Apple's Ability to "Breakout" May Be Limited

CFPB Sets Sights on Credit Card Late Fees, Klarna's Open Banking Play

Hey all, Jason here.

I think I spoke too soon about spring — here in Northern Europe, anyway. After a lovely couple of weeks, I woke up to snow this week — April Fool’s indeed.

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Apple's Ability to "Breakout" May Be Limited

Two weeks in a row talking about Apple? I guess we’re all Apple analysts now.

Fresh on the heels of news Apple acquired UK open banking/credit scoring startup Credit Kudos, Bloomberg dropped a scoop on Apple’s goal of in-sourcing financial services capabilities currently provided via external partners in an initiative dubbed “Breakout.”

Big Tech, Including Apple, Has Uneven Record in Financial Services

While some have been warning that Big Tech has been coming for banking for years, the actual record of major tech companies expanded into financial services is mixed.

Google Pay’s revamp was widely panned, and the company’s effort to offer bank accounts via a network of bank partners, Google Plex, was axed before it ever went live.

Facebook, despite repeated efforts to push into financial services, has yet to make serious inroads. Its stablecoin-and-wallet project experienced repeated setbacks. Ultimately, the stablecoin project was killed, with its IP being sold off to crypto-focused bank Silvergate.

The wallet associated with the project, Novi, did end up launching a pilot in the US and Guatemala — though it ended up using Paxos’ stablecoin, USDP, rather than its own.

Novi is fairly barebones and appears to have gained little meaningful traction. Facebook’s WhatsApp has rolled out embedded payments in Brazil and India, but uptake has reportedly been slow.

Amazon, perhaps, has had the most success in adding financial features and products — primarily through partnerships. The company now offers small business loans and lines of credit, a number of card-related offerings via partners American Express, JP Morgan Chase, and Synchrony, and BNPL via its partnership with Affirm. Amazon also offers a payment platform, Amazon Pay, though it lags considerably behind other payments solutions like Paypal and Stripe.

Apple’s Mixed History in Financial Services

Apple’s success in financial services and with its Wallet app have been similarly mixed. For some users, Wallet is a little-used application that, at best, might be a graveyard for old airline boarding passes.

My boarding pass graveyard in Apple Wallet

Apple Pay is arguably Wallet’s most successful financial feature. Still, according to recent research by PYMNTS, only 6% of US users who set up Apple Pay on their phones actually use the service for in-person purchases.

Some back of envelope math by industry analyst Max Friedrich puts Apple’s revenue from Apple Pay at perhaps $3 billion — certainly nothing to sneeze at, but about 3% of its services revenue and 0.5% of total revenue.

Other consumer fintech features have been even less successful. Apple’s peer-to-peer payments feature, Apple Cash, enables users to send and receive money via text message — but it never made a substantial dent in a market dominated by Venmo, Cash App, and Zelle.

Apple’s peer-to-peer payment functionality; image via Apple.com

Apple Card, its credit card offered in conjunction with bank partner Goldman Sachs, has arguably done better. Research from Cornerstone Advisors in May of 2021 estimated about 6.4 million Apple Card holders — not bad at all for a newly launched program, but presumably not a significant contribution to the ~$365 billion in revenue the company booked in 2021.

Apple has also announced plans to turn iPhones into payment terminals that can accept card payments with no additional hardware. There has also been substantial reporting that Apple intends to offer both split pay and longer-term BNPL via Apple Pay and a hardware subscription service.

Apple’s offerings, like many financial services products, leverage a number of outside partners and vendors, including: Goldman Sachs, the bank partner for Apple Card; CoreCard, the processor for Apple Card; Stripe, the payment processor for accepting card payments on iPhone; Green Dot, for Apple Cash / Apple Cash Card; and plenty of others behind the scenes.

Apple’s Two Goals: Sell More Phones, Increase Services Revenue

Under Tim Cook, Apple has arguably became less of a product innovator while becoming an operations, execution, and financial machine — figuring out how to wring ever-more profit out of its universe of gadgets and services.

