Navigating the Rise of Point-of-Sale Finance
Introduction
If you’re like me, you probably wake up to an article every morning about a new entrant into the point-of-sale lending space. POS lending has been a recurring hot topic for several years now and has heated up again as lenders and merchants prepare to reorient their businesses in light of the economic impacts of COVID-19.
New entrants to point-of-sale find themselves navigating a space with very diverse offerings and business models. Just last month, Ally Financial announced their intent to offer POS installment loans through Mastercard’s Vyze platform with moderate (low-teens to mid-twenties) APR’s and lines extending up to $40K. A week later, PayPal announced their Pay in 4 product: an interest-free, short-term loan for purchases in the $30-$600 range.
The PayPal news is particularly interesting as they stand to compete with fintechs like Afterpay, Quadpay, Klarna, and Affirm – which have taken the market by storm with products that:
Carry low or 0% interest and other fees paid by the consumer
Have relatively short terms, often with an up-front payment
Utilize relaxed underwriting and approval criteria
Generate revenue primarily from merchant discounts
There are three parties in every point-of-sale transaction: merchant, lender, and customer – each with their own set of needs and priorities. As the market matures, winners and losers will be defined by how they navigate the next phase of competition.
Why is Point-of-Sale financing attractive?
To Customers
Customers prefer fixed, easy to understand product structures. Several recent market research studies suggest customers prefer point-of-sale installment loans to credit cards when making purchases. Citizens Bank notes that 62% of consumers surveyed prefer installment loans – and their fixed monthly payments and clear terms. In the same study, Citizens also concludes that 66% of consumers are not interested in opening an additional credit card just to enable a purchase. In a similar survey by Affirm, they concluded 87% of consumers aged 22-44 are interested in paying for purchases via installment loan, and 64% of customers stated that the most appealing aspect of point-of-sale installment loans is “knowing exactly how much I’ll owe and when, including interest”.
Customers are price sensitive. Affirm’s most recent consumer preferences report states that shorter-term products with 0% APR and higher payment amounts were preferred at most credit levels compared to longer-term interest-bearing products with lower monthly payments. It may seem obvious – but with more and more 0% alternatives becoming available to customers, lenders, and merchants without the ability to offer those products are putting themselves at a competitive disadvantage.
The application process is seamless and low effort. Technology has transformed the point-of-sale financing experience in recent years. Applications for financing are built-in directly to retailers’ online shopping and checkout platforms. Customers don’t have to wait for approval. They don’t have to apply for a credit card on a separate page and then enter that payment information. And for a population of customers that are largely younger and concerned about their credit – some online lenders don’t even pull bureau profiles.
These factors have created a perfect storm and generated a tremendous amount of inertia toward the product structures proliferated by online fintech POS lenders. It’s no wonder that we’ve seen the market share of AfterPay and others grow astronomically.
To Merchants
Access to point-of-sale financing drives more sales and larger purchases. According to the same 2018 Citizens Bank study, “76% of U.S. consumers are more likely to make a retail purchase if a payment plan backed by a simple and seamless point of sale experience is offered”. PayPal and AfterPay also posit that consumers spend ~20% more when they are offered POS financing. The incremental revenue gained from these sales outweighs merchant discounts of 5-10% that we traditionally see tacked on to transactions. Some fintechs, like Afterpay, even have the functionality for customers to shop at online retailers directly within their platform. Having relationships with POS lenders may not only help boost sales in-store but drive new customers to shop there. Merchants also receive payment immediately for their goods or services, as opposed to staggered cash flows from an in-house financing option.
Competition is key. As point-of-sale financing becomes more ubiquitous for online retailers, other merchants are forced to seek out their own financing partners to keep up. Merchants cannot stand to lose out on sales to competitors because they don’t offer or have less attractive financing options.
Technological advancements have expanded demand for point-of-sale financing to smaller merchants. The benefits of POS financing are not new to the retail industry. Historically, products like PLCCs and installment loans items were reserved for large national retailers or industries with higher ticket items. However, easy integration of APIs into online shopping platforms and simple merchant onboarding processes now allow small businesses to easily access to financing for their customers as well. At least where access to financing is concerned, the playing field is as level as it has ever been.
To Lenders
Demand. Both customers and merchants alike have an increased appetite for point-of-sale financing. Covid-19 has served only to accelerate the in-progress transition to online retail, and millennial consumers that prefer installment loans make up an increasingly large proportion of the market.
Asset diversification. In light of recent events, point-of-sale financing provides a mechanism for lenders to generate balances while other asset classes, like SMB or unsecured debt consolidation, have cratered. The POS space is not only rife with fintechs, but also large, regional, and community US banks making their own plays toward grabbing market share.
Attractive economics. While customer friendly, POS loans provide strong economics to lenders. From a cost perspective, they are relatively easy to service and don’t always carry the high CTAs of direct or affiliate-based marketing. Even 0% APR products come with merchant discounts on the revenue side – which at 5-10% over a shorter term (sometimes as little as 6 weeks), carry reasonable implied APRs. From a risk standpoint, individual purchases aren’t as high leverage as revolving lines, and upfront payments help to mitigate charge off severity.
What do lenders need to consider?
At AQN, we have been working with pre-launch point-of-sale lenders and more mature institutions interested in entering the space. If you’re either entering or deepening your investment in point-of-sale, here are some of the key questions that you need to be asking yourself:
Is my product sticky? Are customers incentivized to use my product again with the same or a different merchant?
Do the economics of my product hold up in a credit-stressed environment?
How should the current climate influence my underwriting? Should I be worried about loan stacking?
Where do my loans fit in payment priority, especially if I am not reporting to the bureaus?
Many lenders offer many different POS financing options. Does this market saturation affect selection and credit quality after the first look?
As the space becomes more saturated, will discount rates be driven down as lenders race to acquire more merchants?
How is my product differentiated for merchants? Why would they choose my financing over competing options?
What is my B2B sales strategy for merchants and what do I need that is different from my direct to consumer sales model?
How do I manage merchant risk?
Does entering the point-of-sale market threaten to cannibalize or otherwise impact my existing lending offerings?
We’re constantly thinking about keys to successful market entry and scalability, but the near future is as uncertain as it’s ever been. If you’d like to discuss point-of-sale and our approach to lending’s hottest topic, don’t hesitate to get in touch.