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‘Buy Now, Pay Later’ Consumer Financing Takes On Credit Cards

What’s old is new again as many young shoppers buy products using no-fee installment payment plans known as “buy now, pay later.” And for everyone from giant retailers like Walmart (WMT) all the way to small merchants, the payment plans offer a chance to win over Millennials and Gen Zers.

Young consumers are buying the newest electronics, furniture, fashion and other products using buy now, pay later, much as their grandparents might have bought General Electric‘s (GE) black-and-white TVs with installment plans in the 1950s. Credit cards were just getting started back then, and e-commerce and the internet were decades away.

These days, most people shop on the web using credit cards, while digital wallets and other payment methods are taking share. But buy now, pay later is gaining steam. BNPL, as it’s also known, is a way to spread out interest-free payments for consumers, who can also avoid late fees if they pay on time. They also can sidestep credit card balances that accrue with interest until the cardholder pays them off.

While BNPL has been on the radar of payment companies, two recent events give validity to views that it’s a long-term trend, not a flash-in-the-pan amid the coronavirus pandemic. Digital payment company Square (SQ) on Aug. 1 agreed to purchase BNPL provider Afterpay in an all-stock, $29 billion deal.

Then e-commerce giant Amazon.com (AMZN) announced Aug. 27 that it’s working with Affirm Holdings (AFRM), sending its shares soaring. Amazon said it’s testing Affirm’s BNPL plans on orders of $50 or more. The e-commerce giant plans to make BNPL more broadly available in the coming months.

Younger Consumers Adopt ‘Buy Now, Pay Later’

All these players have an eye toward younger consumers.

“Buy now, pay later solutions in general resonate with younger customers,” Julia Unger, Walmart’s vice president of financial services, told Investor’s Business Daily. “They don’t view BNPL as debt. They see it as a payment plan, which is a little bit different. If you have millennials that are choosing BNPL solutions instead of credit cards, we want to make sure from an acceptance standpoint that we’re offering the right solutions to customers.”

More than 45 million people in the U.S. will use BNPL services in 2021, up 81% from 2020, forecasts eMarketer. Most of them will be Millennials and Gen Zers who distrust traditional credit but still want to borrow money to buy goods.

About 1.6% of U.S. e-commerce involved buy now, pay later plans in 2020, according to a Worldpay study released in early 2021. That share is expected to grow to 4.5% by 2024 as these services play a bigger role at the point of sale, Worldpay says.

Further, Apple (AAPL) looks ready to jump into the game. The iPhone maker reportedly plans to launch a buy now, pay later service.

BNPL services generally split payments into three or four equal installments over two months or less. Consultancy McKinsey forecasts that “Pay in 4” players will originate about $90 billion in U.S. consumer loans by 2023, up from $15 billion in 2020.

At Walmart’s website, buy now, pay later offers show up at product description pages, long before online checkout. Meanwhile, despite being archrivals, both Walmart and Amazon have partnered with Affirm. Walmart and Affirm now stretch out some BNPL plans to 18 or 24 months.

Consumers Favor Merchants That Accept BNPL

“This is a new theme that’s emerging in the payment industry,” added Walmart’s Unger. “And we want to make sure that we’re accepting those customers into our ecosystem so they can continue to shop at Walmart at low prices.”

Credit cards
A number of credit card companies now face increased competition from buy now, pay later services. (279photo — stock.adobe.com)

Merchants generally pay BNPL firms fees of 4% to 5% — higher than the 2% transaction fees they pay credit card companies. They’re willing to do that, analysts say, because the services enable them to grab new customers and close sales that otherwise might not happen.

And buy now, pay later is much more than a payment option at checkout. BNPL companies increasingly generate sales themselves with in-app marketplaces and emails to consumers.

Roughly 80% of consumers use debit cards to pay off their BNPL transactions, deducting money from checking accounts rather than putting it on their credit cards. The key is to avoid credit card interest and a balance that needs to be paid off.

