BNPL Buy now, pay later

how an old payment scheme is disrupting the payment industry

If you are in fintech or payment, you must have heard of buy now, pay later (BNPL). It’s one of the 2 of the hottest fintech topics in 2020, the other being DeFi. This year, there is no shortage of news with Goldman acquired Greensky, Square acquired Afterpay, and array of digital banks, fintechs, and incumbent banks coming up with their own BNPL products.

In this article, I will break BNPL into 5 areas:

1. What is BNPL & how does it work
2. Why so popular
3. Current development
4. Potential risks
5. Trends

What is BNPL & how does it work

BNPL is a payment option that allows the users to buy the product now, and pay later. The current BNPL is in 1 of the 2 forms:

1. Pay in X installments: The most common type is pay in 4 installments. You pay 25% of the value purchased every 2 weeks. This option is free. There is no interest charge or any other charge.
2. Short term loans: For longer term payment, typically in 12, 24, or 36 month. In this form you pay interest just like any other types of loan.

The business model

Similar to credit cards, BNPL charges fee from the merchant when consumer makes a purchase. The fee is typically 4–6%. Since most BNPL is using the debit card infrastructure, BNPL will have to pay part of the fee to financing provider, cards network (for moving money from customer to BNPL finance provider), issuing and acquiring processor /POS.

As you probably have wondered, there is nothing new here with installment payment and short term loan, so why BNPL is all the buzz now?

Why BNPL so popular

To sum it up, it’s timing, targeting, marketing, and delivery

Timing

More specifically the decline of credit card usage. In US, credit card has gotten a bad reputation as a way to get people into debt and paying the high fees on interest, late and overdraft.

“In 2019, consumers paid approximately $121 billion in credit card interest, $11 billion in overdraft fees, and $3 billion in late fees according to studies from LendingTree, the Center for Responsible Lending, and NerdWallet, respectively.”

As a result, people have been shifting their payment method from credit card to debit card especially among the younger demographics.

While debit won’t cause us run into those high fees, it also limits our purchasing power. So, it’s not hard to see the need for better payment option, one with flexibility of credit card, but without the high fees.

Target

Based on the chart above, we see that GenZ is the group that uses the least credit carda. Hence it’s no surprise to see the Ads for BNPL are very colorful and lively. For example, Klarna is famously pink and had celebrity endorsement from the like of Snoop Dogg

klarna’s pink color is aimed at younger crowd

Marketing

Once the target segment is clear, then it’s about create offering around the target segment. For example, BNPL partners with stores targeted more for the younger customers (see graph below). In addition, putting on a cool name: BNPL just sounds a lot cooler than installment payment plans or short term loans.

Featured stores on Klarna

Delivery

As a believer in embedded finance, the way BNPL is delivered is a great example: at the point of need and frictionless (real time, not much effort to sign up). Offer a better option when I need it and hassle free is a WIN!

As you can see, BNPL not only entered the market at the right time, but also executed well (target, marketing, delivery). The impact is significant in that payment behavior can be changed (more on this later).

Below are some BNPL’s value to the customers and merchants.

Why do customers love BNPL

Based on 2 different surveys below, the reasons why customers love BNPL are: 1. Avoid paying interest,

2. Pay in installments

3. Make purchase outside of my budget,

4. Easy to use, and

5. Not qualified for credit card.

Why do merchants love BNPL

1. Higher AOV (average order value): Affirm reported 92% and 85% higher AOV, before refunds, when compared to other payment methods in 18 & ’19. PYPL announced their BNPL solution is increasing cart sizes by ~39%.
2. Higher conversion rate: Klarna claims that its merchant customers see a 20% higher conversion rate. Affirm has seen their dollar-based merchant retention at 100%+ for each cohort of merchants that have joined the platform since ’16.
3. New customers: Most BNPL providers have a mobile app and email marketing suite that provides offers and even direct shopping portals to their consumer users. On the SQ/Afterpay call they highlighted that Afterpay drove over 1.0M leads on average per day and became a key marketing customer acquisition channel for their global retailers in attracting highly valuable next-generation consumers.

Point number 3 is really important because BNPL is not just a commoditized payment channel, but a platform with user traffics. Unlike traditional POS machines (Point of sale devices), which was one-and-done, BNPL providers go out of their way to present their customers offers from merchants in their network. And the possibilities is just getting started as we will explore in the next section.

Current development

Below are my observation of what’s happening in BNPL:

1. BNPL becoming superApp, a platform, not a commodity
2. BNPL market potential
3. Response from incumbents
4. Partnership opportunity

BNPL becoming superApp

When you open up the App for Klarna or Affirm, it felt more like a e-commerce platform rather than a payment feature.

Besides shopping, Klarna also announced adding banking services into the App. I love the superApp idea. Any app that uses payment as a hook to an eco-system of e-commerce, financial services products is music to my ears. In the world of apps, user traffic dominates. This reminds me a bit of China’s superApp Alipay. Though a bit different, I think BNPL has a great chance to succeed at the western version of the financial superApp. Because I just haven’t see much of other app that has combined payment with E-commerce so smoothly in the western world. Again, if you combine payment, e-commerce, and financial services together, something magic is bound to happen.

