Buy Now, Pay Later: How an old idea got a new lease of life Transcript

Mark Odendahl  27:36

Welcome to the Industries in Motion podcast from RBC Capital Markets, where we'll be exploring what's new and what's next in today's fast-moving markets and industries to help you stay ahead of the curve. Please listen to the end of this podcast for important disclaimers. My name is Mark Odendahl, and I am the Head of US Capital Markets Research. Let us get into today's episode. I'm very happy to introduce our next guest, Dan Perlin. Dan joined RBC Capital Markets in 2009 as a managing director of capital markets research, covering the payments processing, and IT services industry. He has more than 20 years of research experience. And throughout his career, he's covered several parts of this emerging FinTech industry. I've had the pleasure with pleasure of working with Dan for about 15 years of his 20 years of experience on the street. And I'm really excited to have this conversation with him today on the podcast. Dan, thanks so much for joining today.

 Dan Perlin  01:35

Mark, it's always a pleasure. And it's hard to believe that we've, you know, we've been together for 15 years. There are days when it feels like it's been maybe, you know, just a blink of the eye. And then there are weeks maybe where it feels like it's been a lot longer. But it's great to be here with you today. And thank you.

 Mark Odendahl  04:54

So Dan, we are very excited to talk about the topic today of Buy Now, Pay Later, which has soared in popularity in the FinTech space. Since the onset of the pandemic, we've seen this theme emerge with more and more merchants and more and more consumers, both online and instore, using this offering of on-the-spot instalment payments. Commentators in the marketplace are starting to calculate just how much consumer spending it's accounting for. So let's dig into it right now. Dan, Buy Now, Pay Later, what is it? Hasn't this concept been around for years? And how is it different from a credit card?

 Dan Perlin  05:42

Yeah, no, it's a great question. We, you know, we get that all the time Mark. Instalment lending, you know, as a theme has been around forever, right. So conceptually, on the surface, it's really not new. And that's been one of the big I think, complaints, when we talk to a lot of, you know, the bears around this concept. But there are several attributes that you do need to look at that make it unique, and I think are different from traditional credit cards. So specifically, you know, when you look at the loans, these are item-specific, and these are retailer-specific. So unlike a general purpose card, which basically has a revolving account that's associated with it, whereby the underwriter basically says, “Look, here's $10,000, you know, go hog wild”, and the underwriting decision is ultimately based on the individual's credit worthiness and ultimately, the trust that they're going to be responsible with those funds. Buy Now, Pay Later really targets the item level detail for a specific duration of time. Right. So that's totally unique. And what that 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, you know, open to buy, which typically is around a revolving account. The other thing I would just say is, you know, instalment lending, and Buy Now, Pay Later can very much live in parallel to these revolving accounts. So it's not always a zero-sum game here. I just think that, you know, at the end of the day, when you look at the item specific level of detail, as well as the duration of time, it's a very, very different approach to, to creating an opportunity for consumers to shop.

Mark Odendahl  07:36

But if I dig into that a little bit more, what is the substitute good in the market? And where are the share gains happening in the ecosystem?

Dan Perlin  07:45

Yeah, that's a great question. So, you know, our view has been, and I think continues to be even as it evolves, is that private label credit is going to be the biggest share donor ultimately. And the reason for that is, if you look at Buy Now, Pay Later, and you'll look at private label credit, they do share some similarities in that, you know, private label, credit is store-specific, it does have access to the SKU level data. So that's here, again, item level data, which general purpose cards typically don't have. And the rewards constructs tend to be viewed as I think just a lot more powerful than general purpose cards. And that's because the individuals tend to have an affinity or they have some sort of, you know, affinity to the brand or the store. The problem with private label cards, you know, in our view, now that we look, Buy Now, Pay Later is pretty simple, they have very low utility function, right? It can only be utilized at that specific retailer. Whereas when we think about Buy Now, Pay Later, it has a lot of those same attributes that I just outlined, but it can be utilized across all retailers really in theory. And so what ends up happening is you have this combination of private-label-like rewards, right with this affinity to brands and merchants. But you've got general purpose card ubiquity, right? So you can spread it across all retailers. Now, what's also interesting about it is, you know, Buy Now, Pay Later is also very focused on offering the 0% APRs, whereas private label credit cards tend to have APRs as much as 30%. So it tends to be a little more consumer friendly. The other thing I've just mentioned is that when you look at the consumer interface here, right, Buy Now, Pay Later is wrapped up in this very nice online, mobile experience, the consumer interface is just that much better than whipping out a card and going into a physical retailer, we're just using that card online. So I think private label cards are the ones who are going to be the biggest share donors here. And it's going to be something that's not you know, it's not going to happen, you know, in multiple years, it's going to happen, I think, in relatively short order.

