- 4 months ago
How ‘Buy Now, Pay Later’ Makes Billions From ‘Free
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TechTranscript
00:00This burrito bowl dinner on DoorDash comes to $41, but thanks to Klarna you can make four
00:06payments of $10.40 over the course of six weeks instead. The buy now pay later industry, or BNPL,
00:14has exploded as an alternative to credit cards. We really believe the credit card industry is going
00:20the way of the VHS tape. But will BNPL actually dethrone credit cards, or will they ultimately
00:28just be treated like credit cards? This is the economics of buy now pay later. Three companies
00:36make up the bulk of the BNPL market in the US, though two initially found success internationally.
00:42Afterpay co-founder Nick Molnar launched the company in Australia in 2014 to entice more people to make
00:49purchases at his jewelry store. We built it, we tested it, and it became a very significant
00:55portion of our sales really quickly. All of the top providers offer the typical pay-in-for
01:02zero-interest installment loan that has become synonymous with BNPL. Take that burrito bowl.
01:08Once the customer chooses the BNPL option at checkout, the provider approves the loan based
01:13on its underwriting model. We pay the retailer the next day and then we take all of the non-payment risk.
01:19Then, the customer is put on a four-part repayment plan with no interest. If a payment is late,
01:25some providers charge a fee. Providers also charge the merchants to make the loans available to their
01:31customers. Sometimes that's as much as, you know, 5% of the transaction value. The lion's share of our
01:38income, 90 plus percent of our income, is made from the merchant, not the consumer. Some lenders,
01:43like Affirm, have also begun to offer longer-term loans that carry interest. About 20% of our business
01:49today is 0% and about 80% has interest on them. Afterpay also has a pay monthly option for larger
01:56ticket transactions. Customers pay once a month for a longer period of time instead of every few weeks.
02:02There's a simple interest attached to these loans. We're not doing it on every checkout flow. We're
02:08really doing it on a select few that we believe there's, you know, really strong demand for that
02:13particular checkout that's occurring where paying for might not have the same amount of acceptance.
02:25Physical cards that can be used in a brick-and-mortar store are the next big offering from lenders.
02:31That could more or less double the, you know, the potential market. Let's say you're walking into the
02:37store and you ask us to spend $500 on a jacket, then we approve the loan. And then it's just
02:42sitting out there waiting for you to actually transact. And then at the checkout at the store,
02:47you chip your card, and then we pull that transaction that's waiting out there and attach
02:52it to the transaction and put a loan into your account. As the scope of Buy Now, Pay Later expanded,
02:57the industry's growth has exploded in the U.S. Buy Now, Pay Later transaction volume has multiplied
03:0320 times since 2019. You have a clear macro trend around consumers choosing alternative ways to pay.
03:12And that's led to growing competition for both customers and merchants. In March, Klarna announced
03:18an exclusive deal with Walmart to provide loans to customers through the retailer's fintech arm,
03:24OnePay. It's extremely important for the BNPL providers, particularly the specialist BNPL providers,
03:30to have those direct relationships with the merchants. There's a lot of ground out there
03:35and a lot of transactions that there's currently nobody being offered. And so there's a lot more
03:41more white space than there is fighting over existing merchants. The types of merchants that
03:46have adopted BNPL have expanded, and that's changed what people buy with their loans. BNPL definitely
03:53started with e-commerce retail, generally in that ticket size of $100 to $200. As it broadened out,
04:00you saw even smaller ticket sizes and sometimes even consumable purchases. A LendingTree survey
04:08found that a quarter of BNPL customers have used them to buy groceries up from 14% in 2024.
04:15We don't think it's our job to judge what a consumer's choice is on the financial product that
04:20they want to use. Anytime the consumer is putting down their credit card and using Affirm, we think
04:24it's a good thing. I think the BNPL provider's got to think about that, you know, as to whether
04:29is that an indicator that that specific consumer is experiencing more stress or not. In January,
04:36the Consumer Financial Protection Bureau released a study that said that more than two-thirds of BNPL
04:41loans went to borrowers with lower credit scores. Buy now, pay later can make products look a lot more
04:47affordable than they actually are. BNPL providers argue that most of their customers are creditworthy.
04:53After actually over-indexes in the middle and upper income bracket, you're seeing like really,
04:59really strong consumers using the product. But experts say fast growth isn't just risky
05:05for consumers. Whenever you look at consumer credit, that next customer is always going to be a little
05:11more risky than the customers you've got on your books. And for some providers,
05:15consumer losses are growing. In May, Klarna reported a 17% increase in consumer credit losses
05:22from the year before. Klarna said in a statement that the rise in losses was because it had issued
05:28significantly more loans in Q1 of 25, so it's natural for the dollar value of credit losses to rise.
05:35The company added that in Q2, it reported a record share of transactions repaid on time or early.
05:41But broadly, LendingTree found that 41% of BNPL users paid late in the past year, up from 34%
05:50a year before. A firm has reported a decrease in customer defaults. We're delivering really good
05:56credit outcomes with our approach, which is to underwrite every transaction and to make an honest
06:01assessment at the point of sale. And Afterpay says it has seen strong repayment numbers,
06:06especially compared to credit cards. We disable someone's account the moment they're late on
06:11one installment payment. Our order values are smaller. We're not issuing someone with a few
06:17thousand dollar line of credit over an extended period of time. But regulators and other experts
06:23have drawn similarities between BNPL and credit cards. In 2024, the CFPB issued an interpretive rule
06:32that would subject BNPL providers to credit card regulations. But President Trump and Doge have
06:38since crippled the Consumer Protection Agency, which announced it would not prioritize enforcing that
06:43rule. And that's really a concern to those of us who would like to see these technologies used
06:48effectively to give consumers more choices in digital finance. There's been shifts within the
06:53industry, too. FICO announced in June that it would add Buy Now Pay Later loans to credit reports.
06:59That's after a firm became the first major provider to share consumer data with credit bureaus and
07:04TransUnion. But Klarna and Afterpay say they're withholding customer data until they're assured
07:10its customers won't be unfairly penalized. Klarna said in a statement that it welcomes FICO's ambition
07:16to modernize credit scoring to better reflect BNPL use. It also said that it looks forward to a
07:22system where these products can contribute positively to consumers' credit standing. And Block,
07:28which owns Afterpay, said that the credit reporting scoring and interpretation still
07:33largely operate under legacy frameworks. So the company argues that there needs to be a separate
07:39framework for BNPL and credit cards. A regulatory framework that respects those components of the
07:46product and builds the framework around something that is very different to traditional forms of
07:51credit is one that we've been really hard at work on from the day we started the business.
07:56I don't think that BNPL will replace credit cards. I think it's going to replace credit cards for
08:02certain people and may replace credit cards for many people for certain types of transactions.
08:09Even if BNPL providers would prefer credit cards disappeared, nothing would make our team happier
08:15than if we could see the death of revolving credit in the United States.