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This is a modified version of the report for Applied Microeconomics in Bath Full Time MBA Class of 2020.

Applied Microeconomics

Introduction

Once the start-ups were hard to build financial services such as payment. This primary was because the bank used to spend 75% of their IT budget to maintain their financial service (Strange, 2019). However, Amazon Web Services (AWS) has changed this situation due to providing them IT infrastructure as a service and therefore, they can start the financial service business with quite cheaper than ever (ibid). Although the banking business is supplied as a service owing to AWS and other cloud computing providers, it is not required to supply all banking functions (fraud, regulatory, data, payment, core systems and license) as a unit (ibid). Although now there are a great deal of certain function banking service providers (called FinTech), this essay will focus on Stripe which is the one of the largest online (mainly mobile) payment service providers. This is because the forecast says the global mobile payment market is rapidly growing with approximately 30% GACR (2018-2026) which means the market will be roughly 7 times larger than in 2018 (Fortune Business Insights, 2020). The hospitality and transportation sector are the fastest (35% GACR) and emerging economies in Asia-Pacific are growing more rapidly than any other region, the remarkable example of which is China having a half of world mobile payment transactions (PRIME INDEXES, 2019). This is mainly due to the online payment innovation called Payment Facilitator (or ‘PayFac’) which completely shortened the merchant onboarding operation (CB Insights, 2020). Therefore, the mobile payment industry could be one of the attractive markets and Stripe might play the important role of the market owing to their presence in the market because it is one of the first firms to use PayFac technology (ibid).

Economic Analysis of the Mobile Payment Industry

One of the main reasons why mobile payment is rising can be to remove the pain points in the customer experience of the payment process which is becoming more complex due to E-commerce and the ramification of merchant landing pages (Goldman Sachs, 2017). The buyers of these platforms are not only end-users (2.1 billion in the world in 2019 and potentially 60% of the world population by 2025 because of the wide spreading mobile phone) who are mainly millennials but also the businesses such as merchants (THE PAYPERS BV, 2019). Functionally, the major alternatives of this service are other types of payment method mainly including credit card and debit one because of which four fifth of the transaction by the millenniums delivered on these cards and they considered the payment by the ones is the easiest way (ibid). This is because they think there are several security filters to pay by the mobile payment, which leads them to hesitate to do so (ibid). As well as the demand side, Fintech firms including Stripe are not the only one major supplier of the mobile payment market. The traditional players such as banks and financial institutions are also, the example of which 89% of them in the United States is offering mobile banking services (PRIME INDEXES, 2019). In addition, tech giants (Google and Apple) and electronics (Samsung) are doing so mobile payment apps which prefixed their own brand name, as a result of which 3 apps will dominate 56% of this market in the US according to Juniper Research (ibid). However, Starbucks’ mobile app was the most common mobile payment platform in the US until 2019 in terms of the number of users and still is more popular than Google and Samsung Pay (Merchant Savvy, 2020). This can be because the customers are likely to use for low-cost, high-frequency purchases including coffee in Starbucks owing to not only more smooth purchase transactions but also loyalty and rewards programs offered by certain merchants (ELECTRONIC TRANSACTIONS ASSOCIATION, 2019). In addition, there are the difference of the preference about how many mobile payment apps the customers prefer to install, the major example of which East Asian countries such as China and South Korea may prefer to do so only one app, however, the other area including the United States may not hesitate to do so several apps (Merchant Savvy, 2020). This can allow Stripe and other mobile platformers to the more opportunities to enter this industry especially in the US, however, credit card and debit card are used in 41% and 34% of point of sales spending by value in North America in 2018 according to Worldpay’s World Payments Report (ELECTRONIC TRANSACTIONS ASSOCIATION, 2019). This may mean these cards are stronger competitors rather than other mobile payment platformers as for Stripe. This might be because the customers in the area have ‘security fears’ to use the mobile payment (ibid). In fact, roughly a half of them pointed out the fear was the main reason to prevent using the one (ibid). Therefore, it can be said the structure of the mobile payment market in the world (except China dominated by only two firms including Alibaba and Tencent) is closing to oligopoly which Stripe and other few competitors such as Ayden and PayPal (Braintree) from nearly perfect competition due to low entry barrier which only requires to be approved by Financial Services Authority (FSA).

