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Let’s talk about ‘Buy Now, Pay Later’

Shining a light on the case for Buy Now, Pay Later from a consumer, investor and economic perspective.

Buy Now, Pay Later is trending with consumers, investors and regulators world wide. The reinvention of an old product onto new and exciting digital platforms has the world scrambling for more. As someone part of the generation using Buy Now, Pay Later for everything from dentistry to instagram critical Louis Vuitton bags, I feel it’s time we reviewed the proposition for consumers, retailers and the broader community.

Buy Now, Pay Later (BNPL)has generally been defined as a ‘payment service that allows consumers to delay payment or pay by instalments.’ For regulators a clear distinction of the product is that it doesn’t charge interest to the consumer for the use of credit. This means that instead of parting with $500 today, you can purchase on BNPL for $125 every fortnight over the next 8 weeks, at no extra cost. This creates a win for you, the retailer and the financier.

If this sounds familiar then it’s probably because BNPL is a well marketed, modern version of products like Lay-By, hire purchase and to a lesser extent credit cards.

Consumers + Consumption

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Buy Now, Pay Later has been thrust into the faces of millennials and Gen Z’ers as social media personalities push lifestyle, products and instant gratification. Afterpay has experienced immense growth as they ingeniously engage one of the most ‘influential’ Americans while they launched into the U.S. market.

Since mid 2016 the number of customers using BNPL services has risen from 100,000 to over 5.6 million. The rise of the service has captured the key millennial market that had previously avoided debt like credit cards.

It’s not hard to see why the product is so successful. It brings payments forward, enabling you to shop when you’ve been caught out the day before payday, or when you want to spread the cost of a big purchase out into smaller more manageable payments. The product reduces the barriers to shopping as it doesn’t require you to part with hard earned money at the point of sale. The simplicity of frictionless one-click shopping in-store and online has generated loyal customers with 86% of users confirming they will use the product again.

However, there’s a darker side to BNPL. The modern product is unfortunately a perfect representation of modern values. The mentality of instant gratification and I’ll worry about the cost later. This easily spirals out of control as tracking spending and repayments becomes convoluted and difficult. This difficulty is epitomised by the 1 in 6 customers reporting that they are overdrawn on their account.

It seems like a simple decision, you don’t have enough money today to cover the purchase so you buy now, and pay later. This works on the assumption that you’ll have the money in the future. Unfortunately, a lot of people are caught by other bills that come in and don’t have the funds to meet the repayments. They then get slogged with late fees. Afterpay reported $18.2m in late fees, which is 17% of their total revenue. They count on you missing payments.

Not only are these fees exorbitant and unethical, but they have a tendency to send consumers into a debt trap. Users have reported to consumer advocates like Choice about drowning in debt. Similar to pay day lending, these products can have hidden fees, get customers addicted to debt or lead them into a cycle of credit where they eventually take on more than they can handle.

As with the credit products that came before Buy Now, Pay Later, we need to be careful when we use it. It is a credit facility and if you’re not careful it can spiral out of control.


The consumers aren’t paying the interest on these purchases but someone has to, and that someone is the retailers. In the incredibly thin margins of retail you’d think that payment platforms that drive customers in and reduce payment friction would be an absolute blessing, but this isn’t the case.

Retailers pay commissions between 3–5% of the transaction value, plus fixed costs between 15–40 cents on every transaction to the BNPL provider. When you put it in context that the average retail business has a 3.2% profit margin, then you realise that this is a significant hit to their profitability.

A simple solution would be to add a surcharge to use these services. However, the BNPL providers get retailers to sign agreements that prevent them from passing on surcharges to customers. This has resulted in some retailers abandoning the platforms, or raising the prices on all items which then effects their competitive position.

Consumer demand for modern payment platforms does however mean that retailers are left with no choice but to use some form of Buy Now, Pay Later.

The Investment Case

Retailers won’t have to suffer profit erosion for too long as incumbents are beginning to make a push into the sector. Visa recently announced that they would be entering the BNPL market with a product featuring deferred payments. This, I believe is the beginning of the incumbent surge as the competition is only heating up.

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Investments in BNPL companies have been wildly successful. The three companies in the table above have all listed within the last 3 years and are key players in the segment. The smallest returns is a 1.5x of your investment and the largest is 26x. The market cap of BNPL companies listed on the ASX exceeds $8.9B and is growing. This valuation doesn’t include competitors like Visa, or PayPal either.

The share price growth has been driven by astronomical growth in revenues and customer numbers. In recent half-year reporting Afterpay stated 85% year-on-year growth and Zip Co 114%. It’s easy to understand the returns when you see that. With the number of companies currently in and entering the space it’s almost more surprising that their isn’t a Buy Now, Pay Later ETF.

