Started as a pay-later solution integrated into merchants’ checkouts, Affirm makes money from merchants’ fees as consumers pick up the pay-later solution. Affirm also makes money through interests earned from the consumer loans, when those are repurchased from the originating bank. In 2020 Affirm made 50% of its revenues from merchants’ fees, about 37% from interests, and the remaining from virtual cards and servicing fees.

Origin story

Max Levchin, founder and CEO of Affirm, and former member of the PayPal team, who he had co-founded (as a software engineer) with venture capitalist Peter Thiel, saw an opportunity in the space of credit, back in 2012.

As he highlighted in the IPO prospectus, credit cards, which appeared a few decades ago, had improved from a physical standpoint (from the swipe to the chip), and yet the credit mechanism underlying it had not improved.

The opposite, it had devolved. Opaque credit fees buried into the cards’ financial statements became an opportunity for Affirm. Founded in 2012 with a mission-driven approach, where Max Levchin claims to have a built-in “moral backbone” into the way the company operates credit.

Morality here is intended as clarify and transparency in terms of fees that the consumer and merchant will pay. Thus, from there the Affirm business model was built. Therefore, technology here becomes simply a tool to make more transparent the fees due.

Mission, vision, and principles

Mission: Deliver honest financial products that improve lives.

Vision: To be as ubiquitous, secure, and convenient as legacy networks, yet far more transparent, honest, and both consumer and merchant-centric.

As a mission-driven company which founding aim is to “morally restructure” (make more transparent) one of the most opaque industries, Affirm leverages technology (Fintech) to make available to consumers and merchants a point-of-sale payment solution for consumers, a merchant commerce solution, and a consumer-focused app.

Affirm’s employees like to call themselves “Affirmers” and its five core values are:

• People come first.
• No fine print (no hidden fees or tricking statements for loans on the platform are a key element of its value proposition).
• It’s on us (accountability between employees and outside the company).
• Simpler is better.
• Push the envelope.

Value proposition, and key customers

Affirm main goal is to build a set of “honest financial products.” When the company started, just like PayPal narrowed down its market and scaled from there, it only had a “pay-over-time solution.” This became the battle horse and entry strategy for Affirm. Over the years, as more partnerships were signed and more consumers brought onboard, it expanded its suite of available applications.

Now Affirm comprises a suite of applications that go from its Pay-over-time solution, to Virtual Cards, Split Pay, Marketplace, and Savings.

The suite of applications that Affirm built over the years. It started from a pay over time application, and it scaled from there. (Image Source: Affirm Prospectus).

Affirm has two main stakeholders and customers: consumers and merchants.

Benefits of Affirm for consumers

Affirm claims a few key values for consumers:

• Simple, transparent, and fair (it’s spelled out how much is owed at checkout, and there are no further hidden or additional fees later on).
• User experience through a digital platform, that works in a few clicks for consumers.
  Flexibility and control (perhaps consumers set their payment schedules biweekly, 3, 6, or 12 months).
  Accurate credit pricing as the company claims to outperform traditional credit models (this is one of the core tech advantages claimed by Affirm).
  Consumer trust through the monitoring of the merchants’ creditworthiness.

One of Affirm’s most important value propositions is its ease of use, a smooth platform for consumers. Above an example of the workflow followed by consumers to finalize the transaction and pick a payment plan according to her/his needs. (Image Source: Affirm Prospectus).

Benefits of Affirm for merchants

• More customers, higher conversion, and increased AOV, the company claims that with the option of Affirm at checkout more consumers get to the checkout and higher conversion is achieved. And this applies to higher average order value before refunds as well.
• Increased repeat purchase rate.
• Better data to inform personalized promotional strategies.   
• Broader target market.   
• Ease of integration.  
• Compliance at API configuration, Affirm will handle the regulatory aspect of the loans facilitated through the platform.

Customer profiling

As of September 2020, on the Affirm platform, more than 6.2 million consumers completed around 17.3 million transactions with more than 6,500 merchants with a Net Promoter Score score of 78 for the second half of 2020.

