SECTOR SPOTLIGHT: Buy Now, Pay Later (BNPL) in FinTech

SECTOR SPOTLIGHT is a monthly series on FinTechtris that explores a specific sector within the expansive FinTech space by defining its history, frameworks, business model, leading companies, and outlook.

The financial impact from COVID-19 resembles what happened after the Financial Crisis of 2008 - 2009. Concerned about fees, interest rates, and high levels of debt from loans and credit cards, consumers looked for alternative payment methods in debit cards. For millennials and younger generations, credit is not an option that they qualify for due to low or poor credit profiles. For these spending conscious and debt averse consumers, Buy Now Pay Later point-of-sale (POS) microloan offers have become a popular alternative for payment, by spreading out online and mobile purchase amounts into interest-free installments over time. BNPL has become the “layaway plan” of today’s generation, while credit cards are now considered “old school.”

POS lending is one of the fastest growing segments in the lending sector of FinTech, increasing at 40% volume (YoY) and expected to reach 150% annual growth in 2020, due to an influx of online shopping and government benefits programs. Retailers are also active in this area as they focus on bridging the drop in revenue during COVID-19, by allowing BNPL as a checkout option for their shoppers. The budget-savvy consumer is able to get the product they want now and flexibly pay in full later, at no additional cost — balancing monthly costs and purchasing power.

Let’s explore this segment of the lending sector further, and discuss how these programs function, benefits to both shopper and merchant, top BNPL companies, and how other industry players are getting involved.

How Buy Now, Pay Later (BNPL) Works

With Buy Now Pay Later, the consumer is able to increase their buying power AND decrease the chances of abandoning their shopping cart when it comes time to checkout. POS (or checkout) lenders allow shoppers to break up their total purchase amount over periodic installments (weekly or monthly), usually without fees or interest. These purchases are often small ticket items such as clothing, food, fitness equipment, home furnishings, or recreational items.

A purchasing customer can choose the Pay Later option for payment through the preferred vendor the website partners with. Instead of entering details from their credit card for billing, the shopper would confirm the payment terms (number of payments and amount of each payment), total cost, and account info for the recurring payments.

For the growing group of BNPL companies, adding a no-cost payment option for customers is a key driver in market acquisition. The lending programs themselves are not credit card based, but installment micro loans at point-of-sale that do not require a hard credit check of the shopper. Without a negative effect to their credit profile or interest rates that lead to further debt, consumers minimize impact to their financial health from spending.

Without upfront fees or additional cost to the consumer, Buy Now Pay Later fintechs rely on the merchant to pay a percentage of the sales price as revenue, typically 4% - 6%. Even though this is about twice as much as standard merchant fees, the benefits in volume and recurring spending are worth it (see breakdown in next section). BNPL companies can also leverage virtual credit cards to facilitate consumer purchases, which can earn additional interchange revenue per transaction. Lastly, some of these firms do charge consumers penalties if they miss their automatic installment payments.

BNPL BENEFITS THE CONSUMER AND THE MERCHANT

For merchants that added Buy Now Pay Later options, their platforms have been able to efficiently process more transactions (online and mobile) during an economic downturn, and at a lower level of return risk from lack of payment. Even though higher fees are being paid, retailers are able to take advantage of: an increase in shopping cart size (up to 30%), decrease in abandonment at checkout (down up to 25%), and repeat customers (up to 20% more). In particular, Affirm, Afterpay, and Klarna (some of the largest BNPL fintech companies) saw average order value (AVO) rise 85%, 30%, and 45% respectively.

Shops that had relied both on physical and e-commerce sales have been able to survive due to increased online purchases, boosted by Buy Now Pay Later checkout. Merchants are able to support consumers that are budget conscious, but still need to make purchases monthly during the pandemic. There are also added benefits in customer loyalty from repeat customers, and word-of-mouth community marketing as shoppers let their friends and family know about their purchases.

For consumers, switching from credit cards to to BNPL checkout has been easy as they are able to:

1. Eliminate a poor signup experience. Applying and signing up for a credit card application has added friction and delay to the shopping journey. Due to the personal info to be submitted and verified, the process takes minutes, multiple screens, a decision engine to approve. Buy Now Pay Later is approved in real-time and on one screen. Most retailers plant the seed for BNPL early in purchase experience, by advertising POS financing and payment terms — reducing checkout times and increasing purchase conversion.

2. Qualify right away. Almost 20% of shoppers between 22-30 yrs old have insufficient credit history for credit card approval. Without requiring credit checks, BNPL providers have been able to use alternative data to instantly approve this tier of customers.

