With the start of the festival season, you may see many online and offline retailers offering NO Cost EMI on consumer durable products like Mobile Phones, TVs, ACs, and refrigerators. Have you ever wondered how the NBFC like Bajaj Finance offers Zero EMI and still makes money? This article will share with you the economies behind it.
How It Works :
Suppose you want to buy a TV worth RS 20,000/-. But you don’t have the surplus money to buy. But what if someone offers you an interest-free EMI loan for, say 12 months for an EMI of 1667? Obviously, you will opt for that option as buying a product on EMI, you will not feel the burden of paying lump sum money upfront and you can also enjoy watching your favorite hero movies and series on Netflix. EMI makes to satisfy customer wants and that is the selling point. If you walk into a retail store near you to buy a TV with a budget of RS 15,000/-. If the shop owner says Rs 20,000/- with all the features you are looking for, you walk out saying the price is too much. No one makes money. Suppose they offer you an EMI of 1667 p.m, you will say I can afford that To sell a TV for you three entities work together 1) The manufacturer is ready to give the product at an additional discount of say 7.5% means RS 18,500 (not to the customer) if the shopkeeper sells more units. 2)The shopkeeper makes a tie-up with a Financier like Bajaj Finance to offer No cost EMI. 3) The Customer purchases the TV on EMI for 1667 and Bajaj Finance makes payment to the manufacturer Rs 18,500 instead of 20,000/- 4) Shopkeeper made to buy 20k TV for the customer who is willing to spend only 15k and enjoy high margin. You might think Bajaj Finance paid 18.5k to get back 20k in 1 year, that is hardly an 8% return. Is that too little? Here the magic of cash flows comes in.
Magic Of Cash Flows :
Bajaj Finance does not get 20k after 1 year. He gets Rs 1,667/- every month from customers. So the customer is paying the principal every month. Bajaj Finance pays 18.5k now to get 20k after one year. That translates into a whopping 16% annualized return. Look at the chart below
Customer Pays 20,000
Manufacturer Discount7.50%
Bajaj Finance Pays 18,500
Payment Period 12 Months Advance
MINIL Payout 18500 Month
Amount (EMI)116672166731667416675166761667716678166791667101667111667121667
Monthly Return1.20%
Annual Return16%
IRR Calculation
You might think Bajaj Finance is getting only 1.5k in a year for an 18.5k investment, which means an 8% return. But you are not paying attention that it is getting principal month on month. So the formula to calculate actual return is the Internal Rate of Return(IRR) as there is a series of cash flows. So the actual return it is making is 16%. Scenario 2: Sometimes they will ask you to pay only a down payment of RS 5,000/- and the rest in EMIs. How it makes a difference for the Bajaj finance. Look at below
Customer Pays 20,000
Manufacturer Discount7.50%
Bajaj Finance Pays 18,500
Payment Period 12 Months
Down Payment 5,000
Payout 13500 Month
Amount116672166731667416675166761667716678166791667
Monthly Return2.20%
Annual Return29%
IRR Calculation
By taking an advance amount Bajaj Finance makes a whooping 29% p.a. It’s a good deal for the company.
Win – Win For All :
In the value chain from manufacturing to end consumer, in the above case, the entire person involved is benefited. Let’s see how Shop Keeper: He benefits from doing more sales with high-value products by pitching the customer EMI and enjoys high margins. Manufacturer: As he gets more orders from shopkeepers, he enjoys economies of scale in production. He also makes more sales without going into a pricing war with competitors. Customer: He was satisfied by fulfilling his desire to buy the product without paying a lump sum and enjoys 6% interest if he parks that amount in liquid funds. Financier: Bajaj Finance makes a return of 16-29% return as he is taking the risk of default by the customer. Usually, the default ratio will be low on low-value EMIs.
Bajaj Finance understands this business model and creates an incompatible business in the consumer-durable finance space.