Affirm — Could it make a difference?

The Company

Affirm chose the payments sector as their niche. I think this is partly because of its founder’s experience of successfully building PayPal but more importantly because it recognises the sector’s opaqueness as a source of inefficiency that limits the financial industry from realising a higher potential (this is reflected well in their Mission and Vision statement). Their solution is to provide a more efficient and transparent payment option to consumers which will benefit merchants and build this positive feedback cycle via a more robust loan underwriting system built through AI and machine learning.

Figure 1. Source
  • Merchant solution by offering an enhanced demand generation, reduction in customer acquisition cost (CAC), reduction in checkout page abandon rate, and an increase in average order volume (AOV).
  • Affirm app (or Affirm’s virtual cards) that offer consumers an easier way to experience Affirm’s benefit.
Current status
Step 1
Step 2

Competitive Advantage

There are two competitive advantages that Affirm is currently pursuing and which could act as a strong moat once they reach a certain threshold.

Network Effect

As with most marketplace, it is effectively a race of ‘who can build a positive feedback network cycle faster’. It is hard to build and the threshold to reach is high but once the threshold is reached, benefits immense and will act as a strong moat.

Source: Affirm’s S-1 form

Proprietary risk model enabled by technology

As mentioned earlier, a large part of Affirm’s value arises from its robust underwriting model which can be summarised by the graph below. From this graph, it is clear that their risk model is identifying consumer credit risk more efficiently than that of FICO standard. The company’s weighted-average quarterly delinquency rate is around 1.1% (until 30 September 2020) while an average delinquency rate for the credit card industry is 1.81% (according to creditcard.com). The difference of 71bps may look small but when it is magnified by a growing GMV that is in billions of dollars, it makes a meaningful difference to the bottom line and ultimately to the robustness of a business model (especially when compared to the conventional financial institutions).

Source: Affirm’s S-1 form

Business model & Risks

Revenue

As can be seen from the table below, the company’s revenue is growing strongly across all sources but two things are worth mentioning: concentration and revenue capturing. Both of them could be of less relevance had the company stayed in the private market but since it opted to go public, a radical fluctuation in revenue will hurt shareholder’s equity value which ultimately could negatively impact its brand image and its negotiating power in the consumer market.

Source: Affirm’s S-1 form

Funding capability

Affirm originates its loan (or the advance payment it makes to the merchants on behalf of consumers) from the third party. While it also uses its own equity too (currently about 19% of its equity, higher than a regulatory requirement of 8%), a large portion of such origination relies on Cross River Bank, a bank with $10B assets (it sounds a lot but the largest banks in the county have assets in trillions and hence it is considered a small bank) from Fort Lee, New Jersey. Cross River Banks is an FDIC insured lender with BBB credit rating, lowest tier in an investment grade, for its bond issues. Affirm has a 3-year contract with the bank with automatic 1-year rollover and 90 days termination notice period. Termination in this relationship or a negative event in the bank could seriously damage Affirm’s ability to fund the cash for loans which will break the network loop, depicted in the Competitive Advantage section. This is an indication of two things: 1) Affirm needs a strong partnership with a conventional financial institution and its proprietary risk model (one of their core competitive advantage) is yet to be fully adopted and recognised by the mainstream financial industry and 2) Affirm identifies large banks (such as Citi) as their competitors which means it is unlikely that they will be able to secure a fund origination relationship with a larger and a stronger financial institution.

Future opportunities and growth strategy

Grow tangential to current network chain

  • Diversify merchant indsutry to smooth revenue
  • Omni-channel payments in commerce while increasing touchpoints with conventional commerce through innovative financial products
  • Enhance value to merchants such as better consumer data, more consumer traffic…etc

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