Buy Now, Pay Later Apps vs. Credit Cards: The Pros and Cons | WSJ

Summary

The script explores the rise of 'buy now, pay later' (BNPL) services, comparing them to traditional credit cards. It highlights how BNPL gained popularity during the pandemic, with companies like Affirm experiencing significant revenue growth. BNPL services are praised for their accessibility and instant approval process, but also questioned for their potential to lead to overextension of credit. The lack of some consumer protections and the challenges of profitability are discussed, alongside the competitive landscape with tech giants and credit card companies entering the market.

Takeaways

• 🛒 Buy now, pay later (BNPL) services allow consumers to make purchases and pay in installments, often with no interest.
• 📈 BNPL companies like Affirm, Klarna, and Afterpay have rapidly grown in popularity, especially during the pandemic.
• 🏦 BNPL firms generate revenue primarily through merchant discount rates, fees paid by retailers for each BNPL transaction.
• 💳 BNPL is more accessible than traditional credit cards, making it attractive to consumers with limited or poor credit history.
• ⚖️ BNPL companies perform less formal credit checks compared to credit card issuers, leading to instant approvals for purchases.
• 🚫 There's a risk of consumers overextending themselves with BNPL, potentially leading to debt they cannot repay.
• 🔍 BNPL services are not subject to the Truth in Lending Act, which mandates transparent loan terms for traditional credit products.
• 📉 BNPL companies must balance the risk of customer defaults with the need to approve enough transactions to remain profitable.
• 💰 Rising interest rates can pose a challenge for BNPL firms, increasing their borrowing costs and impacting their profitability.
• 🤝 BNPL firms face growing competition from major players like Apple, PayPal, and traditional credit card companies offering installment plans.

Q & A

What is the primary advantage of using a buy now, pay later (BNPL) service over a credit card when purchasing a product like a pair of Adidas?

The primary advantage of using a BNPL service is that it allows customers to break the full payment into installments with no upfront payment and usually no interest, making it more flexible and accessible compared to traditional credit cards.

How have buy now, pay later services grown in popularity over the last three years?

BNPL services have boomed over the last three years, with companies like PayPal, Apple, and credit card companies joining the trend. The growth has been fueled by increased accessibility and the convenience of installment payments without interest.

What is the main way that buy now, pay later companies generate revenue?

The main way BNPL companies generate revenue is through merchant discount rates, which is a fee that retailers pay to the BNPL company on each purchase made using their service.

How does the accessibility of buy now, pay later services compare to traditional credit cards?

BNPL services are more accessible than credit cards as they can approve purchases on the spot and do not require a deep dive into the customer's credit history, making them more appealing to those with credit difficulties or those who prefer instant approval.

What are some of the risks associated with buy now, pay later services for both the consumer and the issuer?

The risks include the potential for overextension of credit to consumers who may not be able to repay, leading to delinquencies and increased costs for the issuer. Additionally, consumers may not be fully aware of the terms and conditions due to the less formal credit checks performed by BNPL companies.

How do buy now, pay later companies differ in their credit checking process compared to credit card companies?

BNPL companies typically perform a less formal credit check and may look at additional data such as previous usage of their service, whereas credit card companies conduct a deep dive into the customer's credit history, which affects the credit score.

What regulatory safeguards are lacking for buy now, pay later services in the US compared to credit cards?

BNPL services lack some of the regulated safeguards that credit cards have, such as the Truth In Lending Act, which requires lenders to provide all loan information upfront with no hidden costs. This law applies to loans paid in more than four installments, and BNPL often falls just below that threshold.

How do buy now, pay later companies like Affirm and Klarna address the issue of consumers potentially overextending themselves?

Affirm and Klarna have measures in place to ensure they only extend loans to borrowers who can repay. They also restrict the use of their services if a borrower misses a payment and provide disclosures for all credit extensions.

What impact can customer defaults have on the profitability of buy now, pay later companies?

Customer defaults can increase the costs for BNPL companies, as they have to balance the risk of delinquencies with approving enough transactions to cover their operational costs.

