The spectrum of digital innovation, especially in financial services, ranges from digital versions of old processes to the creation of transformative, industry-changing experiences. BNPL was once viewed as the prior - simply a modern incarnation of layaway plans that have been around for almost a hundred years.
But in today’s financial ecosystem, with technology that makes it possible to assess the likelihood a customer will pay for goods over time, BNPL has been widely embraced by customers who can now take goods home before they finish paying for them.
In a recent interview with CNBC, PayPal CEO Dan Schulman said use of the company’s BNPL option soared 400% on Black Friday. This holiday shopping season has confirmed what many of us already knew - BNPL is here to stay.
How we got here
The app based version of BNPL we see today was introduced in 2015 in Australia by Afterpay, giving customers the option to buy from selected brands within the Afterpay app or an Afterpay card in their digital wallet. Purchases are paid for with four equal payments over six weeks with no interest. Square purchased Afterpay, which has 3.6M customers in Australia (almost 15% of the population) and 16M globally, this year for $29B.
A number of competitors including Klarna, Affirm, and Sezzle have since launched in markets where the financial ecosystem has the consumer data and technology to support this model. Each has variations of the basic Afterpay model. Affirm and Klarna offer the basic “Pay-in-4” model (four payments over six weeks) and Klarna also has a Pay-in-30 days option.
Both companies also offer more traditional installment loans that can span 36 months or longer. These are typically larger and have interest fees, but because they are also offered at checkout with similarly low-friction experiences, the term BNPL has evolved to encompass them as well.
Why customers like BNPL
When we talk about customer focus and building digital experiences with a full understanding of the human beings you want to use your product, BNPL is a great example.
Customers can spread the cost of a purchase over six weeks without interest. During those six weeks, many customers will receive two or three paychecks, meaning a bigger ticket purchase can be spread across paychecks without resorting to credit cards and their associated fees.
Since there is no interest associated, BNPL is seen as more similar to debit accounts. This makes it an attractive option for Gen X and millennial shoppers who already tend to favor purchasing with debit cards over credit cards, a shift that has been happening consistently since the 2009 Card Act made issuing credit cards to people under 21 more difficult in the US, causing college students and others in that age group to explore other options.
Why merchants like BNPL (and how providers actually make money)
Lending customers money interest free may not seem like an intuitive way to make money, but it turns out when customers know they can spread their payments over two months without interest, they tend to put more in their shopping carts and abandon those carts less frequently. That increases sales and leaves merchants willing to pay a premium over what they would have typically paid in credit card fees.
More sophisticated merchants also issue co-branded credit cards to their customers and encourage them to use credit cards because of the better economics. Most of those retailers currently restrict BNPL options to customers who don’t already have their credit card, but I expect to see them form similar partnerships with BNPL providers.
Why banks (will) like BNPL
It may be useful to look at how banks make money from credit cards. There are two primary sources - the interest and annual fees that consumers pay, and interchange fees merchants pay for each transaction. Interchange revenue can be significant for banks that have a big merchant acquiring business.
Each transaction that shifts from credit card to BNPL causes the bank to lose consumer interest income and merchant interchange income. US credit card debt is more than $1 trillion and the average credit card APR is about 16%. Migrating some of this to BNPL should have a net positive effect on consumer finances at the expense of the traditional credit card companies.
In total, US consumers pay more than $100B annually in credit card fees and interest to banks. McKinsey estimates that in the US market alone, fintechs have already made a meaningful dent by diverting between $8 and $10 billion in annual revenues away from banks. The banks will introduce their own versions of BNPL to staunch some of that revenue migration to fintechs.
Why will banks embrace BNPL? Because it will be too costly not to.
Where we go from here
To date, BNPL has been dominated by fintech players, but that will undoubtedly change. We’re already seeing the first steps in banks and credit card networks establishing a presence to fight the revenue erosion they are experiencing.
A handful of large US banks already offer variations of BNPL programs. That includes JP Morgan Chase’s My Chase Plan and Citibank’s Flex Plan. Others have announced that they’re working on their offerings in this space.
Mastercard recently announced plans to roll out BNPL services in the US, UK, and Australia, and Visa announced in July that it is rolling out BNPL services in the US, Canada, Russia, and Malaysia. The payment networks’ offerings should make it easier for member banks to roll out branded BNPL services.
As competition increases in this space, the float associated with the “Pay-in-4” BNPL model could become an added feature on existing banking products, like overdraft protection, offered on premium checking accounts with higher minimum balance requirements. Another option would be to connect it with a certificate of deposit; the underlying CD would eliminate losses and the revenue generated from the deposit would more than make up the cost of the BNPL service.
And we certainly can’t overlook the potential opportunity BNPL provides for big tech players. Apple and Goldman Sachs are reportedly working on BNPL solutions for Apple Pay customers. The solutions will reportedly include “Pay–in–4” and longer–term monthly installment payment plan options that will be presented at purchase time if the customer is paying with the Apple Pay wallet.
The loyalty implications of BNPL
Another opportunity for BNPL innovation sits in the hands of retail merchants with loyalty programs. Many already let customers pay with existing fintech BNPL providers, but those programs are a little disjointed. Typically, the merchant doesn’t share customer data with the BNPL provider and has to accommodate their branding within the merchant’s shopping experience.
As this space matures, merchants could offer a co-branded BNPL service (which better protects their branding) connected to their loyalty programs, just as they already do with co-branded credit cards. Airlines and hotels could do this as well.
What’s in your digital wallet?
I anticipate digital wallets continuing to become more popular and versatile. In addition to credit and debit cards, Apple Wallet can already hold event tickets, airline tickets, health insurance IDs, airline and hotel loyalty cards, and much more. It’s only a matter of time before BNPL cards share space with the expanding array of cards many consumers already have in their digital wallets today.
Perhaps the most intriguing thing about BNPL is that it’s greatest potential comes from the same place as its growing popularity - customer experience. People like it because it removes friction from their lives. Now it’s up to serious players across the financial services spectrum - credit card, banking, tech, and retail - to prove they understand their customers and design, build, and market their BNPL solution accordingly.
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