Innovation in Point-of-Sale Finance
Fintech entrepreneurs should take a hard look at the opportunities present in the large point-of-sale financing market
The reports of Financial Technology’s death have been greatly exaggerated. Despite weakness in public valuations and a recent slowdown in originations, direct-to-consumer lending continues to grow. But marketplace lending is still just a small piece of the credit market. Household debt stands at over $12tn, and traditional credit cards are $730bn of that amount. In the race to capture as much of the market as possible, marketplace lenders have stepped on the marketing gas. Direct mail has more than doubled in the past two years. Prosper and Lending Club sent 54 million offers in just one month, last year. Online, the competition is even more heated. With limited channels, competition manifests in lower rates for borrowers and increased cost of acquisition (“CAC”). Lending Club is seeing a CAC of $300 (that includes many repeat borrowers), with some startups seeing a CAC of $1,000 or more. In the pursuit of lower acquisition costs, startups are exploring a number of partnership strategies for distribution. A natural partner for them to consider is the retailer.
By and large, the retail purchase finance industry can be segmented by the credit quality to which each product caters. For prime consumers at large retailers, private label credit cards from Citi and Synchrony dominate the existing purchase industry. About $270bn is currently spent on private label credit cards (out of about $2.2tn in total credit card spend). Subprime consumers have a variety of lease-to-own (LTO) options, from stores with a captive finance arm (Rent-A-Center and Aaron’s and their respective finance brands, Acceptance Now and Progressive) to independent retailers with finance company partnerships. RAC and Aaron’s dominate the $9bn LTO market. Many lease-to-own retailers have developed a negative reputation for their rates and collection practices — regular items can cost 2–3x retail prices over the course of a 20-month lease. High rates and underwriting policies that do not properly take into account a consumer’s ability to repay the lease, lead to over two thirds of leases ending unsuccessfully, with the item being returned to the retailer, despite the customer’s original intent to own the item.
At the same time, consumers are increasingly turning away from credit cards, with credit card ownership declining since the financial crisis for a variety of reasons — fear of debt, lack of access to credit on good terms, and the simplicity of debit cards. Thirty percent of American consumers and over 60% of Millennials do not have a credit card, despite needing access to credit; roughly half of Americans cannot accommodate a $400 unexpected expense from savings.
Acceptance rates are a critical metric for retail partners — a startup that can responsibly offer credit to the broadest group of customers will be the first offered by retailers to consumers in the checkout process. Incumbents like Synchrony typically offer a flat interest rate for all customers, limiting their credit offers to the highest-quality customers. Startups that take advantage of additional sources of credit data and offer tiered interest rates can more flexibly underwrite a larger range of borrowers. Historically, installment lenders have had the advantage of an extended manual underwriting process to verify income, assets, and other credit indicators — an untenable proposition at checkout. Today, however, tools like Plaid allow an originator to quickly verify income and expenses at the point-of-sale, reaching underwriting parity with other lenders and offering credit to a wider spectrum of customers.
Savvy startups are expanding beyond the well-trodden furniture and appliance markets and are entering a number of new channels. Benefiting from the rapid growth of e-commerce, startups such as Affirm and Bread provide credit at point-of-sale to a fresh set of online-only outlets, which do not have pre-existing lender relationships. Beyond retail, companies like Mosaic enable installers to offer customers low-cost financing for residential solar panels while others, like Finrise, Parasail and PrimaHealth Credit are attacking the massive healthcare market. Other categories like medical devices, travel, and auto repair are also ripe for partnerships.
Integration can present another hurdle for retailer adoption. With many retailers using outdated point-of-sale systems, some startups bypass legacy technology and leverage consumers’ own smartphones to offer a simple application process. Blispay, for example, provides participating retailers with signage that directs consumers to fill out a very brief application on their phones. A customer then checks out with a virtual credit card number that is displayed on the mobile phone immediately upon approval.
As the market sours on consumer unsecured credit (see the latest woes of Lending Club, Prosper, and Avant), technology advances also enable new ways of using collateral to reduce risk of default. PayJoy (a Core portfolio company) has developed software loaded on Android phones that deactivates all functions but emergency calls, notifications, and calling PayJoy in the event of non-payment — enabling them to offer lease to own plans to customers that previously didn’t qualify for monthly payment plans. This allows PayJoy to offer interest rates that are 80% lower than those of its competitors. Other possibilities include using technology to recover collateral faster or using digital assets as the collateral itself. At the extreme, this can manifest as predatory lending, but with proper disclosures and oversight, digital collateral can be a powerful way to keep defaults low and pass those savings on to consumers.
Being a Good Partner
Startups selling into retailers need to help their partners increase conversion and average spend. To this end, entrepreneurs will need to compete on:
Acceptance rate: merchants don’t want to waste time and risk losing a customer if a credit application is designed. Platforms that can underwrite a wide swath of consumers offer a better experience to consumers and retailers.
Merchant discount: for most promotional (0%) finance, the merchants pay a discount to subsidize the promotional rate. This amount varies by the terms of the loan, the credit quality of the borrower, and the purchase finance company.
User and salesperson experience: existing non-digital solutions are paperwork heavy and sometimes lead to a rejection after a customer invests an hour or more into the process. Solutions that can pre-qualify a customer in seconds or minutes will see wider use by store salespeople.
Rates and terms: better underwriting enables lower rates for consumers, which in turn reduces monthly payments and increases affordability. Conversion rates and average spend are amplified when consumer pain points are alleviated.
Successful point-of-sale finance programs are a win-win-win for consumers, retailers, and finance companies. Consumers are able to finance an important purchase, often at a promotional rate, while retailers see higher conversion and higher average spend. Finance companies with strong B2B sales efforts get the benefit of lower marketing costs.
Financial technology is still a nascent industry — as the direct-to-consumer lending space becomes increasingly saturated, new credit niches will emerge and grow. Startups will seek to acquire customers at the very moment that credit is required while technology innovations such as just-in-time underwriting and digital collateral will enable the creation of superior products. We at Core Innovation Capital remain bullish on long-term innovation possibilities in fintech and lending.
If you’re building something around point-of-sale financing — or in fintech more broadly, we’d love to talk to you.
Core Innovation Capital is a FinTech venture capital firm investing in companies committed to empowering small businesses and everyday Americans. Our portfolio companies deliver more efficient, well-designed solutions that save people time and money, create upward mobility, and scale broadly — driving both profit margins and consumer value.