscape, because they gravitate more to these interest-bearing loans. They're very profitable. That number is after all of the losses, all of the funding costs. We've talked about losses being higher on the interest-bearing side, obviously, because they're longer-term loans versus the short-term loans. That's after all of that. It's still just a much more profitable product to be sitting in interest-bearing loans. And I think that was the concern with the card product — if people start using the Affirm card everywhere and start doing more short-term Pay in X–style loans, maybe the economics won't be as good. But interestingly, people are using the Affirm card. The mix of transactions is actually even more heavily weighted to interest-bearing loans than the core business. And so it's actually an extremely profitable product, because, as I mentioned, Affirm isn't actually generating that much MDR from interest-bearing loans when it's directly integrated with merchants. So the difference between using a card or buying direct online for those interest-bearing loans is not materially different to Affirm. All in — I talked about the different gross profit levels relative to GMV — blended, Affirm generates about a 4% gross profit on GMV margin, which is industry-leading.
· S0
[00:00:00] S0: Before we started recording, you were talking about how it's a payment network, although it's also kind of a lending company. And right now it's maybe even valued more like a traditional lending company, less like a payment network in terms of the overall multiples. Visa and Mastercard are seeing much better multiples than Affirm is today, but it is definitely a payment network and has network effects. So I'd love for you to describe the payment network component of the business.
· Fraser
[00:00:00] S1: So I'll make the distinction between Mastercard and Visa and American Express. All three are payment networks, but as most listeners will know, Mastercard and Visa are purely the rails, and then the card issuers sitting on top extend the credit. And so they've disaggregated the credit from the payment network. American Express vertically integrates, and so they have the payment network, because they're directly integrated with merchants around the world, as well as extending the credit. American Express is a wonderful business and is very well covered by news media, but it has always traded at a multiple discount to Visa and Mastercard because there is a credit component to it. And so that's why when we talk payment network, we very specifically talk American Express, because Affirm has also integrated the payment network in terms of having direct integrations with merchants — albeit online instead of the cafe down the road or the restaurant down the road — but also having the credit sit on top. Proof of that network effect, when we just think at the highest level, is that Affirm today processes over $50 billion of GMV, still growing over 30% a year. And that's actually growing faster than it was a few years ago, despite the business now being two to three times the size. And so rather than seeing an asymptoting growth rate as the business scales, it's actually been able to maintain or accelerate growth at scale, which is a good indication that the network effects are very real. So Affirm benefits from all the same network effects that are well studied for a business like American Express. As more merchants integrate the Affirm button, it's available in more places for consumers to adopt. And then as more consumers become Affirm customers, it becomes more interesting for more merchants, because there's a larger consumer base to drive more revenue. And if you are a merchant assessing which BNPL button to install, you're generally going to gravitate to the one with the largest customer base, because it's generally going to drive the highest amount of purchase volume. That network effect also feeds through other parts of the business. For example, since IPO, the average user has increased their usage from two transactions a year to seven transactions per year because the product is available in more places.