The Net Promoter Score (NPS) is a measure of a product or service’s ability to attract word of mouth advertising. NPS is a crucial part of any marketing strategy since attracting and then retaining customers means they are more likely to recommend a business to others.

While the company has over 6500 merchants on its platform, at the same time, there is a major contributor to its revenues, Peloton’s partnership. Peloton represented about 28% of Affirm’s total revenues by June 2020. Another important source of revenue for Affirm is the interest income earned from originating bank partners’ loans. When Affirm purchases the loan, it will make money from the interests earned over the consumer’s loan. Yet by 2020, approximately 15% of loan receivables related to customers residing in the state of California. This makes Affirm geographical exposure skewed toward California. The revenues skewed toward a single merchant is a risk, as to the loss of this single partnership, or perhaps a sudden reduced growth from Peloton might widely affect Affirm’s bottom line.

Technological model

Affirm’s stack of applications is all built on a cloud-first platform.

The whole Affirm infrastructure is on top of the cloud, where the company built a set of applications for data management (credit, transaction, SKU-level, merchant consumer, and fraud data). From there, a set of machine learning algorithms, combined with predictive economic models, make up the Affirm’s platform. This platform then provides merchants the API to integrate it at checkout, a set of consumer products, and internal tools.

(Image Source: Affirm Prospectus).

The main elements of Affirm’s technology are:

• Fraud detection capabilities which is a built-in capability of Affirm to assess transaction fraud risk, that leverages data combined with a fraud risk model, together with other 40-80 data points.
• Credit check capabilities, a risk model taking five top-of-mind data points, combined with other 200 data points to assess the credit risk of new consumers.
• Modeling improvements to respond to changes in context, environment.
• Data privacy and security.   

As of September 2020, 47% of Affirm employees were in engineering and technology-related roles. Affirm emphasizes its role as a tech company, developing from scratch part of the platform that offers services to both consumers and merchants.

Distribution, Sales and Marketing models

Affirm go-to-market strategy Affirm has been entering through its pay-over-time solution by expanding its merchants’ partnership. Being in the checkout of known merchants enables Affirm to become a consumer brand while getting to them via other merchants. This is a B2B2C model, whereas the more Affirm grows through merchant’s partnerships, the more it grows as a consumer brand.

And it also speeds up its adoption, as the more consumers trust Affirm as a brand, the more merchants will want to have Affirm as their main checkout option.

Affirm claimed flywheel

As more consumers join through the merchant’s checkouts, the stronger the ecosystem. And as more consumers get exposed to the Affirm brand, they will trust it as the go-to solution. Thus more merchants will want to join. That will make Affirm able to offer more products and grow the volume of transactions on the platform, to offer better data insights to the merchants and further improve the user experience. This is the claimed Affirm flywheel in action (Image Source: Affirm Prospectus).

Partnerships

Merchants’ partnerships are critical for Affirm growth, both in terms of revenues and brand awareness.

The platform has over 6500 merchants, spanning across several industries.

Some of the cherry-picked partnerships that Affirm has signed over the years (Image Source: Affirm Prospectus).

Since merchant partnerships are such an important part of Affirm’s growth, the company has therefore invested in merchant marketing activities, consisting primarily of providing technological support to merchants to develop tools that can help them grow their business while using Affirm’s solutions.

Multi-pronged growth strategy

Affirm growth strategy moves around a few key areas:

• Expand To More Higher Frequency Purchases.
• Expand Consumer Reach (more consumers to the network, repeat use, and new product solutions).
• Expand Merchant Reach.
• Expand to New Markets.

Financial Model And Economics Of The Affirm Ecosystem

The economics of an Affirm’s transaction starts with the consumer purchase. Perhaps assuming a purchase of $1000 on a Merchant connected to the Affirm’s checkout, once the consumer opts in to Affirm plan, she/he will owe $1000 + interests to Affirm. On the other side, the merchant will make $950 out of the $1000 ($50 is the fee Affirm will collect at the end of the transaction). In parallel, Affirm will send the $1000 loan + fee to the originating bank, and it will buy the loan after a few days. From there, the originating bank will send the $50 fee back to Affirm. In this way, Affirm will make money through merchant fees, consumers’ interests on the loan, and on the difference between the purchased loan from the originating bank (this amount might also be negative (Image Source: Affirm Prospectus).

