Affirm is another company to emerge from the Paypal mafia.
Founded by Paypal co-founder and CTO Max Levchin in 2012, Affirm has come to the market with its BNPL (Buy-Now-Pay-Later) solution.
As we will see in this Business Model Canvas post, the company’s ambitions go far beyond credit.
Affirm Business Model
Affirm earns a commission from merchants (ie. Network Revenue) on each sale that typically ranges between 4-6%.
BNPL – Taking on Credit Cards
From a business model perspective, Affirm is centred around merchants. As of its most recent quarter, the company had 12,000 active merchants, buoyed by their partnership/integration with Shopify.
In one part of their business model – as we will see below – they charge merchants a fee of ~5% of the transaction to offer consumers ‘interest free, no-fee loans’ that are payable in 4 installments.
The company counted 5.4 Million consumers in its most recent quarter, and while these consumers are originated via the merchants, all the details/payments for the BNPL transaction are handled on the Affirm app itself.
BNPL is billed as a competitor to the credit-card industry. Currently payment volumes from BNPL total only about 1% of total volumes, but gross merchandise volumes are expected to grow 10-15X in the next several years to over $1T.
A study conducted by the Federal Reserve in 2018 found that debit cards were the most widely used payment mechanism in the US, making up 28% of transactions, followed by cash (26%) and credit cards (23%). While not explicitly named in the study, BNPL is a nascent payment option with only 1% of the transaction mix but growing rapidly.
The Generalist
Within the global BNPL industry, Klarna (Sweden) and Afterpay (Australia) are dominant. Both companies have Market Caps (Afterpay is public, Klarna is planning an IPO in the near future) of ~$30B, while Affirm is worth approximately half that.
How does Affirm make money?
Like most BNPL companies, Affirm earns a commission from merchants (ie. Network Revenue) on each sale that typically ranges between 4-6%. This is the standard model for most BNPL disruptors like Affirm, Afterpay, and Klarna.
In addition, Affirm earns Interest Income from loans that it originates, whereby consumers are late paying back their original BNPL loan.
Transaction Take Rate or Interest Income
This is the model that Affirm offers its merchants:
- Merchants pay Affirm a relatively large cut of the transaction (~3-5%).
- Merchants pay Affirm a much smaller cut (closer to 0%). Affirm monetizes by offering non-zero financing rates.
Technically, the core BNPL model has no fees and is interest-free as long as the 4 installment payments are made on time (ie. ‘Pay in 4’). Affirm’s model does create a pseudo credit-card type model where Affirm earns a small fee and interest on the loan.
The distinction between categories likely has to do with the price of the items that are offered. BNPL originally focused on smaller value items.
Players like Afterpay (capped at $2,000) and Paypal ‘Pay in 4’ (capped at $600) have hard caps on the value of items that can be purchased using their BNPL solutions.
Affirm (upper limit of $30,000) and Klarna (upper limit of $10,000), on the other hand, have higher limits but do some form of ‘soft’ credit scoring (see Klarna’s policy) where users are ‘pre-qualified’ to be able to spend certain amounts.
Many of the leading BNPL players like Afterpay found their niche in low-cost items and are now expanding upmarket by offering higher-priced items. Affirm has always had their sights set on the broader market and boast the highest Average Transaction Value and Average Spend in the market.
The company also has an Average Annual Spend by Repeat Customers of $2,200 and high loyalty to the platform, with 64% of transaction being driven by Repeat Users.
Different strategies result in different respective Business Model Analytics, and Affirm is seeing the results of its strategy in metrics like those above. By being at the higher end of the market, the company opens themselves up to more credit risk, but also a larger merchant funnel.
Lending Risk
When customers fail to pay back a merchant, it is Affirm who is responsible for the loan, not the merchant; this is part of the value proposition that BNPL players offer in order to charge a 4-6% merchant fee. In its S-1 (released when going public), Affirm had a 36-month trailing delinquency rate (default on loans) of 1.1%.
Based on its latest Earnings report, Affirms splits revenue roughly 50/50% between ‘Total Network Revenue’ (commission from merchants/virtual cards) and both ‘Interest Income’ and ‘Gain on sales of loans’ (where they sell their loans to a 3rd party bank).
One way to contextualize this would be to say that at this point roughly half their revenue is payments related, while the other half is lending related.
Retail Customer Acquisition Funnel
The merchants themselves acquire the customers, but all details related to the loan happen on Affirm’s own app, meaning that Affirm does create a customer funnel through its merchant network that itself can become more valuable over time.
This is especially true now that the company is gearing up to launch its own in-store debit card to consumers in the months ahead. They now are offering a FDIC-insured Savings account with 0.65% APY (average percentage yield) to help savers earn interest. Essentially, Affirm starts to look more and more like a Challenger Bank as they expand their core offerings.
