In February 2013, Max Levchin launched Affirm — a point-of-sale (POS) lender that would provide creditworthy millennials, who lacked credit cards and credit scores, the ability to buy and finance items from online sellers at checkout.
Today, Affirm is announcing its one millionth POS loan and celebrating all of the milestones that he and the Affirm team have accomplished since: 900 merchant partners for which Affirm says they’ve increased conversions 20 to 25 percent, customers (36 percent of them) who return to the same retailer to spend more (82 percent more), increased basket sizes (some 35 to as much as 84 percent) and the consumer financial empowerment — Affirm CEO Max Levchin told Karen Webster in an interview before the announcement — that comes with having complete transparency into the “total cost of ownership” of those loans and control over their money.
Now four years and one million loans later, Levchin and Affirm are taking their founding principles and mission to another level — to an entirely new set of customers.
Today, at a keynote at the Operation HOPE summit, Levchin will lay out the dangers of promotional POS financing and, well, affirm Affirm’s commitment to giving all consumers an “honest and transparent POS credit product” and the retailers they partner with an important brand-building and sales-building tool for their retail arsenal.
The Dangers of Deferred Interest
Levchin told Webster that Affirm was founded on a simple idea — that the world is full of people who can and should be given access to credit — but that the tools to evaluate that worthiness were insufficient and thus locked them out of the system. Affirm essentially wanted to build an underwriting model that could allow retailers to profitably offer financing for those buyers.
But Levchin noted, when he and his team started building Affirm, they quickly discovered that despite a long, long history in payments and financial services (Levchin is most famous for co-founding PayPal), the world of point of sale financing was a very different, and rather disturbing, space.
“The more I looked at retailer-sponsored finance, the more I realized people routinely end up paying atrociously more than they bargained for, given the large degree of ‘cost shifting’ that happens.”
Cost shifting, Levchin told Webster, comes in the form of retailers offering a promotional credit product that bills itself as “free” — no interest over a period of time — to buy stuff that consumers really want to buy — maybe even spending more than they would because they are getting it at face value — without interest.
“Who doesn’t like free,” Levchin remarked.
And for those consumers who never make even the tiniest mistake, like say miss a payment by a day, those offers are goodness. But make that tiny mistake, and the consumer pays — a lot. At that point, the consumer’s APR immediately resets from 0 to 29 percent, with additional penalties and fees compounded from the day of purchase. That means that a customer who’s been good for 70 months on a 72-month loan and who misses the payment date by a day on month 71 will see fees and interest rates levied back to month one on the entire purchase amount, Levchin explained.
It’s a POS financing system that, Levchin says, creates some rather perverse incentives for the lender, who is the retailer in these cases.
“Consumers think that the retailer will remind them to make a payment, but they’re not incented to remind the consumer to pay before the payment is late — because if they don’t, they go from paying you for money borrowed to you paying them a lot for money.”
And this, Levchin further asserts, is by design. Lenders, he says, often intentionally underwrite people who can’t afford the loan, because those late fees, deferred interest and penalties are what make these promotional offers profitable for the lender to offer. He says about 60 to 70 percent of consumers pay their loans on time — but the remaining 30 to 40 percent are being used intentionally to finance everyone else.
“This is not only morally outrageous, but it’s bad for business,” Levchin said.
Why Retailers Do It
Retail, Webster noted and Levchin agreed, is brutal — and involves a lot of hand-to-hand combat now as traditional players jockey for position in what is evolving to become a new world order.
And that pressure, Levchin said, doesn’t always foster one’s best decision-making skills.
“Desperate players in desperate times [drive] people to think short term. Retailers have to make the quarter and the year — and they’re in real trouble today — Amazon is eating their lunch,” Levchin said.
But what retailers don’t realize is how damaging it is to their brand when consumers, who like the brand, have a bad experience when using such a credit product at that brand — and then tell their network of friends on Twitter, Facebook and Instagram about it.
“These retailers are fundamentally destroying their buyer word-of-mouth spread,” Levchin said. “A lot of these cards carry the retailer’s logo on them. And that is the one the consumer comes to hate the most because it was the ‘free today, twice the price tomorrow’ card.”
Angry customers don’t come back and and keep lots of their friends from coming back too — at a point in time when retail needs all of them the most.
The Different Way
Levchin says there is an easy way out of these “bad faith negotiations” at the POS — just tell consumers what the true cost of the product is before the customer signs on the dotted line.
“We tell merchants that we will never charge any late fees or retroactive fees; these gimmicks aren’t okay with us and shouldn’t be okay with you either,” Levchin said.
That also means, Levchin acknowledged, that Affirm is giving up some potentially lucrative income streams, including deferred interest, because they explicitly state the total cost of the loan to the consumer up front. Additionally, the upfront cost for retailers in working with Affirm is more.
But, Levchin noted, the transparent product is the long-term play — because it both helps keep the retailer’s current customer base happy and helps to expand it. Among the bigger surprises Affirm has observed over the course of making its one million loans is that POS financing isn’t just a good service for people with limited access to credit — it is a good product for anyone who wants to finance a purchase.
“We saw that if we can extend credit to people without access to traditional forms of credit without charging exorbitant rates, we could certainly do it more broadly,” Levchin explained.
So, now, instead of lending just to those who are invisible and without credit, Affirm is lending to anyone who wants POS credit — and, more importantly, Levchin said — from a retailer and a lender who “isn’t going to rip them off.”
“That resonated much better than I ever expected [it would].”
And it resonated with retailers too, Levchin added, since the “really smart ones” are eschewing the “one-and-done” model that only cares about making the potential risk of enraging the customer. Levchin has found that the more that Affirm can come to the table with a collection of techniques tools, learnings, best practices and products that fundamentally help retailers acquire a customer and continue that relationship, the more they find retailers willing to listen.
“We always want to underwrite the ability to pay. If this person can’t afford this, we won’t lend. The idea of spreading risk across the borrowers, we see that as long-term detrimental to the economy,” Levchin said. “But I think we can increase retail acceptance by 10 to 30 percent just by being smarter and using better data.”
Can Affirm make the market for POS lending a more transparent place that is better for retailers and the customers they serve? Perhaps, notes Levchin — but Affirm probably won’t have to. Because it is a tight retail environment: only the smart survive. And, in this particular case, being smart and being good are completely aligned.