Buy Now, Pay Later series I: the size of the market and economics

Buy Now Pay Later industry has massively expanded in the last two years, becoming a useful service for both merchants and consumers. Providers such as Klarna, Afterpay, or Affirm have already paved a way towards the ecommerce ecosystem, by acquiring new customers and expanding their footprints.  According to Bank of America, the market for these apps is likely to grow 10-15x by 2025 to eventually process USD 650 billion -USD 1 trillion in transactions. There is a need for a better understanding of how these services work, so we present the bigger picture: the size of the market and business models in this space.

Pay later companies then and now

BNPL from today had different forms and names decades ago. The pay by invoice method was very popular in the DACH region – where merchants enabled consumers to first choose and try the goods from the catalogues, and pay for them later on. In LATAM and Turkey, instalments have always been a common practice, the services being offered mainly by banks and they were also linked to cards accepted both online and in-store. POS financing was typically used for purchasing items such as electronics, furniture, and other household goods. This option is still actual and has always been part of the shopping behaviour worldwide.

At present, there is an uplift in the usage of BNPL solutions for shopping, mostly driven by trends such as Gen Z and Millennials looking for convenient budgeting tools, and the lack of interest fees in many cases. As well, the COVID-19 pandemic has also played a crucial role in pushing this new shopping habit further for the obvious reason: it’s financially convenient.

According to a Worldpay report, in 2020, pay later accounted for 2.1% of ecommerce transactions worldwide, continuing to earn market share, and expecting to double by 2024. One can also observe that while a few years ago Australia and Sweden were the top markets in this area, now, the UK and the US are catching up on this. BNPL equates to around GBP 9.6 billion in annual spending in the UK, while in the US accounted for almost USD 20 billion in 2019.

Moreover, per a Coherent Market Insights report, the BNPL platforms market worldwide was esteemed at USD 7,320.6 million in 2019 and is expected to reach USD 33,638.3 million by 2027 at a CAGR of 21.2% between 2020 and 2027. During the forecast period, the fashion industry is anticipated to hold a dominant position in the market.

The business model

Before depicting how these companies make money, it’s important to understand the terminology. As explained by Business Insider, companies such as Klarna, Aftertpay, Splitit, Affirm, Zip and (many) more are BNPL providers. Companies that enable their merchant networks to offer direct providers' BNPL solutions are called facilitators, such as Mastercard, Shopify or Stripe. And the retroactive providers category involves mainly issuers that offer financing options consumers can use for all purchases made on their credit card.

Essentially, the providers partner with merchants to give consumers the option to pay for their goods in monthly interest-free instalments. Merchants pay the provider a certain percent of the purchase amount as a fee, and most of the providers pay the merchants in full and then recover the money from the customers. On the consumer side, some providers run a soft credit check to make sure the merchants’ customers are trustworthy. Others look for economic benefit and charge interest of 10 to 30% on the amount, based on the customer’s credit and the duration of repayment. However, most BNPL providers don’t charge any interest rate as long as they are no delays in paying the instalments.

As per an RBA report, the most common business model involves the provider facilitating transactions by enrolling both merchants and consumers into the agreement. In this type of ‘two-sided network’ that is mainly common for Klarna or AfterPay, consumers typically set an account via the provider’s app or website, and spending limits are often approved on a per-transaction basis. Merchants that enter into agreements with BNPL providers pay a per-transaction fee for accepting BNPL payments, which tend to be high relative to the cost of accepting debit and credit card payments. 

As well, these services can be offered through virtual cards via the providers' app, and they can be used for both in-store and online purchases. Unlike the two-sided model, this scenario doesn’t involve an agreement with the provider. The BNPL company issues a one-time-use virtual card to the consumer, or the virtual card can be re-used and comes with an overall limit. TwistoPay is a good example of this model.

There is also an option for the consumer to pay via instalments with their credit or debit card like Splitit or Oney offers. BNPL providers lend money to the consumers without charging interests yet applying fees for delayed payments. 

And there is also the matchmaker model (extensively explained here), specific to companies such as Creditclick or Divido, where the provider brings together the merchant and the consumers, and the payment is facilitated by the PSPs that merchants work with.

For a clearer picture on what are the key consideration for a BNPL business model, Vesta has created a comparison graph for Klarna, Affirm, Afterpay and Splitit.

Source: Merchant Risk Council 

The BNPL business model was also embraced by bigtechs, such as Amazon or PayPal, more recently. PayPal has introduced in March 2021 short-term, interest-free payments services to its financing options with PayPal Checkout: Pay in 4 (available in the US and France) and PayPal credit (available in the US and UK). As well, in 2020, Visa kicked off its BNPL pilot in the US, and Mastercard has pilot tests in progress with its Mastercard Consumer Installment (MCI) platform outside the US.

With the three key variables that make the difference – no-interests, easy access, and fully digital – BNPL has rewritten the future of credit and lending and it has become a worldwide phenomenon. Apart from Europe, Australia and the US, it will most likely continue to put down roots in regions such as the Middle East, South-East Asia and Africa, where new players arise currently, and this is another reason why the size of the market is likely to enlarge massively. New business models might emerge, and in the near future, we could see these services advancing more in the banking sector, as incumbents will be pushed to further compete with the current providers. And as a wild theory, maybe these companies would consider the marketplace model even more (as Klarna did) and go direct to consumer and build their own platforms to sell.

Now that we know what BNPL means at present times, and we understand the economics of the companies operating in this space, we can dive into the most discussed topics around them: regulation and risk.

About Anda Kania