Buy now, pay later (BNPL, also referred to as “point-of-sale financing” or “installment financing”) is an evolution of traditional layaway plans that allow customers to place a product on hold and pay over time, receiving the product upon completing payment. While these plans were mainly used for big-ticket items, such as furniture or electronics, the recent surge in BNPL has been driven by startups introducing short-term financing for smaller-ticket items.
BNPL commonly offers deferred payment options to shoppers at online and in-store checkouts, allowing shoppers to claim ownership of the product immediately, while the BNPL provider pays the merchant in full for the goods upfront. The customer then pays for the goods in installments, typically over 2-6 months, which go to the BNPL provider instead of the merchant. The BNPL provider screens the shopper using a soft check or hard check, (the latter is reported to the credit bureau), approves the plan, and assumes the credit risk. The provider partners with third-party lenders to originate loans and pays interest in return. Although this is the most common way to fund loans, some larger providers also offer loans utilizing their balance sheets (e.g., Affirm).
E-commerce prevailed as a primary benefactor of the Covid-19-led store closures and social distancing policies, which subsequently led to a higher uptake of BNPL services:
64% of users claimed to have increased the use of BNPL since the start of the Covid-19 pandemic.
The frequency of average monthly purchases per user through BNPL providers increased to 5.0 in June 2020 from around 3.1 per user in June 2019.
The shift to e-commerce translated to significant growth in key metrics such as gross merchandise value (GMV) and revenue for several disruptors:
Sezzle’s GMV and revenue grew more than 250% YoY in FY2020.
Afterpay doubled revenue in FY2020 and recorded GMV growth of 110% YoY.
Affirm witnessed GMV growth of 77% along with revenue growth of 93% YoY in FY2020.
Openpay almost doubled GMV and witnessed revenue growth of 64% YoY in 2020, driven by a 52% increase in merchant sign-ups over the same period.
Payright reported a 63% growth in GMV and almost a threefold increase in revenue in FY2020.
However, the influx of users with lower credit quality poses a threat to BNPL providers' profitability:
Klarna reported losses increasing sevenfold (to around USD 60 million) in the H1 FY2020, citing increased credit losses as a result of the pandemic.
BNPL industry players operate in four segments, with the B2C (app) niche housing the bulk of startups in the space. The heavy B2C focus is a result of BNPL services being used primarily as an e-commerce payment method and the relatively low barriers to entry. Startups from the B2C (app + virtual card) segment account for the majority of total funding and include large players such as Affirm, Klarna, and Zip Co.
The BNPL infrastructure segment is the least populated, with only a handful of startups. One possible reason could be that retailers prefer to take advantage of the brand value of large players by integrating with them instead of building in-house BNPL payment options. Hence, monetization opportunities may be limited for infrastructure players.
Incumbents typically include banks, credit card networks, and financial service providers that offer B2C apps. They provide in-house BNPL offerings that are an extension of their core products (e.g., credit cards and digital wallets). Due to the heterogeneous nature of the product, incumbents and disruptors compete on merchant and customer reach, with incumbents such as PayPal, Visa, and Mastercard possessing a competitive advantage in this area.
More than 90% of SPEEDA Edge disruptors were established after 2010 and have raised a combined USD 10 billion in funding as of August 2021. B2C (app+virtual card) startups have raised a majority of this total with leading disruptors such as Klarna, Affirm, and Zip Co combining for the bulk of it. This can be partly attributed to balance sheet requirements for originating loans, which creates a need for significant funding to maintain merchant and customer base growth. Incumbents, on the other hand, are able to leverage their existing merchant and customer base through core offerings (e.g. credit cards and digital payment methods) to push their BNPL products—requiring less cash on hand.
Sweden’s Klarna is the highest funded disruptor in the space with USD 3.7 billion raised at a USD 45.6 billion valuation as of its USD 639 million round in June 2021. San Francisco-based Affirm is another deep pocketed player in the space with USD 2.9 billion raised ahead of its Nasdaq listing in January 2021.
