While the buy now, pay later industry is changing the way we shop and pay, it also has profound implications for the digital payments market, retailers, and policymakers.
The buy now, pay later services have developed at blazing speed in recent years and are likely to continue to grow exponentially. In the UK, BNPL usage almost quadrupled in 2020, to £2.7 billion in transactions. In Australia, the value of BNPL transactions grew by around 55% in 2019/20, tripling in the previous two financial years, and in the US, the size of the BNPL market is estimated to reach $20.4 billion by 2028.
The reasons for this expansion are intriguing, as are the future implications, especially because BNPL providers are still in the regulatory grey area in most countries. In this article, I will discuss why consumers are looking for new ways to manage their finances, the impact BNPL may have on retailers, and the challenges buy now, pay later providers may face. I will focus on the two markets for which we have the most data: UK and US.
The great habit change
Let’s first look at how the way people spend and save their money changed during the COVID-19 crisis and what factors drove this change.
Less debt and more savings
The pandemic caused unprecedented financial disruption for consumers and businesses, but it also led to an increase in people's savings. In the US, government relief payments provided many Americans with the cash boost they needed to break the cycle of revolving debt, with more than half of recipients using that money to pay off loans. As a result, total revolving consumer credit was $116 million lower in January 2021 than in January 2020. US consumers also reported a significant increase in savings.
In the UK, where the economy contracted by a record 25% between February and April 2020, most workers have been protected by the government's furlough scheme and income support grants. As a result, employment fell by only 1.7% and unemployment rose to a relatively modest 5%.
Household savings also increased in the UK as incomes rose and spending fell. In the first quarter of 2021, the country's savings rate reached 19.9% (up from 16.1% in the fourth quarter of 2020). This was the second-highest savings rate in the country's history after jumping to 25.9% in April–June last year during the first round of COVID-19 lockdowns.
More online shopping
COVID-19 restrictions, social distancing, and lockdowns led consumers to make more of their purchases online. In the UK, the share of online sales was over 30% in 2020, a sharp increase from 20% in 2019, leading to a greater popularity of mobile payments in general and a rise in BNPL payments. Currently, the UK e-commerce market is the third-largest in the world (after China and the US) and is expected to reach £264 billion by 2024, up 37% from 2020. BNPL transactions currently account for 5% of the market and are expected to reach 10% by 2024.
In the US, spending with debit cards has increased by 43% since the beginning of 2020, and by as much as 230% with the BNPL solution.
The forecast states that there will be 45 million users of the BNPL service in the US in 2021, and over 76 million in 2024. Klarna alone has over 7.9 million users in the US. Forecasts suggest that BNPL could contribute to more than 10% of e-commerce spending by 2024 at current growth rates.
Gen Z and Millennial dislike of credit cards
Another factor contributing to the popularity of buy now, pay later is the growing reluctance of younger generations to use credit cards.
In the UK, consumer credit from sources other than credit cards has grown by an average of 9.3% per year over the past decade, compared to 5.5% for credit card loans. The shift in financial habits is most noticeable among younger consumers, particularly Gen Z and Millennials. Data from the Financial Conduct Authority shows that 25% of BNPL users in the UK are aged 18–24, and half are aged 25–36.
In the US, 36% of BNPL users are under 25, while 41% of them are Millennials (26–40 years old). According to the Ascent Survey, 37% of those who have ever used a BNPL service have done so to avoid credit card interest.
A recent report from BNPL provider Afterpay showed that US customers could save up to $459 million in credit card fees and interest in 2021 by making purchases with Afterpay instead of a credit card, which equates to $6 per order.
The impact of BNPL on retailers
The pandemic caused many non-essential stores to close for several weeks. Shopping shifted to online stores, which lad to a change in payment methods and faster adoption of new technologies such as contactless cards, mobile wallets, and mobile banking. Many retailers began offering BNPL options to attract more customers and increase sales.
A study conducted by Accenture shows that
Afterpay will bring $4.5 billion in net benefits to retailers in 2021, including $8.2 billion in incremental sales for retailers and small and medium-sized businesses.