That puts a number of companies in the line of fire when it comes to buy now, pay later market growth. For starters, there’s credit card giants American Express (AXP), Discover Financial Services (DFS), Mastercard (MA) and Visa (V).

Are Credit Cards Losing Volume?

Then there are credit card issuers, such as JPMorgan Chase (JPM) and Capital One Financial (COF). Buy now, pay later plans also encroach on Synchrony Financial (SYF), the biggest U.S. issuer of private-label store credit cards.

One view, though, is that credit card companies may not lose their best customers to BNPL rivals. More affluent consumers likely prefer racking up points in loyalty/reward programs with big purchases, Fitch Ratings analyst Harry Kohl told IBD.

“On the margins, there’s definitely an opportunity for buy now, pay later to take market share of credit cards,” he said. “But it would take a pretty big increase in the size of the buy now, pay later loan originations to make a material impact to credit card originations.”

Most BNPL market forecasts, however — from Worldpay, McKinsey and others — were released before recent major developments, such as Amazon partnering with Affirm.

Which Companies Benefit From BNPL?

Meanwhile, credit reporting bureaus like Equifax (EFX) could get a boost if BNPL firms use their data to assess credit risk for larger purchases.

Square Afterpay
Afterpay shareholders will own 20% of Square when their deal closes. (Reuters/Newscom)

Digital payment company Square (SQ) is a strong believer in the future of buy now, pay later. Afterpay shareholders will own about 20% of Square when the deal closes. Still, BNPL competition is heating up in the U.S. as many startups emerge.

“This space is getting more and more crowded, and obviously there’s a lot of different services and solutions out there,” Square Chief Executive Jack Dorsey told analysts on a recent call.

One view, though, is that BNPL companies will be better off as part of a bigger company, like Square, than battling on their own.

Square makes credit-card readers that plug into mobile devices. San Francisco-based Square plans to offer buy now, pay later options to millions of merchants.

Also, Square plans to integrate BNPL offers with its consumer Cash App, which had 40 million monthly active users as of June 30.

During the coronavirus emergency, Cash App emerged as a digital alternative to traditional banks. Consumers used Cash App’s direct-deposit feature to receive government stimulus payments, for example. Cash app also offers stock trading features and the ability to buy cryptocurrencies, such as Bitcoin.

Opening The Door For Other Players To Be Acquired

Square’s bold move has prompted speculation that other players in buy now, pay later — Affirm, Klarna, Sezzle (SEZNL), SplitIt (STTTF) and Zip — could be gobbled up as well.

Among the likely buyers: Amazon, Shopify (SHOP), Synchrony and Amex, MoffettNathanson analyst Lisa Ellis said in a recent note to clients.

Canada-based Shopify, an e-commerce rival of Square, so far has focused on partnering. Shopify in June teamed with Affirm. And, Shopify acquired a nearly 8% stake in Affirm as part of a three-year deal. Shopify stock has gained 36% in 2021.

Many BNPL upstarts have yet to show a profit. In its March quarter, Affirm lost $1 per adjusted share. Afterpay reported a bigger-than-expected loss in August.

But valuations for buy now, pay later upstarts have jumped, regardless. A June funding round increased Stockholm-based Klarna’s valuation to $46 billion from $11 billion in September 2020. Klarna is expected to launch an initial public offering in 2022. Still, the company’s second-quarter operating losses swelled to $111 million from $10 million a year earlier as credit losses doubled.

PayPal Opts For Home Cooking

While there’s speculation the BNPL industry will consolidate, don’t count PayPal Holdings (PYPL) among potential buyers. PayPal developed its own buy now, pay later service, which it rolled out in late 2020.

Affirm app
Like other BNPL companies, Affirm has yet to show a profit. (ZUMAPRESS.com/Newscom)

Since BNPL providers have yet to show profits, PayPal expects to fare better economically, Greg Lisiewski, PayPal’s vice president of global pay, told IBD.

Lisiewski says that unlike pure-play BNPL providers, PayPal isn’t spending capital to acquire merchants. For PayPal, the priority is keeping transactions on its payment network, which has some 32 million merchants. That shows up in a key financial metric, total payment volume, for PayPal stock.

