“The major winners will be financial services companies that embrace technology.” — Alexander Peh, PayPal and Braintree
In recent years, technology has revolutionized the financial market, creating financial technology (Fintech). Fintech global market is valued at approximately $130bn, the most aggressive projections Expect it to grow to more than $300bn by the year 2022, some others expect to reach that figure in the year 2026. Only in 2020 more than 2,000 private equity transactions worth $45.1bn took place worldwide and $280bn in 970 M&A transactions. (FT Research Partners)
The banking and lending category was the one with more private funding in 2020, with approximately $15.8bn invested in companies, followed by payments and financial management services (FMS) with $7.8bn in funding each. One subcategory in lending that has seen rapid growth recently and is driving the development of this category is Buy Now Pay Later (BNPL). In 2020 companies in this sector, Affirm and Klarna, received financing for more than $500mm each.
Buy Now Pay Later is a new form of financial inclusion that grants financing to any consumer (banked and unbanked) at the time of processing the payment of the purchase of any product through fixed installments within a specified term and with low or sometimes nonexistent interest rates. This new market gives access to a global opportunity of $22tn.
The catalysts for this new value proposition are:
1. Growth of e- commerce: In 2020 the size of the e-commerce retail market reached $3.9tn and it is expected to reach $5.7tn by 2023 (eMarketer). In addition, the share of this market in relation to the total retail market will increase from 16.8% in 2020 to 20.6% in 2023. In 2020, the main payment methods in e-commerce transactions were digital or mobile wallets (44.5%), followed by credit cards (22.8%) and debit cards (12.3%). In 2024 these forms of payment will have a marginal growth/decrease, reaching levels of 51.7%, 20.8% and 12% respectively. Buy Now Pay Later as a method of payment will double in this period from 2.1% to 4.2%.
2. Access to digital data: Digital platforms have made it possible to have real time access to an unimaginable amount of data of different kind, and the accelerated development of machine learning and artificial intelligence have made it possible to strengthen risk algorithms. Traditional financial institutions took a long time to attract a customer, perform credit profiling based on their income, and subsequently provide financing, typically through consumer credit cards. Today, a BNPL company can grant financing in real time at the time of the purchase of the product by generating a credit score that could consider the financial capacity and validate alternative data in multiple digital platforms of the debtor for the purchase of one or several products.
3. Excess capital in search of better returns: Worldwide there is an excess of capital in the markets that is pending to be invested, derived from cyclical and structural factors such as low interest rates and the quantitative easing of central banks. Until February 2021 the uncalled capital in the private equity market represented $3.1tn, an increase of 9 times in the last 20 years. In addition, assets under management of private funds have reached $7.5tn (Mercer).
BNPL solves multiple problems for businesses, consumers, and financial institutions.
- Merchants are always looking to increase their sales and to have higher operating margins. BNPL allows them to increase the purchase conversion on average 44% (Klarna) and the average ticket size (AOV) since it provides an efficient, flexible and accessible solution that positively influences the consumer’s purchase decision. Additionally, it helps businesses build lasting relationships and increase consumer loyalty.
- Merchants pay up to 20% of the transaction in payment to the credit card companies. Using BNPL this commission is reduced to a range of 2–6%.
Consumer Solution :
- Consumers, mainly the new generations, are looking for quick and easy ways of financing. Traditional financial institutions have not been able to offer an adequate product for them. That’s why companies like Hoolah in Singapore offer BNPL financing at the point of sale or online checkout, which is preferred by consumers.
- The new generations are in the process of bankarization and of having a greater purchasing power in the coming years; furthermore, all economies, mainly in emerging markets, have a high percentage of the population that does not have access to financial services.
- Buying products on credit can have a high financial cost for consumers, since the interest rates on credit cards are usually high and the financing that some businesses offer could be classified as usury. BNPL companies as Affirm often charge interest rates between 0–30% depending on the credit score, which is updated in real time with every transaction, using also alternative data such as public information and social media and is shown transparently at the time of payment.
