Buy now, pay later (BNPL) providers have thrived in a low interest and inflation market. As the market shifts the other way, will BNPL be in a fight for survival?
With the appealing offer of short-term loans with no/low interest rates, BNPL providers have boomed over the past few years. A recent report from ResearchAndMarkets.com claims that the BNPL market was valued at $141.8bn in 2021 and will grow at a CAGR of 33% until 2026. Similarly, a report from Juniper Research claims there will be over 900 million BNPL users by 2027, rising from 360 million in 2022.
However, the financial landscape has shifted over the past year and there is now high inflation and interest rates. As a result, it raises the question of whether they will still flourish in the market. Putting it simply, Krista Griggs – head of financial services & insurance at Japanese multinational information and communications technology firm Fujitsu – said, “The short answer is yes, but it depends on a variety of factors.”
Griggs stated that BNPL platforms typically have higher interest rates than other financing options, such as credit cards or personal loans. But they appeal to consumers for their flexibility and ability to avoid interest on the entire purchase amount. The current market has put a strain on finance and consumers might want to avoid more debt.
Another potential challenge for the BNPL industry is a fear the profitability will be hurt by higher costs of borrowing or a drop in usage.
Despite these challenges, Griggs is confident BNPL providers will endure the market and consumers will still look to them for necessary purchase.
Aravind Irodi – senior director, technology at consultancy Synechron – said, “The market dynamics of high interest is pushing down the profitability of BNPL firms with higher cost of funds. Inflation also is pushing down discretionary consumer spend. Both have a negative impact on BNPL providers. Also, credit risk assessment is a key imperative to avoid collection issues in the changed market scenario.” Despite these troubles, Irodi believes BNPL will stay strong during this period as individuals will still look to them for support.
This was a similar sentiment that was echoed by players across the financial market. There is a general sense that things might get tough, but the BNPL offering will remain valuable to consumers.
Richard Wray – COO at payment processor Carta Worldwide – said, “High interest rates are a double-edged sword. On the one hand it will encourage more consumers to embrace BNPL over other forms of credit like credit cards because the interest free rate periods of BNPL become more attractive in a high-rate environment. On the other hand, it puts a squeeze on BNPL providers raising money to lend from the debt market. When we combine higher costs of funding credit with the drop in consumer spending that we’re seeing as a result of inflation and falling real term wages, providers will see a significant impact on revenues.”
Wray added that the ones that will survive will be those that can keep borrowing costs low, and focus on areas where people are still spending, such as bills.
One area that also needs to be explored is the merchant side. With rising costs, whether that is with supply chains, bills or payroll, there needs to be an incentive for them to offer BNPL payment options. For a BNPL payment, merchants are typically charged between 3% and 5% of a transaction value. If customers stop using the feature or the business value drops below a warrantable level, merchants could stop offering the payment type.
The market is not all doom and gloom for BNPL. Earlier this week, British retail firm Frasers Group announced it is launching a BNPL product through the support of Tymit. The Frasers Plus solution will lend customers up to £2,000 and allow customers to pay in three, interest-free instalments. It will also offer the option to extend it up to 36 months with interest.
Similarly, Allianz Trade, Two and Santander CIB recently revealed a partnership to create the first global B2B BNPL solution aimed at multinational corporations.
The market is still quite optimistic about the payment type. One reason for this could be a shift in what people use them for.
Spending for necessity
Using POS finance for necessity items was a common reason among respondents for the survival of BNPL. While many BNPL transactions are for luxury items, like a new video game console that people want to have, there are equally as many payments made for necessary items. Rob Fernandes – chief product officer at BNPL company Deko – said, “it is important to remember the power and main purpose of BNPL is to enable your ‘have to’ purchases, not your ‘want to’ purchases.”
A report from Citizens Advice found that more than two in five BNPL customers borrowed money to make repayments. As disposable income is impacted and essential bills continue to rise, consumers might look to BNPL as a valuable lifeline.
Putting it quite starkly, Brad Houldsworth – head of product at e-commerce firm Remarkable Commerce – said, “It is extremely sad to hear of ‘BNPL or starve’ stories, but I feel that the industry is giving these consumers an alternative to worsened problems. 31% of UK BNPL consumers have problem debt and more than 40% of BNPL customers borrowed to make repayment. This collective distress is becoming a huge issue for the UK economy.”
The strain on finances could welcome fresh customers. For example, Deko’s Rob Fernandes said, this could be a consumer that normally used a credit card with 30-day repayment cycles, but now wants a BNPL service with a two-year repayment plan.
While these flexible repayment terms can ease money troubles, there have been countless reports over the years of people racking up masses of debt through BNPL platforms. With no credit checks needed, it is easy for people to take on more than they can handle. For example, a recent report from CBS News spoke to a BNPL consumer that got taken away with how easy it was to make multiple transactions, but soon got lost among the repayments. A recent report from iNews claimed BNPL is fostering a spike in ‘debt worries.’