Apple has two overarching goals driving all of this: sell more phones and generate more scalable, high-margin, recurring services revenue.

So, getting back to Apple’s plans to in-source financial services capabilities it currently relies on external partners for… according to Bloomberg (emphasis added):

“A multiyear plan would bring a wide range of financial tasks in-house, said the people, who asked not to be identified because the plans aren’t public. That includes payment processing, risk assessment for lending, fraud analysis, credit checks and additional customer-service functions such as the handling of disputes.”

What could Apple’s goals of owning these capabilities be?

Capture More Revenue From Existing Activities

By moving to in-source functions like issuing-processing (eg for Apple Card, Apple Cash, or other, future physical or virtual card products) Apple would retain a greater share of revenue generated by these programs.

If Apple were to begin handling its own payment processing for purchase transactions in its stores and on its platforms, it would essentially allow Apple to ‘pay itself’ for these transactions, rather than third parties (this is something Walmart has long sought to do as a cost-saving measure).

At a high level, makes enough sense, but the specifics of the business case aren’t at all clear, as an external observer. Building its own card processing capabilities would be no small task, though an acquisition is also a possibility.

Enable Faster Development of New Products & Features

One justification for the in-sourcing strategy mentioned in Bloomberg’s reporting was Apple’s reported frustration with the slow pace of development caused by working with outside partners — including, particularly, constraints on geographic expansion.

For example, there were reports that Apple and card partner Goldman were working on a BNPL project as far back as July 2021, but there are no signs of if or when it will launch.

Still, it’s not at all clear that moving infrastructure in-house will speed up development timeframes. In fact, it may be the opposite. While Apple certainly has financial resources and a history of solid engineering execution, building software in the highly regulated banking space tends to be… different (read: complex and slower).

This remains even more true internationally — is Apple really prepared to build its own card processing, fraud, credit risk capabilities, and to do so in every country it hopes to offer financial services in? That seems unlikely, even for Apple.

Given the breadth and quality of fintech infrastructure these days, many companies building in the space opt to use existing services instead of building their own, because doing so tends to be a faster path to market.

Building a Platform Others Can Use… For A Price

This has received relatively less discussion, but I can’t imagine Apple would expend the capital to build core financial services capabilities and not sell those services to third parties — imagine, Apple, of all companies, becoming the real “AWS of fintech.”

Such an approach could be consistent with the platform-and-gatekeeper strategy Apple has taken in other areas of its business — for example, Apple Pay, where the company collects a rumored 0.15% of each transaction (Google offers similar functionality for free); and the App Store, where Apple takes 30% of developers’ transaction revenue.

Imagine Apple selling use of its financial infrastructure — including fraud/credit screening, based on Apple’s proprietary user data, and ID verification, tied to an Apple mobile driver’s license — to third-party banks and fintechs.

Still, in offering financial services infrastructure, Apple would be competing with other providers, something that is not really the case with Apple Pay or the App Store.

And Apple would be — gasp — a vendor, responsible for service commitments it makes to external third parties.

I’m not saying this is impossible, but it is certainly less attractive than the tax-like revenue Apple collects from captive App Store developers who have no alternatives.

There Are Limits to Apple’s In-Sourcing Ambitions

There are limits to how far Apple can go, particularly in the US, with in-sourcing certain capabilities.

Even if Apple builds or acquires its own payment processor, for instance, it would still need numerous partners/vendors to operate its credit card program, including a bank partner (currently Goldman) and a card association (currently Mastercard).

If Apple pushes further into the lending space, whether providing financing for its own products or longer-term installment loans for general consumer purchases, it is almost certain to need a bank partner to issue those loans vs. acquiring the relevant licenses in every state.

Beyond some fairly clear legal limitations on some of the activities Apple itself can undertake, there are also murkier political considerations. The tide in Washington has clearly turned against Big Tech in recent years. Both the left and the right have bones to pick.

Apple hasn’t gotten quite the roasting that Google, Facebook, and Twitter have, but that could change as it wades further into financial services — particularly from an antitrust perspective.