Economic Analysis of Stripe

Stripe is an online API based payment platformer with the mission which is ‘increasing the global GDP of the internet’ (Jewell and Marden, 2018). Their platform has also well documented manuals and then has high integrity for the system of the clients (ibid). This is primarily because they ‘believe that payments are a problem rooted in code, not finance’ and therefore, they concentrate to decrease implementation time to integrate their platform into the merchant’s web sites (Goldman Sachs, 2017). As a result of the concentration, the integration time is shortened from more than 6 months to only a few minutes (just added a few codes in the web sites whose user interfaces are unchanged) (ibid). Their business model is mainly dependent on a per-transaction basis, the example of which when the client product is sold via their payment system, they can earn some portion of the price and therefore as the revenue of the client is increased, their revenue is also raised (ibid). In fact, in general, they impose a fixed rate of 2.9% + 30 cents per transaction, however, the fee is changed by the volume of transactions and the geographic location which the merchants are in (Murray, 2019). In the UK, the fee per transaction also depends on the cards which the customers use in the merchants, the example of which they are imposed at 1.4% + 20p for a European card or 2.9% +20 p for a non-European card (ibid). This means the merchants can deliver the international purchase transactions only with slightly higher fee (for example 1.5% additionally charged in the UK) at least within Europe. Stripe focuses on only businesses, especially small- and medium-sized ones, which is the major difference of PayPal and therefore their revenue is estimated at $450 million as a result of a $20 billion transaction by value in 2015 (ibid). In addition, as a result of counting on their direct sales model (marketing cost such as CAC can be quite low) and low infrastructure cost (AWS and it do only charge for the amount of actual usage which means almost zero fixed costs to operate the platform presumably only except employee salary and rent fee), the profit margin is estimated around 55 %, which is better than industrial average (around 20%) (CB Insights, 2020). Hence the cost structure of Stripe can be said to be relatively competitive in this industry. Furthermore, Stripe is a relatively software developer oriented firm, one of the main reasons for which it has the community of them and therefore the capability of integration for other services is stronger than the competitors because they prefer to work in Stripe rather than other firms (Benson, 2018). This can be because they prefer to introduce their payment platform into new technology such as AI. For instance, a new product (called Radar) can detect fraud transactions in the purchase processing to monitor in real time and score them based on the historical data trend and therefore as the tool has more data, the accuracy of the capability to detect potentially fraudulent transactions can increase, which may mean it has the strong sales and operating synergy for the payment platform (CB Insights, 2020). One of the largest benefits to using their online payment platform can be increasing client firm’s revenue. In fact, the conversion rate of some clients increased by 2-3% due to smoother payment process (or faster processing time) by their platform, which means it also increased the satisfaction of client’s customer purchase experience and therefore on average they could increase by 7% of client firm revenue (Jewell and Marden, 2018). Another major benefit can be that their payment platform can reduce the operational cost of the clients. This is because the cost of development and maintenance for the payment platform is 24% cheaper than competitor’s average (ibid). Hence from the economic perspective, it can be said that the opportunity cost of the usage of moderate payment platforms is higher than Stripe payment platform and therefore, they have a competitive advantage not only for building payment systems from the scratch but also average competitors. In addition, it also has the function to prevent the fraud of purchase transactions (ibid). According to LexisNexis (a legal firm), generally, every $1 of fraudulent purchase transactions charges an online trade an additional $2.62 (ibid). Therefore, it can be said their payment system can reduce the costs of the clients to prevent fraud. Furthermore, on general, mobile payment can be more secure than other type of payment method due to tokenized transaction which means the card number cannot be seen at the point of sales and encrypting the sales information immediately after the customers purchase (ELECTRONIC TRANSACTIONS ASSOCIATION, 2019). Hence, Stripe can offer the secure purchase transaction via their mobile payment platform, which means the merchants can reduce security costs to introduce the mobile payment such as Stripe one. Time can be a major scarce resource and therefore rapid integration into the client’s landing pages could lead Stripe to competitive advantage.

Conclusion

This essay has discussed the mobile payment industry and the key supplier (Stripe) in terms of economics. It has several competitive advantages including the fraud prevention, lower marketing and operating costs (higher profit margin, 55% around), rapid integration without any change of the user interface of the merchant’s web pages and the strong developer’s community. In addition, the industry is growing rapidly (more than GACR 30%), however, the number of suppliers is also rising and therefore the profitability of the firms might be decreased as a result of competitions. Furthermore, the credit card firms such as Visa and Mastercard can be still the largest competitor in terms of payment. This is because the client’s customers still have the fear of security for mobile payment even though technically it is more secure than a credit card. In the future remark, whichever mobile payment system such as digital wallet (Apple Pay) or gateway (Stripe) the merchants select, they finally have to be authorized, done clearing and the settlement by card network of Visa and Mastercard which can charge the same amount of the fee Stripe can earn according to Goldman Sucks (2017). Therefore, even if mobile payment penetrated and dominated the payment process, still the credit firms can earn profit due to the assessments. Hence Stripe has mainly two options, first of which is becoming the authority like Visa or second of that introduces blockchain which is not required to the central clearing and authorization.

Reference

Posted in Business, Finance and tagged Business Finance

This is a modified version of the report for Understanding Finance (Part 1: Investment Appraisal – Eastern plc Assessment Standard) in Bath Full Time MBA Class of 2020.

Investment Appraisal – Eastern plc Assessment Standard

Introduction

This report will answer the requirements of this coursework. These issues are to prepare the NPV calculation for Eastern plc, to explain what the cost of capital of 8% represents and to comment on whether and how this investment may contribute to shareholder wealth.

