From loans to credit cards to hire purchases, the idea of installment lending has been around for a long time. But there's something unique about the Buy Now, Pay Later trend that takes it away from traditional forms of lending. Dan Perlin, Managing Director of Research in Payments, Processing, and IT Services at RBC Capital Markets, says there are several attributes of the current spate of fintech-powered solutions that are different.
“A general-purpose card basically has a revolving account that's associated with it, whereby the underwriter says, "Look, here's $10,000, go hog wild", and the underwriting decision is ultimately based on the individual's creditworthiness and ultimately, the trust that they're going to be responsible with those funds,” he explains.
“Buy Now, Pay Later really targets the item level detail for a specific duration of time – that's totally unique. And what that effectively looks like is if you say, "Alright, I've got a $500 item, split it into four payments over six weeks", you have to make that payment effectively before you can start to reload it. So the major difference here is that Buy Now, Pay Later tends to be a bit more bite-sized and very item-specific. And all of that goes into the ultimate underwriting criteria, as opposed to having this big open to buy, which is typical for a revolving account.”
This also means that people aren't really using Buy Now, Pay Later instead of their credit cards every time. Some situations are more appropriate for each line of credit, creating a new opportunity for consumers to shop.
Taking a bite out of private label credit
Buy Now, Pay Later looks great for consumers, but who’s winning in the marketplace? For these new companies to create a space in the market, they need to take market share from someone else, and Perlin believes that the biggest loser will be private label credit, like store cards.
“Our view has been, and continues to be even as the space evolves, that private label credit is going to be the biggest share donor ultimately,”- Dan Perlin, Managing Director of Research in Payments, Processing and IT Services, RBC Capital Markets.
Private label credit shares are store-specific, it has access to SKU-level data – the details about purchases – and individuals tend to have some affinity to the brand or the store that’s associated with the card. Historically, however, they have a low utility function because they're confined to just one store. Buy Now, Pay Later offers the same attributes, but it can be used across many retailers.
“What ends up happening is you have this combination of private-label-like rewards, with this affinity to brands and merchants. But you've got general-purpose card ubiquity,” says Perlin.
The other big difference is the APR. Buy Now, Pay Later is very focused on offering 0% APR over short durations, whereas private label cards tend to be much higher, often as much as 30%. That makes Buy Now, Pay Later much more consumer-friendly and even offers access for consumers who may not use traditional credit lines.
“I think private label cards are the ones who are going to be the biggest share donors here. And it's not going to happen in multiple years; it's going to happen, I think, in relatively short order,” adds Perlin.
The cost of doing business
What’s difficult to understand is why retailers themselves are interested when they're paying 3.5 to 5% per transaction, which is more than for credit cards. But despite this expense, Buy Now, Pay Later offers something that credit cards don't – incrementality.
“It's all about the incremental sale. So retailers for years have complained about the cost of credit cards and the ultimate corresponding interchange fees that go along with that. The problem is that general-purpose cards are not driving another incremental sale at this point. People use a credit card, and they will spend more than they basically have in their bank account as a result of that. But that's not necessarily considered incremental when you look at the grand scheme of things. Prior to the financial crisis, we had a lot of peak credit. So merchants have gotten a lot smarter about what the credit product brings to bear. But Buy Now, Pay Later shows upwards of 20-30% lifts in incremental share at checkout. And average basket sizes are going up above those levels,” explains Perlin.
“Buy Now, Pay Later is showing upwards of 20-30% lifts in incremental share at checkout. And average basket sizes are actually going up above those levels.”- Dan Perlin, Managing Director of Research in Payments, Processing and IT Services, RBC Capital Markets.
However, the mechanics of Buy Now, Pay Later means it won’t have a negative impact on Visa and Mastercard as traditional merchant acquirers; it’s actually positive for them. The payment is split into three or four, and each of those payments is usually handled with a debit card, so Visa or Mastercard now receives three data processing fees for one purchase. They also still capture the assessment fee, which is a percentage of the face value of the transaction, and of course, the Buy Now, Pay Later companies are also paying to accept Visa and Mastercard debit cards.
A fast-moving industry
The huge boost in popularity for Buy Now, Pay Later has led to a corresponding spike in market activity and a significant market cap. There's significant M&A in the sector, and the market share continues to expand. Perlin believes that the US payment volume in the space alone will jump to around $160bn over the next five years and globally to well over $300bn. Eventually, the industry is likely to evolve to encompass lead generation, advertising, and data monetization.
“You need to be able to sustain incrementality of these transactions at the checkout for a long duration of time. The key players, in our opinion, will likely own their digital wallets or apps; they'll have these opt-ins that will ultimately enable data capture. I think the retailers are going to look at these companies ultimately, as kind of outsourced advertising arms, which is not at all the way I think that people think about this industry today,” says Perlin.
While the private label card industry is likely to run into trouble, the networks are more likely to self-cannibalize. They will create their own platforms, whereby their card-issuing banks embed the Buy Now, Pay Later function into the card itself, which will probably be a virtual card. At the same time, the evolution of the payments industry as a whole will move away from the payments themselves and into data monetization, most likely with an advertising bent.