How are buy now, pay later companies diversifying their offerings to remain competitive in the market?

Companies like Affirm and Klarna are offering services beyond BNPL, such as other financial products, to diversify their revenue streams and remain competitive against larger companies like Apple and PayPal.

What challenges do buy now, pay later companies face in terms of profitability and competition?

Challenges include struggling to turn a profit as they scale up, facing increasing competition from established financial service providers, and having to manage the risk of delinquencies while maintaining a sufficient transaction volume to cover costs.

Outlines

00:00

💳 The Rise of Buy Now, Pay Later (BNPL) Services

The script discusses the growing popularity of Buy Now, Pay Later (BNPL) services as an alternative to traditional credit cards for making purchases. It explains how BNPL allows consumers to pay for items in installments without upfront payment or interest. The script highlights the rapid growth of BNPL companies over the past three years, with major players like PayPal, Apple, and credit card companies entering the market. It also touches on the challenges these companies face in turning a profit as they scale up, and the comparison between BNPL and credit cards in terms of accessibility, credit checks, and consumer safeguards. The segment concludes with insights on the underwriting process and the potential impact of consumer defaults and interest rate changes on BNPL companies' profitability.

05:01

🏁 The Future and Challenges of BNPL Services

This paragraph delves into the future prospects and current challenges faced by BNPL services. It presents the views of industry insiders, including Affirm's CEO, who sees credit cards as the main competition rather than other BNPL services. The script suggests that despite the challenges, BNPL is likely to remain a significant part of the financial landscape. It also discusses the potential for BNPL to become more integrated into the offerings of larger financial service providers, as evidenced by the acquisition of Afterpay by a larger company. The paragraph raises questions about whether BNPL can be a successful standalone business in a competitive market and ends with a reflection on the importance of gaining scale and profitability for the growth of BNPL services.

Keywords

💡Buy now, pay later (BNPL)

Buy now, pay later is a financial service that allows consumers to purchase goods and pay for them in installments over time, usually without incurring interest. It is central to the video's theme, illustrating an alternative to traditional credit cards. The script mentions that BNPL services have grown in popularity, with companies like Affirm and Klarna leading the market, and it discusses the benefits and risks associated with this payment method.

💡Credit card

A credit card is a payment card that allows its holder to borrow money to make purchases, which are then repaid with interest if not paid in full within a specified period. In the context of the video, credit cards are compared to BNPL services, highlighting differences in approval processes and consumer accessibility. The script points out that credit cards require a pre-established credit history, whereas BNPL services can approve purchases on the spot.

💡Merchant discount rates

Merchant discount rates refer to the fees that retailers pay to payment processors for each transaction made using their services. In the video, it is explained that one of the primary ways BNPL companies generate revenue is through these fees. The script notes that the number of retailers using Affirm increased significantly, indicating the growing adoption of BNPL services by merchants.

💡Underwriting

Underwriting in finance involves evaluating the risk of extending credit to a borrower and determining the terms of the loan. The video emphasizes the importance of underwriting in BNPL services to ensure that loans are given to consumers who can repay them. Affirm's CEO mentions that the company must sometimes refuse purchases to prevent overextension, illustrating underwriting's role in risk management.

💡Truth In Lending Act

The Truth In Lending Act is a U.S. federal law that requires lenders to provide consumers with information about the terms and conditions of loans, including costs. The video points out that BNPL services are not covered by this act because they typically involve fewer than the number of installments specified in the law. This exemption is a point of concern regarding consumer protection in the BNPL sector.

💡Overextension

Overextension in a financial context refers to the situation where a borrower takes on more debt than they can manage. The script discusses the risk of overextension with BNPL services, as consumers may not have a complete view of their total borrowing across different platforms, leading to potential financial strain.

💡Default rates

Default rates indicate the percentage of loans that are not repaid according to the agreed terms. Klarna mentions in the script that its underwriting practices have helped keep its default rates below 1%, highlighting the company's success in managing credit risk and ensuring profitability.

