‘Buy Now, Pay Later’: The next digital financing revolution

Rory Clarke analyses the emerging ‘Buy Now, Pay Later’ industry to see whether its prescient potential stands up to scrutiny.

The ‘Buy Now, Pay Later’ (BNPL) industry has grown from the ‘seeds’ of the credit card industry, watered by evolving attitudes towards digital financing. The job BNPL aims to do, its key value proposition, is simple: to enable users to buy products immediately and pay for them in instalments, without any extra interest being accrued. The product fills an ‘opportunity gap’, originating from the evolution of consumer purchasing trends. At a practical level, these services are often integrated into an e-retailer’s website and appear as a payment option at checkout. Two key players, Afterpay and Klarna, will be used throughout this piece as key examples of the burgeoning industry. 

This type of system has several significant advantages for both end-users and retail partners and merchants. The service allows end-customers flexibility in managing their payments without requiring them to apply for a loan, pay additional fees, or provide extensive personal information which might cause delays and frustrate their buying experience.

The targeted segment is those in short-term financial pain. Interestingly, this category is naturally two-fold - ‘actual’ and ‘soft’ - both of which BNPL accommodates. Firstly, they aim to enable customers who would have actually been financially unable to purchase a product/service to do so, with the cost spread more manageably over fortnightly payments. Secondly, they aim to soothe the conscience of reluctant, impulsive or abashed customers who (whilst able to buy-upfront) can more readily accept a ‘spread-out’ an instalment payment pattern, rather than a larger up-front payment. Marketing campaigns emphasising instant gratification can take advantage of these users’ characteristics.

BNPL solves the current purchasing dissatisfaction of certain (likely younger) consumers who are unable or unwilling to get formal financial credit, which can be associated with middle-age and conventionality. Indeed, over 50% of Afterpay’s customers are reported to be aged between 18-34. It provides the convenience & ease which credit cards can lack. Consumers are attracted to the service’s simplicity. Unlike many alternatives, you do not need to understand financial jargon, battle with variable interest rates, or accept the inevitability of fees. The simple instalment option, with a stated fee for lateness, is readily understood. In the words of Anthony Eisen, Afterpay’s CEO, one of its greatest assets is that is not “a chocolate box of different sorts of...options”.

Simultaneously, as a financing tool, it potentially enables purchases to be, in present (and conscious) value cheaper. They reduce purchasing risks and take advantage of the universal perception of future values and costs as lower than those present-day costs - €80 spread over 8 weeks seems cheaper than €80 spent immediately. 

Some BNPL firms operate by partnering directly with ‘retail merchant clients’ (RMCs), who pay merchant fees in return for the provision of services to their customers. These merchant fees are a combination of a flat rate fee per transaction, and a percentage based on the value of the underlying sale. The service is beneficial to retailers as it allows them to capture the business of customers who might require, or simply value, the flexibility afforded by the service. However, arguably more useful are those BNPL services that can be used anywhere and in any shop e.g regardless of whether the financing BNPL has a formal partnership with them. 

Klarna, a Swedish company, and (arguably) the market leader, is one such firm. Unlike Afterpay, it is a ‘pay anywhere’ firm - which allows more consumers to realise the service’s benefits. Indeed, a significant aspect of credit systems’ convenience moves from their ubiquitous acceptance by merchants (or lack thereof). 

Across a sample of 6 major BNPL services in Australia (including Afterpay) between 2016 and 2018, average quarterly revenues more than doubled, from AUD32m to AUD78m. Klarna entered the UK market in 2014. In 2020, it had 10 million customers, rising from 7 million only a year earlier. Afterpay’s own share price has multiplied more than 134-fold since their initial flotation (Anon, 2021). Integral to this were strategic partnerships with lead merchants, for instance, Urban Outfitters and Levis, which indicates and prompts wider adoption by merchants. Finally, Worldpay expects BNPL companies to facilitate 4.2% of all global payments by 2024, with current average annual growth rates of 39% (Mavadiya, 2020). Indeed, such is the growth and attraction of the market that established financial payment services such as Visa and PayPal have begun to create their own BNPL solutions.

BNPL usage is expected to double between now and 2024. Whilst still accounting for less than 5% of overall payments, the pace of growth is impressive. Moreover, general dissatisfaction with traditional banking and financing practices makes it sustainable with shifts towards digital alternatives more prevalent. For standard debit card services, Revolut recently acquired its 1 millionth Irish user. If a digital credit alternative was more readily available, some of those digitally-inclined users would likely take it up as well.  

Furthermore, banking practices have historically been ‘sticky’ -customers stay permanently with institutions they opened accounts with as young adults. We have already seen how BNPL demographics skew young. If these firms can execute the promise they trade on and entrench themselves in the day-to-day financing of these groups, the segment is primed for long-term, sustainable growth. Furthermore, the Covid-19 pandemic “accelerated structural changes” in moving closer to digital solutions and online retail, prompting the Financial Times’ editorial board to ‘bid farewell’ to conventional bricks and mortar establishments in a recent opinion piece.

The industry has been essential for keeping up economic activity during the pandemic with BNPL platforms facilitating an estimated $20-$25 billion in transactions in the US last year. The UK BNPL market is now worth £2.7 billion ($3.7 billion) and has had 5 million users since the start of the pandemic.

However, the reliance on automated technologies has the potential to be a fatal flaw in some BNPL services. Indeed, some, notably Afterpay, do not conduct manual credit checks on consumers. If systems are not properly optimised, firms risk refusing viable end-customers and accepting non-viable ones. The automation of this system raises the risk-level in this regard, as revenues may be lost, or significant bad debts accrued, without the knowledge of the company. This flaw exposes companies to more than mere financial damage; reputational damage from over-extended customers struggling to meet payments, and the damage caused to customers themselves, are distinct risks to the business. This is particularly concerning for BNPL’s young customer-base, who generally have less financial literacy and self-discipline. In this regard, it is worth noting that an Australian Senate Inquiry voiced concern over a reported 1 in 6 young Afterpay customers being in debt. This has led to widespread calls for the industry to be brought under the regulation of the Financial Conduct Authority (in the UK) and similar consumer protection bodies across the world. This would align the BNPL industry with the standard (and heavily regulated) general consumer finance industry.  

The BNPL industry is not a fad or a phase, but a sustainable and serious financing tool, particularly for the digitally native. It is an attractive and feasible digital solution to short term financial pain which many consumers are willing to take a chance on. Once they do, they become product advocates and promote it through word-of-mouth. Much like Revolut, which has now topped 1.2 million Irish users, there is space for the digitally native at least, to adopt BNPL to the extent that it “would be a surprise to find someone who isn’t signed up”.