In the short term there is still tremendous growth on the table and significant global opportunities. In the longer term, the BNPL companies come under question.

BNPL firms are currently trying to differentiate, and capture separate markets and demographics. FlexiGroup’s Humm is a great example of a successful niche which has focused on more expensive white goods, while Brighte focuses on solar panels. That being said, the competitive landscape is what economists call perfect competition. Each company’s product is a near perfect substitute for another company’s product, and all offerings are essentially the same.

The competitive pressures are exacerbated when you consider the ease in which incumbents can enter the space. Visa and Latitude are the first to arrive, while major banks have launched Beem It and I wouldn’t be surprised to see competitors like Apple Pay enter the market soon either. As markets adapt to disruption the question will be, can the upstarts survive?

Key risks for providers and investors are where the profit margins are made. Two key areas to investigate margins are late fees and interest rates. Afterpay’s current financial report states that 17.6% of income is derived from late fees and in it’s previous report that figure was 24.4%. A business that makes a fifth to a quarter of its income from penalising customers is simply not sustainable — especially given the customer centric world we live in.

Interest rates may surprise you as a key risk for these firms but it’s actually critical to their success or failure. The National Australia Bank (NAB) provides key lending facilities to both Zip Co. and Afterpay. The total exposure NAB has to Buy Now, Pay Later is over $1.1 billion at an average interest rate of 4.35%. These firms are priced in as relatively low risk, this could be as the companies match their retailer commission fees to their interest rates. If NAB re-rates the risk of this segment or there are interest rate rises, then these costs will need to be passed on to retailers who simply can’t afford it.

In Zip Co.’s half-year report they advise that a +/- 1% change of the BBSW (the benchmark price for their loan) is a 4.62 million dollar movement in interest expense. Interest rate swings have the potential to completely eradicate these business models. If interest were to move from the near 4% where they are now to 6%, and it can’t be expected for retailers to absorb the cost, then what will these firms do?

Luckily, it doesn’t look like there will be any interest rate hikes in the short or even medium term so they have some time to sort this one out.

Economically Speaking

If the increase of credit could combine with the retailers ability to pass on price increases then central bankers would get what they want — a rise in inflation. Unfortunately that hasn’t happened yet, but the new payment systems are definitely heading in that direction.

The credit used in Buy Now, Pay Later behaves in essentially the same way as credit from a credit card. The opportunity to use this service is a convenience for both the shopper, who can buy today, and the seller, who can record the sale immediately and reorder stock. Overall it saves time and becomes a more efficient way to transact.

Households typically don’t view credit as an asset or liability but just as money available to use. Realistically, you shouldn’t view a $1,000 credit card limit the same way you would view $1,000 in cash; as spending today on credit means you’ll have to reduce spending in the future to pay it back.

The scale of the BNPL market and growing number of customers means that the additional credit can make a meaningful impact on the economy. In the short term, as these platforms grow it will expand credit and growth. Enabling more consumption, production and inventory. In the longer term the market will get fully saturated and consumers will cyclically use and pay down credit with no huge impact on the demand for money or overall growth.

There is one critical exception to this. In an economic downturn BNPL could become extremely risky. As harder times hit households they will inevitably turn to these products for relief. Unfortunately the tougher times will cause subsequent defaults and with 1 in 6 customers being overdrawn in good times it’s not hard to imagine 3 or even 4 in 6 customers overdrawn during tougher times.

An economic downturn will drive up demand for short term credit whilst simultaneously pushing defaults up. The increased demand will mean BNPL firms will need to draw down on their banking facilities while the defaults will reduce their ability to meet repayments. The big question is whether these firms can stay afloat and survive a downturn, and the banking system should be worried as recent forecasts put a recession within the next 3 years.

The Verdict

Buy Now, Pay Later is an old product with a new design. It’s well marketed, and adapted to the demands of modern consumers and technology. There are risks for consumers and there certainly are ‘at-risk’ client segments, but mostly consumers need to be aware of how much they are spending and manage their finances accordingly.

Retailers, investors, regulators and banks take on the biggest risks with the BNPL products. A generation that has never embraced debt like their predecessors has gone ‘all-in’ on these services and we need to be aware of the risks that creates. There’s still lots of upside for everyone as consumers continue to drive growth and incumbents make the space more competitive. Overall, it’s a great innovation that requires some thought from policy makers to ensure consumers, retailers and the community are adequately protected from the risks of excessive credit.

If you have any questions then please feel free to comment, and if there is anything you’d like to see analysis on or read about in the future then let me know.

Also, please note that this article does not represent financial advice or the views of any organization; it is only the opinion and analysis of the writer.

Thank you for reading.

Chris Leeson

Bringing finance and economics to you with a focus on in-depth analysis and everyday life.

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