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Apple (NASDAQ:AAPL) has a suite of services to monetize its loyal customer base of high-end hardware devices. One of these services includes Apple Pay, a mobile payment service that facilitates in-person, online, and in-app (iOS) payments. Apple’s financial services ventures have become significant revenue-generators. The trend of payment solutions towards Buy Now, Pay Later (BNPL) has also prompted the tech behemoth to enter the field with the launch of its ‘Apple Pay Later’. Apple’s move into a fintech business model that has yet to prove its sustainability calls into question its long-term monetization plans in this space.

From Apple Pay to ‘Apple Pay Later’

It’s 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 each transaction processed through Apple Pay, and is expected to generate approximately $4 billion in revenue in 2023.

The growing prevalence of BNPL over the years has essentially forced various sectors of the financial services industry including banks and online payment processors to roll out their own versions of the service and thus keep up with the changing consumer habits. is kept Apple introduced ‘Apple Pay Later’ in June 2022, but its official launch has been postponed to 2023. The service enables users to pay for a purchased item in four installments over a period of six weeks. One important aspect for shareholders to note is that Apple will be taking on credit risk in order to offer this service; A wholly owned subsidiary will conduct credit checks and issue short-term loans. The tech giant is really going a long way in keeping consumers engaged and keeping firms like Affirm (AFRM), Klarna, and PayPal (PYPL) from losing Apple Pay users.

Before we evaluate the potential of ‘Apple Pay Later’, it is important to understand how typical BNPL companies make money. There are various forms of BNPL services, the most common being the ‘payment in four instalments’ service, usually over a period of about six weeks. These short-term loans typically do not charge interest to consumers. Instead, BNPL companies charge retailers in the form of a few percentage points of the total order value facilitated through BNPL services, in return for improving merchant conversion/checkout rates by way of offering such convenient payment solutions to their customers. Charges a ‘Merchant Fee’. at credit risk. According to the Consumer Financial Protection Bureau, BNPL companies charge merchants “between 3% and 6%” of the total order value.

With the BNPL space becoming increasingly congested and competitive, the negotiating power is shifting into the hands of traders, encouraging them to reduce the rates charged by BNPL firms on purchases made by them. As early as January 2022, Klarna CEO Sebastian Siemiatkowski claimed:

I wish I could persuade them to pay 6%, but it was a long time ago that I heard any deals quoted at those levels.

Apple’s negotiating power with merchants may differ from that of other BNPL players, depending on how well ‘Apple Pay Later’ penetrates its established base and becomes the preferred payment method of users . Nevertheless, intense competitive pressures reduce the revenue potential from this service. The tech behemoth certainly has a strong balance sheet which enables the company to take credit risk and engage in price competition. In the previous quarter, the company’s ‘cash and cash equivalents’ position stood at $23.6 billion. The question is whether the credit risk is worth taking for the sole purpose of keeping users hooked to Apple Pay and generating (potentially reducing) payment fees. Furthermore, while the tech giant indeed benefits from a huge cash balance, it is unclear what proportion of its balance sheet will be allocated to facilitate short-term loans, and how much capital will be needed to cover potential credit losses. will be required. If the use of ‘Apple Pay Later’ stops on its growing installed base, there is a limit to how much it can continue to credit 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 can be used more productively to enhance the value proposition of the Apple ecosystem.

Declining merchant fees for BNPL firms have forced them to look for new monetization avenues, and Apple may have to follow suit if it really plans to be a serious contender in the industry.

Leveraging user activity data for targeted advertising

The growing use of BNPL services gives these firms access to a wealth 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 effort a step further and are encouraging brands to list themselves as shopping destinations inside BNPL apps, and consumers through various coupons and rewards directly inside the app. We are encouraging you to start your shopping journey. Essentially, BNPL Apps strives towards becoming an e-commerce destination. The strategy aims to deepen consumer engagement with the app, and enhance the value proposition of its own advertising solutions by better attracting high-intent buyers.

Given BNPL firms’ shift toward targeted advertising and e-commerce, Apple investors wonder whether the company will follow suit. During the launch of Apple Pay in September 2014, Eddie Cue (Apple’s senior vice president of Internet software and services) announced 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 applauded its focus on upholding the privacy rights of its users, and has highlighted this as a competitive differentiator to enhance its brand value and inspire consumer loyalty. In fact, on the latest earnings call, CEO Tim Cook focused on Apple’s privacy when asked about the company’s digital advertising ambitions:

First and foremost, we focus on privacy and so we won’t do anything that takes away from that. We think privacy is a basic fundamental human right, and so we look at it through the prism of how we view it.

That being said, Apple already has targeted ads in its News and Stocks apps, and plans 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 a possibility that the company may do a U-turn on its decision not to collect and use purchase history data from the ‘Apple Pay’ app to feed into targeted advertising efforts can be created (if not already created). ,

Note that Apple allows iPhone users to disable personalized ads in their settings, and “78% of iOS 15” users have actually chosen to opt out. It’s not surprising that most users opted out, given that Apple was displaying ads in places where people had low purchase intent (such as the News app). Being targeted with ads at locations where users intend to engage in other activities (such as reading a news article) results in annoyance and compromises user experience, essentially prompting them to disable such ads. does.

Apple should focus on showing ads in places where users display more purchase intent. Furthermore, developing ‘Apple Pay’ into a more prominent shopping destination, the way the BNPL firm is trying to transform its app, will enable the company to better target users who exhibit high purchase intent. . People are less likely to be bothered by personalized ads when they are on a shopping platform. For example, people find ads displayed on their Amazon homepage to be less intrusive than YouTube ads where people want to consume content.

The fact that most iPhone users have already opted out of personalized ads presents a stumbling block to their targeted advertising ambitions. Although Apple could potentially try to ask for permission again between the next iOS updates when it expands advertising to new locations. If Apple wants to be a serious challenger in the BNPL space, it may inevitably lean towards the development of e-commerce, whether through Apple Pay, or an entirely new app dedicated to shopping.

summary

Apple’s ventures into financial services attempt to better monetize its installed base, and enforce moats around the Apple ecosystem. A key feature of ‘Apple Pay’ is that it maintains the company’s focus on privacy. The development of the payment solutions industry towards BNPL has led Apple to launch its own ‘Apple Pay Later’ service, exposing shareholders to credit risk and raising questions as to whether this is the best use of Apple’s rich cash position, following pushed into the suit.

The reduction in merchant fee rates for BNPL firms has prompted a shift towards alternative forms of monetization, primarily targeted advertising. BNPL Companies is striving to transform its apps into e-commerce destinations where users begin their shopping journey, in an effort to better attract high-intent buyers, keep users more engaged and enhance their advertising solutions. conducive to improving the capacity of If Apple wants to grow the financial services trend, it may need to shift towards creating its own shopping destination, essentially cementing the gap in the Apple ecosystem. As a result, Apple may face a tug-of-war between maintaining its privacy standards and the BNPL-led shift toward targeted advertising and e-commerce.

Any buy or sell decision in Apple stock should take into account the performance of its various hardware segments and suite of services in aggregation. Given that this article will focus exclusively on ‘Apple Pay Later’, a neutral ‘Hold’ rating would be assigned to the stock.