A credit card disruptor: Zip Co

Larry Diamond is the CEO of Zip Co, which has had a huge run this year. It's one of the new buy now, pay later companies, along with Afterpay, and now FlexiGroup is in there, too, and a whole lot of other companies are in there.

Anyway, this stock has gone from a dollar to $4 in just a few months. It's quadrupled. It's just been a part of the boom in buy now, pay later companies.

Basically, they call themselves a credit card disruptor, so they're quite different. All these models are different, so it's good to know what it is and it's good to listen to Larry Diamond explain it. 

Here's Larry Diamond, the CEO of Zip Co.

Well Larry, obviously the buy now, pay later space has got quite crowded, and there seems to be a lot going on.  Could you just take us through your business model?  Because I think there's a lot of confusion about who's doing what?  And everyone seems to have a different model.  What's yours?

Yeah, absolutely.  I mean, Zip's very much a credit card disruptor.  We looked at the market five or six years ago and saw consumers falling out of favour with the credit card, and namely because pretty hard and clunky signup processes, a strong focus on interest-bearing behaviour, and banks really designing these products so that customers end up with pretty high revolving interest balances.

We saw an opportunity to really create a digital fairer and better alternative to the credit card, which essentially did a couple of things.  One is we made it interest-free, so we removed the concept of interest, under our Zip Pay offering.  The other thing that we did is we made the minimum monthly payment multiples of what a credit card is.  Rather than you're looking at your statement and you're telling it's going to take 15 years and eight months to pay off the balance, we've got fixed monthly payments that's significantly higher, which basically encourages customers to pay back the balances in months, not years.

Then also just building a very strong relationship with the customer, so a strong focus on brand.  In short, it's really a digital credit line, where we approve customers for an account limit.  All those transactions are basically interest-free, and then each month or each week, you can basically pay single repayment, to effectively clear the balance, or pay it off over time.  The second part of the model is we don't just issue the credit, but we also process the payment.  Similar to a closed loop American Express model.

So, how do you get paid?

Yeah, so we have two main fee drivers, both a mix of merchant pay and also customer pay.  We charge merchants a merchant services fee that's a little bit higher than their credit cards, our average rate is probably 3-4 per cent.  What that does is it really brings that incremental dollar, so what we see in the market is we're able to refer new customers to our merchant partners, where arguably they'd pay significantly higher customer acquisition costs for that.

We also drive higher baskets and repeat behaviours, so they have to pay a slightly higher merchant services fee, as we sit in between payment processing and marketing.  The other half of the fee driver is really a $6 monthly account fee.  We have a $6 monthly account fee.  If you carry balances, we basically levy that fee under the Zip Pay product, and if you pay back during the billing cycle, it's completely free.  Effectively, half merchant, and half customer pay.

You say that it's interest-free, and it's a $6 a month account fee, right?  That's effectively interest is it, or not?

It's definitely a customer fee, but it's certainly not interest.  It's $6 account fee for effectively holding the accounts, and we remove the concept of interest under the Zip Pay product.

Your revenue driver on that basis is the number of accounts, rather than the amount of money that you lent?

Exactly, correct.  You can transact as often as you like, but it's simply a $6 monthly account fee.  That's up to $1000 Zip Pay product.

When I look at your quarterly, 1,166,000 customers, is that the number of accounts you've got that each of those customers is paying $6 a month?  Is that the metric?

Yeah, so the way to think about the driver is just under 1.2 million customer accounts.  Both the Zip customers that have access to an active Zip account, to make transactions, but a large chunk of those customers might be paying back within the 60 day billing cycle, in which case we wouldn't derive the monthly account fee, but of course we would derive the merchant fee income.  Then a portion of those customers are paying a $6 monthly account, so it’s a portion.

Let's focus on the merchant fee.  What is the merchant fee?

Our merchant fees really go from about 2 per cent up to about 10 per cent, so for the average, it's 3-4 per cent.  Generally, the longer the interest-free period, the higher the merchant rate.  But essentially we have a range of merchants on the platform.  We have small and medium-sized enterprises, we have mid-market, and we have enterprise.  If you look at it, generally the small and medium-sized businesses pay a slightly higher merchant services fee, just based on lower volume, and the bigger end of town will obviously have a bit sharper rates.

Right.  I see.  It isn't so much to do with the interest-free period as the size of the business?