“We are building a new bank, hopefully the largest bank in the world, by using technology from the ground up. Today, we help them buy mattresses and sets of dishes; tomorrow, a used car, maybe a new car, then a house.” Affirm CEO Max Levchin
The Generalist
Community-Centric or Commercial Partner Strategy?
Affirm is focused on commercial-partner strategy with Shopify. This partnership offers merchants an integrated experience between Shop Pay and Affirm’s BNPL solution.
In recent weeks, we have activated Shop Pay Installments powered by Affirm for more than 10,000 Shopify merchants. We expect this number to significantly increase as we move towards general availability in June.
Affirm Earnings – Q3 ’21
As this solution is just now rolling out to Shopify merchants, having the original 10,000+ just come on to the platform in the last 30 days, the expectation is that this partnership will drive a significant amount of merchant volume for both Shopify and Affirm.
According to Shopify’s marketing materials, 1 in 4 merchants sees a 50% higher AOV, along with a 30% faster checkout time. That is why the combined Affirm product is as much a Customer Acquisition Cost (or “Marketing Device“) as it is a Payments cost.
Shopify actually owns a significant % of Affirm (> 5%) stock thanks to the deal the two companies struck around the integration. How the companies split revenue in this integration is not clear, as the merchant pays for the Shop Pay Installments solution as a whole, it doesn’t pay for for both BNPL from Affirm and payments from Shopify.
Acquisitions can also function as an extension of Partnerships, and Affirm recently acquired Returnly for $300M in late April of 2021. This gives the company an additional tool in the post-transaction returns process that it can offer merchants to help remove friction for online purchases. They also acquired Canadian-based Paybright back in December 2020 for $340M to expand their pipeline into the Canadian market.
As the company has a significant runway in the next 5 years in both BNPL and consumer finance, expect to see more commercial partnerships with Fintechs and innovative eCommerce players in the years ahead.
Fundraising and Valuation
Affirm is a venture-backed company that recently completed an IPO on the Nasdaq. The company sold 24.6 Million shares at $49 per shared back in January for a total proceeds of $1.2B valuing the company (Ticker: AFRM) at around $13B at the time of IPO. It had raised more than $1.5B prior to the IPO.
Affirm Business Model Canvas
A business model is defined as:
“the rationale of how an organization creates, delivers and captures value.”
Alex Osterwalder et al invented the Business Model Canvas to help individuals and organizations conceptualize how to analyze, create, and develop business models.
Affirm Value Proposition
Allows consumers to Buy-Now and Pay-Later (BNPL) in 4 installments without fees or interest:
- Alternative to Credit Cards for Consumers
- Marketing and Loyalty Channel for Merchants, increasing AOV and Retention
- Savings Account to help Consumers save more money
Affirm Business Model Analytics
It seems that in the case of Affirm, the major business model analytic that mattered was their delinquency rate.
The company said in its filings that its 30-day delinquency rates, ex-Pay in 4, were 2.7%, up from 1.5% from the same quarter ending in September last year and up from 0.8% in 2021
PYMNTS (Q4 ’22)
The ‘ex-Pay in 4’ refers to their higher value, higher interest rate, higher risk set of loans. They were aggressive with Customer Acquisition and targeted higher Average Transaction Values relative to the competition.
All factors considered, the relative ARPU (Average Revenue Per User) – CAC (Customer Acquisition Cost) – LTV (Lifetime Value) ratios could have worked out for Affirm if their delinquencies hadn’t spiked – but they did.
This was certainly a foreseeable risk when looking at BNPL as a whole.
As a result, the most interesting Business Model Analytics to track going forward as the industry evolves will be around the credit portfolio of the BNPL players themselves: late of late payments and/or defaults.
Business Model Innovation – BNPL
It seems that for better or for worse, this is always the case in a loan-based business model in banking.
2022 – Delinquencies and a Share Price Death Spiral
The delinquencies appeared to start spiking in Q3 or Q4 of ’21, right around the time their share price peaked (Ticker: AFRM). The company’s stock price peaked in early November 2021 and proceeded to drop nearly 95%, and approximately 90% YTD In 2022. This was among the worst of anything related to Digital Banking (but not the worst).
Fellow competitor Klarna also had a terrible 2022, down 85% in a private financing round, dropping from a peak valuation of $45.6 Billion in Q2 ’21 to $6.7 Billion a year later. Both them and Affirm were among the most aggressive players not just for market share, but for loan values offered.
These products skew much closer to typical credit card debt, so it is hard to fully blame BNPL; nevertheless, the BNPL sector remains weak coming out of 2022.
As it stands now, delinquencies may have stabilized for Affirm due to an increase in underwriting standards in the second half of the year.