3. Avoid High Fees and APRs. Growing up as being averse to debt, the younger generations of consumers have avoided credit cards with revolving balances. This type of debt becomes a hindrance in the future as customers realize that they have spent beyond their means and can no longer afford to pay more than their monthly payment — extending the total amount and time needed to pay down a card to $0. Despite higher rewards programs and offers through traditional credit cards, shoppers would rather make 5 installment payments of $100 than see a $500 credit card balance on their statement each month.

Speed, consumer convenience, and no fees are a great way to sum up Buy Now Pay Later benefits for consumers.

TOP BNPL COMPANIES

Despite the recent surge in demand due to the pandemic, Buy Now Pay Later fintech companies have been around for a few years — many of which benefited for tremendous growth since 2018. As a niche within the lending sector of FinTech, BNPL app downloaded increased over 150% year-over-year (from 2018 - 2019).

The largest and well-known firms are Affirm, AfterPay, Klarna, Simpl (India), Paays (Canada), Ovo PayLater (Indonesia), Sezzle, PayBright (Canada), LazyPay (India), zipPay (Australia), Uplift (Canada), and Splitit. Some key differentiators among this group:

• Affirm is the juggernaut in the US, led by ex-PayPal leader Max Levchin; this industry leader has started to migrate towards similar programs for business lending and consumer banking;

• AfterPay has made notable partnerships with retailers like FinishLine, grown over 125% in active customers, and exceeding 4M customers domestically early this year;

• Klarna, with headquarters in Stockholm, acheived more than 1M daily transactions through 11M global monthly users in 2019;

• Splitit actually allows consumers to leverage their existing credit cards through its installment program without added fees or interest. Instead of seeing a $150 balance due on your AMEX statement for a recent purchase, you can $50 installments at no cost — essentially evening out your monthly cashflows.

As the Buy Now Pay Later begins to get crowded, expect these larger companies to build out exclusive partnership programs with rewards and alternative banking products like a daily spend card to increase customer retention.

How other players can get involved in BNPL

For financial institutions, fintech companies, and banking technology providers, its not too late to join in on the parade. BNPL firms as whole have not tapped a significant portion of merchants and rettailers around the world with partnerships either. Here are some strategies by each category of player to participate and excel with Buy Now Pay Later:

Banks can quickly provide portfolio financing programs to BNPL fintechs as a capital partner for short-term microloans. As the industry becomes more comfortable with this alternative lending structure, high ticket items such as vehicles and group travel packages may require funding from institutions. Fintechs and banks have already partnered with deposit products — it only makes sense that a lending partnership would also take place.

E-commerce Platforms have already started notable partnerships with top BNPL companies — Walmart and Shopify joined with Affirm, Ebay with AfterPay, Esty with Klarna. Smaller and niche-focused platforms should start to see growth here as well, especially travel platforms hit hard from the pandemic and ready to fulfill pent-up demand for vacations and getaways. The industry as whole is waiting to see how Amazon will get started in this space — joining with an established firm like Affirm or building its own infrastructure and program.

Card companies are experiencing the most disruption to their revenue streams from Buy Now Pay Later. The largest card networks have made early moves in this area: Visa purchased a controlling position in Klarna (2007) and developed its internal installment program for developers within its issuance network as a pilot; AMEX offers installment financing options on its platform after a customer makes a purchase at any retailer. Anticipate remaining card networks to experiment with their own partnerships and programs in the next year, and allow issuing banks to customize features and options for cardholders.

WHAT COMES NEXT FOR BUY NOW PAY LATER

The huge surge in popularity for BNPL comes at a time when unemployment, and income are unstable for most around the world. The concerning risk is that alternative payment options stretches consumers thin and beyond their means, incurring fees and interest that come with traditional credit cards.

Financial institutions are being conservative in offering new product lines or risking their own capital for lending in an economic downturn, typically a time when credit availability tends to tighten. The next 6-8 months will tell a critical story in terms of default rates and losses for these fintechs.

Klarna recently announced 7x times losses year-over-year at $60.6M, which was offset by a 44% increase in sales and international expansion into the US. If loss rates are kept in check over the few months, banks may start offering clients a similar option through their own debit or credit cards or become exclusive financing partners for BNPL giants.

Overall, the demand and future are aligned with the growth and success within the Buy Now Pay Later. Bundling these options with deposit products, niche-based offers for students, freelancers, and businesses — are all extensions taking place over the next year. In the long-term, BNPL firms can become lenders themselves (gaining their own licenses in multiple jurisdictions) and offering retail investors an alternative investment marketplace, comparable to LendingClub.

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