Why Business Models Matter in the World of Payments

Posted by
John Thomas
July 6, 2022

As we enter the summer of 2022, we are witnessing an economic witching of sorts, a confluence of several factors conspiring to send markets into a tailspin.  That plunge is also taking the payments companies down. Some call these “Black Swan” moments.  A more apt moniker for such pivot points are “Gray Rhino” moments – that is, they are predictable, and a series of warnings had been issued.

While many payment firms were posting spectacular customer and revenue growth with attendant lofty valuations, they were also incurring eye-popping loses. Why? These firms were leaving card fees on the table, targeting SMBs that were not credit worthy, subsidizing low interest rates with card fees, ignoring fraud prevention, and overpaying rewards and rebates to growth at any cost. Since many of these customers were not creditworthy to begin with, the payment firms are incurring unsustainable credit losses as well as defaults. The strategy of loss-driven growth works if interest rates are low, companies stay private, and investors continue to invest at higher and higher valuations.

It didn’t take long for all that to change!

Interest rates are going up.  This increase in interest rate will have two impacts:

   1.   SMBs will struggle, potentially resulting in greater credit losses and defaults.

   2.   Investors will have lower risk alternatives and will likely lose their appetite for lossy investments

As margins decrease – with companies basing their entire economics on extending credit to un-creditworthy entities and spending more than the LTV of a customer on acquisition – and the cost of capital rises, many FinTech companies find themselves in an unpalatable position. The meteoric rise and recent downfall of Buy Now Pay Later(BNPL) companies demonstrates that massive credit exposure, delayed profitability, and an untenable bet on the “come line” is not a sound business strategy.

The issue at hand is one of timing and ease.  It is easy and quick to start a FinTech or Payments company that splices together a few systems and attempts to arbitrage the small margins made possible in the interstices of others’ innovations.  It is much harder and takes much longer to build a resilient company that is based on a sustainable business model.  The latter companies are not buffeted about by every icy economic wind that blows.  The former are incredible when the going is good and prove to be a house of cards the moment the going is not so good.

We’ve seen this movie before. We saw it in the dot-com crisis of the late nineties, we saw it in the CDO craze of 2008, and we are seeing it again in the thin companies in the Financial and Payments space.

Business models matter.  Presently, it’s the Payments space’s turn to learn this lesson.