Buy now pay later – replacing the credit card or fintech flash in the pan? 24 March 2021
For a sense of perspective, Revolut, probably the most well-known challenger bank, was valued at $5.5 billion in July of 2020. N26, the German digital-only bank, is valued at $3.6 billion. Only Stripe, the American payments technology provider, is larger than Klarna, with its recent $600 million raise making it the most valuable private fintech in the world at $95 billion. Klarna has gotten so big, they even purchased a Super Bowl ad this year, shelling out $5.5 million to put their services in front of the largest American television audience of the year.
So, what is driving BNPL’s incredible success and some eye-popping valuations? Paying in installments is not exactly a revolutionary idea. The option of paying in installments has been around for ages. Layaway purchases became popular during the Great Depression. The Klarna’s and Afterpay’s of the world have simply capitalized on explosive ecommerce growth by creating slick, easy-to-integrate payment options for retailers and customers. In a competitive digital sales environment, the easier a retailer makes it to buy their product, the more they will sell. Without comprehensive ecommerce offerings in 2021, any retailer is going to struggle.
Second, there is the Covid impact. Ecommerce was already on the rise pre-Covid but this past year has put it on a rocket ship. The explosion of online buying has coincided with a flourishing of different ways to pay for things, like BNPL. Comparethemarket.com found that in the UK, 19% of shoppers are using the BNPL form of credit compared to 11% pre-pandemic.
Next, the BNPL concept aligns well with the preferences of younger generations. It may be a cliché but millennials and Gen Z really do prioritize instant gratification. BNPL companies deliver instant gratification in a fintech wrapper. “Buy now pay later products especially resonate with young consumers, who, since the start of the pandemic, have contributed to the significant shift in online spending,” Shopify COO Harley Michael Finkelstein said during an earnings call on Feb. 17. BNPL makes products more accessible to younger people with less buying power by reducing the upfront cost.
Furthermore, younger generations are more interested in debit cards than credit cards. In a 2015 survey, Chime, the American neobank, found that 67% of millennials prefer debit cards over credit cards. A credit card is essentially a running BNPL tab, but they carry a certain stigma associated with high interest rates and lifelong debt. Younger people seem more comfortable with debit cards and then only using credit on a purchase-by-purchase basis.
One final, Europe-specific point related to credit cards that is important to keep in mind: Europe is a big market full of people who like buying stuff. But, for complicated reasons like interchange fee caps, credit cards have never become popular on the old continent. That doesn’t mean Europeans are credit averse. They aren’t shy about taking on debt, especially in Northern Europe. An environment where people want to buy a lot of things and are willing to take on credit, but where virtually no credit card companies exists, has been ripe for Klarna, which is Swedish, to introduce their micro-credit tool to great success.
The confluence of these trends means more players want in on the action. Paypal, Visa, and Shopify have all launched their own BNPL offerings. These companies are now playing catch up to the Nordic and Australian BNPL companies that have established themselves thanks to the propitious dynamics in those markets.
One cause for concern, however, is the liability inherent in BNPL business models. When a shopper elects to pay in installments, the non-payment risk is borne by the BNPL company and the credit checks can be a bit of a black box. For certain types of financing, like the popular “Pay in 4” plan, they claim their credit checks won’t be visible to other lenders or affect users’ credit scores. It is likely an algorithm-based process with speed of approval being the most important aspect. Remember, instant gratification is the goal. The problem is, in the aforementioned comparethemarket survey, they found that more than a quarter (27%) of those who’ve taken advantage of the delayed payment in the past year couldn’t afford the purchase at the time. That leaves BNPL on the hook if the payments are never made.
Beyond loan book liabilities, there are customer welfare considerations. In Australia, their securities and investments commission (ASIC) found that 21% of customers had missed a payment and 20% had cut back on essentials because they had overspent. In response to these findings, Australian BNPL companies banded together to create a new code of conduct with the goal of protecting consumers. Provisions include credit checks for purchases above $2000, not offering BNPL to minors under 18, and no additional purchase will be allowed for customers who are late on a payment. These rules of the road can help keep companies and the industry on track while avoiding the dreaded “predatory” label.
Concerns about lax credit and missed payments haven’t prevented credit card companies from becoming some of the biggest companies in the world. There is no reason BNPL companies can’t do the same. However, if they are to maintain their respectable image compared to the vulturism often associated with the credit card industry, they will need to follow codes of conduct like the one being implemented in Australia. This will mean fewer horror stories of people piling up mountains of BNPL debt. And just maybe cement BNPL’s status as the “credit card” for the next generation.