Have you ever wanted a nice winter coat that was outside of your price range? You could put it on a credit card, but that would demolish your budget for the month. You could purchase it through a layaway program, but that means you will have to wait to get that warm, fashionable look. Or, you could use the rapidly growing Buy Now, Pay Later (BNPL) plan to get the best of both options.
Like layaway, BNPL enables consumers to pay in small monthly installments, but it is unique in that consumers get to bring home the item immediately. Consumers are able to just walk away with their purchase because BNPL services, like Klarna, Affirm, and Afterpay, pay the retailer for the item upfront and then recoup those funds when the installments get paid off. Most of the income for these companies is derived from processing fees that merchants pay, which can be double or triple what retailers pay to credit card processors, and a smaller portion of the income comes from late fees paid by consumers.
Last year, BNPL services grew by as much as 200% and management consultants Oliver Wyman estimate BNPL firms facilitated between $20 billion-$25 billion in transactions in the U.S. alone. In just the first nine months of 2020, the four big providers – Klarna, Affirm, Afterpay, and PayPal’s Pay in 4 – saw a more than 50% increase in payment volumes, but collectively these firms handle a meager portion of global e-commerce spending. With so much room for these companies to grow and reach more consumers, it is no surprise that Bank of America predicts that such services could have an annual value of $1 trillion by 2025.
Retailers such as Walmart, Macy’s Inc. and Sephora have incorporated BNPL into their payment options to adjust to the growth of online shopping due to the pandemic and also to capture younger shoppers who tend not to use credit cards. Pandemic-related retail sale declines have been somewhat offset by the income from store-branded credit card fees. For Macy’s, credit card income from store and co-branded cards is expected to account for almost all of its operating income in the current fiscal year, even though Macy’s signed up fewer store-branded credit card customers in 2020 because of temporary store closures. But to attract new customers, Macy’s tapped Klarna to create a host of BNPL shoppers that it hopes will eventually move over to store-branded credit cards. The experience seems to be a positive one for Macy’s as 40% of the shoppers using Klarna are new to Macy’s and 45% are under forty years old.
Historically, BNPL services were used to spread out the cost of large purchases, but in the past year more customers have used the service for items costing $500 or less. Currently, fashion and beauty product purchases make up about 70% of pay-later transactions, and the most frequent holiday purchases by U.S. users of Afterpay included thermal clothes from Old Navy and Crocs clogs. This purchase pattern seems to fall in line with the prevalence of young users trying to find ways to make purchases without racking up credit card debt on top of student loans. But Alan McIntyre, the head of Accenture’s global banking practice, also has concerns that around 40% of people using BNPL are doing so because they could not get access to traditional credit for whatever reason.
Although the BNPL companies claim their services cause less financial damage than credit cards, there are growing concerns about the harm these relatively unregulated services can cause. The criteria to sign up for a BNPL service is quite lax. All that is required is for the user to be eighteen years or older and to have a credit or debit card as a backstop for their payments. Only a handful of companies choose to take the extra step of running a credit check before allowing access to the service. The simple sign-up, easy checkout process, and delayed payment format contribute to the convenience of BNPL, but they also create a service that encourages impulse buying. Racking up charges with these services can turn disastrous quickly once a person starts missing installments because services like Afterpay and Klarna keep adding on late fees and some companies like Affirm charge a non-compounding interest rate of 30% (much higher than the average credit card interest rate of 16.43%). According to a report from Credit Karma, nearly 40% of U.S. consumers who used BNPL have missed more than one payment and 72% of those saw their credit score decline.
As a result, regulators in Britain and Australia have started to consider tightening rules around the industry to approximate those of banks. The British Financial Conduct Authority (FCA) recently proposed that providers need to undertake affordability checks before lending and ensure customers are treated fairly, especially those who struggle with repayments. Some companies, such as Klarna, have been receptive to such regulation while others, like Laybuy, want to maintain the status quo for fear that the innovation and simplicity of the service will be tarnished. What is unclear at the moment is how such fintech services fit into the U.S. regulation scheme since the companies do not have bank charters, some do not charge interest, and lending laws vary by state. With expectations that Biden’s Consumer Financial Protection Bureau will be aggressive, experts believe that the sector will come under more scrutiny in the near future. And while the regulatory future of BNPL services is uncertain, there is no doubt great growth potential for these companies as more in-person shopping goes online.