While the Covid pandemic has killed millions of people and many businesses were closed around the globe, there are few businesses that skyrocketed during the pandemic. Buy Now Pay Later or BNPL is one of those businesses. And the wave has not ended yet. With the historic rise of inflation, unemployment, and the pressure to meet the demands and trends in this era of social media many players have entered this market. Buy Now Pay Later has been rising and placed itself as a permanent payment method at almost all online retailers.
While it gave rise to many startup companies around the globe, it created concerns for some banks, credit card companies, and small online retailers. While some consumers are happy with the BNPL business model and enjoying it, some are paying huge interest for the trap of their wants. In this article, we will discuss the business of BNPL companies, their rise, how BNPL companies earn money and what it means for end customers, and finally the future of BNPL. So stick around.
Rise of BNPL
March 2020, a historic lockdown time throughout the world, people were forced to stay at home, and the demand for online shopping surged which gave rise to the not-so-popular payment method of Buy Now & Pay Later. Buy Now Pay Later allows consumers who can not afford to buy the product at the moment, to Buy the Product and Pay in installments, and that too without any interest. It’s so convenient that you don’t have to wait for weeks to get the background or credit check and you will get instant approval to use the BNPL service. Doesn’t that sound too good to be true? Well, it is.
There is a saying that there are no free lunches in this world. And if you are offered one, then there is definitely some hidden cost you can’t see at the moment. The same is true for BNPL companies. Though the BNPL lends you the money at no interest. It’s not free. But before going there, let’s understand how this BNPL works.
Suppose you were scrolling through social media and now you see a newly launched pair of shoes endorsed by a star. Now you can’t resist the urge to buy them. You open the online store website and you see the same shoes for $200. But then you don’t have that much cash in your bank, and you were about to leave the site. But wait a minute. Now you see another payment method there called Buy Now Pay Later in installments and 0% interest. Now it gets interesting from here. You can get the product now and then you can pay in installments and there is no interest as well. You can’t ask for more. So you go ahead and apply for BNPL, you pay $50 now and commit to paying $150 in the next 6 weeks, which means you’ll pay $50 every 2 weeks.
Now some of you say that it’s awesome. I got my shoes and I can also do some showoff and pay 3/4th of the price in the next 6 weeks. What’s wrong with this? While few of you with some business knowledge will ask, Ok now I got my shoes and I’ll also pay the rest of the $150 in the next 6 weeks, how is the BNPL making money with this? Are they doing any social service? Well, definitely No. They are making really good money. Let’s see how?
Make money with BNPL
Now Let’s see how BNPL companies make money with all this. There are 2 major sources for BNPL companies to make money.
- First, the BNPL companies make money by charging their customers interest rates of up to 25% for any missed payments. According to a survey by Reuters, of all the customers who use BNPL in the US, at least ⅓ of them fell behind in paying on time. And then give a huge sum of interest over the months.
- The other source of making money for BNPL companies is retailers. BNPL companies take a cut on every purchase made using their service from the retailers. As BNPL helps retailers boost their sales, retailers are not hesitant to give a share of purchases to the BNPL service providers. The terms and conditions vary between retailers and BNPL companies.
Now, a lot of you will still ask if I am paying my installments on time. It’s still an interest-free purchase for me. Well, it looks like. But it’s not.
Long term Danger
So till now, it looks like that BNPL is not charging you if you are paying your installments on time. And it only charges interest if you miss your payments. But it is partially true. Let’s see how?
As I mentioned earlier, BNPL companies charge retailers for providing the BNPL service to their customers and they charge somewhere between 5-7% of commission from retailers. So ideally the $200 shoes you bought from the online seller were actually between $185 to $190 which the seller had inflated to $200. But now you say. Even if I was buying this using a credit or debit card. It was still the same. Well maybe Yes. Or maybe No.
So let’s understand this first from the customer’s point of view. If there was no BNPL option, would you still be buying those shoes? As most of the BNPL customers are people who live paycheck to paycheck. Now if they have to pay for their wants while they are struggling to make their needs met, they will be hesitant to buy such items in the first place.
Now in the second part let’s see from the retailer’s point of view. If a customer is buying an item using Cash or Debit then retailers spend very little to no cost on those purchases. Whereas if the purchase is using a Credit Card, retailers have to pay 3-4% of the cost to process that transaction. With BNPL retailers have to pay 5-7% of the cost. And that’s why retailers inflate the rates on their websites. And that’s why when you go to a store of the same retailer they offer “Discount on paying Cash”.
So now you ask why retailers are giving these options if they are not making anything from them. Well, they are making sales. They inflate the prices and customers who can’t afford to pay in full choose the BNPL and retailers still sell the items. For customers that are paying using a debit card, retailers make 5-7% more. And if customers make purchases using credit cards, retailers still make 2-3% more than paying in cash. But customers are paying the hidden cost. The retailers who don’t have a BNPL option might have less price for the same item. Or maybe Amazon or other big retailers who have their own BNPL option, as their intent is not to earn through BNPL but through increased sales of products.
What Customers can do?
So now you know the hidden truth behind the Buy Now Pay Later. And though it looks like free money, it is not. In Fact, it can be dangerous in the long term. As more and more BNPL companies will come up with their own platform, it’s very likely that customers will miss paying on time.
Buy Now Pay Later plays with the emotions of customers by giving them free money for some time. But customers don’t realize that this money is actually not free and they have to return it soon. And the things that were not affordable 2 weeks back, are still not affordable. So now the question comes Is Buy Now Pay Later not good and we should not use it? Well, I can not answer this question for you. But you can answer it for yourself. But there are 2 things that you can definitely do
- First, make sure you know the difference between your needs and wants. If you are working for your needs to meet and living paycheck to paycheck. Then don’t fall into the trap of Buy Now Pay Later for your wants. If there is something that is super important to buy, then use BNPL wisely and make sure you don’t make a habit of BNPL.
- And second, try that instead of relying on Buy Now Pay Later you make a habit of Save Now Spend Later. And then you will never fall into the trap of free money.
Future of BNPL
The BNPL is a rapidly growing industry and the Covid pandemic gave the industry another era. The industry saw transaction volumes grow from $33 billion in 2019 to $120 billion in 2021. The BNPL business model evolved from the lower interest rates and rising online market during the pandemic.
But Although the lending option looks lucrative, it’s becoming hard to sustain with growing inflation, rising interest rates, incoming regulations for BNPL, and a potential recession. The signs are already visible in 2022 with the drop in the valuation of existing BNPL companies. Klarna’s valuation has dropped 85% to $6.7 billion from $45.6 billion a year ago. Affirm also disclosed losses in 2022, and the stock has dropped more than 75% YTD.
With these market conditions, it’s becoming very hard for commercial companies to offer competitive credit at scale. Many companies who were successfully testing the BNPL model in 2021 have put these businesses on pause for now. A few BNPL companies are acquired like AfterPay was acquired by Square (Block lately) and Paidy was acquired by PayPal.
But we still think that the next decade will actually transform the Buy Now Pay Later industry and we will see another form of BNPL. The market will shift from third-party BNPL providers to healthy brand relationships. And with many retailers and commercial banks bringing their BNPL versions will give end customers a trust factor as well. The regulations in the industry will also help in this scenario. And by sorting out the challenges, BNPL can be a successful industry for both customers and retailers.
Well, That’s about the Buy Now Pay Later business. Let me know what you think about it in the comments below.