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In this article, we discuss how Buy Now, Pay Later (BNPL) firms will need to balance both growth and risks to build profitable and stickier platforms.
BNPL is one of the hottest trends in payments and an incredibly hot area of investment right now. The trend is not expected to change anytime soon given the increasing number of BNPL firms attracting investments, and growing deal sizes and valuation. Americans are expected to make an estimated $80 billion worth of BNPL purchases in 2022 and BNPL transactions are expected to reach 10% of all e-Commerce transactions by 2024 amounting to $120 billion.
Installment payment plans are nothing new. Retailers like electronics and furniture stores have allowed customers to pay off large purchases in installments for decades. BNPL brings the concept into the digital age by allowing any retailer to offer installment payments for any product, no matter how small, both online and in-store.
Unlike other payment types, customers are often exposed to BNPL at different points in the buyer's journey. For example, when browsing products online, they may see the BNPL installment price on the product page, which helps make the product feel more affordable. Consumers can also choose BNPL at checkout. In addition, some issuers and financial institutions are now offering buy now, pay later so that cardholders can pay for specific transactions in installments, allowing them to better manage cash flow and potentially avoid late fees.
BNPL is considered the evolutionary descendent of credit cards. Just like music went from CDs to MP3s, and most recently, streaming music; Credit Cards went from physical cards to virtual cards and instant issuance to BNPL with experience just like streaming credit.
In a rapidly growing market, where both customers and merchants love the product, everyone from banking and FinTech firms to Big Tech firms like Amazon and Apple are rushing to offer the product.
However, these providers face a significant problem.
Lenders don’t make money on ‘interest-free’ loans. Compared with traditional installment loans, BNPL makes less money for lenders with the ‘current’ business model in place today.
The primary revenue streams for BNPL loans include the following:
The key issue with BNPL is that total profit made from MDRs that range from 2% to 8% and bust rates of 25% to 35% — combined with other fees earned — does not equal the money made from a traditional installment loan for the same loan amount.
Let’s look at the two scenarios below to illustrate the difference:
|Traditional Installment Loan||BNPL|
|Term||36 months||Pay in 4; 36 months installment loan, if bust|
|Net Interest (Profit)||$430||$204|
Note: Assuming zero cost of capital, zero servicing fees, no late fees etc. for simplicity
As shown above, for the same loan amount, lenders make less than half of profit with BNPL compared with a traditional installment loan.
To compensate for the lower revenue, BNPL players will either need to increase the merchant discount rate (which might not be compelling given the costs to merchants, discussed next), or come up with other ways to boost revenue. In the above example, merchant discount rate for BNPL loan would need to be about 20% to make a net profit of $430.
BNPL is expensive for Merchants: As mentioned, merchants that accept BNPL pay between 2% and 8% in fees plus interchange costs; plus, in some cases a flat per-transaction fee — typically 15 to 30 cents. There are also administrative costs paid to BNPL firms for billing, servicing, and collections.
BNPL has an uncertain regulatory landscape which is a risk to BNPL firms. Compared to the heavily regulated credit card industry, BNPL providers have operated with relatively limited oversight. This is a risk to BNPL firms, especially as regulatory scrutiny has been on the rise.
In December, the Consumer Financial Protection Bureau (CFPB) issued a series of orders to five major BNPL providers to collect information about the risks and benefits of their solution. The CFPB is concerned about the potential for consumers to accumulate debt too quickly.
BNPL can confuse customers. BNPL loans are handled by a separate company and not the merchant. So, when an item is canceled, and a refund is needed customers get confused who to reach out to — is it the merchant or the BNPL firm?
While some merchants may assist with this, others may not. Consumers are left having to manage the refund and/or credit process directly with the BNPL provider. The experience can be frustrating and can outweigh the slick experience offered at checkout.
BNPL creates a consumer spending behavior possibly worse than credit cards. Borrowing money always comes with consequences. In the case of BNPL, seamless checkout makes it easier for customers to impulse buy and overspend. If customers struggle to spend too much on credit cards, BNPL could tempt them to rack up even more debt outside of their credit card limits. One of the things merchants like about BNPL, despite the cost, is that it leads to larger purchase amounts.
Banks and FinTechs firms that provide BNPL will need to balance the following elements to build profitable BNPL businesses:
BNPL is here to stay. Banks and FinTechs that build the right business and pricing strategies, comprehensive product roadmaps, focus on digital delivery and experiences, and build robust risk and compliance programs will be ones that create profitable and stickier platforms for both merchants and consumers.
Leveraging our deep expertise in financial services and Payments, including former entrepreneurs and business executives on staff, Sia-Partners can help with the following to help accelerate your successes in the market: