The True Cost of Buy Now Pay Later

The True Cost of Buy Now Pay Later
Dhun Karai Partner – Financial Advisory Grant Thornton Australia Ltd.
Feb 13, 2023

Buy Now, Pay Later (BNPL) services have been in the mainstream since 2015 and have surged in popularity over the last three years, with a forecasted compound annual growth rate (CAGR) of more than 40 percent over the next decade. Initial activity in the retail sector seemed in favor of BNPL and for consumers, BNPL appeared to be an easy way to access a credit-like product. Australia was the country where BNPL products began to grow, which quickly spread globally. Companies like AfterPay (now under Block/SQ) and ZipPay have become global players and Klarna and Affirm are the world’s largest BNPL pure players. A plethora of copy-cats sprang up across the globe to take advantage of Covid-19 restrictions on physical interactions but getting market traction and brand recognition has proved difficult for most. Now, the market is changing with traditional players, such as acquirers, networks, and banks, offering installment plans and marketing offers to slow the departure of customer transactions and the disintermediation of their merchant relationships.

Accessing BNPL is much easier and faster than applying for a credit card, and unlike credit cards, consumers can pay the item off in fixed installments. The registration process is seamless and BNPL is conveniently available at checkout as a payment option on most e-commerce platforms. This is made possible as providers charge merchants a portion of each sale (akin to merchant service fees), and only need to charge customers late fees if they fail to meet their repayments.

At its peak, the global BNPL market value was estimated at US$125 billion and is currently expected to hit around US$3.2 trillion by 2030. North America has the largest market with revenue share of 30 percent in 2020, and the fastest growing region is Asia-Pacific. In Australia, the Reserve Bank of Australia’s latest RBA data confirms the popularity of BNPL, showing in FY22 there were roughly seven million active BNPL accounts (Australian Bureau of Statistics: Australian population 26 million) and AU$16 billion spent, which is an increase of 37 percent over the previous year. However, these positive forecasts have not led to market performance, as BNPL fintech providers have seen significant decreases in valuation, as much as 90 percent or more, since their peak in early 2021.

BNPL transactions appear to be overwhelmingly sought after by Millennials or Gen Z who often shop online and are generally averse to traditional credit cards. BNPL transactions are vastly skewed towards e-commerce, with online sales representing 82 percent of total BNPL activity in 2022, however point of sale BNPL transactions are reportedly increasing. The dominant retail sectors are large, discretionary purchases, such as electronics ( 36 percent ), fashion (30 percent), and household items and furniture (24 percent). In order to help bolster the growth of their business, fintech providers are expanding how they interact with the payments market. In some instances, BNPL providers are using custom-built online Artificial Intelligence-based (AI) models to influence consumer decision-making and to accelerate their penetration in the consumer market. BNPL providers also use direct marketing activity, strategic partnerships, and product alignments to boost their prevalence and retailer sales.

Cost to merchants

BNPL works by merchants entering a contractual agreement with the BNPL provider, and only customers who are signed up with the BNPL provider can use the BNPL service at those merchants. Currently in Australia, merchants pay anywhere from 3-8 percent in merchant service fees on BNPL transactions, well above the 1.25-1.5 percent credit card transaction fees, and 10¢-35¢ per transaction for debit cards. BNPL providers themselves make around 90 percent of their revenue from merchants, and while justifying the higher costs as marketing tools, they are in essence a payment type offering credit facility. On top of this, data from annual reports show that many BNPL providers are shifting their business models to be more focused on merchant fees rather than consumer fees, further exacerbating the burden on retailers.

Rising concerns for consumers

This year in Australia, Australian Securities and Investments Commission (ASIC) released a report before interest rates started to increase, showing one in five Australian consumers were actually missing their payments under BNPL schemes, and often using BNPL products to pay for essentials like groceries and energy. In some cases, consumers were paying off one BNPL product with another BNPL. These distressing trends – which are reflected globally – illustrate many consumers using BNPL payments are “stuck in a revolving door” of debt. As a result, the BNPL industry is facing a multitude of challenges including lax lending practices, lack of credit checks, poor complaints handling, poor disclosures, disproportionate fees and charges, lack of reporting, and no regulatory oversight.

Globally, there are additional concerns for the data rights, protection, and security of consumer information. In Australia, Consumer Data Rights (CDR) was passed as law in 2020 which aims to provide more control over how consumer data is used and disclosed. Currently, BNPL providers are excluded from the CDR measures, and data security can become an even bigger problem when a customer transfers from one BNPL provider to another. 

Regulator intervention

As rising inflation and the interest rate cycle bites consumer affordability coupled with a looming global recession, regulators are calling for BNPL issues to be addressed now for consumers, merchants, and for the providers themselves as their valuations continue to dive.

Options that have been proposed by regulators include installing credit checks, and affordability tests in the BNPL application process to stop people from obtaining credit beyond their financial means. In addition, regulators have called for more stringent consumer protection laws and strengthening the current code of practice to become mandatory, which is currently voluntary for BNPL providers.

If Australia were to introduce tougher BNPL restrictions as a result of its Regulating Buy Now, Pay Later in Australia – Options Paper, it could pave the way for additional countries to consider a similar approach.

Considerations for merchants

While we have heard a lot from consumer groups and the regulators on BNPL issues, merchants and retailer groups have been virtually silent. Merchants have spent the last three to five years encouraging consumers to shop using BNPL products; they must speak up so regulators and providers know how merchants will be affected by any changes to the current system.

If there are tighter regulations on BNPL products, merchants will most certainly feel the ramifications of reduced consumer spending and compliance costs. The potential restrictions also pose a range of additional questions:

  • How are retailers protected from consumer harm impacts when any regulation is minimal?
  • Should retailers be relying so much on expensive BNPL products to boost their sales and lower their already squeezed margins?
  • How can the retailers and merchants have more control over BNPL sales and customer experience, and ultimately their bottom line?

Whatever the outcome for BNPL regulations in your market, BNPL providers may need to re-think their long-term customer acquisition and relationship strategy and move away from simply being a marketing tool for merchants. If BNPL providers were to become a sales tool with benefits, including elimination of the losses of unclaimed lay-buys, lower inventory costs, and immediate sales revenues, these benefits would cross both sides of the retail industry with positive outcomes for both consumers and merchants.

Dhun Karai has over 25 years in senior executive roles in Banking and Financial Services spanning the Commonwealth Bank of Australia and Woolworths Group. She has been a leading voice for merchant payments innovation, access, regulation, and security, and provides strategic and operational advisory services to major corporates, retailers, payment networks, government services, and regulators. Dhun can be contacted at Dhun Karai, Partner – Financial Advisory.

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