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Why disrupters such as Afterpay outwitted the banks

By James Wright |8.31.2021

With the big four finally beginning to wake up to the threat to their credit card revenues, Afterpay may have chosen the right partner at precisely the right time.

Why disrupters such as Afterpay outwitted the banks (

The success of Afterpay left many in the investment community scratching their heads. How did a simple layby company grow to a $39 billion valuation seemingly overnight without a single incumbent challenging the upstart disrupter?

Disruption is not a new phenomenon; it has been around for as long as commerce has existed. In 1942, Austrian economist Joseph Schumpeter coined the phrase “creative destruction” to describe the process where capitalism “revolutionises the economic structure from within, incessantly destroying the old one, incessantly creating a new one”.

Set up in 2014, Afterpay was a beautifully simple idea – to bring the antiquated notion of layby into the 21st century. It satisfied customers’ need for instant gratification by receiving the goods upfront, but allowed them to pay off the transaction in four regular instalments.

It tapped into a younger generation that was sceptical about accumulating large credit card debts that would compound at exorbitant interest rates. While it skirted around the responsible lending rules, retailers were eager to tap into a new cohort of consumers, and the company grew quickly.

Afterpay was not, however, an overnight success. It took time and considerable effort to bring the business to scale, particularly to sign up large numbers of participating retailers. It was expanding rapidly and building a loyal base attracted to the brand culture and customer experience.

If buy now, pay later was such an obvious threat to credit card profits, why didn’t the banks take them out earlier or launch competing products leveraging the natural advantage of their sheer scale?

The reason lies in the types of people who inhabit large businesses and the nature of their shareholders. Every business commences life as a start-up, driven by entrepreneurs with a passionate vision of profitable new markets.

Taking risks, and winning

Investors in these ventures understand the risk-reward trade-off and choose to back the founders and the business concept with capital they are prepared to risk. The odds are that most start-ups fail before scaling and capturing a profitable market segment.

But for those that succeed, the returns can be spectacular – as in the case of the Afterpay investors who reaped the rewards of holding.

Larger businesses are entirely different animals. They are run by corporate managers whose objective is to incrementally improve the business model through efficiency and consistency at scale. Often, layers of bureaucracy can creep into these businesses as they become larger and more complex to manage.

Their investors are generally more interested in the consistency of returns and the security of their capital. Arguably this has not been helped by the focus on short-term returns and an ageing demographic’s hunger for dividends.

Large corporate leaders are not generally rewarded for investing in new and riskier ideas, particularly when they have the capacity to undermine their core business profits. Instead, they navigate the corporate ladder by making incremental improvements and hoping that disruption doesn’t occur on their watch.

Incubator units

Responding to this challenge, many firms set up small incubator units designed to invest in the ecosystem likely to challenge their profitability. The idea is that they get to see new business models and technologies as they are evolving, with the hope that picking winners will allow them to respond in a timely manner, or at least offset their inevitable profit declines.

However, the commitments in these areas tend to be relatively small compared with their main business activities, and the chance of picking the winner in a broad array of start-ups is relatively small.

While some larger businesses attempt to buy and absorb interesting start-ups as they are scaling, these acquisitions often struggle.

The entrepreneurial spirit tends not to flourish well in big businesses as the innovation and disruptive DNA gets lost in a foreign culture. The reality is that most large firms simply wait for them to mature and then gobble them up.

Perhaps Square is different, and is one of those rare ambidextrous companies that can manage its core payments business while still taking considerable risks into new scaling ventures.

It’s led by a serial entrepreneur and, on the surface, its shareholders seem supportive of its creative innovation and higher tolerance for risk.

With the banks finally beginning to wake up to the buy now, pay later threat to their credit card revenues, Afterpay may have chosen the right partner at precisely the right time.