💡Interest rates

Interest rates are the percentage at which interest is paid by borrowers on borrowed money. The video discusses how BNPL companies may be affected by changes in interest rates, as higher rates could increase their borrowing costs. This could impact their profitability, especially if merchant fees do not sufficiently offset these costs.

💡Diversification

Diversification in business refers to the strategy of offering a range of products or services to spread risk and increase revenue opportunities. Affirm and Klarna are mentioned in the script as companies that are diversifying their offerings beyond BNPL services to remain competitive and manage market challenges.

💡Competition

Competition in this context refers to the rivalry among businesses for market share. The video script notes that BNPL companies face increasing competition from established financial service providers like Apple, PayPal, and credit card companies. Affirm's CEO views credit cards as the main competition, not other BNPL services.

💡Regulation

Regulation in finance involves the rules and oversight provided by government agencies to protect consumers and ensure fair market practices. The script mentions that Klarna supports additional regulation of the BNPL sector, indicating an industry recognition of the need for consumer protection and transparency in financial services.

Highlights

Buy now, pay later (BNPL) services allow customers to purchase items without upfront payment and pay in installments, often interest-free.

BNPL firms like PayPal, Apple, and credit card companies are growing rapidly, with a focus on young millennial demographics.

Despite the growth, BNPL companies are struggling to turn a profit as their customer base expands.

Affirm, a public BNPL company, reported a revenue increase of over 100% in the past two years.

Merchant discount rates, paid by retailers to BNPL companies, are a primary source of revenue for these services.

The number of retailers using Affirm increased from 6,000 in 2020 to 235,000 in 2022, indicating BNPL's growing popularity.

BNPL services are more accessible than credit cards, appealing to those with credit difficulties or no credit history.

BNPL platforms can approve purchases on the spot, unlike credit cards that require pre-approval based on credit history.

BNPL companies perform less formal credit checks and consider additional data for approvals.

There is a risk of overextension with BNPL, as it can provide spending power to those who may not be able to repay.

Affirm and Klarna have measures in place to prevent overextension and ensure borrowers can repay loans.

BNPL lacks some consumer safeguards present in credit cards, such as those provided by the Truth In Lending Act.

BNPL platforms are structured to avoid Truth In Lending Act regulations, which require full loan disclosures.

The Consumer Financial Protection Bureau warns of the risk of overextension and the inability to see borrowing across multiple platforms.

BNPL companies must balance the risk of delinquencies with approving enough transactions to cover costs.

Klarna claims its underwriting practices keep default rates below 1%, highlighting the importance of risk management.

BNPL companies may need to raise merchant fees to compensate for higher borrowing costs due to interest rate fluctuations.

Affirm and Klarna are diversifying their offerings to remain competitive against larger companies like Apple and PayPal.

Some industry experts believe BNPL as a standalone business may not be successful in the competitive market.

Despite challenges, BNPL is expected to stay due to its potential for growth and service expansion.

Transcripts

- [Narrator] If you want to buy this pair of Adidas,

you can use your credit card

or a buy now, pay later service.

The result seems similar.

You don't pay upfront, but with BNPL,

you can break that full payment out into installments

usually with no interest.

Buy now, pay later firms

have boomed over the last three years

and companies like PayPal, Apple,

and credit cards themselves are joining in on the hype.

But as some of the companies scale up

with their growing customer base,

they're struggling to turn a profit.

Here's how buy now, pay later services compare

to credit cards and what it means

for the next time you're checking out.

- Everything today is pay-as-you-go.

- [Narrator] Dan Dolev is an analyst who follows companies

like Affirm, Block and PayPal.

- Credit is becoming a pay-as-you-go thing

especially in very young millennial demographics.

- [Narrator] Buy now, pay later companies took off in the US

during the pandemic.

Affirm, the only BNPL focused company that's public

in the US reported its revenue more than doubled

over the last two years.

One of the main ways these companies make money

is through merchant discount rates.

A fee the retailer pays

to the company on each buy now, pay later purchase.

- Selling is better than not selling

and merchants are willing to accept somewhat

of a discount in order to make the sale.