PayPal doesn’t charge merchants a service fee for buy now, pay later, unlike Affirm, Klarna and others. In August, PayPal said it would no longer charge consumers a fee.

“We are a multi-product global payments business, whose core business is payments,” Lisiewski said. “Payments is about scale. We don’t have to make a lot of money on buy now, pay later transactions. Just having more payments volume on our network is good for our business.”

Using The Online Checkout Button For BNPL

PayPal stock has gained 22% in 2021. The company integrates BNPL offers into its online checkout button. PayPal also expects buy now, pay later to be part of its “super app,” which offers users loyalty rewards, discounts, trading in cryptocurrencies and more.

“We’re seeing an uptick in transaction size and transaction volume when consumers take advantage of Pay in 4,” Lisiewski said. “We’re very bullish about its ability to drive commerce for our merchants and deliver value to consumers.”

While analysts generally agree that Millennials and Gen Zers are the biggest users of buy, now pay later, there’s less consensus on what their personal financial profile might be.

At Fitch Ratings, Kohl says many BNPL users have small credit card lines of $1,000 or less. By tapping buy now, pay later services, consumers don’t have to use up their credit card limits, he says.

Consumers must be approved for BNPL purchases. But they typically provide less data than in credit card applications or auto loans. Buy now, pay later companies conduct a “soft” credit search that does not look up someone’s FICO score.

In addition, BNPL providers do not report use of their products to credit bureaus, Kohl says. So buy now, pay later debt doesn’t impact credit scores.

As a result, consumers could try to make multiple purchases using different BNPL providers. That has raised worries that in some cases, consumers could wind up in more debt than with credit cards.

BNPL Not Just For Low Credit Score Consumers

But Affirm Chief Financial Officer Michael Linford says buy now, pay later is not just for consumers with low credit scores.

Peloton stock
Many customers of stationary bike maker Peloton are using buy now, pay later. (Peloton)

“Users range the full credit spectrum from super-high FICO scores with pristine credit to folks who are distrustful of revolving credit vehicles all the way down to people who have thin credit files or no files,” he said.

Affirm’s biggest customer has been home fitness giant Peloton Interactive (PTON), which makes pricey treadmills and stationary bikes. Affirm originates upward of $1 billion in loans at the exercise equipment company annually. Average credit scores sit at about 740, according to McKinsey. Peloton stock has retreated 34% in 2021.

Affirm’s upper limit on purchases is $17,500 — much higher than PayPal’s $1,500 limit. The core “Pay in 4” plan focuses on purchases of less than $250, says McKinsey. While most BNPL firms do not charge interest, Affirm does charge simple interest in over half of its transactions.

As the BNPL market takes off, a “land grab” is underway. Service providers are vying to sign online checkout deals with large retailers. Aside from Amazon and Walmart, Affirm has signed up Nordstrom (JWN), Neiman Marcus, Dick’s Sporting Goods (DKS), Williams-Sonoma (WSM) and Adidas (ADDDF).

Klarna has signed up Macy’s (M), Costco (COST) and Sephora.

‘Buy Now, Pay Later’ Marketing Campaigns

While most consumers tap buy now, pay later installment plans at online checkout, there’s also an opportunity for proactive marketing. BNPL companies help drive new, younger customers to merchants, analysts say.

Some BNPL companies have invested heavily in building brands. Klarna, for example, features advertisements with celebrities. With clients such as Etsy.com (ETSY), Klarna targets younger shoppers.

Klarna operates an online marketplace with hundreds of retailers. Consumers shopping from its app can buy Apple products, for example. That’s even though the company itself is not a checkout option at Apple’s website.

Meanwhile, Affirm says 30% of its transactions now originate at its mobile app.

Survey Favors BNPL Services

A Bank of America survey in May found that 42% of consumers chose their BNPL provider because of deals or discounts available on their apps.

