Unpacking the "Buy Now, Pay Later" Disruption

In recent times, FinTech discussions have largely been focused on advanced and complicated products that deploy technology in new ways, such as cryptocurrency, decentralized finance NFTs, etc. While the focus has been on those spaces, Buy Now, Pay Later companies have been creeping up in size, market adoption, and impact, only arriving on many people’s radars after the acquisition by Square of one of the major players in the space, Afterpay, for $29 Billion. 

Predictably, there has been a frenzy in the sector since then, with several companies raising large rounds and considering acquisitions, according to reports. Examples include the £80 Million round raised by Zilch (UK), taking their valuation to £200 Million, Dubai-based Tabby raising $50 Million in its Series B to reach a valuation of $130 Million, Israeli Behalf (backed by Visa) raising $100 Million in debt, and Swedish Klarna seeing its value leap $14.6 billion to $45.6 billion in a three-month window between rounds. Other giants such as Mastercard, Visa, and Apple have also gotten in on the action through partnerships with fintech players. In Africa, Credpal, ALAT, Payflex, and Carbon are among the companies leading the charge.

So, what’s behind all this action, and how do these companies really make money?

The BNPL Business Model

It’s as it says on the sticker – you buy what you want now, and you pay for it later, usually at 0% interest rate…unless you default, but we’ll come back to that. Typically, the companies enter partnerships with retailers who then include the BNPL companies as checkout options. Customers are pre-approved for credit up to a particular amount, so the process is seamless. The customer then pays the sum back in regular intervals over the course of 4 to 6 weeks. 

The way BNPL companies make money is called factoring, and it’s an iteration of a business model that has been around for centuries, with documentary evidence dating from the Egyptian civilization. Essentially, the retailers sell the customer’s debt to the BNPL company at a discount, which the company then collects in full and takes the difference as its profit. For instance, a bag priced at $100 would be charged to the company at $90. When the BNPL company gets the money from the Customer, it would have made a profit of $10. If customers do not pay on time, the company would charge fines and make additional profits that way. 

The merchants benefit because they’ll make additional sales as people are incentivized to buy things they might not otherwise have bought if they had to pay upfront, and the company gets all the revenue upfront, which is great for cash flow. All that without any of the risks of chasing down the loan by itself. 

Industry Growth

According to a Worldpay report last year, pay later accounted for 2.1% of e-commerce transactions worldwide, continuing to earn market share, and expecting to double by 2024. One can also observe that while a few years ago Australia and Sweden were the top markets in this area, now, the UK and the US are catching up on this. BNPL equates to around GBP 9.6 billion in annual spending in the UK, while in the US accounted for almost USD 20 billion in 2019.

Moreover, per a Coherent Market Insights report, the BNPL platforms market worldwide was esteemed at USD 7,320.6 million in 2019 and is expected to reach USD 33,638.3 million by 2027 at a CAGR of 21.2% between 2020 and 2027. During the forecast period, the fashion industry is anticipated to hold a dominant position in the market.

Supporting Trends 

Several factors are driving this amazing growth. First, there’s the fact that younger people are averse to the existing credit (card) system, with nearly 40% of BNPL shoppers saying that avoiding credit card interest payments drove them to try BNPL, according to a recent survey conducted by Motley Fool. 

Open banking frameworks are also aiding this trend. More countries are introducing laws to facilitate the sharing of financial data among specified categories of companies in a secure and data protection-compliant manner. The ability to tap into that data using advanced analytics methods is a crucial reason why a relatively new company would be able to make credit decisions with a similar degree of accuracy as a bank that’s over a century old. 

In addition, the close integration of the BNPL services with e-commerce retailers is another plus. First, this is how the vast majority of young people (and older ones, increasingly) shop. Shoppers can go on any site and if that site is integrated with their BNPL system of choice, they can check out in as little as one click without needing to enter any credit card details, which is a pain point that many startups including Fast (US) and OurPass (Nigeria) have been working to solve, to remove the risk of identity theft and increase convenience by eliminating the card entry step. Given that the number of retailers on board with BNPL is rapidly increasing, it appears likely that the services will continue to grow and become ubiquitous.

Regulatory Intervention – Sooner or later?

They probably will become ubiquitous, but certainly not unchecked, if regulators have their way. So far, in most places, BNPL companies have been able to operate without the regulatory stricture of traditional banks and credit card providers. 

For instance, in a recent report, Fitch Ratings said the sector’s debt performance reporting is “opaque.” Many such providers do not report the use of such services to credit bureaus, the rating provider said. That means that consumers could potentially access debt from multiple BNPL providers, far above what they would be able to get from traditional lenders, and possibly more than their ability to pay, which then leads to increasingly large fines that the customer would then be liable for. There have also been accusations of misleading advertising on fees as well as how the loans could affect customers’ credit scores.

Regulators have started taking notice around the world. 

In the UK, the Financial Conduct Authority (FCA) has indicated that BNPL companies should be subject to the usual credit rules of a hard credit check and affordability test, as well as restriction on repayment timelines, although the law is expected to take at least two years to change after being tabled before parliament. The US fintech regulations ecosystem is much more fragmented, but at least one state, California, has taken a hard stance, accusing Afterpay of collecting taxes on “illegal loans” and compelling the refund of $900 Million to customers. 

In Australia, the rules in the Australian National Consumer Credit Protection Act of 2009 do not apply to certain types of loans, including short-term interest-free credits, so BNPL companies have free rein, for now, resulting in the companies adopting a self-regulatory approach, with the Australian Finance Industry Association (AFIA) announcing on the 1st of March 2021 that its Code of Practice for the BNPL sector had come into effect. According to the association, the Code goes above and beyond the law to set best practice standards and strengthen consumer protections.

Elsewhere, while there have been calls for closer scrutiny and, in some cases, accusations of harmful practices by BNPL companies, there’s yet to be much in the way of definitive regulatory action targeting them. Those regulations will certainly come, however, as the services become more widespread. You could even say the companies are buying now and will pay later. 

What do you think about Buy Now, Pay Later Services. Do you think they'd encourage impulse spending, and do you or would you use them? Leave a comment with your thoughts and don't forget to share with others who would find this interesting.