08 September 2014

Payday Loans, E-Commerce... and Internet Gambling?

TL;DR: In the future will an e-commerce user be able to take an immediate payday loan to buy something?  If so, could they do the same to deposit on with an Internet gambling service?

Some weeks ago there was a segment on John Oliver's Last Week Tonight (US-based comedy/news TV show) on Payday Loans.  I didn't know anything about them so other than the information from the show itself so I did a little reading (Wikipedia - Payday Loan).  In essence the loans are:
  • Short-term (e.g., 30 days), but easy to roll into another short term loan
  • High risk - loan is unsecured
  • Extremely high interest (no joke, from 350% to over 3000% APR equivalent)
  • Not necessarily linked to a payday event
  • Somewhat like a pawnbroker, although pawnbroker loans are secured against goods left at the shop
  • Somewhat like a credit card but with a much lower bar to loan money and much higher interest rates
  • Sometimes not subject to usury laws (unreasonable interest rates).  These laws vary by State in the US and in some cases there seems to be ways to bypass them (e.g., partnering with a Native American tribe).  I've no idea what the legality of them are in countries other than the US
  • Reliant on the consumer having previous payroll and employment records available for review by the lender
  • Moving online
Those last two points are the most interesting.  Available data must be increasing rapidly due to rapidly increasing tracking of digital consumers (Big Data anyone?) and we all know what happens when online is a viable replacement for retail.

Instead of judging the fairness or morality of short-term lending practices, I'm instead going to apply a little Internet business logic to see how payday loans might intersect with e-commerce and Internet gambling.  And while I use use specific company names to provide a few illustrative examples, I have no insights or inside information on what these companies are actually up to.

Internet e-commerce payments are dominated by a few big players like Paypal or Stripe.  They charge 2.9% of price plus a small fee per transaction.  The fees are typically paid by the company and built into product pricing.  These companies provide an interface to various customer financial instruments, including credit cards.

In markets where it is legal to gamble online, I can use a credit card to deposit gambling funds through services like Datacash or Neteller.  Services like these have effectively been available since Internet gambling started.  There are many different service charging structures depending on what type of financial instrument the customer uses.  For credit cards they're similar to Paypal and Stripe fees although some services can charge 10% or more.

Now take a look at a company like Zest Finance.  They use a Big Data approach to mash lots of customer data together from a variety of sources to create a much more realistic and near-real-time view to enable more accurate underwriting.  Using an increasingly large pool of rich and near-real-time customer data amplifies the value of their service.  And while readily available and commoditized knowledge of applicant profiles based on digital usage and other people-data services may be strongest in the US, no doubt this trend will move on to other countries as well, including countries where Internet gambling is legal.

Now take a look at zestcash and spotloan.  They are online versions of a payday loan retail store.  Both enable you to apply for a short-term loan online and receive the money within a day.  Zest Finance "powers" the underwriting side of zestcash and spotloan.  Both zestcash and spotloan list interest rates of around 380% APR on their respective websites.

It is Internet business-as-usual to disintermediate land-based operations so nothing surprising about moving payday loan retail shops online.  Additionally, the margin gap for retail payday loan businesses and credit cards is enormous and there-in lies a big opportunity for more efficiently determined risks, interest rates and taking a slice of the margin differences.

Now it gets interesting.  The former President of Zest Finance has moved on to a company called 2checkout as their new CEO.  2checkout is a second tier payments company similar to Paypal and Stripe.  2checkout was effectively purchased by Chicago Growth Partners (“CGP”) and Trident Capital.  I don't know if there are common investors or not with Zest (Flybridge, GRP, Lightspeed, Matrix) and 2checkout.  If there is an investor connection in addition to the leadership one, the assertion I'm going to make becomes even more realistic.

And what is that assertion?  That there is a long tail of online users that want to buy something but don't have enough money in their bank account or available from a credit card at that moment to make the purchase.  As a result a sale opportunity is lost that could otherwise be made if an immediate payday loan was available to them.  The only missing link is immediate under-writing calculations and integration of a short-term loan service into the payment user journey.  As Big Data techniques move from batch to near real time analysis, such rapid calculations should become realistic for companies like Zest Finance.  And if Zest ties up with a payments provider like 2checkout, that will address the user journey integration requirement.

If those two things happen, a company like 2checkout can offer a new and differentiating payment instrument to their b2b customers - giving their end users an immediate loan to make a purchase that otherwise wouldn't be made.  2checkout service users will just receive their settlements as usual, completely insulated by whatever mechanics enable the 2checkout payment.

Now taking the same logic and applying it to Internet gambling, a generalized payments service that included short-term loans as a payment instrument could provide such a service to Internet gambling services as well.  And ultimately the justification could be that such services are no different than credit card use.  Credit card companies could be accused of being overly "discriminatory" to whom they issue credit cards and "inefficient" in their underwriting assessment.

As an investor, you may be excited by what you've read here.  Moving a land-based operation (payday loan shops) online, an automated long-tail segmentation of fat margins through Big Data techniques, and enabling a new customer demographic to spend money online sits square in the middle of many digital business models.  Additionally, the funds transfer segment of Internet businesses has been a historically rich gold mine making it even more compelling.

However, with respect to Internet gambling, while betting on credit does go on, there can be negative repercussions when it's taken to excess.  Reputable gambling companies generally avoid policies leading to credit card chargebacks and they would prefer to not to be part of a "gambling debt" story in the news where their brand is highlighted.  Punters betting within their means as a budgeted form of entertainment should be the preferred customer for reputable gambling companies.

Regardless of whatever judgment you have about this, my view is that this capability is or will shortly be technically possible in markets where there is a high degree of readily available and near-real-time data on applicants.  There are only a few ways to prevent or slow this from happening:
  1. Ban the practice at a regulatory level and actively enforce such a ban.  You're seeing this approach in some states in the US with respect to payday loan practices.
  2. Reduce or restrict availability of the financial and Internet profiling data that enables near-real time underwriting and risk calculations.  Given the on-going privacy erosion trend, I'd guess this is an unlikely tactic.
What do you think?  Ridiculous idea or will we see short-term loans in e-commerce payments or even Internet gambling account top-ups in a few years?

(Again, please don't assume that any of the companies listed here are pursuing the strategy I outline above!  They're just used as examples of something that could be done and I am in no way implying that this is their intent.)