A common thread in the BNPL industry is players using partnerships and acquisitions to expand their merchant and customer base. This includes companies such as Afterpay, which expanded from Australia into the UK in August 2018 with the acquisition of Clearpay (before it was acquired by Square in a deal announced in August 2021), and Zip Co, which made four separate acquisitions to expand into Europe, the Middle East, and the US.
Katapult (formerly Zibby) offers a point-of-sale, lease-to-own financing solution for non-prime consumers to purchase durable goods. The applicable transaction amount falls in the range of USD 100 to USD 3,500, and the lease can be up to 2x the cash price of the item. The payment terms are between 10 and 18 months, with payment frequencies ranging from bi-weekly to monthly payments. Katapult does not charge late fees, and customers who pay early can get the items at a discount. The company charges an origination fee of USD 45 and 5% of the cash price for early payment within 90 days of the transaction.
Katapult’s management team is led by Orlando Zayas (CEO), who spent 15 years at General Electric and was a former CEO at financial services firms such as TEMPO and DRB Financial Solutions. Furthermore, Derek Medlin, a former executive director at J.P Morgan and Chase, serves as the company’s COO.
The key components of Katapult comprise a behavioral learning model that supports a credit decision engine. It also offers real-time insights on purchases and customer scoring post-purchase. In December 2020, Katapult reported an approval rate of 60%, considerably lower than large players because of its waterfall financing solutions, where customers declined on prime lending platforms are then passed to Katapult. As of June 2021, its waterfall financing partnerships included Affirm, ChargeAfter, and Versatile Credit.
Katapult was listed on the Nasdaq in June 2021 via a SPAC (FinServ Acquisition Corp.) The transaction gives Katapult a pro forma enterprise value of around USD 1 billion, implying an EV/EBITDA multiple of 14.1x and 6.6x on estimated 2021 and 2022 EBITDA. Curo Holdings, a provider of e-commerce point-of-sale solutions, stood to benefit as it owned around 40% of Katapult through USD 27.5 million in investments.
The company allocated the funds (approximately USD 50 million) to strengthen its balance sheet for possible M&A deals and product development. At the time of the announcement, Katapult had raised USD 286 million in total funding since inception.
In FY2019, Katapult reported USD 88 million in total lease originations with USD 92 million in revenue. Furthermore, it made an EBITDA loss of USD 11 million and a net loss of USD 19 million in FY2019. However, Katapult projected to earn USD 250 million in revenue in FY2020, with USD 40 million in EBITDA and USD 27 million in net income. It aimed to grow revenue to USD 1.1 billion by 2023 at a CAGR of 87%, and net income to USD 142 million at a CAGR of 74%.
As of December 2020, Katapult had established more than 150 merchant partnerships that include Lenovo, Wayfair, Wing, and Motorola. In addition, Katapult partners with e-commerce platforms such as Shopify, WooCommerce, Magento, and BigCommerce. It onboarded 26 new retail partners in Q1 2021, including Texas Mattress Makers, Vivid Racing, Expert Fitness Supply, and Voro Motors. In June 2021, it was reported that 45% of customers are repeat buyers, with an average of 1.9 leases per customer.
B2C (App+Virtual Card):
Incumbents in the BNPL space include banks, credit card network providers, and payment technology providers that commonly enter the industry by developing in-house products. This is an expected strategy, given that installment financing is an extension of their core products. Furthermore, their existing merchant reach allows them to bypass re-integration with merchant checkouts, translating to a competitive edge.
Leading payment technology providers and credit card networks such as PayPal, Square, Visa, Mastercard, and American Express offer B2C solutions leveraging their existing merchant and customer reach. However, while the solutions from incumbents like Visa may be restricted to one specific network, leading disruptors establish partnerships across networks to appear more attractive to merchants and shoppers. In addition, incumbents frequently invest in BNPL startups, with all four credit card network providers having participated in startup funding rounds. Leading startups such as Klarna, and Affirm focus on monetization through the merchant, while credit card networks focus on the shopper as the primary avenue for BNPL monetization.
