July, 2022
I’ve gotten increasingly bearish on the expense management market, more so in a high interest rate environment. My biggest concern with these businesses is current contribution margin and path to long term profitability.
From my experience looking at both corporate and consumer credit cards, the biggest variable cost for medium stage credit card businesses is cost of capital. Pre interest rate hikes, it was in the range of 8-10% annually.
However, most corporate cards are charge cards and not revolving credit, where the balance is paid off each month, cost of capital only applies for a 30-60 day window, which blends to ~0.7% of spend. And this cost will only keep rising as interest rates go up.
Second biggest variable cost for these companies is rewards, offered in forms such as points or direct cash back at an average rate of around 1.5% of TPV. Based on BVP data, average utilization of rewards is ~40%, which results in the net cost being ~0.6% (40% x 1.5%) of spend.
The third biggest variable cost is processor (such as Lithic/Marqueta), bank (issuing bank) and card network (Visa/Mastercard) fees. Based on data we’ve seen, this is around 0.3% of spend.
So for $100 in spend annually, revenue from interchange will be $2 (2% of TPV) and total costs will be $1.6 ($0.7 - capital, $0.6 - rewards, and $0.3 - processor/bank/card network). Hence, contribution margin here is $0.4/$2 = 20%.
20% CM which could decrease with rate hikes + increasing CAC makes the road to profitability long and tricky. This changes if businesses are able to layer in software which has higher GM but seems unlikely for players typically serving SMBs, which market a near free product.
Brex just announced it’s going to strategically move away from serving SMBs as they push to increase the share of software as part of total revenue, presumably to increase CM and drive towards profitability