These issues have caused a drop in customer trust. Rather than waiting for a regulator, Fujitsu’s Krista Griggs urged providers to implement their own strict underwriting standards and champion greater customer education. “By doing so, they can assure customers that they are providing responsible lending and help restore trust in the BNPL industry. Additionally, by working closely with regulators to ensure compliance, BNPL providers can differentiate themselves as trustworthy and reliable options in the market.”
The watch of regulators
To try and curb consumer debt risks, regulators around the world are looking to boost protections. This is another challenge facing BNPL firms in the coming year, with the uncertain landscape putting a question mark over how they will operate.
For example, the Hong Kong Monetary Authority recently issued a circular to banks on BNPL products to implement new consumer protection measures. These include requirements for banks to make the risks of BNPL clear and ensure fees are clearly outlined.
The US Consumer Financial Protection Bureau is also planning to increase regulations around BNPL due to fears these services are harming consumers. Equally, the EU approved new rules to the Consumer Credit Directive to ensure improved assessment of a customer’s ability to repay.
The UK’s FCA recently affirmed that BNPL heads could face up to two years in jail if they fail to toe the line on financial promotion rules. It follows warnings from the regulator that promotions must be clear, fair and not misleading.
At the time, an unnamed senior source at one BNPL firm told City A.M, “The FCA has identified what can only be described as a loophole to try to enforce regulation on the sector. And that loophole is an incredibly broad definition of what a financial promotion is. The FCA appears to have taken the position that any information that explains how the product works is a financial promotion and therefore needs to go through a regulated sign-off process.”
These are just the tip of the iceberg and firms will need to be prepared to adapt their operations.
Turning a profit?
Chief of concerns for many BNPL firms will be whether they will turn profits during this time.
Carta Worldwide’s Richard Wray said, “The profit model for BNPL providers is highly questionable and that was true even before high interest rates kicked in. It’s a market built on low borrowing costs and high volume to provide credit, and there isn’t much margin in between. The reality is that, on average, BNPL companies lost money in 2021. With soaring borrowing rates and delinquencies continuing to rise it is critical that BNPL providers find new sectors and use cases for their services. The bigger question for me is whether this is good for consumers and the wider economy?”
In a similar vein, Fujitsu’s Krista Griggs said, “Whether BNPL companies will be able to turn a profit during these increasingly uncertain times is a complex question. It is important to understand that BNPL companies operate on a thin margin, and their profitability largely depends on their ability to acquire and retain customers. Ultimately, the more customers BNPL providers can retain, the more revenue they can generate.”
The BNPL sector is very competitive and there are bound to be those that fail. Those that survive will need to either alter their offering so there is a greater potential for profit or innovate so they can differentiate themselves and gain a larger customer base.
There are a handful of ways BNPL providers can look to differentiate themselves. For example, Griggs suggested they could increase their partnerships with banks that are looking to integrate BNPL into their existing services, which would allow them to offer seamless customer experience.
Wray had a similar idea. He stated that established banks, tech companies and payments firms are exploring the BNPL space. This leaves a good opportunity for struggling firms to be bought out and integrated with the financial services provider.
However, Wray also believes there is room for partnerships between the two. He said, “Standalone BNPL providers need to boost revenues as margins tighten through increased transactions. At the same time, consumers are retreating to established payment methods that align with their emerging needs.”
By integrating BNPL payment cards or POS systems used by established providers, means they can easily increase their market reach. Additionally, the partnership could lessen the impact of interest rate rises, he said.
Customer centricity is becoming the heart of modern finance and for Deko’s Rob Fernandes, the best way to adapt is by becoming less one-dimensional so they can better meet customer needs. “A one-size-fits approach is least likely to succeed in a depressed market where consumers are far more thoughtful about the suitability and viability of finance. Most BNPL products available at the moment are too rigid in terms of basket size coverage and repayment terms to fully meet the needs of consumers.”
Mimicking credit cards?
One potential way for BNPL firms to adapt their services for the current financial market is by increasing interest rates. For example, they could increase interest rates to similar levels of credit cards but continue to make their services easily accessible to the masses. However, this risks BNPL losing their edge, particularly if regulations hinder their ability to offer lax credit checks.
Brian Hanrahan – CEO at payments firm Nuapay said, “Credit cards have traditionally been difficult to access as they require affordability checks. BNPL can lower the barriers to entry for consumers to access credit. An increase in consumer interest rates would likely reduce consumer usage and increasing the interest the merchant pays would likely only be acceptable to merchants if there was still a net financial benefit to them i.e., the increased sales bring more value than the increased cost of offering BNPL. If the BNPL companies experience an increase in defaults on payments, they may choose to reduce lending or re-focus on more considered larger value purchases.”
While the standard interest rates might increase during this period, Deko’s Fernandes said there is no chance they will try to replicate similar levels to credit cards. “Of course, the rising rates may prompt them to be more thoughtful about these costs, for example offering low cost rather than interest-free finance, but they are highly unlikely to move away from BNPL altogether given the role it plays in providing access to additional customers and sales.”
