How ‘Buy Now, Pay Later’ Makes Billions From ‘Free’ Loans | WSJ The Economics Of

Summary

Buy Now, Pay Later (BNPL) services, like Klarna, Afterpay, and Affirm, have rapidly grown in the U.S. as an alternative to credit cards. Offering interest-free installment payments, these services are expanding into physical retail, with some offering longer-term loans. Despite the benefits, including making products more affordable, concerns about rising consumer credit losses and potential regulatory challenges persist. Experts debate whether BNPL will truly replace credit cards or become another form of debt, especially as more consumers with lower credit scores use BNPL, raising questions about financial risk and credit reporting.

Takeaways

• 😀 BNPL (Buy Now, Pay Later) is rapidly growing as an alternative to credit cards, offering consumers a way to make purchases with zero interest installment loans.
• 😀 The BNPL market is dominated by three major players in the U.S., with companies like Afterpay and Klarna leading the way, though some started internationally.
• 😀 BNPL typically involves a pay-in-four model, where customers pay in four installments with no interest. Late fees may be charged, and merchants pay a fee to the BNPL provider.
• 😀 Affirm has expanded its offerings to include longer-term loans with interest, catering to larger transactions and providing more flexibility to customers.
• 😀 BNPL companies are expanding their services to physical cards, enabling users to use BNPL at brick-and-mortar stores, which could increase the market size significantly.
• 😀 The BNPL industry has grown exponentially in the U.S., with transaction volume multiplying 20 times since 2019, as consumers increasingly choose alternative payment methods.
• 😀 Some BNPL providers, like Klarna, have partnered with major retailers such as Walmart to offer exclusive payment plans, expanding the consumer base.
• 😀 BNPL services are no longer limited to e-commerce; consumers are now using them for smaller-ticket items and even groceries, with 25% of BNPL users spending on groceries.
• 😀 There are concerns about financial risk as over two-thirds of BNPL loans are being used by consumers with lower credit scores, raising questions about consumer debt and financial stress.
• 😀 The rapid growth of BNPL has led to higher default rates. For example, Klarna reported a 17% increase in credit losses, while other companies like Affirm are seeing improvements in repayment rates.
• 😀 Experts and regulators are comparing BNPL services to credit cards, with some suggesting they should be regulated similarly. However, BNPL providers argue for a separate framework, considering the unique nature of the product.

Q & A

What is Buy Now, Pay Later (BNPL) and how does it work?

BNPL is a payment option that allows consumers to split their purchases into interest-free installments, typically over four payments. The payment plan is approved at checkout, and the provider pays the retailer upfront while taking on the nonpayment risk. If a payment is missed, some providers charge a late fee.

How did Afterpay, one of the leading BNPL providers, start?

Afterpay was launched in Australia in 2014 by Nick Molnar, initially to drive sales in his jewelry store. It quickly became a significant part of the sales strategy after it was tested and proved successful.

What role do merchants play in the BNPL model?

Merchants pay BNPL providers a fee, which can be as much as 5% of the transaction amount, to offer BNPL as a payment option to customers. This fee is how most BNPL providers make their income, rather than from the consumer.

Are BNPL loans always interest-free?

No, while the typical BNPL option is interest-free (usually with a pay-in-four structure), some companies like Affirm have introduced longer-term loans with interest rates, especially for higher-ticket items.

What recent innovations are BNPL providers offering beyond online purchases?

BNPL providers are now introducing physical cards that can be used in brick-and-mortar stores. This would allow customers to buy items, such as a $500 jacket, and have the transaction attached to a BNPL loan.

How has the BNPL market grown since 2019?

The BNPL transaction volume in the U.S. has increased 20 times since 2019. This rapid growth is attributed to consumers opting for alternative payment methods, signaling a shift away from traditional credit cards.

What is the relationship between Klarna and Walmart?

In March, Klarna signed an exclusive deal with Walmart to provide BNPL loans to customers via Walmart's fintech arm, OnePay. This partnership highlights the growing competition in the BNPL space as providers seek direct relationships with merchants.

How are consumers using BNPL loans differently from before?

Initially, BNPL was used for retail purchases, typically in the $100 to $200 range. Now, the loans are being used for smaller ticket items, and even groceries, with a quarter of BNPL users reporting they have used it for grocery purchases.

What risks do experts associate with the fast growth of BNPL?

Experts warn that rapid growth in BNPL may lead to greater consumer risk, as companies extend loans to less-creditworthy individuals. This could lead to higher default rates, which BNPL providers must manage carefully.

How are BNPL providers like Affirm addressing credit risk?

Affirm tackles credit risk by underwriting every transaction at the point of sale. This thorough assessment helps the company deliver 'really good credit,' and it aims to ensure only qualified individuals are approved for loans.