Updated: Aug 18
I hate the “Buy Now, Pay Later (BNPL)” business model – it’s evil!!
When I first heard of the Buy Now Pay Later model that many fintech companies were getting into a few years back, I had an instant adverse reaction. I could see where things were heading and it was not good. As time passed, my fears have started coming true!
I got a taste of this new business model recently when my wife put a purchase on our credit card via a local BNPL app. When asked why, she mentioned the skin clinic pushed her onto the app even though she wanted to pay the full amount right there! Their marketing gimmick “it’s only 4 equal interest free payments” worked on her. I told her that paying “cash” or 100% upfront on the credit card would have gotten her a big discount and we wouldn’t have additional sms “purchases” to remember for the next three months. This company is hoping to double dip on the fees – fees for using the app and credit card fees if I don’t remember to pay off the card fully!
Things didn’t just end here. Last month she had another appointment and naturally they tried to upsell additional products. She initially refused, saying she didn’t have her purse on her and couldn’t remember my credit card numbers either. “Don’t worry”, smiled the sales clerk, “We already have you on record with the app so it’s approved without further verification”.
The fact that my wife could now make infinite purchases at the shop so easily, without her card, payment app, CCV, or pin is worrisome (from a security point of view). However, I couldn’t help but be impressed how smooth and easy the whole purchase process was. And I’ll be reminded of this each month for the next three months.
What is BNPL?
BNPL is basically a payment option that allows consumers to purchase products or services and pay for them in installments over time. BNPL companies essentially act as intermediaries between retailers and consumers, offering an alternative payment option to traditional credit cards.
The BNPL business model typically works as follows:
A consumer selects a product or service to purchase from a retailer that offers BNPL as a payment option.
The consumer chooses to pay for the purchase in installments over time, rather than paying the full amount upfront.
The BNPL company pays the retailer the full amount of the purchase upfront.
The consumer makes payments to the BNPL company over a set period of time, typically in installments over a few weeks or months.
The BNPL company charges the consumer interest or fees for the use of its payment service, which is how it generates revenue.
BNPL companies typically market their services to consumers as a more flexible and convenient alternative to traditional credit cards. They often offer interest-free payment plans for a limited time or low fees compared to credit cards, making them an attractive option for consumers looking to make purchases without incurring high interest rates.
The Good Ol Days
Growing up in the nineties and noughties in Australia, things were much simpler. Credit cards were relatively rare (none in my family), cash was king and walking to school was a 2-miles trek, uphill both ways, barefoot and under a foot of snow!
Growing up in a one-income family, money was tight and my mum meticulously budgeted everything to the dollar. We didn’t have a credit card so we had to save up for everything with cash. For some purchases, layby was available.
I can still remember picking up toys from the shop a few days before Christmas after mum had been paying it off all year, a few dollars each month. Months of patience and waiting and hoping finally paid off and it was in my hands!! The great thing about the laybys was that there was never a credit card bill shock in the new year.
As I grew up, credit cards became more and more common. However, their use came with a heavy price, namely the high interest rate and fees (should you miss a payment). I did get a credit card but was rightly fearful of them, having seen several friends get into trouble. For many people, the temptation to consume is too much to ignore.
A New Business Model
When I first heard about Afterpay in 2015, I could see trouble ahead for general consumers. The newest iteration of the BNPL model was slick! The easy transaction between sellers and buyers with minimal friction comes at a heavy price that is invisible to consumers. Venture Capitalists saw it too and poured billions into the new fintech BNPL companies that had sprung up all around the world. For a while, it seems that every BNPL company turned into a unicorn overnight and there was no end in sight.
There was no shortage of what goods and services you could use BNPL on. No amount was too high or low either. In fact some coffee shops went out of their way to encourage you to put your purchases on BNPL!
Now Venture Capitalists aren't dumb to just dump billions into anything without the expectation of large returns. They understood the business model too well. BNPL companies make money by charging fees to both merchants and customers, and ties together with e-commerce companies very well. The Covid-19 lockdown worldwide was a massive boon, further helping the spread and adoption of BNPL.
Follow the Money
Now, given that the BNPL companies don’t charge interest on the purchases, it’s natural to ask how they make money. Here are a few ways that BNPL companies generate revenue:
Merchant Fees: BNPL companies charge merchants a fee for each transaction processed through their platform. This fee is typically a percentage of the purchase price, similar to the fees charged by credit card processing companies.
Interest and Late Fees: Many BNPL companies charge interest or late fees if customers don't make their payments on time. These fees can vary depending on the company and the terms of the payment plan.
Data Analytics: BNPL companies collect a lot of data on consumer purchasing habits, which they can use to generate insights and analytics for retailers. They may charge retailers for access to this data or use it to create targeted marketing campaigns.
Referral Fees: Some BNPL companies offer referral fees to merchants who promote their services to their customers. This incentivizes merchants to promote the BNPL service and can help the BNPL company attract more customers.
Not to be left behind, I recently saw Apple start their own BNPL model which is an ingenious move that I’m sure many other brands with global presence will follow. Apple is now able to increase their earnings by simply using their inventory instead of using external financing or their own cash flow.
Furthermore, Apple will be a lot more effective locking users into their web of products and with more details on the behavior of their customers, will be able to fully exploit this with all their products for every cycle!
Getting back to the original reason why I hate the BNPL model. The model works too well, especially for those that may not have a credit card or access to credit the usual way. This is akin to subprime lending in the mid 2000’s and we know how that ended! For the convenience of “4 interest free payments”, consumers will pay a heavy price for using BNPL services. Especially those that can least afford it, leading to a potential debt spiral.
There’s a lot of dark clouds building up in the distance for the entire BNPL industry. We are coming out of a low/zero interest environment with central banks all over the world lifting interest rates up quite a bit in the past 1-2 years to combat inflation. I can see two major developments happening:
Funding and access to cheap credit will dry up. BNPL companies will be forced to source money at a much higher interest rate to operate their business model. It will be hard to push this increased cost onto businesses (as they are trying to lure more businesses to join the system) so the cost increases will mostly be borne by the consumers via hidden fees, higher interests and bigger penalties (for missing payments).
VC will stop financing BNPL companies directly and opt more often for a debt arrangement to mitigate risk. With funding drying up, many smaller BNPL companies will struggle to survive and there will be consolidation of the industry, leaving only a few big players worldwide. Decreased competition also means a worse deal for the consumer!
Things aren’t looking good for the retail consumers. Avoid using BNPL if you can and be extremely careful if you use it!
**After my initial draft of this post, I came across a great video from “2 Cents” also pushing back and warning consumers about the BNPL model.