Mark Odendahl  09:46

And correct me if I'm wrong, but why would retailers pay more for this? I think they're paying 3.5, 5% or more to accept Buy Now, Pay Later. Is that more than a credit card?

Dan Perlin  09:59

Yeah. It is dumbfounding, right for a lot of people when they look at this. So yes, the short answer is when you roll up all the fees on credit cards, it is more expensive, and in some instances, quite a bit more expensive. But the simple response is this, it's incrementality. It's all about the incremental sale. So retailers for years, and you and I have talked about this, you know, for the better part of 15 years, right have complained about the cost of credit cards, and the ultimate corresponding interchange fees that go along with that. And that's fine. The problem is general purpose cards really are not driving another incremental sale at this point. And what I mean by that is, yes, 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. And if we think about, you know, prior to the financial crisis, you know, we had a lot of peak credit. So merchants have gotten a lot smarter about what the credit product brings, the credit card brings to bear. But Buy Now, Pay Later is showing, you know, upwards of 20-30% lifts in incremental share at checkout. You've got average basket sizes, they're actually going up above those levels. So the way that I think the market needs to be thinking about, you know, this Buy Now, Pay Later concept and these fee structures is way, way beyond payment, right? Splitting something over six weeks, or a 24-month period is fine. I think that will drive some additional share. But the reality is ultimately gonna come down to lead generation and advertising in our opinion. And I think that that's, you know, that's where this industry is heading, and will ultimately evolve.  when we think about, you know, the companies that in a few years are ultimately going to be the leaders here, they're going to be the ones who have, you know, have access to really good data analytics, they have access to really good lead generation. And quite frankly, you know, it's going to be more about digital advertising and less about the financial services aspects of this business. So incrementality is the key, the sustainability of that will determine whether or not these fees that they're charging today are going to be around two years from now.

Mark Odendahl  20:02

And let's talk about the generational impact here and and talk about spending patterns in the marketplace right now. Is this trend more pronounced with the younger generations? And what does that mean, as we were as we transition from generation to generation in the different forms of payments?

Dan Perlin  20:23

What we find right now is that Gen Zs and millennials are obviously very popular in terms of utilizing this product. And there's a lot of reasons for that, right?  they've lived through some very difficult financial times, they've seen what the traditional financial industry has, has to offer, and, you know, they want a lot more transparency and ease-of-use, and quite frankly, you know, the consumer interface that they're dealing with is entirely digital, right? Most are digitally native. And so, to think that they just wanna use the traditional rails and products are not, not as easily done. So as we go through this potential generational shift, yeah, I think there's going to be huge opportunities. You know, I mean, at the end of the day, the spending power of a lot of these millennials and Gen Zs are pretty huge. But there's still a lot of consumers out there that maybe don't fit into that core demographic that very much are interested in utilizing Buy Now, Pay Later. And some of those are going to be, you know, early users of credit. People, maybe that don't have as easily a way or a path to get that traditional revolving account. In here, again, they don't need airline points, or they don't need massive cashbacks. What they want is to be able to, to attain that product or service. And that in and of itself, is the reward, right? So the rewards constructs, as we think about them long term amongst different generations are very, very different. And so I think that I think you're right to, to bring up the point of this generational shift, and I think it only accelerates the trend, if anything.

Mark Odendahl  12:11

So let's switch topics a little bit. And this is primarily why we're doing this podcast to begin with is the significant M&A that we've seen in the sector, the significant market cap that we've seen generated in the sector. So you know, Square’s in the middle of a very large, I think, close to $30 billion pending merger in this area of firms market cap, I think is $40+ billion. So how do you underwrite all this, all this money, and all this market cap being generated in the sector?

Dan Perlin  12:43

Yeah, it's, it's, these are big numbers. And they tend to, you know, big numbers tend to, you know, be really all tied to growth. And so when I look at  those types of transactions with Square and Afterpay, and Affirm's valuation and others, quite frankly, in the private market, you know, the reality is, it's, there's just a lot of growth, a lot of market share that we think will happen over the next five years. So specifically, when we look at the US, you know, the Buy Now, Pay Later space, as we as we forecast it, is going to be somewhere around $160 billion in payment volume. Or about 10% of the ecommerce market by 2024, which, incidentally, is pretty consistent some of the other more mature markets like Australia, around the world who've reached those levels of attainment. And if you believe those numbers, then that's a 65%+, you know, compounding growth rate over the next couple years, just in the US. If you think about the global opportunity, which is going to be relevant for all these companies you just mentioned, it's certainly well over $300 billion, so double that, and probably growing somewhere in the 30s, or maybe a little bit higher. That's just on the surface, then you start to layer in, well, how big is the private label market, which we just talked about? That's $190 billion annually. How big is general purpose card market? That's over $3 trillion. You know, so there is a massive jump ball that I think quickly adds up. And what I think will happen also is, you know, this isn't going to get dispersed to everybody. I think, as we've seen with payments over the years, you know, concentration tends to get funneled down to the hands of the few. And so it'll probably be you know, four or five companies that dominate the space. I think exclusivity arrangements are not likely to be a big part of it, there will be some, but I don't think it'll be a big part. Nor do I think any retailer really wants to have more than only a couple of providers on their landing page, it just starts to make checkout a little more, a little more crazy. So I think the valuation that we see in the market today is very much predicated off of the runway of growth, but also some major market share shifts out of some of the legacy products that exist today.

