A no-cost credit solution for all...
What I think will be one of my biggest value-adds in venture capital is my knowledge of and connection to markets typically underserved by traditional venture capital. While companies that allow you to invest cash into stocks from your phone are a great idea for some people, many are simply looking for products that make it easier to live. Apps, stores and products that help secure basic necessities and occasional luxuries. One area in particular, financial services for extremely low-to-mid income earners, are often expensive or unavailable altogether.
According to BankRate, 60% of Americans do not have $500 in their savings account to cover an unexpected emergency expense. So when life happens—a broken refrigerator, the need for new school uniforms or supplies, or an oven that goes kaput—many families are forced into exploitative, expensive options for cash. Because of the circumstances, alternative financial services providers, like rent-to-own, lease-own and car title lenders are perceived by their customers as being positive, because when you need something and you need it desperately, these organizations and service providers can be a lifesaver. However, predatory lenders often place customers in a more difficult position than when they started. Zebit is here to transform that relationship through a no-cost credit model. Check out my interview with Zebit CEO, Michael Thiemann below!
*This interview was a bit lengthy so I’ve trimmed some of the fat, cut down on my general fluffiness and pieced it together for your reading pleasure!!*
Megan: Hi Michael! Let's kick off with learning a little more about you and your background before Zebit. What should the world know about Michael Thiemann the CEO?
Michael: So I am a fourth generation San Franciscan and grew up in a family of modest means. There were seven kids in the family and my dad was a civil servant and I can clearly remember him taking out a thousand dollar loan every year so he could pay the parochial school tuition for his kids. With that as a background, I've always been super sensitive to how people are treated and the kind of deals that they get. It always seemed to me, growing up in that background, that we didn't have access to a lot of the mainstream deals that seemed to be prevalent.
But I was very lucky to get a scholarship to Stanford and then later had an employer sponsor me at the Harvard Business School. So I was lucky enough to get the education. I've got an electrical engineering degree, which is really software, but at the time at Stanford, we didn't have a computer science department. If you wanted to do software, you were an electrical engineer, and you focused in computer science.
For most of my career I have worked in a big data analytics world, I was very, very lucky to get in to that early in my career. The things I'm most known for are a series of applications that were real time syntac and financial services. This is back in the early 90's so this is really seminal work. We were dealing with AI and machined learning and adapting systems. I was doing that starting in 1989.
My first commercially successful product was Falcon, which is the most successful product in terms of account penetration and the history of the payment systems business, it sold well over two billion accounts today. And Megan, you almost certainly used Falcon almost every day, because it is what builds individual profiles for each credit card in someone's wallet so that as they use it, there could be a fraud alert based on patterns of behavior around the use of that card.
Also, a product called Profit Max, which is one that although, at the time I was really excited, looking back on it, the whole point of profit max was how do I give people so much credit that they can never pay me back?
So this was for bankcards and that sort of thing. We were looking at it a big data optimization problem and got very excited about it, but looking back on it years later, what it really did was give people so much debt that they couldn't pay it back, but not enough that they would not pay.
And that kind of ... yeah, and that's kind of an onerous, right? The idea was how do I maximize, so as a bank that issues credit cards, how do I optimize my profit? And the way you do that, is by having people run a balance, right? And if you never pay your balance down, you pay interest for the rest of your life.
Megan: So you think that could have been the tipping point for you to start Zebit? Was it, "Oh, hey, wow, this is kind of out of control. People could be paying interest for the rest of their lives. This needs to change."
Michael: Well you know that's a really good question. And I don't think there was any tipping point while I was working because in those days, while I was working, you're just so focused on making a business successful, that I think most people don't take a step back and look at the impact of their work on society in general, or individuals in general. And I was really focused on helping businesses. These were all B2B companies that were helping businesses first to lower fraud, which is an honorable thing, right? You want to reduce fraud, because fraud essentially costs all the honest people tax.
After I retired for the first time in 1999, I did a lot of volunteer work for education and hospitals and other things. When I reflected back on my career, I realized even though I had a really successful career, what had I really done for individuals, to make individuals lives better? I really hadn't done anything. I had made companies more profitable, and I had given them tools that they didn't have, but I didn't really make anyone's life better. And so when the opportunity came up to be the CEO of one of my former employees companies, that was Global Analytics Holdings, he really inspired me to go back to work. This is 2009, a decade after I retired. Saying look, let's change the credit world for the underserved.
