Buy Now, Pay Later Apps vs. Credit Cards: The Pros and Cons | WSJ
Summary
TLDRThe 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
- ๐ Buy now, pay later (BNPL) services allow consumers to make purchases and pay in installments, often with no interest.
- ๐ BNPL companies like Affirm, Klarna, and Afterpay have rapidly grown in popularity, especially during the pandemic.
- ๐ฆ BNPL firms generate revenue primarily through merchant discount rates, fees paid by retailers for each BNPL transaction.
- ๐ณ BNPL is more accessible than traditional credit cards, making it attractive to consumers with limited or poor credit history.
- โ๏ธ BNPL companies perform less formal credit checks compared to credit card issuers, leading to instant approvals for purchases.
- ๐ซ There's a risk of consumers overextending themselves with BNPL, potentially leading to debt they cannot repay.
- ๐ BNPL services are not subject to the Truth in Lending Act, which mandates transparent loan terms for traditional credit products.
- ๐ BNPL companies must balance the risk of customer defaults with the need to approve enough transactions to remain profitable.
- ๐ฐ Rising interest rates can pose a challenge for BNPL firms, increasing their borrowing costs and impacting their profitability.
- ๐ค 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
๐ณ 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.
๐ 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.
Mindmap
Keywords
๐กBuy now, pay later (BNPL)
๐กCredit card
๐กMerchant discount rates
๐กUnderwriting
๐กTruth In Lending Act
๐กOverextension
๐กDefault rates
๐กInterest rates
๐กDiversification
๐กCompetition
๐กRegulation
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)
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