Buy Now, Pay Later: rapid growth but challenges on the horizon

Buy Now, Pay Later (‘BNPL’) has grown rapidly in recent years, driven by changes in consumer preferences (younger customers often prefer instalments over traditional revolving credit cards) coupled with a COVID-boosted shift in shopping patterns towards remote commerce. As BNPL has grown from a niche ecommerce payment method to a mainstream form of consumer credit, so has scrutiny from investors, regulators, and the public. 

BNPL was popularised in large part by Klarna, which beginning in the mid-2000s digitised legacy paper-based processes for catalogue purchases in the Nordics and then began to nudge consumers to roll those purchases over into instalment credits. The product experienced strong uptake in continental European markets that were traditionally averse to the revolving credit cards, not only due to instalments being easy to understand, but also due to brand perception (credit cards often being perceived as ‘bad’ or ‘uncool’), and saw a powerful fit with easy checkout processes for remote commerce. BNPL’s expansion to the credit card-centric UK and US markets was initially greeted with scepticism, but it gained traction in those markets due to its convenience. 

As the success of the product has grown, the number of BNPL providers has proliferated, with over 50 in the European and North American markets today. Many have grown via geographic expansion, and Klarna, Zip, and Afterpay have entered multiple markets. 

Meanwhile, traditional credit providers have largely missed the boat on filling consumer demand for flexible, digitally-enabled short-term credit tied to remote commerce purchases. Even today, a few banks in Europe offer instalments or BNPL, as indicated in the figure below. Banks face a variety of challenges in the space, including a lack of capabilities to distribute credit via merchants, conservative risk appetites, tighter regulation, and philosophical scepticism regarding the BNPL business model. For many banks, focusing on post-purchase instalments is a more natural fit (since the transaction shows up in mobile/online banking and can be positioned as a ‘wipe to move to instalments’) with an easier path to market.

Fintech BNPL players continue to charge forward in the absence of meaningful competition from traditional credit providers. As a result of the proliferation of providers and their appetite for growth, further consolidation via mergers and acquisitions is inevitable. As illustrated below, Klarna, Zip, Affirm, and Afterpay have all made multiple acquisitions, while payment giants PayPal and Block (Square) entered BNPL via M&As (the latter by acquiring Afterpay). Acquisitions will continue as winners seek to scale, enter new geographies, and expand across the value chain. 

Figure 3: Timeline of BNPL M&A activity (Top Buy Now, Pay Later providers, excluding Klarna)

Figure 4: Timeline of Klarna M&A and other select events (Y-axis= millions of users)

Source: Klarna, Crunchbase, Flagship Advisory Partners research

Despite the lack of competition from traditional providers, rapid geographic expansion, and rigorous M&A activity, the BNPL industry faces meaningful challenges. As illustrated in the figure below, Klarna’s net loss widened significantly in 2021, due in part to increased credit loss rates. Klarna has rapidly entered new geographic markets (to which it attributes some of its profitability challenges) and has made 12 acquisitions over the past 5 years. Many of these acquisitions have been established to become a remote commerce ‘super app’ that offers shopping and loyalty in addition to credit. This ambitious strategy has not always gone smoothly, and Klarna has grappled with historic regulatory challenges and negative public perception. The BNPL provider is keen on shifting its brand association from BNPL to other services, demonstrated by a series of value-chain expansion activities and the launch of Open Banking platform brand ‘Klarna Kosma’. 

Continued losses at Klarna and others (e.g., Afterpay’s losses also widened prior to its acquisition by Block) have prompted many observers to question the fundamental economics of the model. Critics argue that the high approval rates necessary to gain adoption lead to high credit losses, and that fintechs cannot prop up the necessary costs of funding to achieve sustainable margins. As a result, critics argue that effective interest rates become unreasonably high for consumers, and that BNPL providers’ customer acquisition and operating costs are too high relative to small loan amounts.

Figure 5: Klarna’s 2021 results

Note: GMV = Gross Merchandise Volume; gross revenues exclude net results from financial transactions

 Source: Klarna annual report 2021 

As BNPL has grown, so has public and regulatory scrutiny. While BNPL is often marketed as a flexible form of payment, critics argue that BNPL is simply a digitised version of credit cards and traditional purchase financing that results in a higher cost to consumers. Part of BNPL’s growth can (arguably) be attributed to the fact that it operates under a lighter regulatory regime than traditional credit products in many markets. Regulators are taking notice. As indicated in the figure below, aspects of BNPL are currently unregulated in many markets, but a variety of initiatives to tighten up regulation are underway. The EU is likely to propose to include BNPL in the scope of the Consumer Credit Directive, the US Consumer Financial Protection Bureau has opened an inquiry into BNPL, and the UK FCA and HM Treasury have indicated greater scrutiny.

Despite these challenges, we do expect BNPL to continue growing, as it meets key customer needs for frictionless commerce. As it grows, the BNPL industry will mature and consolidate to a smaller set of more scaled and viable providers, product catalogues will expand to generate new revenue streams, regulation will increase, the fintechs will edge towards becoming more like incumbents (e.g., Klarna is already a bank), and forward-thinking traditional incumbents will regroup and will regain some of the ground that they lost.

This article is part of ‘Who’s Who in 2022’s payments ecosystem? Full rundown of key topics and actors reshaping the industry as we speak’, a thorough analysis of the payments ecosystem by pinpointing the key trends that shaped the market over the last year, but also the most important names needed to be taken into account when it comes to relevant case studies in the field. The article is published in Who’s Who in Payments Report 2022. 

About Flagship Advisory Partners

Flagship Advisory Partners is a boutique consultancy and M&A advisory firm focused on payments. We provide strategy, delivery, and M&A support to financial institutions, PSPs, fintechs, technology providers, brands, and investors. We serve clients globally from offices in Europe and the US.