Mark Odendahl  14:49

I know you get this question a lot in investor meetings with particularly portfolio managers. What is the impact on the network? So Visa, MasterCard, what is the impact on the traditional merchant acquirers?

Dan Perlin  15:03

Yeah, you're right it is, it has been topic du jour for a while. And I think for the better part of this year, I think the most people don't realize really the mechanics of Buy Now, Pay Later and really thought that the networks were in trouble. What I would say in aggregate today, Buy Now, Pay Later is a net positive for Visa and MasterCard. And t the reason for that is typically the benefits of these instalment payments, when they get split into these various components are very positive for the networks. So if you think about splitting something into four payments, right, which is very standard, the consumer is usually paying back those instalments with a debit card. And that tends to be about 70/80% of the instalment payments. So that means that Visa and MasterCard are now receiving three incremental data processing fees. And they are a fixed fee per transaction, versus just one transaction that would have occurred if they were using that debit card at the point of sale. So that's incrementally positive. Visa and MasterCard, still captured the assessment fee, which is paid for by the card-issuing bank to be a part of their network effectively. And that is a percentage of the face value the transaction. So no real change there, because that's over the amount of the entire purchase. But then one of the things that people also forget about is that the Buy Now, Pay Later companies, you know, in order to accept Visa and MasterCard debit cards, you know, you need to have a merchant acquirer involved in that. And

Dan Perlin  17:00

what that means is likely there will be consolidation amongst the acquirers, as they partner with these Buy Now, Pay Later companies. So that's an absolute probability. But, you know, the reality is they're not being disintermediated entirely at this point. So from that perspective, I would say, the short answer is networks net positive today on the incremental fees, and the virtual card opportunity. And then on the acquirers’ net net, I would say, you know, neutral.

Mark Odendahl  17:49

Well, we've learned a lot here, there's significant growth, there's significant M&A, yet, you know, it's still a very competitive part of the marketplace in payments. Where will this industry end up in 5+ years from now?

Dan Perlin  18:06

So, you know, here, again, I think the industry is really all going to be about lead generation, it's going to be about advertising, it's going to be all about data monetization, and it's just not going to be about payments. And again, that's because you need to be able to sustain incrementality of these transactions at the checkout for a long duration of time. The key players likely, in our opinion, you know, will own their own digital wallets or apps, they'll have to 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. And so when you think about the fee structures, you know, in the future, most of that is ultimately to come out of the advertising budgets of these merchants and not the cost of payments, whereby you are going to be able to sustain some higher price points. I think the private label card industry, you know, as we were just talking about is going to be you know, a little bit in trouble here, I think they're going to have to create their own products, which we're starting to see happen, which means they're going to have to self-cannibalize some of their traditional models, which all great companies do, so that should come as no surprise. I think the networks are going to create their own platforms, whereby their card-issuing banks, you're going to be able to utilize this type of product, it’s going to be embedded in the card function itself, digital virtual cards more likely. And I think that you know, at the end of the day, the networks are also going to have to figure out a way to better interject themselves in this direct bank instalment world but you know, the message I would just leave here with is lead generation advertising data monetization is where it's all at, payments is not, and so this industry group, you know, may or may shift, quite frankly from traditional payments to more of an advertising bent over the next five years.

Mark Odendahl  22:05

Well, that's great, Dan. This has been a very educational session, as it relates to an emerging trend in the payments sector, where you are a leading expert. So thank you very much for today's conversation.


Dan Perlin  22:19

Thanks, Mark, and I'm looking forward to another 15 years with you buddy.

Mark Odendahl  22:23

What else lies ahead in today's ever evolving markets and industries? We'll be keeping track right here on Industries in Motion. We also ask you to listen to Lori Calvasino’s podcast Markets in Motion provided by RBC Capital Markets. Until then, thank you for joining us on this episode recorded October 29 2021. Make sure you subscribe to Industries in Motion, wherever you listen to your podcasts. If you'd like to continue this conversation, or you’re interested in more information, please contact your RBC representative directly or visit our web site at for further insights. Thank you.