The revenue impact is primarily due to improved online checkout conversion rates, larger shopping carts, new customer acquisition, stronger customer loyalty, and an increase in repeat purchases. Afterpay is expected to bring $590 million in cost savings to merchants by 2021, with over 80% of the savings coming from lower customer service and customer acquisition costs.
The question of no surcharge rule
On the flip side, a free BNPL service for customers means those costs will be allocated to merchants. Afterpay said its average global merchant fee for 2019/20 is just under 4%; Zip Co's average fee was estimated at 3%.
Most retailers are prevented by BNPL providers from charging a surcharge on goods purchased through BNPL, but this may be an area that may be regulated in the future. As long as the costs of prohibiting surcharges outweigh the potential benefits, the BNPL network will remain in balance.
Over time, this could change and about half of BNPL users said they would switch to an alternative payment method if faced with a hypothetical surcharge on BNPL payments. 40% said they would pay the surcharge, and about 10% said they would walk away from a transaction altogether.
More challenges of the BNPL market
It is certain that the buy now, pay later market will be scrutinized by regulators, because lending money has never been without consequences.
Regulations on the way in the UK
Tighter regulations are on the way in the UK, as the government has just published a new document for consultation on BNPL regulation.
The Treasury statement suggests that the legislation will be less stringent than some have called for. In early 2021, the Financial Conduct Authority suggested that BNPL products should be subject to FCA lending rules, requiring providers to carry out a hard credit check and affordability test when customers choose to pay in installments.
However, leading UK BNPL providers such as Klarna, Laybuy, and Clearpay welcomed the consultation, and the Treasury was not as harsh as the FCA in its ruling. "There is relatively little evidence at this stage that there will be widespread consumer detriment. BNPL should be subject to regulation that is proportionate but not so onerous that it impedes product choice or restricts consumer choice," the Treasury statement said.
Among the Treasury's proposals is the introduction of rules to govern how BNPL firms treat customers in financial difficulty. In addition, proportionate regulation should allow consumers who are unhappy with the way a BNPL firm has treated them to complain to the Financial Ombudsman Service. The regulation may come into force in late 2022 or 2023.
The risks of BNPL for consumers
Other questions about the future of BNPL relate to concerns that buy now, pay later solutions tend to be used for "wants, not needs." They encourage impulse buys, and if someone is struggling with overspending on a credit card, BNPL can be a tempting opportunity to pay off one debt with another. According to a study by Credit Karma, 40% of US consumers who have used BNPL have missed more than one payment, and 72% of them have seen their credit scores decline.
Experts point out that regular users of BNPL are depriving people of "emergency money" because using the buy now, pay later option becomes a fixed cost that discourages saving and leaves no room for flexibility. According to one study, 64% of American adults today are able to pay for a hypothetical emergency expense of $400 with cash or savings.
BNPL providers emphasize that they enable financial inclusion for people who do not have access to credit, but that's a double-edged sword. Some of those who use BNPL services would not qualify for a credit card, and future regulations could require consumers to qualify beforehand — in other words, a credit check.
The YouGov survey of UK consumers shows that most people with poor credit ratings do not use BNPL to access credit they cannot get elsewhere. Only 15% of respondents said that being able to access credit not available elsewhere was “very important” to them. This data suggests that most consumers use BNPL to enjoy the benefits rather than out of financial necessity to use it.
BNPL has already rewritten the future of lending and has become a global phenomenon. Millions of people have moved to online shopping, especially for buying electrical and tech goods, but also fashion and household items. Buy now, pay later has become an easy purchase option that offers customers no vested interests, easy access, and a completely digital experience.
Most buy now, pay later business models assume that retailers partner with vendors and pay a percentage of the purchase amount as a fee.
So far, most retailers have benefited from BNPL solutions by seeing better conversion rates, access to new customers, and larger shopping carts.
In the future, the issue of a surcharge may arise and customers may have to pay a fee to use BNPL solutions.
The future is also likely to bring regulations to the BNPL sector, which are already on the way in several countries. The stricter regulation may mean that BNPL providers will have to differentiate themselves from other installment services or credit card issuers and fit into a more regulated environment.