Walmart
The use of BNPL has helped Walmart warm up to younger consumers. (vvoe/Shutterstock)

PayPal sends out emails alerting consumers of opportunities to buy products using the installment plans. Lisiewski says the email campaigns typically coincide with events like back-to-school sales. PayPal recently wooed its BNPL users with emails targeting Apple and Home Depot (HD) products.

PayPal also expects synergy between its BNPL offerings and its Honey business. It purchased consumer shopping app Honey Science for $4 billion in 2019.

How much BNPL could cannibalize other consumer lending methods remains to be seen. Many big merchants, such as Macy’s, offer private-label credit cards. Some large retailers, such as Gap, have offloaded the private-label card businesses to bank partners. Even so, they share in profits.

Many merchants are adopting buy now, pay later even if it impacts their private-label credit card business, analysts say.

In addition, it remains to be seen how Amazon positions Affirm’s BNPL offering vs. its other in-house offerings. Amazon Prime offers consumers 5% cash back on reward store cards through Chase, Synchrony and others. Amazon stock has gained nearly 8% in 2021.

Questions About Rollout Of BNPL Services

One possibility is that some retailers roll out their own in-house BNPL services instead of paying fees to Affirm and others. Payments firm Certegy aims to sell an in-house buy now, pay later platform to midsize companies.

Another question is how soon BNPL could migrate from its roots in online shopping to brick-and-mortar stores. Walmart’s Unger says the retail company expects BNPL offerings to have a bigger presence in retail stores.

A Bank of America report says that could be part of Apple’s strategy. That is, if it gets into the buy now, pay later market. Apple is said to be working with Goldman Sachs on a BNPL offering.

“We believe Apple Pay usage and merchant acceptance is much higher in-store than online,” said the report. “If Apple were to introduce Apple Pay Later, it would likely have a better chance of gaining traction at physical merchants rather than the e-commerce channel.”

Launched in 2014, the Apple Pay digital wallet is used in less than 10% of offline transactions. Online adoption is similar, said a D.A. Davidson report.

Visa, Banks Fight Back

Financial industry incumbents aren’t staying on the sidelines. Alliance Data Systems (ADS), which specializes in offering retailer debit and credit cards, made a move. It acquired a small BNPL player, Bread, for $450 million in late 2020.

Jamie Dimon
JPMorgan CEO Jamie Dimon said if customers want BNPL, then “we’ve got to learn to do it.” (Eric TSCHAEN/POOL/SIPA/Newscom)

Visa aims to make it easier for banks to provide installment loans to consumers. Visa has developed point-of-sale and post-purchase options for credit card issuers. The company calls the program Visa Installments Solution. It has teamed with payments firm i2c to expand the installment payments offering.

Visa stock has been boosted by making other moves in digital payments.

Some U.S. card issuers have launched post-purchase offerings. These notify customers via email that a recent purchase is eligible for installment plan payments. Chase offers “MyPay” while American Express offers a “Pay Over Time” feature.

At Walmart, Unger said, “We’re definitely seeing the banks as well as the networks reacting to this change in the industry because they know they have to.” Walmart stock has gained 2% in 2021.

“I like BNPL,” JPMorgan CEO Jamie Dimon said at a June financial conference. “If that’s what customers want, we’ve got to learn to do it.”

Banks May Need To Get Aggressive

According to McKinsey, banks need be more aggressive with pre-purchase, installment plan marketing.

“Banks are not effectively leveraging their existing scale to highlight their ability to drive incremental traffic to merchants,” said the McKinsey study.

At PayPal, Lisiewski has a similar view. “I think we’re seeing the card industry reacting because of the consumer demand they’re seeing. There are plans out there from American Express and Chase where you can convert a transaction into installments. What they’re now trying to figure out is how do they move earlier in the shopping funnel to have a bigger impact.”

Some banks are taking a defensive approach.

Capital One in December became the first major credit card company to block customers from using cards to pay off BNPL purchases. It called the practice “risky for customers and the banks that serve them,” according to a Reuters report.

Follow Reinhardt Krause on Twitter @reinhardtk_tech for updates on 5G wireless, artificial intelligence, cybersecurity and cloud computing.

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