Obviously, volume speaks all languages.  We do a lot of work with businesses like Bunnings, Fantastic Furniture, Appliances Online, and that's where we have our Zip Money product which is $1000 up to $30,000.  There it is based on the interest free period, so if you have a 24-month interest free campaign versus a 50-month interest free campaign, to provide those economics to the customer, merchants are helping subsidise that cost and they will pay a higher merchant fee in that case.

Are you finding that merchants are signing up with multiple providers of these sort of services?

Yeah, I think merchants and businesses, retailers, have really become quite aware of alternate payment methods.  Interest-free has obviously been around for a very long time, since Harvey Norman's been offering interest-free.  But certainly, the new world of payments and alternative payments are certainly on the radar of merchants.  The way that they think about payment methods is they think about, "Well, if customers are demanding these payment methods, we don't want to lose that sale."

As a result of that, we've seen a lot of new payment methods pop up in Australia.  We've obviously got Zip, Afterpay, but even the likes of Alipay for example, and George has been doing a fantastic job signing up banks and also retailers to accept Alipay.  I think retailers, businesses, will offer what makes sense.  They tend to have a checkout that has a range of complementary products, so you wouldn't have four of the same, but certainly the right mix of payments, more than one, helps appeal to a wider customer base and helps convert the customer.

How does it work actually on one of their websites?  If I went to say, I don't know, Drummond Golf, I know that's one of your new customers, and if they were also using Afterpay and one of the others, and I was buying a set of golf clubs, and I wanted to use...  Is there a choice, you can either use Zip and you get this service?

Yeah, some of the retailers as you say, will have multiple.  The likes of Target, Officeworks certainly offer credit cards, PayPal, Zip, and Afterpay.  We all exist at the checkout and what merchants are doing is really offering customers choice.  The products are quite different, so Zip, we do allow longer payback periods which tends to work quite well for larger purchases, particularly phones, computers.

But also, we've got 1.2 million customers that have access to their digital wallet, so when they see the Zip logo on the product page, or at checkout, that experience is really seamless.  You sign in with the username and password, and confirm and pay.  It's both a mixture of new account creation to help customers spread the payment over time, but also, it's also a convenience factor, helps drive conversion, particularly for the customer who's on the bus, on the train, has their mobile device, they don't want to key in their credit card, a username and password is obviously very attractive to them.

Right.  It sounds like you're fairly analogous to the Harvey Norman interest-free terms that you mentioned before.  Is that true?

I think we actually, we play in both areas.  I mean, the unique thing about the Zip wallet is we can cater for $150-500 purchases, but we can also cater for $2000, $3000, $5000 purchases.  We're quite unique in market in that we can offer an interest-free, regardless of the size of the transaction, whereas some of the other players tend to either focus on the small or the big.

Because our credit line is based on flexible monthly repayments, it does allow you to cater for both without getting stuck.

You're cash positive now, is that right?

Yeah, that's right.  We've had about five consecutive quarters of positive cash flow, and just in the last half, it's probably about a $10 million turnaround in the cash EBITDA level.

You just raised $56.7 million in March.  What are you going to do with that?  Why did you do that if you're cash positive, and what are you going to do with it?

A good question.  For us, we see a wonderful opportunity in the market.  I think we're very privileged that to be successful in market, you need to have a good product-market fit, but you also need to have timing.  Timing really is out of your control, and I think what we're seeing here is a wonderful time in market where the opportunity set has actually gotten a lot bigger than probably what we thought about when we started the business five or six years ago.

We're seeing open banking coming through, we're seeing terminals like Westpac and so forth becoming much more technology-enabled, which means it's much easier for us to plug into those ecosystems, and we're seeing general fallout of credit cards towards debit cards and digital wallets.  For us, we really just want to focus more on growth.  We've been obviously very disciplined in our growth to date, and we see a really great opportunity in market.

We want to be investing in customer acquisition, which includes consumers and also merchant partners, so more customers, transacting in more places, and more places means obviously acquiring some of the big end of town, but also starting to cut channel partnership deals.  We've just signed a couple with the likes of Adyen, Tyro, Westpac's integrating us into their terminals, and we hope to be able to do the same with some of the other banks, and more often, so getting into a wider range of categories, not just retail and electronics and travel and health services, but also everyday bills and so forth.  Anywhere a credit card is accepted. 

Then finally, the other areas are just really investing much more in product and engineering.  We are a technology business focused on payments and financial services and having very strong product engineering and data science will just help us roll out products quicker, faster, to our customers and iterate much more quickly as we compete in market.