CFPB Sets Sights on Credit Card Late Fees

Having made significant progress in prodding banks to reduce or eliminate overdraft fees, is the CFPB now setting its sights on credit card late fees?

Based on the report it released last week, it appears that may be the case.

The report’s arguments are reminiscent of discussions around bank overdrafts, including the potential to set up a case that card issuers are ‘dependent’ on fee income, as about 10% of the total costs incurred by consumers comes from late fees:

Image: CFPB Credit Card Late Fee Report, 2022

The CFPB’s report also highlights that card late fees are disproportionately borne by lower income and non-white card holders. According to the CFPB’s statement:

“Low-income areas, areas with high shares of Black Americans, and areas with lower economic mobility all bear more of the late fee burden. In 2019, credit card accounts held by cardholders living in the United States’ poorest neighborhoods paid twice as much on average in total late fees than those in the richest areas.

Cardholders in majority-Black areas paid more in late fees for each card they held with major credit card issuers in 2019 than majority white areas. And people in areas with the lowest rates of economic mobility paid nearly $10 more in late fee charges per account compared to people in areas with the highest rates of economic mobility.”

Subprime Issuers Likely to Draw Most Attention

Segmenting the data by credit score tier yields an even starker picture. Unsurprisingly, subprime and deep subprime users are much more likely to incur late fees:

Image: CFPB Credit Card Late Fee Report, 2022

And subprime and deep subprime consumers account for a disproportionately high share of fee income compared to their share of accounts:

Image: CFPB Credit Card Late Fee Report, 2022

With private label cards and subprime specialist issuers driving fee income (emphasis added):

“Subprime cards and private label cards are particularly susceptible to late fee charges. For example, the average deep subprime account gets charged $138 in late fees per year, and deep subprime accounts are more likely than super-prime accounts to carry smaller balances.

As a result, deep subprime cardholders pay late fees that represent a higher percentage of their balances (11% compared to 0.8% for super-prime accounts). These late fees are in addition to accrued interest charges.

For private label cards, late fees comprised the overwhelming majority—91%—of all consumer fees and 25% of total interest and fees (compared to 45% and 7%, respectively, for general purpose credit cards).”

The report sets the stage for a re-run of aspects of the playbook the CFPB used on bank overdraft fees. The agency is likely to characterize the fees as punitive and out of proportion to the actions that cause them (paying late.) Private label and subprime issuers are likely to receive increased scrutiny, due to the higher rate at which their cardholders incur late fees.

Klarna’s Open Banking Play

Klarna is best known for its buy now, pay later products, but that characterization belies the growing capabilities the company offers.

Klarna holds a Swedish banking license, acquired European payment network SOFORT in 2013, and now is launching an open banking platform dubbed Klarna Kosma.

While, at first blush, it might seem like a strange move, it may prove to be quite savvy. Klarna has built an immense consumer business — and now it’s taking the infrastructure it built to power its own business and monetizing it as a B2B product.

Klarna’s open banking infrastructure has roots in Klarna’s own underwriting, which leverages bank account transaction data to assess borrowers’ ability to pay.

According to Klarna’s press release (emphasis added):

“By providing simple access to more banks than any other Open Banking provider, Kosma rapidly reduces the time for new fintech services to reach global scale and provides the essential building blocks for innovation in financial services.

Kosma provides financial institutions, fintechs and merchants with the essential connectivity to build the next generation of fintech apps and services by providing simple and secure access to 15,000 banks in 24 countries around the world through a single API.”

Open banking infrastructure isn’t the only internal capability Klarna could monetize externally. The analytics engine used to assess open banking data, fraud screening, identity verification — in theory, Klarna’s entire lending and payments stack could be made available à la carte.

Now, how attractive using those capabilities is may depend on whether or not a potential customers perceive Klarna as a competitor or not.

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Other Good Reads

Why Apple Acquired an ‘Open Banking’ Fintech (Ron Shevlin/Forbes)

SoftBank to slow investments following crash in tech holdings (FT)

Where will the crypto dam break? (Nigel Morris)

Contact Fintech Business Weekly

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