BNPL market potential

Currently, BNPL is still in infancy. It’s a market with huge TAM and triple digit growth potential.

We will start by looking at the high level. It’s no surprise that we have seen a sharp rise to e-commerce globally due to the pandemic. eMarketer expects global online sales to grow from $3.4T in ’19 and to reach $4.8T by ‘23E. Along with that growth is digital payment. And in the digital payment arena, BNPL is expected to have the highest growth.

Currently in US, BNPL accounts for only 1.6% (~$18B) of the ecommerce according to 2020 data. This is expected to quadruple to $74B by 24' to reach $74B according to Worldpay data:

What’s important to note is that the growth in BNPL usage has grown from its intended younger segment to the older:

This is interesting as it reminds me of Clayton Christensen’s Jobs to be Done. You start with a small niche, once your product becomes good enough, you start to spread to other segments, and I believe we are seeing that here as well.

Response from incumbent

After laying out the bull case for BNPL, it’s not hard to see incumbents’ active response:

Citi, Chase, Amex, and a number of other incumbents are offering to pay specific purchase on their credit card in installment, and calling it BNPL. While it is hard to forgo the credit card cash cow, patching an add-on to existing credit card just won’t work, first principle of design.

BNPL has great customer acquisition strategy because it’s at the point of purchase, not afterwards. Also, I have mentioned in the superApp section, there is no value in commoditized feature, but an eco-system combining payment, e-commerce and financial services is a WIN. And none of these incumbent solution is doing so.

Partnership

Large BNPL players are securing partnership relation with large merchants or platforms. Affirm with Shopify and Pelton. Klarna just announced partnership with Stripe. The smaller players are partnering with companies that have access to network of merchants. Splitit and Four have opted to partner with major payment networks including Visa and Mastercard as a way to take advantage of extensive relationships with merchants and retailers.

While this kind of partnership for growth will only continue, I think what’s interesting here is that BNPLs are furthering their partnership with merchants that went beyond traditional POS. For example, Klarna works with merchants to go deep into the consumer journey and optimize conversion pre-checkout, during, and after. This is why they often announce merchant “partnerships.”, More importantly, this is why the e-commerce part is so crucial to the BNPL eco-system.

Risk

Debt problem: Just like any debt product, BNPL can have debt problems. In a recent study, 1/3rd of US consumers have fallen behind on repayments (and 72% of those consumers said their credit score had declined). In the UK, one in ten BNPL shoppers has been chased by a debt collection agency.

Part of the reason contributing to this problem is BNPL is too easy to use. With BNPL embedded into checkout, and process so seamless, people have argued that consumers are getting BNPL without fully understanding the product. On the contrary, this is also the reason why BNPL has been so successful.

As the industry progress, BNPL’s underwriting model will get better. Coupled with the imminent regulatory change, I don’t see the risk that BNPL’s debt problem getting out of hand.

Trend

1. Regulatory change
2. B2C to B2B & embedded vertical
3. Customized BNPL
4. Move away from network

Regulatory change: Currently BNPL is not regulated. As it gains more popularity, we will likely see regulation in the space. In general, this is good for its development.

From B2C to B2B: BNPL started in the B2C space. As the space gets crowded, we will see more companies with BNPL in the B2B space. For example Billie, a B2B focused BNPL got investment from Klarna.

Further in the B2B space, BNPL will be embedded into specific verticals. For example, Ula, a company that provides supplies to mom & pop shops in Indonesia & has received funding from Jeff Bezos, is planning to add BNPL as a payment option for its users.

Customized BNPL: As the data above shown, we are currently still in the infancy of BNPL with BNPL only account for 1.6% of e-commerce. As the trend grows and it will, I anticipate to see BNPL designed for a specific target group of users. Who says that the installment should be in 4 with equal payment?

Move away from network: This is purely my speculation. As the BNPL has more merchants in its network, it has the capability to integrate with these merchants and bypass the cards network (Visa & Mastercard) for transactions, at least the initial transaction at the checkout.

Such closed loop transaction not only gives BNPL more share of the revenue per transaction, but also makes the experience more customizable and keeps all the data. Of course there are reasons against it such as chargeback handling, reporting, compliance,…,etc.

Conclusion

As a former fintech entrepreneur I know how hard it is to change user behavior, especially payment behavior. BNPL succeeded in doing so without any true innovation, and when tech giants have failed (think of Google Pay, Facebook Pay, and Amazon Pay). Timing, as more people are switching from credit card to debit, right execution (target, marketing, and delivery), and younger users who are less sticky and more willing to change are all relevant factors.

I am optimistic of BNPL’s future. Let me repeat: an eco-system that nicely combines payment, e-commerce, and financial services is a WIN.

Thank you, and please leave any comments or suggestions.