‘Is there enough of a buffer in the system to absorb unexpected expenses at the personal level?’: Neal Desai, Kafene

We’ve covered a lot about buy now, pay later over the years. BNPL’s rise was strong, given how it is embedded into a merchant’s checkout process and appealed to younger customers who preferred financing certain transactions and not the revolving credit of a credit card. Honestly, BNPL’s takeup and growth has overshadowed the emergence of other forms of financing. One of those is lease to own – if you’re my generation and grew up in the US, you’re probably familiar with lease to own through Rent-A-Center commercials. In my mind, that always associated lease to own with some kind of shady business to finance subpar pre-owned furniture with cigarette burns.

Neil Desai is my guest today – he’s co-founder and CEO of Kafene, which takes a lease to own financing model and embeds itself within in-store shopping experiences of over 1000 merchants. Embedding lease to own opens up new products and experiences for lease to own customers, primarily subprime buyers. Neal and I talk about the difference between BNPL and lease to own and why there’s room for both. Neal feels it’s a better model for many people. We discuss the challenges and opportunities in building out Kafene’s merchant network and the flywheel that Neal feels is kicking in now. We also look at consumer lending in light of what’s happening economically today. 

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The following excerpts were edited for clarity.

Purchase demand elasticity

We saw pretty resilient customer behavior through November, December, and even January. February was the first month where we started to see some impact and March has been more impactful still in terms of consumers holding back from a lot of types of discretionary spending.

The banking crisis and its ongoing impacts are actually showing up significantly in consumer spending patterns. It's not that they have less money – it's that we've started to hit a tipping point in terms of customer perceived fragility.

Fear is starting to creep into the system, and that fear is driving a little bit more responsible purchasing behavior. 

So consumers are starting to exhibit more and more responsible buying behavior. That's probably a good trend. And if the trigger for that is fear or uncertainty about the future, or whether the trigger for that is just diminished access to easy credit, it's probably a good thing. On the other hand, there are entire classes of expenditures that we just can't control like rent and food.

In our case, for Kefene, it’s appliances, tires. If you get a flat, you have to replace it. And so the question then becomes, is there enough of a buffer in the system to absorb these kinds of expenses at the personal level? And if not, then my hope is that companies like ours can continue to extend credit to consumers so that they can get these necessary purchases taken care of. 

Small dollar options for consumer finance 

We are in an interesting period where consumers have a fair number of options. I'll break it down in a relatively non-traditional way, which is just to think about it by dollar amount. So let's just make the world really simple. Let's call it small dollar and big dollar. And let's also talk about the 100 million Americans that don't have access to sufficient credit. So you've got a huge population out there of prime consumers that essentially has access to nearly unlimited credit: tens of thousands of dollars, if not hundreds of thousands of dollars. 

But for most consumers here in the United States, their credit cards are near limits. So if they need to buy something, like a $300 purchase or lower, maybe it's a medical bill, maybe it's an unexpected grocery bill. In the small dollar space, there are a lot of options. You can go to a payday lender, try to get a payday loan – that order of magnitude is $300 to $500. If you have a $1000 or $1,500 limit on a credit card, and you've got some spare capacity, you can use some of that. You can go to a pawn shop if you have to. These are not appetizing options, but they are our options. You can borrow from a friend, for that matter. There's a lot of companies out there that offer intra week paycheck advances. So you can get $300 if you need it. 

Big dollar options for consumer finance

But what do you do when it's $1000? You blow a tire, you have a repair to your car; your refrigerator breaks, you need a new dishwasher. $300 isn't gonna get you very far. And so that's the space that we play in. 

We are looking for every possible way to extend $2,000 on average to consumers that have FICO scores in the high 500s on average. So this is a space where it is very difficult to use traditional types of lending products to serve that need. Number one, the consumer won't get enough money and number two, the lender wouldn't get paid back in a way that would make the business sustainable. 

Kafene’s model

Kafene has figured out how to do this by using a structure called lease to own and what lease to own does is it essentially recharacterizes the transaction at the point of sale. Rather than being an unsecured loan where the consumer then takes that money and goes out and buys the product, Kafene goes out and buys the product on the consumer’s behalf. We then rent the product back to the consumer over a period of 12 months on average. And to the extent that consumer completes their rental payments or exercises any number of early payment or early purchase options, the consumer owns the good. In that regard, it functions a lot like a 12 month installment loan. 

The key difference, though, and this is really important for our consumer base, is that the consumer can cancel anytime. This is technically a rental agreement that auto renews every month. We obviously have to find a way to make that profitable and we have, but from a consumer flexibility standpoint, especially in our consumer base, and especially in a macro environment that's getting a little bit dicey, that cancellation flexibility is really important. 

Are you going to cancel the tires on your car? No, probably not. If you upgraded your television, a semi discretionary purchase, or you purchased a new dining table, or a bedroom set or something like that – these are types of things where if times get tough, the consumer can use their discretion to make a determination as to whether or not they want to keep making payments on that item. And if they don't, they put the item back to us with no credit impact. In fact, their credit score will still go up, because they've probably made a few payments before they exercise that return option. So, Kafene is really focused on financing the types of goods that can be essentially rented back to the consumer. And in doing so, it's able to provide multi thousand dollar purchasing power where traditional lending falls way short.