As we’ll see Affirm makes money primarily via fees earned from merchants. However, when the consumer opts into the Affirm plan, if the company buys this loan from the originating bank, it will also make money from the interests earned over time. Let’s assume two scenario to understand the economics of the Affirm’s platform:

• Affirm gets the merchant fee, but it doesn’t buy the originating bank’s consumer loan: In this case, Affirm will make money only from the merchant fee earned. As the consumer loan gets to the originating bank partner, the bank will pay back the fee to Affirm.
• Affirm gets the merchant fee, and it does buy the consumer loan from the originating bank: In this case, instead, Affirm will make money both on merchant fee and on interests maturing from the consumer loan. Indeed, as the loan is passed to the originating bank, Affirm will buy this back after a few days. Therefore, the originating bank will pay to Affirm the merchant fee. And Affirm will take over the consumer loan. This means the consumer will pay the installments directly to Affirm. It’s important to understand this dynamic as this changes the whole financial model. In fact, Affirm will anticipate the cash to the originating bank to buy the consumer loan, and it will earn it back as the consumer completes the loan payments. This results in a cash negative financial model. Where Affirm anticipates the money from the loan, it gets it back over time, with interests. As those are personal loans, they do not have any collateral, neither is guaranteed nor insured by a third-party. Therefore, any failure from the consumer to pay back Affirm will generate a large loss. It’s important that Affirm can fairly predict the consumers who will be able to repay back to loans, and therefore only purchase those with higher potential predictive scores.

Revenue model

Affirm primarily makes money by collecting fees from merchants, and through the interests earned on consumers’ loans, when those are purchased from the originating bank (the bank to which the instalments are initially due by the consumer). Affirm also issues virtual cards to consumers through the app, thus making money as a portion of the interchange fee from the transaction.

Therefore the revenues can be broken down into:

• Merchant network revenue collected as Affirm charges a fee on each transaction processed through the platform. In 2020, 50% of Affirm’s revenues came from the merchant network fees.
• Interest income earned on the loans purchased from the originating bank partner.  In 2020, Affirm generated 37% of its revenue, from interest income. 
• Virtual card network revenue for the creation of virtual debit cards used by customers at checkout which generated 4% of its total revenues in 2020.
• Gain (loss) on sales of loans as Affirm sells a portion of the loans purchased from the originating bank partner to third-party investors through its platform, which generated 6% of its total revenues in 2020.
• Servicing income for providing professional services to manage loan portfolios on behalf of Affirm’s third-party loan owners which made up 3% of its revenues in 2020.

Cost structure

Operating expenses primarily comprise commitment made to the originating bank partner, the provision for credit losses, funding costs, processing and servicing, technology and data analytics, sales, and marketing.

Cash Generation (or Cash Burning)

Since its inception, Affirm accumulated a deficit of $462.4 million as of September 30, 2020, primarily financed through sales of equity, borrowings, and third-party loan sale arrangements.

Key Business Models Highlights

• Affirm’s primary goal is to make loans and pay later solutions as transparent as possible in an industry driven by opaque gains and hidden fees. 
• Affirm is a fintech platform entirely built on cloud infrastructure pay-later solutions to consumers at checkout and a set of other applications for both merchants and consumers. 
• Affirm technology is based on a mixture of proprietary applications and machine learning models which aim is both to predict the ability of consumers to repay their loans (as Affirm has no collateral for the purchased loan), for consumers to have the scoring of merchants’ trust and to offer a set of additional tools to merchants and consumers.
• The company primarily makes money through merchants’ fees as consumers opt in the Affirm’s pay-later solution. Affirm also earns interest when it buys back the consumer’s loan from the originating bank. 
• Affirm leverages on flywheels come from data networks, merchant partnerships, and brand recognition at the consumer level to scale up its operations.

Find the Full 10-Pages Business Model Analysis in 100+ Business Models.

The framework used to analyze the Affirm business model

The VTDF framework is the basis to analyze the Affirm business model.

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