BNPLs: Businesses Needing Provided Legibility
BNPLs: Businesses Needing Provided Legibility
Patrick McKenzie (patio11) •
Jan 7th, 2022
Payments innovation has accelerated in recent years, including multiple fundamentally new payment modes. Most nations did not historically see a new mode in a typical decade. We've had at least five since iPhones hit pockets. One capturing a lot of attention and payment volume recently is Buy Now Pay Later (hereafter, BNPLs).<br>BNPLs are fascinating and unfortunately not understood very well, partly because (in an ongoing theme for Bits about Money) their core customer is not in the social class which spends most effort in understanding the financial system, and partly because they combine old mechanisms in a way which is very novel. Let’s dig in.<br>I work at Stripe, which builds infrastructure for the global Internet economy. We work extensively with BNPLs and with the businesses that use them, just like we aspire to work extensively with every way a customer and business would like to transact. I will note for hygiene purposes that there are three large global brands (Affirm, Afterpay, and Klarna) which are each publicly traded. My opinions are my own and are informed by my general professional expertise. Factual representations below are on the public record (or are my errors).<br>How BNPL presents to a user<br>The overwhelming use case for BNPL is in consumer transactions for discretionary medium-duration non-durables or medium-amount durables, for reasons which will be very apparent later. Think makeup, clothes, and exercise bikes, but not (generally) food or cars.<br>A new user for a BNPL is recruited either at the point-of-sale (POS) in an offline transaction or during the checkout flow during e-commerce. They’re presented with an endorsed third-party offer of credit: sign up for the named BNPL provider and, upon successful underwriting, get offered terms go here.<br>The bread and butter offering in the BNPL space is “pay in four installments”, though there are others (pay in 3, revolving credit, etc). To make this discussion succinct and comprehensible for non-specialists, we’ll talk mostly about the mechanics of “pay in 4.”<br>The timing of the installments is crucial to the offering: the first one is drawn immediately (typically from a debit card collected from the user during the instant underwriting flow), with the other ones being drawn automatically from the same card 2 weeks, 4 weeks, and 6 weeks after the transaction.<br>This is a credit offering; the user is getting use of someone’s funds for a few weeks. Another crucial point is that the credit is free to the user. The installments are equal and include no interest charge if paid as agreed.<br>What happens if the user doesn’t pay as agreed? That’s complicated, and highly sensitive to where the user is located and which BNPL they’re doing business with. It is dictated both by desired user experience, by how willing the BNPL firm (or their capital partners) is to subsidize credit losses, and by local regulation of consumer lending. Some BNPLs have no late fees; some have ones which are capped at low dollar amounts. Late fees are far less crucial to the BNPL economic model than they are for consumer lending generally, particularly subprime consumer lending, which BNPLs are sometimes (unjustly) grouped with.<br>BNPLs underwrite each user (and each transaction) individually. This is entirely done by a computer and happens in milliseconds.<br>Subsequent BNPL transactions follow the same model, except the underwriting process is faster since the user already has an account and doesn’t have to repeat data entry.<br>How BNPL presents to an accepting business
As we covered for credit cards, the payments industry charges partially to facilitate the orderly movement of money and data and partially for marketing. Businesses have three goals of marketing: increasing customer propensity to use them, increasing frequency at which they come back, and increasing amount spent (“basket size”, in retail lingo).<br>BNPLs pitch themselves to businesses as more marketing efforts and less simple payments rails. They’re more expensive than cards by about 300 bps. (Payments nerds always quote prices in basis points, hundredths of a percent, rather than in percentage terms. In addition to this being a shibboleth to get oneself mocked on Twitter, it reduces ambiguity. If I had said “3% more expensive than cards” you might not know whether I meant “so about 3.1% plus some fixed fee” or “about 6% plus some fixed fee.” It is, of course, the latter.)<br>Clearly BNPLs need something to justify costing twice as much (or more) as the default option. They claim they radically increase conversion rates (by X0%), basket sizes (by X0%), and repurchase frequency, without substantially cannibalizing card sales. (You can read the specific claims on their sites.) The math follows very quickly from there, particularly for retailers in segments like fashion and makeup who have...