Obviously, we're going to also invest a bit more in our Pocketbook business.  Pocketbook has about 700,000 users, it's one of the largest PFM, personal financial management apps in Australia.  It's a free app, and it's got really strong customer evangelism.  This is really the, if Zip is about credit and payments, Pocketbook is very much about savings and goals, and obviously we want to do a lot more with that product as well.

And then enter new markets.  We've just rolled out in New Zealand, but we are looking offshore.  Again, these trends that we're seeing here are quite global in nature, and we'd like to be a part of that conversation.

Just on the subject of new markets, obviously Afterpay has started in the US.  Are you worried about being left behind there, or are you happy for them to hack through the forest with their machete, as it were, and then you follow-up later?

Look, I think Afterpay has done a fantastic job over in the US, and has really helped educate the market on alternative payments and interest-free instalments.  I think it's been a great outcome for the entire industry.  And so for us, we still think the American market is very early on, very under-penetrated, but many other markets are facing similar structural challenges and customer behaviours.  For us, it's still incredibly early on in the cycle globally, many, many markets, not just America.

Yeah, we're not really worried in being left behind and we think there are many ways to play in different markets, again, for us, it's being very focused on the Australian market and then incrementally starting to look overseas.

How much growth do you think is left in Australia?  How penetrated is the market now with these alternative payment methods?

I still think it's pretty early on.  I mean, for us, given that the Zip product is quite different to the other pay laters, it is more a credit line.  We see the addressable market is obviously the number of credit cards in Australia.  There's no reason why we can't convince those customers to switch over, and then you have a debit card population, which is looking at buy now, pay later products as a better way to budget.  They aren't interested in credit cards, so arguably the addressable market's even bigger than that because it allows debit card customers to buy now, buy more, buy better, and do it in a fair way.

I suppose the thing that makes this possible is that when you're buying stuff online, you don't actually need a physical credit card.  You have to just key in the number.

Yeah, exactly.  You look at the NPP platform which is coming out, and that's using a mobile phone as an alias for a BSB and account number.  I think what we're seeing is it's all becoming a lot easier.  Sixteen digit card numbers are no longer necessary.  You can also tokenize credit cards, so the whole checkout is I think becoming simplified, but our view is the current stage in three or four years’ time, we see payments as actually going invisible.  Much like the Uber experience where your funding source is tokenized in these platforms, and the actual buying experience happens almost with the payment in the background.

Explain what you mean by that.  I'm just having a bit of trouble getting my head around that.

Yeah, so if you can imagine now you go to the checkout online, there's four or five different methods, you select the method, you then sign in, username and password, and then obviously confirm the purchase.  That's where we're seeing a mixture of payments at the checkout, but if you think about the Uber experience, the payment actually happens invisibly.  I order the Uber, the Uber arrives, and then I just walk out of the Uber, and the payment happens in the background.

I think what we're seeing is contextual customer experiences, whether you're grabbing a loan bicycle, or even shopping on Instagram, when you hit the buy button, the payment happens invisibly in the background.  I think we're going to see a lot more of payments being much more deeply integrated into just the customer experience, which means it's going to be less about customers selecting which option, but they've already done that previously.  That’s a few years away.

And you're limited at the moment to actually signing up merchants, so you can only really sell, use your product through merchants who have become accredited, and you've currently got just a bit more than 14,000 of those.  I mean, is that the way it's going to stay do you think?  Do you have to continue to just keep signing up merchants?

I mean, I think the attraction but also the challenge with the Zip model is it is a bit of a closed loop network.  You can't use your Zip account down the road at the coffee shop today.  For us, we are focusing on increasing the network of acceptance, both through direct acquiring, but also channel partnerships, and it's obviously critical for us that Zip is accepted in everywhere you would use a credit card to really get the efficiency of the network.  We're spending a lot of time working out how we do that, because the closed loop network has a huge amount of benefit in terms of introducing customers, giving them a great experience, and helping retailers drive extra sales.

Just back to that capital raising to end with Larry, I just wondered, does the fact that you did that mean that you expect now to slip back into cash negative territory, cash burn, as you put the foot down on the accelerator?

I think we really want to keep the cash flow breakeven line.  We're generating pretty good cash each month, so we can scale up, make investments, and I think still retain that line.

Great to talk to you, Larry.  Appreciate it, thanks.

Thanks so much, Alan.

That was Larry Diamond, the CEO of Zip Co.