Consumer Liquidity, Fingerhut, and Good vs. Evil
I remember the first time I truly understood the power of credit. I was 22 years old, working in leveraged finance, and I came across a company called Fingerhut (backed by Bain Capital Ventures and Battery Ventures). Fingerhut may be one of the most elegant and evil business models I have ever seen. Essentially, they are a catalog retailer, much like LL Bean or The Sharper Image, selling consumer electronics, jewlery and other semi-luxurious indulgences. Based on that description, who would you think is their target customer? Probably middle to upper middle class professionals with large amounts of disposable income, right? Wrong. Just the opposite. Fingerhut’s mission is to get their catalog into the hands of sub-prime (low income) consumers, under the tagline “Now You Can.” Basically, they have an embedded sub-prime credit vehicle which extends loans to their customers, who otherwise can’t afford the items in their catalog, so that these luxuries become attainable. That practice, in and of itself is not so offensive, but here is where it gets fucked up. The same Sharp 37″ Aquos LCD HDTV selling on Fingerhut right now for $999, is widely available on Google for $859 or less if I actually felt like sifting through all the results. So Fingerhut charges sub-prime consumers a 15% plus premium for goods they shouldn’t really be buying, and their customers don’t blink. Why? Because Fingerhut extends a semi-usury line of credit to their shoppers who don’t have the cash (or credit) to buy the cheaper good elsewhere. Now, insert all the nightmares you have already heard about sub-prime lending into the model, and you have a pretty good sense of how these consumers are getting raked.
So, here’s what’s interesting. When a sub-prime consumer is going to default on some outstanding debt, they typically have more than one creditor chasing them for money. So how do they choose who to pay and who not to pay? With company debt, there is a very clear capital structure where senior lenders (low interest rate lenders) have a liquidation preference (right to collect 1st) over junior lenders (higher interest rate lenders), and both types of lenders get their money before equity holders (owners) ever see a dime. But consumer debt doesn’t work like that. If I have $100 in the bank to pay my creditors, but I owe $75 to HSBC, $75 to my landlord, $75 to AT&T, and $75 to American Express, it is up to me to decided who I pay and who I don’t. Now, a rational consumer will pay the debt that carries the highest interest first, but it’s almost a coin flip if they are going to completely default on HSBC or Amex. In fact, they will probably pay AT&T before they pay either credit card company, because the immediate impact of losing their cell phone is more “real” than the thousands of dollars they are going to rack up in debt by not paying HSBC (even though if you said, turn your phone off for a month and I’ll pay you thousands of dollars, they probably would do it). Anyway, the point is: where do you think Fingerhut’s debt fits into this decision making process of who to pay? Let’s just say the landlords of Fingerhut customers are not happy campers. And there is where I first understood what it meant to make a consumer more liquid. There will always be demand for a credit product that makes a consumer more liquid, especially if that liquidity is not available anywhere else.
Now obviously, whenever a lender is able to create a credit product that no other lender is offering, they are exposing themselves to a higher default risk, but in Fingerhut’s case, they have subsidized this higher risk of default (or rather they can tolerate a higher default rate) through the increased margins they are able to realize on the retail catalog sales.
When the economy tanked, and before I started to work on JumpPost, I spent about 2 months (with the help of a west coast venture capital firm), trying to figure out how I could make a now cash-strapped American population more liquid. My energy turned to consumer finance and credit products, as that seemed to be the best way to put a little extra cash in people’s pockets, but amongst other very serious business risks, I learned that businesses in this space tend to dip their toes in murky waters. I think most people, at one point or another in their career, are faced with an inflection point where they need to decide “Am I on the side of good, or the side of evil?” It’s not necessarily quite so binary, and everybody’s definition of good and evil is different, but I think you need to be able to wake up in the morning and like the guy who you see in the mirror. So, I found another way to put cash in consumers pockets: JumpPost. We’re heads down getting an alpha product up and running, but as early as January, we’re going to start helping consumers earn a little extra spending money…And that feels pretty good. Dudes at Fingerhut, probably not feeling quite so good.
Jordan Cooper's Blog: startups, venture capital, etc... 
I think the good / evil point – while often murky – hits every entrepreneur at one point or another. We had a chance to work with Offerpal about a year ago – who were boasting about ridiculous effective CPMs (for both Facebook and Mobile products…) and after examining the actual “offers” we would be transferring to our consumers, we passed – and perhaps laid a potentially significant amount of cash on the table – because we saw the offers as a bit disingenuous… As I’m sure you’ve read by now, Offerpal’s CEO Anu Shukla, recently stepped down facing that same exact criticism.
Yair
November 20, 2009
right. I actually looked at Offerpal as an investment a few years ago…One of the most technically elegant arbitrage models I’ve ever seen…again, sometimes there is beauty (and $) in the dark side…
jordancooper
November 20, 2009
Jordan, very interesting post! Sounds like Fingerhut essentially extended credit to a consumer who could not usually get it, especially for the sort of products that Fingerhut offered. But because these products (ie. TVs, slick cell phones, etc.) were deemed the day-to-day important / necessary by the consumer, they would pay down this debt first and foremost. Is that correct?
Smart, although deplorable, that Fingerhut would charge a higher price to help give them more of a cushion to absorb higher default rates.
jeff iacono
November 20, 2009
that’s exactly right Jeff. Consumers pay down the Fingerhut debt, because 6 months after they buy the TV they can’t afford, they want Fingerhut to help them buy the Blueray player they can’t afford. If they default, they lose a line of credit unavailable elsewhere.
jordancooper
November 20, 2009
Jordan,
This is very interesting stuff. I totally agree about waking up in the morning and liking who you see in the mirror. Working in financial services, it’s a trade I see many people take the wrong side of! Cheers to you for helping consumers obtain liquidity in a smart and ethical way.
Best,
Adam Coons
(will’s friend)
Adam Coons
November 20, 2009