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The rise of BNPL
The Buy Now, Pay Later (BNPL) model, which lets consumers finance their retail purchases, sometimes at zero interest, has established itself as a viable alternative to credit cards and is quickly becoming a fixture in the retail space. The model’s proponents attribute its success to the use of sophisticated risk management algorithms that allow companies to lend to previously unbanked clientele. However, there is reason to believe that by giving easy credit access to a high-risk demographic, BNPL companies are encouraging excessive spending and putting their clients "at greater risk of financial difficulty," according to the former chief executive of Britain’s Financial Conduct Authority.
One of the main reasons for the meteoric rise of Klarna, Affirm, and other similar BNPL lenders is their web of partnerships that spans all retail sectors and includes the most popular brands. A prime example would be Affirm’s relationship with e-commerce behemoth Shopify, which gave the former instant access to thousands of online stores.
It is also no coincidence that alternative lenders have become household names during the pandemic. Faced with stagnant sales amid mass unemployment and falling incomes, the aggressive adoption of lending solutions that are far more tolerant to consumers with unestablished or compromised credit history was seen as one of the few ways to restore retail growth. The bet paid off: online stores saw a mass influx of buyers they had failed to attract previously, particularly among the younger demographic. This perfectly captures the essence of BNPL as an industry: its mission to lend affordably to the underbanked is only made possible by retail business’s thirst for growth.
Strong relationships with a network of retailers also allowed the three early pioneers in this area — Klarna, Affirm, and Afterpay — to scale extremely fast, capturing most of the industry growth and later driving consolidation. Although the impact of the pandemic has definitely propelled those startups to new highs, they are unlikely to lose footing when consumers start returning to in-store shopping due to their integration into stores’ point-of-sale systems.
Part of the ecosystem
What particularly stands out is BNPL companies’ ability to grow at a low cost without sacrificing their margins, which is rare. Klarna was profitable from 2011 to 2018, and Affirm reported its first profitable quarter a few months before its IPO in January 2021.
Traditional lenders have been quick to react to this success, with Capital One going so far as to ban payments to BNPL providers. Banks like American Express, Citi, and J.P. Morgan Chase have developed similar competing products, while TD and Commonwealth Bank chose partnership instead, extending access to alternative financing straight from their banking apps. In the long term, it is unlikely that any of these approaches will impact the BNPL industry. Consumers want these solutions at the point of interaction, and as long as their retail partners can guarantee unfettered and exclusive access to their ecosystems, alternative lenders will continue to account for the lion’s share in online and in-store lending.
In contrast, financial authorities have the resources to pose a more realistic danger to BNPL, with ongoing discussions taking place in the U.K. and Australia, among other regions, to regulate how alternative lenders operate and report their activities. However, most of the proposed measures aim to protect consumers by making credit agreement terms more transparent and forcing alternative lenders to run a hard credit check and report loans to credit agencies. After all, it is unlikely that BNPL lenders create worse systemic risks than payday loans, for example, which many states are still battling to regulate.
The most prominent risk that alternative lenders face comes from the quality of their credit portfolio. The very same age demographic that is driving the adoption of BNPL lending also has a difficult time paying off their credit card debt. There’s an aggregated delinquency rate of 9% among 19-29-year-olds, by far the highest of any age group (30-39-year-olds, for example, have a 6% rate). (tweet this)
Two things to keep in mind here:
- Traditional lenders and numerous startups have tried very hard in the past to reinvent lending for younger consumers, without success. Affirm even started originally by underwriting student loans. Despite the supposed vastly superior risk management systems that Klarna and their peers use, it is doubtful that these systems will fare better in the long run. Higher delinquencies for younger people have less to do with their consumption habits and a lot more to do with the fact that millennials are the poorest and most indebted generation in U.S. history.
- In spite of the high risk, lenders are still happy to do business with young borrowers. Many employ marketing efforts specifically to attract and retain teenagers and twenty-somethings because their lifetime value is still fairly high. For a product that caters to the underbanked, the genuine concern should be that their underwriting standards produce a credit portfolio that is much worse than industry benchmarks, not that it necessarily fails to improve on existing credit debt metrics. As long as BNPL lenders are in line with the general industry standards, the lenders themselves and their investors should remain satisfied.
Enabling the new market
Overall, BNPL is still mostly about helping retailers find new consumers, and making lending accessible and affordable is a means to achieve that goal. For example, Affirm’s most significant retail partner is Peloton. This company sells luxurious indoor bikes that cost a couple thousand dollars and make up an estimated 30% of Affirm’s entire revenue. A long list of luxury brands, such as Farfetch, Maven Women, and Henri London, promote their partnerships with BNPL lenders, in an attempt to seem more accessible for consumers due to the availability of cheap financing on their websites. Much in the same way Apple, with the help of mobile carriers’ financing plans, made otherwise prohibitively priced iPhones into a staple product over a decade ago, these brands are trying to convince consumers that were typically priced out of shopping with them that they deserve better.
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About the writer: Ravil Rakhmatullin is a Business Researcher at Inside and has worked on developing complex AI-driven data-intensive products that transformed the core way the businesses are run. Morbidly interested in following the continuous evolution and growing economic and social importance of platforms/marketplaces and FinTech.