Apple (NASDAQ:AAPL) has a suite of services to monetize the loyal customer base of its high-end hardware devices. One of these services include Apple Pay, a mobile payment service, facilitating in-person, online and in-app (iOS) payments. Apple’s financial services ventures have become important revenue-generators. The payment solutions trend towards Buy Now, Pay Later (BNPL) has pushed the tech behemoth to also enter the arena, with the launch of its ‘Apple Pay Later’. Apple’s move into a fintech business model that is yet to prove its sustainability raises questions over its long-term monetization plans in this space.
From Apple Pay to ‘Apple Pay Later’
It has been almost a decade since the tech giant introduced ‘Apple Pay’ as a way to monetize its installed base of hardware devices and make the Apple ecosystem stickier. Apple generates revenue from this service by charging card issuers an interchange fee of 0.15% on every transaction processed through Apple Pay, and is expected to generate revenue of around $4 billion in 2023.
The rising prevalence of BNPL over the last several years has inevitably forced various segments of the financial services industry, including banks and online payment processors, to roll out their own versions of the service and thereby keep up with changing consumer habits. Apple introduced ‘Apple Pay Later’ in June 2022, but its official launch has been delayed until 2023. The service enables users to pay for a purchased item in four instalments over a period of six weeks. A key aspect to note for shareholders is that Apple will be taking on credit risk to offer this service; a wholly owned subsidiary will be conducting the credit checks and issuing the short-term loans. The tech giant is indeed going a long way to keep consumers engaged and avoid losing Apple Pay users to firms like Affirm (AFRM), Klarna and PayPal (PYPL).
Before we proceed to evaluate the potential of ‘Apple Pay Later’, it is important to understand how typical BNPL firms make money. There are various forms of BNPL services, the most prevalent is the ‘pay in four instalments’ service, usually over a period of around six weeks. These short-term loans do not typically entail interest charges for consumers. Instead, BNPL firms charge retailers ‘merchant fees’, in the form of a few percentage points of the total order value facilitated through BNPL services, in exchange for improving the merchant’s conversion/ checkout rates through offering such convenient payment solutions to its customers and taking on credit risk. According to the Consumer Financial Protection Bureau, BNPL firms charge merchants “between 3% and 6%” of total order value.
The BNPL space is becoming increasingly crowded and competitive, shifting negotiation power in the hands of merchants, enabling them to encourage BNPL firms to lower the rates charged on purchases facilitated by them. As early as January 2022, Klarna CEO Sebastian Siemiatkowski claimed:
I wish I could convince them to pay 6% but it was a long time ago that I heard any deal quoted at those levels.
Apple’s negotiation power with merchants could differ from other BNPL players, depending on how well ‘Apple Pay Later’ penetrates across its installed base and becomes users’ preferred payment method. Nevertheless, the intensifying competitive pressures does subdue revenue potential from this service. The tech behemoth certainly has the robust balance sheet to enable the company to take on credit risk and engage in price competition. Last quarter, the company had a ‘Cash and Cash Equivalents’ position of $23.6 billion. The question is whether the credit risk is worth taking simply for the purpose of keeping users engaged with Apple Pay and generating (potentially diminishing) payment fees. Moreover, while the tech giant indeed benefits from an enormous cash balance, it is unclear as to what proportion of its balance sheet will be allocated towards facilitating short-term loans, and how much capital it will need to put aside to cover potential credit losses. If the use of ‘Apple Pay Later’ takes off across its growing installed base, there is a limit as to how much credit it can continue extending to users from its balance sheet. More importantly, it raises the question of whether this is the best use of its cash position, and whether that cash could be used more productively to augment the value proposition of the Apple ecosystem.
The dwindling merchant fees for BNPL firms has them exploring new monetization avenues, and Apple may have to follow suit if it indeed plans to become a serious contender in the industry.
Leveraging user activity data for targeted advertising
The proliferating use of BNPL services grants these firms access to a treasure of purchase history data across their user bases. This lucrative source of first-party data has enabled BNPL firms to monetize users through a new avenue, targeted advertising.
