Neologism: noun; a new word, usage, or expression (from the Greek νέο- néo and λόγος /logos).
Sometimes, the ability of businesses to invent new words for old ideas appears to be limited only by the creativity of the management consultant types who invent them*. A cynic might say that a startup is just another word for a new business; that a pain point looks much like any problem waiting to be solved, (perhaps by the same management consultant who invented the word); and that a holistic approach is just making sure you look at every aspect of a problem (on this last one, the cynics probably have it about right). But, as the philosopher and psychiatrist Frantz Fanon pointed out in one of his most famous aphorisms: “To speak a language is to take on a world, a culture.” Words mean what we decide and accept them to mean. Which is why a startup tends to refer to businesses with large growth ambitions; why a pain point is seen as a problem whose solution is necessary to the success of the business and why ‘Buy-now-pay-later’ (BNPL) is more than just revolving credit dressed up for the masses. But what exactly is BNPL, and why does it matter more than revolving credit? We need to speak about BNPL so we can understand the culture behind it.
To buy something you need the ability to pay. Originally, credit cards extended that possibility with credit lines, earning interest on outstanding balances in a model that was simple to understand and operate. Apply for a card, accept what the issuer determined your credit worthiness to be (how much you could spend), buy and repay later. But it was a lengthy process, and manual for the most part. The issuers did what they could to make it easier. In the United States it wasn’t uncommon to wake up and find three or four pre-approved physical cards, ready to spend after an initial activation, lying on your doormat with the morning mail. It was a simple, scattergun approach that was expensive to run, but with annual interest rates at over 30 percent, nobody was counting.
But lower interest rates and the competition they engendered, along with digital everything and e-commerce, combined and ubiquitous smart phones changed the rules. The question became, how to reinvent the model?
Let’s be clear, credits cards aren’t disappearing anytime soon. In the United States, outstanding balances are edging towards the one trillion dollars with over 500 million card accounts operational. That’s pretty near two cards for every adult over 20 years of age. And ‘card delinquency’ – another neologism signifying how much isn’t paid within 30 days of the due date – is still less than two percent. So don’t shed any tears for the credit card issuers, they’re doing just fine thank you very much.
Where BNPL found a niche was in the online market and in carefully segmenting that market. It’s always worth remembering that the very first payment card – Diners Club – was, in essence, a highly segmented offering: it targeted business diners at upmarket restaurants in New York. And in the early days, credit cards too were highly segmented, before becoming ubiquitous. So BNPL has gone back to the basics of payments: segmenting the merchants, segmenting the buyers and coming up with offers for both of them which, when they meet in the middle, generate revenues for everyone.
Bit there are other subtle differences to BNPL that make it different to a credit card and which justify the different name.
BNPL is digital and in most cases operates in the equivalent of a closed loop. In other words, it has broken out of the mould of the card schemes to create its own payment and settlement rails. That’s a pretty significant development, made largely possible by the fact that it is an online proposition up to now. So by integrating with the main payment gateways and payment service providers it could target a large number of retailers with a single integration. It also explains why, until recently, it has remained an online proposition, the complexities of moving instore being significantly greater than for online payments.
Juniper Research, in its excellent white paper ‘Buy Now Pay Later – Reshaping the Payments Market’ (Basingstoke, UK, August 2022), traces the origins of BNPL back to the mid-1800s and the emergence of layaway plans in which a given item was bought on instalments with the item delivered once the final instalment was paid. The difference with BNPL is that the item is delivered once the initial instalment has been made. What has changed since 1850? A demand for instant gratification, (and the ability to check the credit worthiness of the buyer). But what is really different in this form of payment to that of a credit card is that BNPL is used to buy a specific item and not for general purchases. This is important. In allocating the cost to one item it creates a psychological safety net in the mind of the buyer that they are not overextending themselves. The refrain ‘I’m maxed out on my credit cards’, meaning I can’t afford anything, doesn’t really apply to BNPL in the same way. (Which is not to say that the risk taking on too much BNPL credit doesn’t exist, it certainly does).
The BNPL business model is as old as civilisation itself and the very first interest bearing loans. It makes money from loaning an amount and charging interest on it. What is interesting is that BNPL makes much of its income from the merchant itself, charging them a flat fee, and a percentage that can be anything from two to eight percent. This is very unlike the credit card models where merchant discount rates are – sort of – linked to the interchange rate, which is generally much lower than what BNPL charges. But in fact, both models are charging merchants for bringing them business, only BNPL is more explicit about it, and because it claims to be more segmented and targeted can also ask for more from the merchant upfront. There is an argument to say that BNPL is, in fact, not a lending product, but a promotional tool to drive sales. That justifies a different approach, (but someone has to got to repay, sometime).
From consumers interest and late payment fees are also a source of income and given the very high approval rates, with minimal checking for small amounts and consequently high default rates, these begin to be significant. And there is a definite tendency to raising revenues from consumers by extending payment options.
In the UK, a recent study showed 41 percent of BNPL users struggling to make repayments. It is salutary to remember what happened another sector making soft loans with punitive rates: payday loans – small loans with short repayment periods, and very high interest rates, were recognised as toxic and, in a sector where the regulator has tended to act with a relatively light touch on the basis of caveat emptor, were ultimately regulated to the point where businesses operating in the sector were one-by-one liquidated. BNPL will need to be careful to avoid the same fate.
Like most growth businesses, BNPL companies are in a race for growth, to sign up users they can monetise with merchants and to capture the data that will allow them to manage their business efficiently. The next move is likely to be from online to instore. Fully 75 percent of commerce remains instore, so scope for growth there remains huge. The challenge will be technical integration at the point of sale and customer interaction in such a way as to avoid delays at checkout. These issues are far less significant online. Nobody is waiting behind you while you complete the BNPL check in the comfort of your own home. For this reason, recruitment is likely to be online, with fast interaction on the BNPL’s app or webapp instore. One retailer in the US even invited shoppers to sign up elsewhere in the store in anticipation of paying at checkout. Technical integration also will be important. Retail systems rely on automated payment information flows and BNPL operators will need to implement these. That’s never easy in a retail environment, particularly at scale and particularly in smaller outlets. Virtual cards may be an answer to this but are not a panacea.
Ingenico’s PPaaS is working with several operators to facilitate acceptance in the most user-friendly way at checkout.
Expect the operators to continue to fight for users – so industry consolidation is probably on the cards – and to deepen their relationships with users so they can justify the fees they are charging to retailers. Like the hotel operators who claim to channel their loyalty programme members to the hotels they operate, BNPL will need to do the same to continue justifying their fees to retailers and be able to show it with hard facts and figures.
* No offence to management consultants, I used to be one.