They are in a regulatory blackhole, in Australia merchant fees are tightly regulated, cannot be more than actual processing cost. Many companies here charge more to pay bills by credit card or shops have minimum amount before credit cads are accepted. Moreover since Afterpay technically doesn't give consumer credit they are not bound by national credit rules as well. They don't and can't do credit checks
Just to expand upon what the parent said, their fee is significantly higher than the companies that just process credit cards (around 6% compared to the industry standard rate of 2.9%).
I believe they eat the loss when the customer defaults, though.
To play devil’s advocate though, if a 6% payment fee allows a merchant to make a sale they wouldn’t have otherwise made, then that might be a net win from their perspective. I.E. eating some decrease in profit is better than making nothing at all.
It’s basically the app version of offering interest free payments on a purchase.
Totally agree - I was just poiting out that just like 2.9% credit card fees that get ammortized over the total sales by the means of higher prices (meaning even if you use cash, you don't get a discount[1]), the 6% has to come from somewhere.
[1] Some gas stations have a different cash rate to pass the savings on to the customer
And yet, magically and by the power of the market, the fee will still be paid for by customers. It isn't like the merchant has a non-customer source of income. The money has to be coming from them.
If you don't want to pay the surcharge, shop somewhere that doesn't offer Afterpay. Or somewhere that doesn't honour the TOS, I once got an extra egg in my soup for paying cash.
Which doesn't make it an externality, because they are still choosing to use the vendor. My favourite take-out place for a solid 2 years was the cheapest on the street and probably because they didn't support Afterpay or credit cards. The customer has all the power to avoid the cost if they want to.
They pay the Afterpay surcharge because they want a standard shopping experience that supports lots of different ways of paying. If they want to shop on price Afterpay will vanish from their view.
Capital recycling: Here's how Afterpay earns its margin.
How Afterpay makes money
BNPL companies like Afterpay earns their revenue in two ways:
Merchant fees from retailers: the company takes a percentage fee of every dollar that is transacted via its platform. This commission rate, referred to as “Afterpay Income” varies is between 3% and 6%, varying depending on the size of its is retail partners; and
Late fees from consumers: the company charges late payment fees of $7-$10 per late payment.
Breaking down Afterpay income
Merchants pay Afterpay a commission, referred to as Afterpay Income. This commission ranges between 3% to 6%. The more volume you do with them, the lower the rate I gather.
In FY20, the income as a percentage of underlying sales, or Gross Merchandise Value (GMV) transacted through the platform was 3.9%.
This indicates that there is a portion of retail partners that pay less than 4% of fees to Afterpay.
Hot Tip: If your retail business offers Afterpay and you’re paying more than 4%, then perhaps it’s time to get a price check.
There are costs of sales associated with earning Afterpay income.
Afterpay’s cost of sales include:
- Provision for bad debts (customers that are at risk of not paying);
- Other variable transaction costs (processing fees); and
- Financing costs (cost of working capital).
After deducting these variable cost of sales, Afterpay’s gross profit was 2.25%, referred to as Net Transaction Margin (NTM).
In other words, for every $100 that you spend using Afterpay, the company collects $2.25 of gross profit.
Finance costs
Like most businesses, a constraint to Afterpay’s growth is working capital. Afterpay needs cash to fund the gap from when funds are paid to its retailers to when it eventually receives the cash from consumers in six weeks.
Let’s break this down. Say you buy a $1,000 pair of Yeezys via Afterpay. The retailer will get paid $940 upfront, being $1,000 less a 6% commission. On the same day, Afterpay collects its first installment from the consumer of $250. Afterpay is out of pocket by a total of $690. Aftepay will collect the remaining $750 from the consumer over six weeks.
Afterpay needs capital to fund this $690 gap. It does so by borrowing from several Tier 1 lenders: Goldman Sachs, CitiBank, Bank of New Zealand and NAB. The average interest rates on these facilities ranged from 1.65% to 3.2% in FY20.
How it really makes money: Capital recycling
So summing up, after starting with a 4% merchant fee, Afterpay’s Net Transaction Margin drops to a mere 2.25% after paying transaction fees, interest and bad debts.
Doesn’t sound that special, does it?
Well yeah, it doesn’t.
But here comes the big reveal that gets investors salivating about the BNPL business model.
It boils down to the company’s velocity of recycling capital.
Traditional banks make money by earning the difference of interest between what they charge to borrowers (mortgage holders), versus what they pay to depositors (savers). Most banks make a net interest margin of ~2% per annum.
But what the banks earn in a year, Afterpay makes in six weeks. Customers are required to repay Afterpay over 42 days (six weeks), and Afterpay makes the same amount of commission even if they decide to pay it earlier.
In fact, it’s better for Afterpay if customers pay off their debt faster, because it means that Afterpay can redeploy the capital faster.
To put this in practical terms, let’s assume that a consumer spends on average $100 per transaction via Afterpay.
If this consumer only uses Afterpay once per year, Afterpay makes $2.25 per year of transaction margin and a 2.25% Return on Capital (ROC) before operating expenses.
But if the consumer uses it 10 times per year, Afterpay makes $22.50 per year. The initial $100 of capital that Afterpay borrowed is redeployed every time a new transaction is made. The return on capital is now 22.50% because the same $100 is now generating $22.50 of annual net transaction dollars.
In its FY20 report, Afterpay reported that its longest cohort of users are transacting up to 25x per annum — which implies that Afterpay could be generating a whopping 56% of ROC per annum on its oldest users.
- their late fees are capped
- there is zero interest charge
- they have a policy of never taking legal action to pursue payment
- non-payments don't affect your credit rating
On what is your argument based? There is literally nothing in common.