Both Affirm and Klarna — which is underpinned by a bank — claim to have stabilized delinquencies by tightening their underwriting standards in the latter half of 2022.
American Banker
During its share price death spiral in 2022, Affirm continued to grow, with its user base growing from approximately 9 million to roughly 15 million active consumers over a 12 month period.
Competition will increase exponentially going into 2023:
- Apple is launching Apple Pay Later
- Walmart has backed the BNPL Fintech ‘One’
- Visa, Mastercard, and a slew of banks are launching BNPL products
Furthermore, Affirm’s partnership with Amazon is set to expire in January, 2023, leaving some to wonder if Amazon itself won’t launch their own BNPL product.
The devil is in the details of the BNPL model:
- Afterpay kickstarted a lot of the initial public market growth in the Australian market where they ran the traditional model (‘Pay in 4’) and kept Average Transaction Values relatively low
- OG Klarna pioneered the model in the Swedish market before entering the European market, and was consistently profitable until their U.S. expansion and rollout of Financing products
- Affirm tried to come in at the higher end of the market and build a product that looked much more like credit card than the typical ‘Pay in 4’ BNPL model
Thus we can’t make any dramatic proclamations such as ‘BNPL is dead’ especially after seeing that the heavyweights like Apple and Walmart are only entering the market in 2023. But the nuts and bolts of the business model need to be firmly established in order to bring Affirm back towards any sort of glory.
While Afterpay and Paypal have subsequently joined Klarna and Affirm in the high-risk, high-reward Financing/Loans realm, it remains to be seen what the skew is between Network Revenue from typical BNPL transactions (merchant pays) and Interest Income (consumer pays).
Klarna, for example, has somewhat pivoted a lot more towards retail/eCommerce with the launch of their Spotlight shopping app, giving them a much more diversified business model. Afterpay was bought by Square (Block) in Q3 ’21, meaning that of the Top 3 upstart BNPL players from 2021, the playbook is wide open for Affirm heading into 2023.
Affirm Outlook – 2023 and Beyond
In a recent Q4 ’22 letter to shareholders, Affirm CEO Max Levchin noted the following:
We took market share by significantly outpacing e-commerce growth with our Gross Merchandise Volume (“GMV”) increasing by 62% year-over-year, approaching 2% of all US
Affirm Shareholder Letter
e-commerce
In the big picture, we know that eCommerce volume is continuously eating into a greater share of retail sales volume, so if Affirm has 2% of that market share now, imagine the value of that in the future – or so this line of thinking goes.
The company boasts a Net Margin (or Revenue Less Transaction Costs ‘RLTV’) of 4.2% of GMV. That means Affirm would generate approximately $4.20 in Net Revenue every time a customer spends $100 using Affirm’s products from the merchant. Those are eye-popping numbers.
Their average loan life is 4.6 months, meaning that the majority of their GMV (Gross Merchandise Value) is driven by longer-term Loan products compared to the typical BNPL ‘Pay in 30’ model.
But the market will only really care about their credit underwriting from here forward, as acknowledged in the shareholder letter.
Managing credit performance (always job #1 at Affirm) and prioritizing early delivery of projects to maintain our transactional unit economics, even as the Fed continues to move.
Affirm Shareholder Letter
The market seems to be much less concerned with market share and even potential profitability, and more concerned with future provisions for credit losses that can blow the entire business up if not managed correctly.
In their latest quarter, against a backdrop of $361 Million in Total Revenue, driven by:
- Total Network Revenue – $139.9 Million
- interest Income – $136.8 Million
- Gain on Sale of Loans – $63.6 Million
- Servicing Income – $21.4 Million
This was against a ‘Provision For Credit Losses’ of $64.3 Million. They swung to a loss of $18.6 Million in the quarter.
We can see that the ratio between ‘Network Revenue’ and ‘Interest Income’ is about 50/50. The challenge for Affirm is to maintain growth while tightening credit standards. If they can find a way to start becoming profitable and increase free cashflow on a quarterly basis without taking on significant balance sheet risk, the market may warm up to them again in 2023 and beyond.
It is hard to predict any outcomes for Affirm going forward one way or another because their stock has been beaten down so badly you wonder how low it an go. Simultaneously, the mechanics of the business model and BNPL in the riskier loan products with high interest rates looks like a tricky market heading into 2023 and beyond.
Will Affirm learn from its mistakes and become a force once again among Digital Banks?
It is not entirely impossible, especially given that a member of the infamous Paypal Mafia – Max Levchin – is guiding the ship. But it certainly won’t be instantaneous and the market as a whole will see a lot of big twists and turns in the years ahead. Yet it still feels that most big Fintech/Tech players see a huge TAM (Total Addressable Market) and opportunity in BNPL long-term.