- [Narrator] The number of retailers signed on to use Affirm

jumped from just 6,000 in 2020 to 235,000 in 2022.

Part of the reason

for its popularity is that buy now, pay later

is more accessible than a credit card.

- BNPL is very attractive

to people who have credit difficulties.

- [Narrator] Todd Baker is a lecturer

at Columbia Law School who's worked as an executive

in finance and teaches about emerging FinTech.

- Other people do it just because it seems like a good idea.

- [Narrator] Let's go back to that cart with our Adidas.

with a credit card,

You need approval to use that credit

often well before you put your shoes in the cart.

Companies like Affirm, Klarna and Afterpay

on the other hand, can approve on the spot

and make approvals purchase by purchase.

That's because of the different ways they check your credit.

Credit card companies do a deep dive

into your credit history that shows up on your credit score.

Buy now, pay later companies

typically perform a less formal credit check

and look at additional data

like previous times you've used their service.

BNPL can give more spending power

to people who may not have access

to credit or have credit built up, but that can be an issue.

- There is a risk that credit will be extended to you

in a situation where you're not likely to be able to repay

and that's not good either

for the issuer of the credit or for the consumer.

- [Narrator] Affirm's CEO Max Levchin

says the company accounts for this.

- We do have to say no

and tell our consumers with love and compassion

you're overextending yourself.

Please don't buy this.

- [Narrator] Klarna says it also takes measures

to make sure it only extends loans

to borrowers who can repay.

Both Klarna and Afterpay restrict use of their services

if a borrower misses a payment.

Buy now, pay later lacks some of the regulated safeguards

that credit cards have for consumers in the US.

That's in part because they're not covered

by the Truth In Lending Act.

This is a law that requires that lenders provide you all

of your loan information upfront, no hidden costs.

It applies to loans that are paid for

in more than four installments.

Buy now, pay later falls just below that.

- The product was structured essentially

to avoid the application of the Truth and Lending Act.

The beauty of BNPL for the retailers

that it's instantaneous

and the provision of significant disclosure

before a particular transaction would be very difficult.

- [Narrator] Affirm says it provides a truth

and lending disclosure for all credit extensions

and Klarna says it supports additional regulation

of the sector.

The Consumer Financial Protection Bureau also warns

that consumers could risk over extension

meaning they have more debt than they can handle.

This could happen because they could borrow

from multiple lenders at once

since BNPL platforms can't see borrowing activity

on other platforms.

Customer defaults, when they happen,

can have an impact on company's costs.

So they have to balance the risk of delinquencies

with approving enough transactions to cover their costs.

- That's the key to a successful buy now, pay later.

It's underwriting, underwriting, underwriting.

- [Narrator] Klarna said that its underwriting practices

have helped keep its default rates below 1%,

but delinquencies aren't the only thing

that can undermine profits.

Shifting consumer habits can cut down on transactions

and many buy now, pay later programs rely on funding

that is sensitive to interest rates.

Since merchant fees make up the bulk of their profit,

companies might have to raise them to make up

for higher borrowing costs.

- If interest rates go up a lot, then they're in trouble

because the cost of money's gonna be too high

to more than offset with the merchant discount rate.

- [Narrator] Affirm and Klarna offer services beyond BNPL

and are continuing to diversify their offerings

but they're also facing increasing competition

from Apple, PayPal and credit card installment plans.

Still, for some buy now, pay later CEOs

like Affirm's Levchin, the competition is clear.

- The enemy or the competitor is the credit cards,

not each other.

- [Narrator] Despite these challenges,

Delev thinks that buy now, pay later is here to stay.

- And as they become bigger and offer more services,

they will be able to gain scale and increase profitability.

- [Narrator] But some buy now, pay later firms like Afterpay

have been bought by larger companies.

- The fundamental question has always been,

is BNPL a business

or is it just a product for other providers

of financial services?

And I think the consensus seems to be shifting

towards the idea that BNPL

as a standalone business is not likely to be successful

in the competitive market.

(gentle music)