There are all these terrible products. And unfortunately what happened there, we built a great company, it still exists and it's grown rapidly, and it's profitable. It's the largest online installment lender in the UK. But with all that great stuff said, we were still charging interest rates at 10 percent to 25 percent a month. And we were the poster child. So you just realize how bad things were, and how bad things are. And so we tried to really find a better way to make this happen.
We called it White Hat Lending, let's find a way to do White Hat Lending. Let's find a way to really help people get a fair deal. And after struggling with this for many years, because we were focused on things like cash loans, or rent to own, use to own. And what we realized was that any of these models, where there was a cash loan in the middle of a purchase transaction wasn't solving the problem, because cash lending by it's very nature, is a very expensive business. The regulatory nature of it, it's very expensive in terms of the capital costs, it's just an expensive business.
And when you inject that business into the fundamental need that the end user has, which is they want or need a product. They need that refrigerator, right? Or I want that X-Box. Whatever it is, you're adding a layer of overall expense that far exceeds the retail transaction. And the light bulb moment was people don't want cash loans, people want the same things they need. So let's just eliminate the cash loan, let's just take that complex financial transaction out of this mix. This is what Mark and I realized that if we were the retailer, not only do we get a much less friction in regulatory structure, because we can operate under what's called the Retail Installment Sales Act in each of the 50 states, rather than the cash lending regulations. So it's a much easier regulatory environment.
Though we can cash through the retail margins, which in fact actually exceeds the IRR margins of the cash lending. So by being a retailer through value proposition is buy now, pay over time, zero percent always. We can actually capture an IRR that's in excess of even payday lending. Now, in order to do that, you have to have a bunch of infrastructure around it, and build a company around it, but that's the fundamental fact that we have dis-intermediated the cash lending.
Megan: So with that in mind, can you tell me a little bit about the economics? How does it work building a credit company that has no interest, no fees and no penalties? In the future you’re looking to set it up as a work benefit, it can be taken out of people's paychecks, but can you explain to me how the economics work in building that out now?
Michael: Sure, sure. So, the basic economics at the highest level are that we offer a value based proposition, which is buy now, pay over time at zero percent and no penalties. Not a value proposition, not lowest price, free returns, free shipping, everyday discounts.
So those things I just mentioned cost the average retailer a lot. I mean, just think about free returns. If you never exercise the free return right, you are subsidizing incredible expense from the people that do. For the average retailer, that's like five to 10 percent of sales. If they're in the clothing business, where they accept a lot of returns. So we don't do any of that, although I can give you a caveat, is that we are going have a premium membership for our most active clients. So that they can get things like free shipping and free returns when that's a big part of the value part to them. But today, that's not at the forefront.
Megan: And who pays for that? The customer or their company?
Michael: What we would do, when we have a premium membership, it'll be just like Amazon Prime, right? You'll pay $120 right up front. That might be paid by your employer, we are talking to some ... about some employers about paying for that or subsidizing that. But it would be an up front fee, but that fee is really necessary if you want to offer those additional services. It just is, because otherwise, people who aren't using them are subsidizing the people that are.
Michael: So now let's talk about what those economics look like, and what the cash flows look like. We give credit to everybody credit. We are the only credit provider that I know of, where everyone is approved. As long as you have an income of at least $16,000 dollars a year, that’s minimum wage, we will give you credit.
As long as you have a minimum of $16,000 a year in income, we will give you a starter credit line, which is $220. No one else will do that. This is a unique value proposition. That's part of why our customer acquisition cost is so low.
Yeah, so let's look at what the cash flow's look like for a deep subprime customer. So here's a minimum wage person making $16,000 a year. They would go to either then their employers benefit site, where there's a frictionless process for them to get registered, or let's say that they see something on Facebook that says, "Everyone approved for credit.", and they click on that. We then verify their income either using a third party data source that we have. We have access to maybe 35 or 40 million workers, where we have access to their worker documentation. If they aren't in one of those databases, then we ask for either a pay stub upload or a one time ready-only access to their bank account history through Yodlee.