Prominent banks such as JPMorgan Chase, Citizens Bank, and Citibank compete on larger balance sheets, lower cost of funds, better underwriting models, and an established customer base acquired through their core offerings.
More recently in July 2021, it was reported that Apple was working with Goldman Sachs on its in-house BNPL product “Apple Pay Later”. The product seems to be an extension of its installment financing for Mac and iPad purchases made through the Apple Card. Following this, Square announced that it would acquire the leading Australian BNPL provider Afterpay for USD 29 billion, a 31% premium to its market value, via a share swap.
PayPal entered the BNPL market with the acquisition of “Bill Me Later” in 2008, when it was still under eBay, for nearly USD 1 billion in cash and stock options. Bill Me Later, founded in 2000, offered deferred and flexible payment options at the point-of-sale for online shoppers. It was projected to generate USD 150 million in revenue in 2009 and was considered to have one of the leading credit decision-making and underwriting models in the consumer credit industry. Bill Me Later operated as a separate business under PayPal until it was rebranded as PayPal Credit in June 2014 and expanded into the UK and Germany. PayPal Credit offers financing options up to 6 months for purchases above USD 99 at zero interest and 24% APR thereafter.
In August 2020, PayPal launched “Pay in 4” in the US, allowing customers to split purchases over four separate interest-free installments. The payment facility enables customers to spread transactions between USD 30 and USD 1,500 over six weeks. Missed payments incur penalty fees that vary by state depending on where customers reside. PayPal is primed to challenge leading disruptors such as Klarna, Affirm, and Afterpay due to its significant global network (more than 300 million consumer and merchant accounts across 200+ markets), allowing it to offer BNPL financing to PayPal merchants at no extra cost. In addition, the BNPL option will also appear in the PayPal digital wallet for existing customers, bypassing redirections to third-party gateways. PayPal reported over USD 1 billion in BNPL transaction volume in Q1 2021 with a total of 5 million customers and 450,000 merchants (March 2021). It also revealed that the average order value (AOV) for BNPL purchases is roughly 2x that of its standard AOV.
PayPal expanded its BNPL solutions to the European market (including the UK, Germany, and France) and most recently to Australia in March 2021. Furthermore, Paypal announced its plans to acquire the Japanese BNPL player Paidy for JPY 300 billion (approximately USD 2.7 billion), reported to be a majority cash deal in September 2021.
Founded in 2008, Paidy is a Japanese BNPL solution provider launched in 2014 that initially offered its payment option at checkout, allowing users to settle payments with a consolidated monthly bill. In October 2020, Paidy announced “Paidy 3-Pay,” a financing option enabling customers to split transactions into three equal payments with no interest or account set-up fees. Paidy also offers additional solutions such as Paidy Anywhere (registering Paidy as a Visa card) and Paidy Plus (pre-approved limits for financing). The company uses proprietary algorithms in its credit underwriting decisions. As of March 2021, it had access to more than 700,000 e-commerce sites in verticals such as beauty and health, fashion, digital content, and consumer durables. In April 2021, Paidy announced a new feature, Paidy Link, which can be used to link Paidy’s app with third-party digital wallets. The launch partner was PayPal, giving Paidy customers access to around 29 million PayPal merchants worldwide.
Paidy’s average order size is around USD 400 to USD 500, while smaller ticket purchases (ranging from USD 50 to USD 200) are also emerging. Additionally, Paidy had attracted investments from payment giants such as Visa and PayPal in 2018 and 2019, respectively. Paidy has raised a total of around USD 400 million to date and counts more than 6 million registered users (September 2021).
Following the acquisition, Paidy will maintain its brand and operate under the leadership of Russell Cummer (Founder/ Executive Chairman, Paidy) and Riku Sugie (President/CEO, Paidy). The acquisition is expected to close in Q4 2021. Since Japan is considered to be a hotspot for growth in the BNPL space, given its consumer affinity towards e-commerce, the acquisition strengthens PayPal’s footing in the BNPL space and expands its operations in Japan.