- Sometimes, especially in emerging economies, consumers have limited financial education, which does not allow them to make financing decisions in an informed and effective way. BNPL companies offer financing in a clear and simple way at the time of payment processing and ensure that the consumer is at all times informed of the key aspects of the loan that is being granted.
Financial Institutions Solution:
- Traditional financial institutions generally assume high costs for the generation of loans. On average, these institutions spend $100–250 for the placement of credits and between $125–250 additional to activate a credit card. In addition, these costs are not covered operationally until 1.5 years after the loans are placed, which is the time that financial institutions generally take to generate profitability.
- Traditional financial institutions are increasingly looking for more efficient ways to offer flexible and digital products to consumers, which entails a robust investment in resources and technological knowledge, this is not part of their core business. Today there are BNPL solutions that offer the infrastructure in a white label model so that these institutions can offer more flexible and instant loans to their consumers.
“People need banking, not banks.” — Ranjit Sarai, President’s Choice Financial
Differences BNPL vs Traditional Credit Cards
The exponential growth of BNPL in recent years as a subcategory of the lending vertical has been due to the convenience, flexibility and ease it offers to consumers to finance their purchases in physical and online businesses in real time; and in addition, the high variety of ways in which they can generate income from businesses and creditors.
The revenue model of companies offering BNPL solutions can be given in the following ways:
- One-sided commission: BNPL company buys the product at a discount from the merchant (Merchant Discount Rate ), usually between 2–6% and charges the retail price to the consumer on installments.
- Two-sided commission: BNPL company buys the product at a discount and charges an additional upfront commission to the consumer.
- Interchange fee: The BNPL loan issuer charges an interchange fee for processing the transaction, similar to how credit card issuers do.
- Simple interest: Some BNPL companies, such as Affirm or Klarna, may charge 10–30% APR while building the consumer’s credit score.
- Late payment fee: Sometimes BNPL companies can charge a flat fee of $7–10 for late payment.
BNPL solutions have grown in popularity in the wake of the pandemic and the accelerated growth of e- commerce. Today most relevant fintech players in the market (according to the equity raised) are Affirm ($1.2bn IPO, $1.5bn VC and PE), Uplift ($690mm), Sezzle ($300mm), Splitit ($265mm) and Perpay ($2.5mm) in the United States; Klarna ($3.7bn) in Europe; Afterpay in Australia (acquired by Square for $29bn, $450mm VC & PE), and Akulaku ($218mm) and Hoolah ($400k) in Southeast Asia.
On the other hand, traditional financial institutions, payment processing companies and technology players in other industries trying to integrate Embedded Finance have also shown interest in offering BNPL solutions to their clients. Such is the case of PayPal, which already integrates “Pay in 4 installments” directly into the e- commerce checkout pages, the payment aggregator Square with the acquisition of Afterpay to offer consumers BNPL lending solicitation and management solutions within the CashApp app, Visa which is launching its API so that Visa credit card issuers can offer flexible payments, banks such as Goldman Sachs, Citi and RBC are partnering with third parties to offer a deferred payment scheme, and even Apple has partnered with Goldman Sachs and Affirm to offer BNPL within Apple Pay in the United States and Canada respectively.
Without a doubt, BNPL schemes have brought a more flexible and consumer-friendly alternative to the digital age consumers and are disrupting the lending industry as we traditionally knew it by forcing financial institutions to offer flexible, transparent, and digital solutions. At the same time, they are the bridge between digital payments and lending solutions and are driving the consolidation of the Fintech industry after several years of growth. Lastly, they are an alternative to boost Embedded Finance and allow businesses in any business vertical to offer financing to their customers easily and efficiently.
Buy Now Pay Later has managed to establish a new paradigm in lending processes, has attracted large amounts of capital in search of attractive returns and has forced all players in the financial ecosystem and businesses to rethink the way in which they offer products to their customers.
“A man who pays his bills on time is soon forgotten ”— Oscar Wilde
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Gonzalo Soriano. VC Investor at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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