We have all recently heard/read an article or story regarding the growing business of the so-called “Buy now, pay later”. Every week there is a new company in the banking or payments sector entering or launching a BNPL product (i.e. Revolut, Apple, Monzo, Amazon, Square, etc.). All these players are entering because they must think that there is still a piece of the cake on the table. However, I’m not so sure that there are any pieces left, or even if the profitable cake ever existed in the first place.

Despite its popularity and growth, the BNPL profit model is highly questionable:

• A $100 sale earns (on average) $4 in merchant revenue with 56 cents in late fees = $4.56.
• Expenses are $4.75 – of which $1.00 are credit losses, 16 cents funding, 34 cents share purchases and $3.25 in marketing, operations and salaries.

It is clear from these numbers that BNPL companies will never make huge profits (at least with the current business models); they are very high volume, very low margin businesses and extremely sensitive to funding costs.

The industry is struggling to turn a profit, with its average industry profit margin sitting at -2.6 per cent.

There are several arguments that could explain the difficulty behind this business being profitable any time soon:

• None of the pure-players (Klarna, Affirm & Afterpay) are as-of-today profitable (FY2020) – this could be explained due to the recent increase in investment due to their expansion plans although it should be marked as a red flag.
• Extreme competition – the last few months have seen a big increase in the number of players in the BNPL market, mainly due to the low entry barriers it presents (i.e. soft regulation, no need for state-of-the-art technology, etc.). This increase in competition harms the proceeds of most players: the path to profitability for most of these companies is to achieve massive scale, a feat not aligned with the extreme competition scenario.
• One of the main streams of revenue for most players in the sector are the infamous late fees, particularly for the Fintechs (i.e. 63% of Zip Money´s rev comes from customer fees) who take high credit losses because of their loose underwriting. These fees have received bad press around the world making, for instance, Paypal droping late fees worldwide.
• Rising delinquencies and losses – the rapid growth in popularity of these products thanks to COVID can provoke bursting the credit bubble, with a rise in delinquencies and losses, directly affecting BNPL P&Ls.
• Credit rating – the majority of BNPL players do not use credit bureaus for new applications, or update performance, and the information that they do use (soft credit check) is sometimes limited (i.e. past purchase history, duration of the purchase process, etc.)
• Klarna and others have based their growth in partnerships with large retailers (i.e. H&M, Sephora, etc.), however they are not infinitive. Its difficult to find large retailers with no BNPL payment option integrated in their checkout (i.e. Zara)

So then, what’s the reasoning behind everyone trying to get a piece of the BNPL cake? Here’s what I believe:

• Pivoting to other banking products – cross-selling other, more profitable, financial products (i.e. credit cards, higher AOV loans, insurance, etc.)
• Expansion to other industries – all of these players have a large user base (customers and merchants) that can be targeted with non-banking products (i.e. experiences, services, insurance, accommodation, etc)
• Future expectations of lowering the current expenses mix – scale economies, better funding costs, etc.
• The insanely large pools of capital currently in the market are creating inefficient money-losing business models (i.e. transport, quick delivery, third-party delivery platforms, etc.) 

On the other hand, some analysts (i.e. Credit Suisse) are forecasting the BNPL model to show positive operating margins by FY 2023-2024 and to achieve 20-30% of operating margin by ~2026-2027. However, they also describe some factors that could limit upside to contribution profit margin beyond FY 2021 like expectation for continued increase in competition among BNPL providers, mix shift to larger enterprise customers, economic-sharing agreements with partners, etc.

This all leaves us with many unanswered questions that I invite you all to address:

• Will BNPL players eventually be profitable?
• How do you explain the exponential increase of BNPL players in an (apparently) unprofitable market?
• Will BNPL players find other ways to monetize their large customer bases?
• Will the incoming regulation harm the current BNPL business model?
• Can this phenomenon evolve into a credit bubble and financial crisis?
• Will the BNPL model change customers’ minds about merchant-subsidized credit, making traditional banking rethink their risk and economic models and even the underlying value propositions? (i.e. launch interest-free credit cards)

Disclaimer

The opinions expressed in this publication are those of the authors

Author

Pablo López Gil-Albarellos