If any business was involved in e-commerce during the pandemic, odds are they did rather well. Several such companies including Pelton, Netflix and others saw tremendous growth during 2020 as a result. Interestingly, one of the areas that also saw a boom involved buy now, pay later (BNPL) services. Rather than having to pay the full purchase price of an item or service, short-term installments were permitted. In most cases, these extensions were completely interest free and without additional costs. In fact, many merchants subsidized BNPL companies to offer these options to consumers. Knowing that some might be on the fence about a purchase, this added perk could tip them over the edge. And for an increasing number of consumers, BNPL services are becoming a norm.
Though BNPL services sound a lot like credit cards or layaway plans, there are notable differences. Differences in fees, access, and credit score impacts are among the most significant ones. Likewise, for the most part, BNPL companies are unregulated in the finance sector. This seems rather odd given the nature of their services. But even more intriguing is how an economic downturn might affect BNPL companies as well as consumers. As interest rates and inflation increase, everyone involved could share an increasing amount of risk. It’s therefore little surprise that recent valuations of these enterprises have taken a substantial hit as of late.
“People are buying more than they should, and they admit it. Whether it’s aggressive marketing, whether it’s impulse buying, whether it’s a belief that, ‘I’ll have more tomorrow,’ they’re using lots of these [BNPL services].” – Marshall Lux, a Harvard Kennedy School Research Fellow
The Rise of BNPL Services
Prior to the pandemic, BNPL companies were essentially nonexistent. But it soon became clear that merchants online wanted to encourage purchases among their customers. Certainly, they could offer discounts, BOGOs and other incentives. But as it turns out, buying now and paying later was a big hit with consumers. In Europe, BNPL services are promoted as a way to try out a product before paying in full. This helped establish greater trust between e-commerce sites and customers. In the U.S., BNPL companies marketed better cash flow for customers as a result of spreading out payments. In both cases, many people began using these services when making routine purchases. Without any interest to pay, and a bit longer to pay in full, there appeared to be little downside. And merchants were happy to pay the fees to host BNPL services on their sites.
Today, there are several BNPL companies on the market. By far, Affirm is the largest one, but others like Klarna and Zip are similarly well known. PayPal has also gotten in on the game, and Apple will soon launch its own BNPL services under Apple Pay Later. In each of these instances, customers usually extend payments into four installments over six weeks that are interest free. This has clear benefits over traditional credit cards that often have high interest rates. These offerings are also better than traditional layaway plans that hold the item until full payment is received. It’s no wonder that consumers have seen BNPL as a means for immediate gratification without adding additional costs.
“What it signals to me is this is a means to an end. It’s a considered choice about how to make money go a little further and still achieve the goals that you want and still get the things that you feel like you need.” – Charlotte Principato, Financial Services Analyst, Morning Consult
A Potentially Risky Venture
For the most part, the road had been pretty smooth for most BNPL companies through the pandemic. But in the last two quarters, the industry is experiencing some readjustments in overall valuations. Just as Peloton and Netflix have experiences their own post-pandemic woes, so have these companies. For example, after experiencing 528% YOY growth as of Q3 of 2020, Klarna growth has slowed substantially. As of Q1 of 2022, its YOY growth is now about 53%. At the same time, companies offering BNPL services are being devalued by investors. Affirm has experienced an 87% decline in its value since its peak in November of 2021. Zip’s valuations have tumbled about 155%.
These statistics doesn’t necessarily mean BNPL services are going anywhere. In fact, they have become known as the “Gen Z credit card” because of its popularity among this generation. But inflation could tempt consumers to bite off more than they can chew with these BNPL companies. In addition, BNPL companies do not report to credit agencies and are not regulated by the Consumer Financial Protection Bureau. In theory, this allows consumers to easily overextend themselves using BNPL strategies without anyone knowing. Not only could this be bad for customers but for merchants and BNPL companies as well.
“The opportunity to stack your debt by using multiple Buy Now, Pay Later loans through multiple service providers is one of the biggest risks I see.” – Terri R. Bradford, Research Specialist in Payment Systems, Kansas City Federal Reserve
An Unpredictable Future Ahead
According to some experts, the BNPL services industry is expected to continue to grow in coming years. Average annual growth is projects at 43%, reaching over $180 billion in total revenues. Given its unregulated nature, and attractive allure, this indeed may be the case. But there are some additional risks to the industry even if regulatory changes don’t occur. Perhaps the most concerning involves rising interest rates, which could undermine profits for many BNPL companies. Since most use securities to fund short-term installment loans, higher rates will mean higher company expenditures. This could spell trouble for the industry as a whole.
Over the long-term, it is possible that BNPL companies will have to comply with new regulations set by the CFPB. They may also have to start reporting to credit agencies for greater transparency about consumer credit worthiness. But for now, no one expects such changes to take place in the next few years. This is why most financial gurus anticipate the current devaluations are simply post-pandemic adjustments. Despite these predictions, the bottom line is BNPL services are new and have yet to weather an economic downturn. In all likelihood, much will be learned in the coming years about precisely the role BNPL services will play in consumer finance.