The Apple Inc. (NASDAQ: AAPL) ecosystem never stops growing. During the dying days of March, the global hardware firm introduced its own version of the buy-now-pay-later (BNPL) service which allows Apple Pay users to split purchases into four payments while incurring neither interest nor fees. The soft launch of Apple Pay Later (available only in the U.S. for now) marks the juggernaut’s official entry into the burgeoning BNPL space, although the service’s blueprint has been reported as early as 2021.
In this article, we analyse how BNPL sits within the larger business model of Apple, how the foray may impact the industry, as well as implications for potential and current investors in the most valuable company today by market capitalisation.
From hardware to services and back
To utilise Apple Pay Later, users must access their Apple Wallet app that is linked to a bank card. This naturally induces prospective consumers into the company’s payment services. One of such offerings is the Apple Card which derives revenues from (i) net interest income from credit card lending and (ii) point-of-sale (POS) financing activities.
Another offering is Apple Pay which serves as a payment method. The business model is heavily reliant on the fees it charges to card issuers such as banks like JPMorgan Chase & Co. (NYSE: JPM) and Bank of America Corporation (NYSE: BAC), amounting to 0.15% for credit card holders. While Apple does not breakdown components of its services business which comprises advertising, cloud and others, the service segment is an undoubtably profitable one at nearly double the margins of its product segment.
During the 2023 first quarter earnings call, CFO Luca Maestri mentioned the growth strategy of improving reach through unveiling new services, citing Apple Pay as an example. Apple’s focus on payment services was further detailed in Project Breakout last year, subsequently followed up by a slate of new financial initiatives. BNPL essentially encourages users to use Apple Pay more frequently and acts as a low-cost acquisition tool to onboard more Apple Card holders. Therefore, Apple Pay Later looks like a piece of the puzzle in the larger picture to shore up its payments and more broadly, the services segment.
Although the plan appears to predominantly grow its high margin services business, at its heart, Apple remains a hardware seller as over 82% of its revenue comes from product sales. BNPL plays on consumers’ psychology by encouraging immediate gratification.
Consumerism creates an ownership effect: people tend not to return their purchases despite lacking the means to afford them due to attachment. This phenomenon may be more acute among younger demographics such as Generations Z and Alpha. Couple that with the premium perception that augments the desirability of owning an iPhone among Gen Z consumers, Apple Pay Later is looking to encourage higher sales of its hardware products. Moreover, as the number of Apple Pay users increases, the company’s ecosystem is also strengthened through its growing trove of data. One illustration of data usage is to optimise the in-store retail experience, thereby enabling the business to sell more devices and gadgets. Analysts echo this sentiment, stating that Apple could potentially convert Android users by boosting demand for iPhones.
Will Apple supercharge the BNPL industry?
Narratives from incumbent BNPL players such as Klarna, Affirm (NASDAQ: AFRM), and Afterpay – a subsidiary of American payment conglomerate Block Inc (NYSE: SQ) – seem to inspire confidence. But the knee-jerk dip of Affirm’s share price on the day of Apple’s announcement revealed investors’ wariness about the threat of this new entrant. There are nevertheless reasons to believe that the entry of Apple Pay Later is beneficial to other players.
To begin, the entry of a powerhouse can supercharge the growth of the BNPL industry given Apple’s strong presence in the retail space, especially among higher-income households to fuel larger spending tickets. Next, the BNPL industry has a bad reputation of instigating user overdrafts, sending throngs of consumers into debt. Such phenomena prompted greater regulatory scrutiny in many developed parts of the world.
Apple Pay Later has taken a step in the right direction by restricting payments only via a debit instead of credit card to discourage taking more leverage to pay back existing loans. Providing transparency to users at checkout by showing payment amounts may help Apple navigate future regulatory concerns, and such features have been polled to be generally well-received by users. Bad debt, exacerbated by the current rising interest rate environment, has weighed on the valuations of BNPL firms. Adoption of practices to wean off ill-advised consumer habits can kill two birds with a single stone, supporting companies’ valuations and giving regulators comfort to scale back enforcements that raise compliance costs.
BNPL features offered to consumers differ across the playing field. A couple of parameters stand out from the user’s perspective. One bucket is the costs associated with using this service: interest rates and fees. For instance, Apple Pay Later is interest-free while Affirm’s interest rates vary between 0% to 36% depending on credit. Another bucket pertains to the debt headroom available: maximum loan limit. Apple’s bad loan exposure is limited as it caps its loans at US$1,000, while Affirm disburses loan at more than 10 times the quantum. A third relevant consideration for consumers is the payback timeframe. Apple Pay Later does not charge fees while competitors like Klarna and Afterpay do.
From an investor’s standpoint, it may be useful to consider whether Apple Pay Later can successfully convert existing customers from other BNPL contenders. Apple Pay Later may enjoy low customer acquisition costs due to its sticky, synergistic ecosystem. This could prove to be a tricky obstacle for present BNPL players to overcome. The counterpoint to this is the fledgling nature of the industry, with BNPL accounting for under 5% of U.S. transactions. Disparate average order value (AOV) of customers also signal modest customer overlaps between BNPL providers. All these imply that there is significant space for players to coexist and grow with minimal cannibalisation.
The fifth perspective
There is arguably insufficient evidence for investors to draw on to conclusively determine whether Apple Pay Later justifies any uplift in the behemoth’s market valuation. The company is inviting selected users for its pre-release version, made available only in the U.S. What investors can do is to continue to watch for any significant improvement in Apple’s product and service segments that coincide with new, major initiatives related to Apple Pay Later. Beware of exogenous factors such as seasonality and consumer sentiment that could affect Apple’s overall performance. As of now, it is still early days for Apple Pay Later so maintaining a wait-and-see strategy may be more prudent.