The Buy Now Pay Later Model is a simple loan, which originates with a retailer, and is then sold to a BNPL lender at a discounted rate. In contrast to the credit or debit card, which imposes a merchant fee for using the payments infrastructure and associated risk, merchants pay the BNPL by discounting the financing instrument. This is not free, it is a horse of a different color.
Put another way, consider spending $100 at Macy’s that goes through a BNPL lender. If the arrangement is for a 5% discount, Macy’s receives $95 net and takes charge (sometimes to marketing expense) for $5. We discuss the flow and discounts in a recent Mercator Advisory Group Viewpoint titled BNPL Borrowing: Confessions of a Credit Card Manager.
In the current form, BNPL is not a long-term sustainable model. That does not mean it is not an excellent option that many retailers’ payment options, it means that the process will evolve. Will the network challenge Mastercard, Visa, Discover, or American Express? Probably, but the payment networks take the challenge seriously and will not cede the space easily.
Credit and debit cards come into play in BNPL as consumers settle their payment responsibilities with a lender. The BNPL will probably take the first payment when the BNPL loan closes and will charge a bank account or card. When recurring payments happen, the settlement will typically continue to occur on the account. This flow adds a net charge to the process, which needs to be figured out in the long term, or else someone (the consumer) will end up paying for discount and interchange in the pricing.
We are going to see changes in the BNPL model. Profitability is one reason; credit risk is another. We have yet to see black ink on issuer profitability statements, and Mercator identified one top BNPL lender, which took in $544 million in net operating income between January and June 2020. Still, they lost $63 million during that period. Beneath it all was a whopping $144 million in net credit losses, enough to make a banker twitch. Superbowl commercials don’t come cheap, neither do credit losses.
Here is an article covered in Payment Source this morning which illustrates a shift with a creative solution. Expect it to be one of many.
- Affirm has taken its buy now/pay later model a step further by introducing a debit card that lets shoppers use installment payments for any merchant purchase.
- The move will further encroach on traditional credit card issuers’ turf by expanding access to Affirm’s financing, which had previously required merchants to offer it proactively.
- The Affirm Card is available now via a waiting list, and Affirm plans to roll it out broadly this year in a variety of colors, the San Francisco startup announced Thursday.
The full details are yet to be published, but here is how we think it will work. A consumer will be pre-approved for a BNPL credit line. As the transaction occurs, funds get pushed into the debit card to fund the purchase. The liability is not on a credit card; it is on the BNPL account. The debit card is an execution vehicle.
This product change is significant. Instead of offering the BNPL loan during the sales transaction, the consumer works within a credit line. It may be a horse of a different color, but the POS interchange will be lower than credit cards by using debit rails. We do not know how this change will affect the merchant discount, but we expect it to eliminate that merchant expense.
As with any evolutionary move, one change brings another. In this case, we expect that Affirm will strengthen its credit policies, which react to regulatory criticism in the industry that calls for responsible lending.
So is it a credit card or debit card? No, it is a BNPL loan. And that model will change drastically over the next two years.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
