Buy now pay later - What's the catch?
Breaking down the seemingly unprofitable business model of Affirm and similar businesses
Good morning and happy Monday!
Most are familiar with the time value of money. It is the concept that $1 today will be worth more than $1 received x amount of years from now. This is for a variety of reasons, the two most important being:
Inflation decreasing the purchasing power of said dollar
The potential rate of return you forgo when that dollar is not in your possession
Buy now, pay later (BNPL) companies completely throw that out the window. Want to purchase something for $1,000? How does it sound to pay in 4 installments of $250 over a couple of months. Did I mention these can be interest-free payments?
Companies like Affirm, and now Afterpay, have seen some lofty price tags for being the facilitator of these transactions. Square made plans to acquire Afterpay for a staggering price of $29 billion. Klarna, the Euro leader in BNPL space, raised $639 million earlier this summer, earning a valuation of $45.6 billion1. Are valuations that inflated, or can we find a way to justify the business model of this buy now, pay later company?
For starters, this type of financing could not have had a better opportunity fall into its line of sight. With everyone locked inside over the past year and a half, purchases were being made to improve the at-home lifestyle. Peloton and other home gyms saw sales surge, gaming setups were becoming next-level, air purifiers, AC units, and space heaters were a necessity. Anything and everything was being picked up, and consumer spending is only getting started. Combine these trends with the freight train of e-commerce, and BNPL is in a position to thrive.
You have likely seen a hyperlink to one of these services under your online purchase. The goal of the companies here is simple - provide an alternative credit solution so customers don’t need to rely on credit cards. Some of the advantages of this route for the consumer are:
Doesn’t require a great credit score (a soft credit pull can sometimes occur)
Most payment plans are interest free, so long as the payment structure is followed. Otherwise some hefty fees and interest rates will be tacked on
Its convenient - you are already in the process of checking out, why not defer some of the payments?
And for the merchant?
Let’s use Peloton as an example. Everyone knows someone with a Peloton, and we also know that those things aren’t cheap. For some, putting $2,500+ into a workout station at home could be the right move. For others, that is simply too much money upfront. Luckily, Affirm is partnered with Peloton and offers payment schedules of 12, 24, or 39 months with 0% APR! You could be paying as low as $71.67 per month for a sweet new ride.2
This is the basis of the BNPL profit structure. Peloton loves that they can access a whole new customer base (those less inclined to make big purchases, or people without access to credit or large sums of cash). Because of this, Peloton would be happy to pay the fees that Affirm wants for “sourcing” this deal. It seems like a win for everyone, and it mostly is, except for some of the consumers getting tied into bad habits.
Because BNPL can make large purchases seem otherwise insignificant, there is not a doubt that in the U.S this can be exploitative. People love to spend, and this just offers a way for people to spend in a seemingly harmless way. However, when the late fees come, followed by an accrued interest amount, the consumer can quickly find themselves underwater in debt - probably the exact thing they used the BNPL to avoid3.
This is the other main source for these companies to make some money. Obviously there will be users that make all their payments on time, never incur late fees or interest rates, and use the BNPL structure to keep their liquid capital for a longer period of time. Others cannot use the system appropriately and will find themselves dishing out extra payments to these credit companies.
The volume of transactions these companies have access to will continue to grow, and Square making this acquisition is just highlighting the consistent transition from traditional finance to a digital world.
As mentioned, utilizing these companies appropriately is a great way to not tie up capital. But, as with everything, there is always fine print that needs to be carefully considered.
Thanks for taking the time to read today,
Joey
https://techcrunch.com/2021/06/10/fintech-giant-klarna-raises-639m-at-a-45-6b-valuation/
https://www.onepeloton.com/shop/bike-plus
https://www.fool.com/the-ascent/research/buy-now-pay-later-statistics/
https://www.marketwatch.com/story/the-buy-now-pay-later-wave-klarna-affirm-and-rivals-hope-to-take-u-s-by-storm-11622225931
Awesome post, Joe! Thank you for the great info! Cool to see the comparison of benefits between the consumer and the companies contracted with BNPL services. Keep up the great work brotha!!!