Why Optionality Might Not Work in Fintech

I’m a big fan of optionality.

Whenever I’m making a big life decision (where to live, which job to take, etc.), I try to choose the path that will create the most options for me in the future.

(Editor’s Note – the decision to have kids is, by far, the best decision that I’ve made in my life, and it has reduced my optionality by an insane degree, so this isn’t a hard and fast rule.)

However, when it comes to fintech analysis, I think I’ve let my love of optionality steer me wrong.

So, today I am going to take a hard look in the mirror at some of the takes that I’ve gotten wrong and try to figure out why optionality in fintech can often cause more harm than good. 

Apple

After it was reported that Apple was going to be adding Affirm’s BNPL offerings into Apple Pay, Sheel Mohnot, Co-founder and General Partner at Better Tomorrow Ventures, tweeted this:

Which prompted me to tweet this:

Which turned out not to be true, as TechCrunch reported a few days later: 

Two years after it was announced at WWDC, Apple’s U.S.-only Pay Later feature is no more. TechCrunch has confirmed the news, which was first noted by 9 to 5 Mac.

Here’s the full statement offered to TechCrunch:

Starting later this year, users across the globe will be able to access installment loans offered through credit and debit cards, as well as lenders, when checking out with Apple Pay. With the introduction of this new global installment loan offering, we will no longer offer Apple Pay Later in the U.S.

Our focus continues to be on providing our users with access to easy, secure and private payment options with Apple Pay, and this solution will enable us to bring flexible payments to more users, in more places across the globe, in collaboration with Apple Pay enabled banks and lenders.

Whoops!

Credit to Sheel, either for his inside knowledge or his guessing ability, but I also think it’s worth reflecting on why my guess – that Apple would partner on BNPL and continue to offer its own BNPL product – was wrong.

First, it’s important to say that this is a major pivot for Apple.

The company has been working on a big project – codenamed Breakout – for the past couple of years. The purpose of Project Breakout was to bring more of the company’s financial services business (much of which had been outsourced to partners like Goldman Sachs) in-house.

The objective of the project, from my perspective, seemed to be a combination of profit (improve the unit economics by cutting out partners) and control (Apple famously got into quite a few tussles with Goldman Sachs on the design and function of the Apple Card).

Apple Pay Later was the first financial services product that came out of Project Breakout. Apple got its own state lending and collections licenses so that it could originate and service the loans itself, and it funded the loans off of its own (ample) balance sheet.

Project Breakout wasn’t without its hiccups, as Bloomberg reported last year:

Expanding into financial services is one of Apple Inc.’s biggest growth opportunities. But it’s also one of the most challenging. The company’s new initiatives have suffered engineering and technical setbacks that have led to slow progress and missed deadlines.

Over the past eight months, the tech giant has announced at least two new features: a “buy now, pay later”-style service and a savings account program that will be tied to the Wallet app. The former, called Apple Pay Later, was introduced in June and was set to launch last September.   

And beyond the technical challenges, I always thought it was a bit of an insane risk for Apple to be the lender of record for its BNPL offering. Whatever margin it picked up by cutting out its bank partner couldn’t possibly be worth the increased reputational and legal risk that it was courting.

But still, the company persisted. Apple Pay Later launched in March of last year.

The second thing that’s important to point out about this week’s news is that Apple isn’t retreating from BNPL.

If Apple was just trying to retreat from BNPL (and financial services more broadly), it would have simply plugged in an exclusive BNPL partner like Affirm and called it a day.

But that’s not what happened. 

Apple is adding Affirm into Apple Pay, but it’s also working directly with banks and issuer processors to enable credit and debit card issuers to offer installment loans linked to their cards within Apple Pay. 

As Tom Noyes pointed out on his blog, Apple doing this directly rather than working through the payment networks (which each have their own BNPL scheme) is a big deal:

Apple is NOT using either networks’ installment products; instead, they created a new Apple scheme. This is a very big olive branch to banks from Apple. Rather than creating their own BNPL, Apple has enabled every bank to do so from their existing card relationship.    

So, what are we to make of this?

Well, this isn’t a money-saving thing. This isn’t Project Titan, Apple’s now-defunct initiative to build an electric vehicle, which it spent billions of dollars on.

This is a strategic pivot. 

As Tom Noyes observed, this is Apple going out of its way to offer an olive branch to banks (who have, in the past, been a bit frustrated by Apple Pay).

I think what this move tells us is that Apple knows that it can’t have its cake and eat it too. It can’t be the next great platform that financial services activity is conducted on (which is what I think its Apple Wallet/Apple Pay strategy is focused on) and, at the same time, be a provider of best-in-class financial services products (Apple Card, Apple Pay Later, Apple Savings, etc.)

Having that optionality was probably appealing, in an abstract, strategic sense, but in a more practical, our-bank-partners-hate-us-because-we-keep-trying-to-compete-with-them sense, it was likely unworkable.

Apple has now picked a lane (and FWIW, I think they picked the correct one).

