BNPL: Big Bang or Big Crunch?

[This opinion piece by Chris Warburton was originally posted on RO-AR.com]

Buy Now Pay Later (BNPL) was a hot topic of a couple of conversations last week.

Over the last couple of years, it has been an area of significant growth, and one that recently has had a lot of media coverage. This is especially true regarding concern for consumers who may borrow too much and get into problem debt… but are the dynamics all they really appear?

A few observations from the week.

1. The market segment is, at the moment, smaller than may appear – with around 8 or so main BNPL players in the UK, total receivables are far behind the credit card sector.
   
2. The original business model is driven off, closed-loop relationship with merchants – higher fees for more sales. Most of these stores appear to be high-end or brand direct-to-consumer retailers… think BOSE or Nike, rather than Curry’s and Sports Direct… how many of us have main retail relationships outside big-box retailers… for something special, maybe, for everyday spend probably not… this has largely limited market size, up to now.
   
3. Most purchases have been low balance, low ticket items, spread over a few payments over a period of weeks… total outstanding liability has been low and payment history can be built up quickly before lending more.

However, all is not necessarily well in the BNPL world and despite early profitability, many are now losing money. Administration expenses and bad debt losses exceed merchant fee revenue in many cases, and with no interest charged, the resulting cash flow does not look great in the short term.

You get the sense that the current strategy, with investment, is to outgrow losses – Ie “okay lose money now, but for returns at a later date”.

With some players already exiting the market, you wonder how robust a strategy this really is, and with this push for growth comes the real risk for many.

Risks with Growth

To expand the market there are a couple of big levers that can be pulled.

1. Extend time between payments, making it more attractive for consumers. However, the longer the time to pay the greater the inherent risk of non-payment. After all, the greater the time between instalments, the higher the likelihood a consumer’s situation changes and they cannot pay. Currently Zilch is at 6 weeks (similar to a credit card), and Klarna is at 3 months.
   
2. Expand to more retailers, especially big-box retailers. The more mass-market retailers, the more transactions, spend volume and hence merchant fees. However, the risk profile of customers who spread the cost of buying specialist products can be quite a different profile from those doing this for food (not in all cases, but for some). The more mainstream spend captured, the more risk that will be encountered.
   
3. Increase transaction value. Current values are typically low, below or in the hundred, not in the thousands. Moving to higher values means more fees, however, it also concentrates risk and loss if the customer cannot pay.
   
4. Loyalty programmes. As we have seen in credit cards, these can capture more spending, especially diverting from competitors. However, these also cost money to provide, and were heavily squeezed due to pressure from merchants to lower fees (especially from big-box retailers)

In the search for growth, each of these trends seem to be being explored across the industry.

Whilst there is undoubtedly a profitable niche in the market at a smaller scale, scaling this up to a wider mass market, especially without the infrastructure, the question needs to be asked if the business model is really sustainable.

Will it in fact all go crunch… collapsing and impacting some customers as collateral damage along the way?

Managing with fine margins

From my time at Amex, many years ago, I remember just hard this management can be. Relying on merchant fees as a primary source of income results in very fine margins, requiring many sophisticated risk management and collections hoops to make it profitable.

It seems these techniques are currently missing in BNPL at the moment… (and we have not got to the pressure from lowering merchant fees fully yet either)

So where next?

Despite these challenges in the market, more mainstream banking players, are also now moving in, no doubt in search of their own growth in lending.

I do wonder if this evolution is actually the path we will see to mainstream profitability for the mass market business model.

For example, I have just been given the option to spread the cost of my fuel purchase by my banking provider. It was 3 instalments for free (apart from the personal data I had to provide). As a consumer (and given the cost of fuel) it is a great deal and you think why not!

What is more, if I need to spread over more payments I can… at 19% APR… it really is an intro to mainstream consumer lending… some financial services players know how to do.

We have seen this approach before in the credit card market, which already has up to 6 weeks of interest-free and often 0% balance transfers to spread payments too… I do wonder if this is where we will end up here too… is it the same in a different wrapper

Is this is future? And is this sustainable? It could be. Watch this space.

… and if you are running a BNPL collections process, getting ready today with modern collections techniques and processes can really help your business to manage within its profit margins… all of this will help for this future.

Have a good week everyone.