You have to put 20 percent down. And we use either debit card or credit card. 90 percent of our business is through a debit card. Or, as you mentioned, we don't have payroll deduction today, we are actually launching that in early 2018. We've already got clients committed to it, so we will have that, and that will give another form of payment, where that form of payment is legal, but 90 percent of our customers use a debit card. And so they put 20 percent down. So they would put $20 down. And we should ship the product immediately. And they take title to it, so we don't take any of the security, interest here, no one's gonna come and take their refrigerator back, whatever it is you bought.
So you put $20 dollars down and then the remaining payments are either taken off your debit card automatically, and 90 percent plus of our members use automated payment. But around 10 percent use what's called self service payment, where they have to go into their phone and make the payment manually. And we take those payments on payday. So they are synchronized to your pay calendar. Because that's the time you're most likely to have the money to pay. And so if you pay twice a month like most people are, then for that $100 purchase, you'd pay about eight or nine dollars a pay period over the next six months. And if you make all of your payments, we collect the whole $100.
Megan: What is the default rate? How many people end up not paying?
BUSINESS LESSON: Default rates are top secret. Thank you for sharing them with me off record, Michael. Back to the interview…
Megan: Does that in any way influence requests from your customers about starting credit reporting?
Michael: We are going to start doing credit reporting. Hopefully this year, before the holidays. Because these are people that want to build credit. And if you're familiar with the way the credit world works, once you have that credit, typically the only way to get some of the report positively is to pay them. And some of these credit report services cost like a hundred bucks a month. So they're charging a poor person a hundred dollars a month to repair their credit. It's ridiculous. So we'll do it for free. Just come buy something, and we'll return your credit for you. So it's really a revolutionary option for a population that has just had no good options.
And of course, even if you don't pay us back, we don't charge any interest or penalties. And we have very soft collections. The very first thing that our CSR's are trained for is to say, look, don't stress out, we know you may be having money problems, we're here trying to help you, not hurt you. Let's talk about your situation, if you can't pay us back right now 'cause you have to put food on the table, put food on the table. Right? Don't pay us before you put food on the table.
Megan: So you mentioned that you guys were meeting all of your metrics, or meeting most of your metrics. Can you tell me a little bit like, what that ramp up has looked like over for the past two years? And how many people you're serving, and kind of what are the high points you guys are most proud of?
Michael: Sure, sure. So we only launched this product last June.
*We went further off the record about Zebit’s KPIs. I will keep the details private but still try to give you a bit of insight into the business! Key points: 1. CAC is low, possibly the lowest of any financial services product 2. I covered bad debt earlier and 3. High website conversions.
Megan: What is something that you think VC's don't understand, or something that VC's are missing when you explain this product to them? And then my last question is, what does Zebit look like in the coming years, coming two years, to coming five years strategically where are you trying to go?
Michael: Sure, so I already mentioned the thing that well over 75 percent, 80 percent of VC's totally miss is they don't understand the demand for a product like Zebit. Because our price might be higher than the lowest street price you can find on the internet, it's like, well why would anyone want to buy from you? And those VC's just don't understand the underserved market. And I think very, very few VC’s who know that market and would serve the subprime customer. I mean, just look at what they fund. They are funding products that target the top 20 percent of the population, and understandably so, because the top 20 percent of the population spends 80 percent of the money. But that leaves 80 percent of the population at least partly out of that formula, doesn't it? And I think that's your thesis, right? Your thesis is, there are all these underserved people that could benefit from technology, from the Internet, from all of these things that can make your life better, but no one cares about them.
So that's what I would say when people look at Zebit, that's the number one thing that they miss is, why would anybody want Zebit, well guess what? 75 million people, for 75 million Americans, we change their life. We are life changing.
Michael: It is. It's a total game changer. Now, where are we gonna be in five years, whatever? The whole vision here is we have the ability to serve everybody. To essentially serve multiple credit tiers with a no cost credit product. Not just the deeply underserved, that's where we're sort of starting, because that's where the biggest need is. But we'll be able to grow people into higher credit tiers where eventually maybe they will get all those benefits that they get today when you pay in full. Free returns, and free shipping and everything else.
Once we can segment the credit tiers, and once we know that that piece of our business, the credit risk is low, then we can provide those other benefits, and we can begin to serve everything from deep subprime, all the way to near prime and above. And eventually we can be Zebit in the cart for high quality credit tiers. And you can go to Amazon and instead of checking out with PayPal for Visa, check out with Zebit. And know I'm gonna get no fees, no interest and no penalty.