It is hard to argue about the success of Buy Now Pay Later (BNPL) lending, but the big picture goes far beyond Klarna’s success or the thrill of Affirm’s IPO. The product will not entirely displace the credit or debit card, which provides anytime/anywhere access, but BNPL’s digital design, embracing credit model, and merchant-focus can teach bankers a thing or two.
BNPL lending lacks structured reporting requirements, as you find in the credit card business, where issuers answer to central banks about capital adequacy, fair lending, reputational risk, interest rate risk, and clarity in terms. But, the BNPL concept is not new by any stretch. GE Finance, the predecessor to Synchrony, had a similar model to BNPL five decades ago. When I began in the credit business with the Household Finance Corporation in 1977, we offered identical merchant financing with companies like Singer Sewing machines, auto repairs, and furniture. Funding these items came with low fraud risk and a sound customer base. Few “bad guys” need a sewing machine, after all.
But what BNPL brought to consumer lending is a model that works well in electronic commerce. It makes small loans with a quick settlement and creates a merchant-centric model, which diverges from the standard consumer-centric banking model. The process works effectively, and we cover the UX highlights of Affirm, American Expess, PayPal, and Afterpay in a recent Mercator Viewpoint titled “BNPL Borrowing Confessions of a Credit Card Manager.”
Mercator envisions the BNPL market that will soon fragment, with specialized use cases. Even the genius of Max Levchin can’t fill the need of every consumer type. Citi can’t, Chase can’t, and neither can Max.
In this case, fragmentation is good. It allows BNPL to still focus on the merchant and specialize. There can be specialty financing models that focus on three credit tranches: good, bad, and ugly.
Today’s read provides a perfect example. Seeking Alpha talks about “Rent-A-Center: A Hidden BNPL Gem.” In the hierarchy of credit products, the rent-a-center type business is close to the bottom. Instead of dealing with a traditional bank, many clients only qualify with a non-bank lender that does not pass title or ownership on the purchase until the rental pays in full.
But, despite its warts, the rental industry makes money. The article continues:
- New age Buy Now Pay Later companies are commanding incredible valuations after COVID-19.
- Rent-A-Center is a chain of lease to own stores with a 3rd party lease to own solution Progressive Dynamics.
- Its recent acquisition of Acima catapults RCII to become one of the largest lease to own players in the US and boosts both growth and profitability substantially.
- Lease to own has a very similar model to BNPL, yet LTO companies like RCII trade for a very low valuation despite strong profitability.
It’s the merchant model!
- BNPL providers offer short term financing options for consumers that buy from specific merchants. For example, let’s say you’re trying to buy a $300 pair of shoes, but you don’t have the cash or credit card. If the merchant works with an eligible BNPL provider, you can pay the charge in 4 weekly installments with zero interest.
- The BNPL provider usually earns money from a combination of consumer late fees as well as merchant fees. The consumer benefits by paying later, and the merchant benefits by getting higher conversion as more consumers can afford the product. It doesn’t sound like an exciting business model, but the market has bid up many of these fast-growing BNPL providers.
As someone with long life in the credit industry, I tended to be an aggressive lender, but there are boundaries. In my early days, I had the highest lending authority allowed for licensed lenders in the state of New York. Still, when you think about building a business where late fees are a significant part of the business model, That’s one reason why the BNPL needs more regulatory guidelines.
Expect the BNPL to form in segments that address local markets, not just top tier merchants. That is important to serve large businesses, not only Macy’s but also Mainstreet USA. You will see some companies focus on weaker credits and others that focus on the well-heeled, just as you see with Capital One and Bank of America today. Then, as BNPL matures, expect specialty financing options, such as Goldman Sachs’ excellent Apple Mastercard and even Harley Davidson motorcycles.
But what will not change is pricing. The promise of “no-interest” will not mean no charge. It might instead mean service fees. And for interchange, you will not see the servicing cost go away. Instead, it will be reflected in the acceptance terms, called merchant discount.
Lending is more than a service; it is a business.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group