The slip of a giant
Signs of struggle have been seen in the BNPL industry. Last year, BNPL giant Klarna suffered an 85% downround which saw its valuation drop from its peak of $46bn to $6.7bn. This followed weeks of speculation of a downround and a 10% cut in its global workforce.
The company blamed the drop on the worst stock downturn in 50 years. A statement at the time said, “The fresh investment in Klarna occurred during possibly the worst set of circumstances to afflict stock markets since World War II: high inflation, rising interest rates, mounting fears of a recession, the aftereffects of the first global pandemic since 1918, strains on commerce caused by supply chain disruptions, rising gas prices, and, especially in Europe, the dislocations caused by the war in Ukraine.”
It also pointed out that the valuation is still three-times higher than it was in 2018 and it was outperforming peers for the same time period.
Many of the respondents didn’t see this downround as a warning sign of things to come, but rather a reaction to high valuations in the whole FinTech market. Synechron’s Aravind Irodi said, “The valuations of some of the BNPL companies skyrocketed in a short span which is getting rationalized like the overall FinTech market. Competitors such as Affirm have also seen a similar downsizing. The valuations are likely to remain subdued until a clearer forward path emerges for these companies.”
Fernandes added, “Rather than undermining the credibility of the sector, an economic downturn actually provides an ideal stress test to shake out the responsible and sustainable lenders from those that are not.”
However, Rob Brockington – CEO of financial wellbeing platform Claro Wellbeing – believes consumers should be worried about what this downround could mean for the industry. He said, “with Klarna suffering an 85% downturn in valuation, it is likely to be looking for new opportunities to generate revenue. But this will probably come at the detriment of consumers. If BNPL products were to introduce higher interest rates like credit cards to boost profits, more customers will become vulnerable to getting into financial trouble.
“As BNPL is an unregulated industry, consumers are at the mercy of the providers. There is little to no support available to those customers that find themselves in debt from an overreliance on the services.” He added that if these providers report transactions to credit agencies, it could mean accumulating debt through BNPL could affect the ability to get a mortgage or credit card. “With financial pressure already at a high, this is a real danger for customers.”
To ensure that this doesn’t happen, Brockington urges BNPL providers to improve their transparency in communications with customers so they are fully aware of risks. Without this, these services could push more people into financial difficulty.
This isn’t to say all BNPL providers are unregulated. For example, in 2020 UK-based FinTech Zilch became the first BNPL firm to be regulated by the FCA.
If the start of 2023 is anything to go by, BNPL could be in for a good year. In the first month of the year, several BNPL providers secured investments to bolster their operations. Among these was Tranch, which offers flexible finance to SaaS sellers and service providers. It secured $100m in seed equity and debt funding from Soma Capital, FoundersX and Clear Haven Capital Management.
Other notable deals in January are MENA-focused BNPL platform Tabby, which raised $58m for its Series C, and Singaporean B2B BNPL provider actyv.ai, which netted $12m in its pre-Series A.
Will 2023 be good for BNPL
Much like the last three years, 2023 is set to be a year of significant change. The financial landscape is in a tough spot and many financial services companies are going to feel the pressure and look to adapt to changing market demands. The overarching belief of respondents was that BNPL will have a transformative year, but the winners will see their market position strengthen.
Nuapay’s Brian Hanrahan stated that 2023 will be a year of change for the sector, for all of the reasons previously discussed. But with that, firms will need to adapt. He said, “As interest rates increase, the cost-of-living bites, and potential regulation is brought in, BNPL providers will need to adapt to remain competitive. This means balancing the needs of consumers to spread more items over a prolonged period of time, while ensuring merchants have a cost-effective payment option.”
Carta Worldwide’s Richard Wray sees the market splitting into two groups. The companies that work alone and those that partner with others. It will be the latter group that experiences the most growth in the coming years. “BNPL will be at its most valuable when it’s partnered with established players, fusing with traditional payment methods to build solutions that really help consumers tackle the cost-of-living crisis and recession.”
Deko’s Fernandes concluded, “This year will be transformative in defining and shaping the future of the industry. Regardless of the macroeconomic view, BNPL as a whole is the fastest-growing form of payment in the UK and while there will be challenges to the model, it is an opportunity for some providers to demonstrate the effectiveness of their consumer offering, and for others to redefine themselves or exit the space.
“As a result, this year actually offers the promise that BNPL will become properly entrenched in the payments sphere. Ultimately, these challenges will drive a positive evolution of the product that will better serve both merchants and consumers, with the market forces that had already turbo-charged BNPL in recent years, serving as the filter. As such, like so many popular retail experiences, BNPL will simply adapt rather than die. Far from this being the beginning of the end, it’s really only the end of the beginning.”
Copyright © 2023 FinTech Global