In fact, BNPL firms are taking this endeavor a step further by encouraging brands to list as shopping destinations inside the BNPL apps, and encouraging consumers to start their shopping journey directly inside the apps through various coupons and rewards. Essentially, BNPL apps are striving towards becoming e-commerce destinations. This strategy aims to deepen consumer engagement with the apps, and augments the value proposition of their own advertising solutions by better attracting high-intent shoppers.
Witnessing BNPL firms’ shift towards targeted advertising and e-commerce, Apple investors are inclined to wonder whether the company will follow suit. Amid the launch of Apple Pay in September 2014, Eddy Cue (Apple’s senior vice president of Internet Software and Services) proclaimed that:
Apple doesn’t collect your purchase history, so we don’t know what you bought, where you bought it or how much you paid for it.
Apple has long lauded its focus on upholding the privacy rights of its users, and has highlighted it as a competitive differentiator to augment its brand value and induce consumer loyalty. In fact, on the latest earnings call, CEO Tim Cook re-iterated Apple’s focus on privacy when asked about the company’s digital advertising ambitions:
First and foremost, we focus on privacy and so we would not do anything that stepped away from that. We feel that privacy is a basic fundamental human right, and so that’s sort of the lens that we look at it under.
That being said, Apple already places targeted ads in its News and Stocks apps, and is planning to expand ads to more places on the iPhone; “the company’s advertising system uses data from its other services and [a user’s] Apple account to decide which ads to serve.”
Given Apple’s growing advertising ambitions, there is indeed the possibility that the company could make (if not already made) a U-turn on its decision to not collect and use purchase history data from the ‘Apple Pay’ app to feed into targeted advertising efforts.
Note that Apple does allow iPhone users to disable personalized ads in its Settings, and “78% of iOS 15″ users have indeed chosen to opt out. It is not surprising that the majority of users chose to opt out, given that Apple was displaying ads in places where people’s shopping intentions are low (e.g. News app). Being targeted with ads in places where users intend to engage in other activities (such as read a news article) results in annoyance and compromised user experience, inevitably inducing them to disable such ads.
Apple should focus on showing ads in places where users display more shopping intent. Moreover, evolving ‘Apple Pay’ into a more prominent shopping destination, similar to how BNPL firms are striving to transform their apps, would enable the company to better target users when they display higher shopping intent. People are less likely to feel disturbed by personalized ads when they are on shopping platforms. For example, ads displayed to people on their Amazon homepages feel less intrusive than YouTube ads where people intend to consume content.
The fact that the majority of iPhone users have already opted out personalized ads does present a roadblock in its targeted advertising ambitions. Though Apple could potentially try to ask for permission again amid the next iOS update when it expands advertising into new locations. If Apple wants to become a serious challenger in the BNPL space, it may inevitably be inclined towards e-commerce evolvements, whether that is through Apple Pay, or an entirely new app dedicated towards shopping.
Apple’s ventures into financial services strive to better monetize its installed base, and enforce the moat around the Apple ecosystem. A key attribute of ‘Apple Pay’ is the fact that it upholds the company’s focus on privacy. The evolvement of the payment solutions industry towards BNPL has pushed Apple into following suit, by launching its own ‘Apple Pay Later’ service, exposing shareholders to credit risk and raising questions over whether this is the best utilization of Apple’s rich cash position.
The squeeze in merchant fee rates for BNPL firms has induced a shift towards alternative forms of monetization, primarily targeted advertising. BNPL firms are striving to transform their apps into e-commerce destinations where users start their shopping journeys, in an endeavor to better attract high-intent shoppers, conducive to keeping users more engaged and improving the potency of their advertising solutions. If Apple wants to keep up with evolving financial services trends, it may inevitably need to shift towards creating its own shopping destination to continue bolstering the Apple ecosystem moat. As a result, Apple may face a tug of war between upholding its privacy standards and BNPL-led shift towards targeted advertising and e-commerce.
Any buying or selling decisions in Apple stock should take into consideration the performances of its various hardware segments and suite of services in aggregation. Given that this article focuses particularly on ‘Apple Pay Later’, a neutral ‘hold’ rating will be assigned to the stock.