Block

One of the early predecessors to Cash App was a mobile payments app called Square Wallet. It allowed consumers to make payments simply by telling the cashier their name, which was (and you’ll have to trust me on this) a truly magical experience.

When Square killed the product in 2014, they explained the decision by saying that they didn’t want to constrain the places that a consumer could pay to only merchants that used Square’s point-of-sale systems: 

I think what we learned there and why we shut it down is if you tried to contain what a consumer wants to do, you effectively are removing utility from them.

So, instead, Square (now Block) set about building two different product ecosystems – a set of payments, banking, and commerce solutions for merchants (Square) and a set of payments, banking, and investment solutions for consumers (Cash App).

Block has been enormously successful in building these two product ecosystems into market leaders. However, it has always maintained that the company’s endgame (and the reason why investors should buy and hold $SQ rather than sell it) is to merge the two ecosystems into a single, uber-profitable closed-loop network.

This was a plan that most analysts (including myself) really believed in. Hell, it was a large part of the justification for Block paying what turned out to be a ridiculously high price for Afterpay in 2021:

Afterpay, the pioneering global ‘buy now, pay later’ (BNPL) platform, will accelerate Square’s strategic priorities for its Seller and Cash App ecosystems. Square plans to integrate Afterpay into its existing Seller and Cash App business units, enable even the smallest of merchants to offer BNPL at checkout, give Afterpay consumers the ability to manage their installment payments directly in Cash App, and give Cash App customers the ability to discover merchants and BNPL offers directly within the app.  

The only problem is that this optionality, which Block has been cultivating for the last ten years, has proven much harder to capitalize on than the company and its shareholders hoped.

As The Information reported last year, the Square and Cash App teams at Block have had a horrifically difficult time working together, even on simple and obviously beneficial projects. 

Here’s my favorite anecdote from that story:  

In 2019, when Square was adding Cash App as a payment option to its point-of-sale tablets, Cash App’s product team wouldn’t agree to share some of the data Square’s product team wanted, such as details about the customers who used Cash App to pay at Square terminals. The Square team thought that data would help them more easily detect fraud on Square and allow Square merchants to create more effective marketing campaigns, according to two former managers familiar with the talks.

Cash App staffers wanted to protect the privacy of the app’s users, relying on technology that can limit the risk of hackers stealing credit card information. Instead of sharing the user data, they said Cash App would assume the risk of fraudulent transactions, one of the former managers said. In addition to squabbling over data, the teams took months to decide on a revenue-sharing agreement for the fees the Cash App transactions would generate from Square merchants.

Eventually the quarreling teams agreed on an even split.

From the point of view of Block, the parent company, the allocation of revenue between the divisions has little significance. The consolidated profit statement that Block reports publicly excludes fees paid by Cash App to Square, as well as the other way around. But those fees do affect divisional revenues, which the company does report publicly. And the profits of each division determine the future budgets they receive, which gives them an incentive to fight with each other, even at the expense of the company’s overall well-being.

Fighting over an internal revenue split! What the actual hell?

From what I can tell, Block CEO Jack Dorsey has been working extremely hard to break down the silos inside of the company and accelerate progress towards the closed-loop endgame:

A top priority this year will be tightening the integration across Square sellers, Cash App and Afterpay, the company’s buy now/pay later arm. Block immediately plans to eliminate “four or five” different versions of the Square app that previously targeted different user groups, creating a single app called Square, with tabs for users to access services targeting sole proprietors or restaurants, for example. 

Block also plans to promote Afterpay within Cash App by displaying BNPL offers there, and also by inviting Afterpay app users to fund BNPL purchases with the Cash App Card

I’m glad to see this renewed focus on ecosystem integration at Block (and I have a lot of faith in Dorsey as an executive), but solving this problem is going to be tough. 

By giving the Cash App and Square teams significant autonomy, Block allowed those two products to grow into monsters while maintaining maximum optionality for the future. Realizing the value of that optionality will require stripping away a lot of that autonomy, and the Cash App and Square teams aren’t going to enjoy that experience.

And that brings me to a question that I’m suddenly not so sure I know the answer to … 

Is Capital One’s Acquisition of Discover a Good Idea?

I thought so! I’ve been very bullish on it since it was announced back in February.

But now I’m a little bit less sure.

A big part of the value of the acquisition is the flexibility that it gives Capital One.

With its own payment network, the bank has the option to significantly increase the profitability of its debit cards (three-party networks are exempt from the Durbin Amendment), significantly increase the profitability of its credit cards (if it’s willing to migrate them off Visa and Mastercard), make a big play into BaaS and embedded finance (being Durbin exempt is a powerful lever), or even to compete directly with Visa and Mastercard (if it is willing to allow other issuers onto its network).   

The option value created by this acquisition will be tremendous. 

However, as I’ve made clear in this essay, I’m becoming a lot more suspicious of the value of optionality. 

It looks great on a whiteboard, but in the real world, where you need employees to understand and execute against a clear and unambiguous strategy, it’s very hard to benefit from.

Quantum uncertainty is a neat principle, but it sucks being Schrödinger’s cat.