Preparing the NPV calculation for Eastern plc

As a result of the calculation, the NPV of this investment is approximately £9.2 millions or more precisely £91,931,456. This NPV is calculated to sum up the discounted cash flows in the life of project including the end of year 5 which the plant and equipment, which the company is going to invest, will be disposed. Each discounted cash flow is computed to multiply the net cash flow by discount rate which is equal to the cost of capital (8%). The net cash flow or free cash flow if the company financed by only equity is the cash flow which subtracts of all obligatory payments from gross profit adding the depreciation. The gross profit will be estimated to 35% of the sales which is going to earn selling 4 million units per year with the current price of £2.50, however, the price is expected to inflate by 4% per year. The depreciation is emulated using the Straight Line Basis method which means the investment subtracting from disposal value (£0.15 millions) is divided by life of project (5 years). The obligatory payments are the investment, fixed cost, tax payable and working capital change in this case. £2 millions of investment in new plant and machinery will be paid immediately and the remains (£6 millions) will do so at the end of the first year. The fixed cost is estimated be £2 million per year, however, this includes the depreciation (£1.57 millions), and therefore the actual fixed cost will be £0.43 millions per year. The tax payable is reckoned to multiply tax rate (20%) by taxable income which is to subtract gross profit from depreciation and fixed cost. The working capital change of a year is determined to subtract the working capital of 1 year later as of the year from the working capital of the year which will be maintained at 10% of the following year’s sales. The detail of calculation is in the MS Excel sheet which is also uploaded with this report.

Explaining what the cost of capital of 8% represents

What the cost of capital of 8% represents can be the minimum rate of return on the prospective investment projects as for the investors, who are supplying funds for Eastern plc. In addition, it can be also the degree of risk to invest this investment. Therefore, if Capital Asset Pricing Model (CAPM) theory hold and this cost of capital is financed by only equity, the investors require almost 7.2% premium for the risk of this investment owing to the fact that 10 years British government bond rate is 0.79%, which used as a risk free rate. Moreover, if the theory hold, this additional risk premium might depend on the company’s beta. According to Statista, the average market risk premium in the United Kingdom, 2019 is 6.2% and therefore, the market implied the company’s beta can be approximately 1.12. This means the company might be more sensitive than the whole market return. In comparison with other London stock exchange listed plastic companies such as Daios Plastics SA having beta 0.0133 and Lordos United Plastics Public Ltd with beta 0.0237, the risk can be significantly higher than competitors and therefore the investors require higher return for the company. This can be because the structure of asset might be weighted to debt which the lenders own less business risk than stockholders if the assumption that the cost pf capital is financed by only equity relax.

Comment on whether and how this investment may contribute to shareholder wealth

This investment may contribute to shareholder wealth. This is mainly because the NPV is a positive with a large cash flow owing to relatively highly competitive advantage of the company only if the sales figure is feasible. Therefore, this investment will earn a large amount of free cash flows which they are expecting and then those cash flow will be back to the investors as a dividend. The depreciation using the Straight-Line Basis method can be affected the NPV positively because if they adopted the other method, they would have to pay more cash flow as depreciation and then the NPV will reduce more than using Straight Line Basis.

Posted in Business, Finance and tagged Business Finance

Figure 1

Will index funds continue to beat active funds?

Introduction

Today, only a few active funds can compete with index ones. As for most individual investors, investing ETFs (Exchange traded funds) or other index funds can be the best option. Moody’s Investors Service anticipated passive investment will outweigh active ones in the United States until 2021 (Kim and Cho, 2019). Therefore, most active fund managers will no longer be able to charge the fund fee. As a matter of fact, according to figure 1, the fund fee, even asset weighted average one, has been decreasing steadily as active fund fee has done so (Platt, 2019).

Unethical Issues

However, these investment trends might involve several problems such as gender and unethical issues. One of the major dilemmas is to invest the funds indirectly if the companies indexed by the funds act unethically. In fact, no less than half of United States listed companies income was created from alcohol cannabis or tobacco (Nauman, 2019). This means the investors are in favor of such corporation revenue taking activities at least circumlocutory. In addition, investing the fund can be equal to advocating gender bias. To illustrate this, the number of female hedge fund employees was less than a fifth of the total employees (Fortado, 2019).

‘Correct’ Index Funds

To avoid the issue, the Investors can choose ethically or politically correct index funds such as ETFs having a gender lens and higher environmental, social and governance (ESG) criteria (Bolshaw, 2019). However, the most critical matter for the investors is to earn enough money, which has to be at least bigger than the deposit rate or the government bond one. There is a tendency for women led funds to gain higher revenue than male one (Fortado, 2019). This might mean even if the investors select ethically appropriate ETFs, it may earn the expected income. Therefore, this passive funds preference probably does not change.

Conclusion

As a result of this trend, there may be new arbitrage opportunities. Michael Burry argued that the tendency in passive investment through ETFs and index funds, as well as the trend to quite large size among asset managers has strayed smaller cap stocks without exception (Kim and Cho, 2019). According to his statement, if this direction continues, non listed small cap stocks will be undervalued more than ever. Consequently, these companies may not collect the money to expand the current business or build a new one from the capital market. However, in this situation, the small cap funds can overcome the passive ones as for the revenue. This may mean active funds oriented for smaller cap might beaten ETFs. As a consequence, the index funds will dominate or have already done, though, the dominance will no longer last.

Reference