Building a merchant network 

We partner with over 1000 retailers and we’re signing up several hundred new merchants every month. So we're starting to grow very quickly. And we partner with those retailers to make sure that when a customer walks into that retail location, there's a way to get that customer financed.

If you think about your average furniture, appliance, and electronics store, 50% of their customers don't have enough purchasing power. Now by dollar, it's about 20%. But from a margin perspective, this is incredibly valuable for retailers. Retailers will typically offer something like their own branded credit card. If you walk into a Best Buy, or you walk into Crate and Barrel or something like that, there's that branded credit card that they offer well qualified consumers. But what about the other half of the population? 

So in a world without Kafene as a lease to own option, that other half of the population either spends less money or can't afford to make the purchase. Kafene is designed to be there for that part of the population for whom the storebrand credit card or the Synchrony offering just doesn't make sense. They don't qualify. 

We are 99%+ in physical stores. And if you think about why that's the case, it's because that's where the purchasing behavior is for the types of categories that we’re in: appliances, tires, and things like that. There just isn't that much transaction volume online yet. Now we acknowledge that that may change going forward. And we also acknowledge that a lot of companies have attempted to go to the online space first. For our use case and the types of goods that we're focused on today, it just doesn't make a lot of sense. Wayfair has low single digit penetration of the overall furniture market. Most furniture gets purchased because people want to sit on it first – they want to walk into the store, see it, touch it, and then make their buying decision. 

Rent A Center as a lease to own model

Rent A Center is a super interesting company, because in many ways, it laid the foundation for what Kafene does. And from that regard, they've done a lot of really good work. They started and continue to be an operator of brick and mortar locations, renting goods to consumers. The problem is that these are relatively old school technology businesses.

And the way that they make their money is through pricing that would essentially be significantly higher than the value of the service being delivered. It's like a payday loan in the form of a lease – to the point where the consumer is paying a tremendous amount of money for a good that is typically used and low quality. So if you walk into a Rent A Center today, you'll see furniture, TVs, sofas, but the sofas have cigarette burns. The refrigerator smells. The television has a crack or a scratch on it, right? Everything is ‘lightly used’, I guess they would call it. And the upshot of it is that the consumer is essentially spending a lot of money and getting pretty low value for price. 

10 years ago, what choice did consumers have? They couldn't walk into the corner furniture store that was selling brand new furniture with durable construction. They couldn't get financed there. And so they had no other options. Kafene will partner with that furniture store down the block. Kafene now presents an opportunity for that consumer to look at the total spend that they would be spending in a Rent A Center, which still exists, and compare it with the total spend that they would be spending at that retailer down the block that is designed to serve all types of customers, and typically offers significantly better value for price. 

As a company, we facilitate higher quality goods getting into our consumers hands at lower prices. And the way that we do that is by not worrying about how to maintain inventory, not having all of the overhead associated with brick and mortar locations. We let retailers handle retailing – we handle the financing.

More options to pay

There's a massive proliferation of payment options right now. It's highly unlikely that having a ton of payment options at checkout improves the outcome for either the retailer or the consumer. It's confusing, it's cluttered. We're still finding our way. What I would say is there will always be convenient options. And there will always be options that are born of necessity, 

When I talk about convenience options, you would find that cash, or digital wallet payments, credit card usage, high value, credit transactions, those things are all essentially substitutes for a well qualified prime consumer. If they had to make a purchase using any one of the 16 different methods available to them, they're just going to choose the one that is most convenient. And right now there's a lot of focus on transparency – that's not always going to be the case. Transparency will become table stakes. You're seeing credit cards increase transparency. You have Apple Pay Later now. So that is a space where largely you're finding one payment method substituting another.

On the other hand, lease to own is unique in that lease to own you have no other options. If that retailer doesn't carry Kafene or another lease to own option, it's going to definitively miss out on sales. There is no substitute – our consumers don't have the ability to pay in cash. They can't pay with a credit card – they don't have sufficient line left. So, while I think there's going to be significant consolidation, I do think that there is always going to be a place for options such as ours for certain consumers. 

Lease to own moving up market 

Now, the interesting thing is lease to own under different names is moving up market – we can call these things subscriptions. If you think about your cell phone and the payment plan that most people are on in the United States for their cell phones, it's essentially X dollars per month over three years, then upgrade, and it feels like something fundamentally different. It's not – it's lease to own just called something else. 

And so, as lease to own starts to get into territory where it's delivering a convenience benefit for consumers, it's going to have to compete, and I think it will, successfully against other convenience methods, but it doesn't have the same necessity attached that it does for the primary demographic.

Kafene in 2023

We have two major priorities. Priority number one is we expect further macro instability. And as that instability occurs, it becomes more and more important for us to deliver more financing opportunity at larger scale to consumers that are going to need it. Flexibility is going to become increasingly important as consumers suffer whatever potential negative consequences there may be coming down the road. And so number one is just scale. We have to do more, cheaper, faster, more efficiently to serve more consumers.

Initiative number two is to take the core ability that we have -- to understand this consumer behavior quite well -- into adjacent markets. Not to talk too much about it yet, but we're launching additional verticals very soon, so that we can have that same elegant point of sale experience for other types of service and goods providers at point of sale. You'll hear more about that in the next three to six months.