This episode of Future of FinTech is on the future of Buy Now Pay Later (BNPL), and will cover why it works where other consumer lending ideas haven’t, why millennial consumers are the driving force behind BNPL, what makes a great BNPL merchant, and untapped BNPL opportunities outside of ecommerce.
Guests this week include:
- Lawrence Lin Murata, founder of Slope
- Bobby Tzekin, founder of Wisetack
- Dana Stalder, General Partner at Matrix, Director at Afterpay
Highlights from Future of Fintech: Buy Now Pay Later
This interview has been lightly edited for length and clarity.
Fintech has tried to do consumer lending for a while. Why did BNPL work where other consumer lending ideas did not?
DANA: A couple of trends are the underpinnings. First—the rise of millennial consumers (and Gen Z consumers behind them.) It’s that generation's general dislike of unsecured credit lines, and their preference for debit cards over credit cards to avoid fees, revolving debt, and high APRs. They have a general mistrust for consumer and financial service products.
Nick Molnar, who was 25 years old when he founded Afterpay, ran an ecommerce website for much of his teens and early college years. He felt nobody had built a modern “credit-like” product for his generation. The concept was: How do we give people credit-like features on their debit card without all the bad stuff that comes with unsecured credit lines?
It’s crazy how much these companies are worth. Klarna is worth $45 billion, Afterpay $29 billion, and Affirm $25 billion. Is that valuation taking away from money credit card companies would have made from these consumers, or is it new revenue that is being generated?
DANA: Buy Now Pay Later absolutely is and will take share from credit card spend, and this is a trend that will continue for the next 15 years. We're at the very beginning of a long-term shift here, and I think the major card issuers all understand this.
Is Buy Now Pay Later a feature or an independent business?
DANA: It's hard to argue that it's a feature and not a business given the scale of the dominant players in the U.S. market. Afterpay, a six-year-old company, had $800 million in revenue this year and is still growing at 100% year-on-year, so that passes the company-versus-feature test.
Consolidation is inevitable in this category because there is so much market opportunity at stake and the competition has come in so quickly. There are scale advantages in running payment networks. The Square and Afterpay merger is just one example of bulking up for the next phase of scaling this category. I expect more consolidation in the next couple of years.
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Another hot trend is business Buy Now Pay Later. Lawrence, you just started a company doing that. When you started, were you concerned with it being a competitive space?
LAWRENCE: When we were exploring the problem, we talked with marketplaces and business owners. We realized that this is super common offline already with net terms.
But with COVID, a lot of the B2B transactions moved online. My parents are a good example. They've been wholesale for about three decades, and they've been used to doing everything offline. They're the least tech-savvy people. With COVID, going to China and visiting factories stopped and they had to start sourcing inventory online.
When we talk as small business owners, it feels very Greenfield. Usually, we're competing against traditional invoice factoring companies or traditional bank loans.
There might be 10 players in this space, and they're all going to raise money—everything in fintech is getting funded nowadays. Do you worry about that?
LAWRENCE: It is something that we keep in mind, and we do keep track of competition. When we started this, we never imagined that credit products like Buy Now Pay Later would be the hyped space. For us, it was more problem driven.
Right now, our focus is to make sure we build the best experience for the customers and then just grow.
What makes a great merchant for you?
LAWRENCE: There are a few things. One is whether we think we can underwrite them. Some industries get a lot of pressure from offline dynamics. For example, for wholesale, non-perishable inventory, net terms are offered offline, so any online B2B marketplace needs to offer this.
We look at GMV and average order volume because we're in the early stages of building this. We want to make sure that we get more data points per dollar deployed.
Bobby, you started Wisetack in 2018. What's the story behind starting it, and what do you think about this market?
BOBBY: We're doing a couple of things differently. We're considered embedded fintech because we're an API platform. We're embedding Buy Now Pay Later options into software that is already serving tens of thousands of businesses.
For example, we work with a couple of companies in home services that serve businesses like plumbers and electricians. We embed into these software providers and the plumbers and electricians can then offer a Buy Now Pay Later option. Everything we've done is an API—super easy to integrate and get started.
The other part that differentiates us is we like small businesses that are not ecommerce. We've optimized for a more complex transaction than checking out with a shopping cart on a website. When something breaks in my house and I need someone to give me an estimate, I'm going to consider the scope of the work. There's going to be back and forth and it's going to take time to get the work done.
We've built something that works for these cases. It's embedded for an in-person transaction and a more complicated workflow. There's lots of small businesses involved, so it's a platform that takes the model to the next level of abstraction.
How are you underwriting people when they're getting plumbing services?
BOBBY: What is similar is that we look at identity. We look at who's on the other side. Are they who they say they are? We look at signals, mobile phones, and IP addresses to ensure it's the right person. We look at ability and willingness to pay. We soft pull a credit check. And we're also using more traditional data to ensure we want to make that loan.
Who takes the risk of fraud? Is it the merchant that takes the risk, or is Wisetack on the hook if someone doesn't pay?
BOBBY: We're on the hook unless the business did something blatantly wrong, like not providing the service or doing a terrible job, in which case they're responsible for not holding up their end.
One of the things that makes BNPL work is the merchant discount rate. When you buy an item using BNPL, the merchant pays a cut to the BNPL provider. What are the ranges of discount rates for the various types of businesses that the three of you are in?
DANA: The take rate is roughly 400 basis points. The merchants, on average, pay four percent plus the cost structure underneath, the card interchanges and losses. That works out to a roughly 50% to 60% transaction margin.
For an average merchant, if you're paying 250 basis points for card processing and 400 basis points for a Buy Now Pay Later solution, is it worth the extra one and a half percent discount that you're paying? I think the data is pretty clear that it is well worth it. There are very few things a merchant can do to increase average order value and conversion-to-check-out integration of these Buy Now Pay Later platforms. So, it’s a super high ROI.
It's also worth mentioning that 400 basis points is a blended average. With all of these financial products, the bigger merchants pay a lot less and the small businesses pay more.
LAWRENCE: We see it in a similar way when we partner with merchants. We're helping them increase the AOV (Average Order Value). We're encouraging small business owners to purchase larger orders and increase customer loyalty and conversion rates because about one-third of the cards get abandoned in those marketplaces.
In terms of pricing, we're still figuring it out. Right now, we're charging a six percent flat fee to the merchant and no interest to the buyer.
BOBBY: Ours is a similar story. There is a merchant processing fee, right in that ballpark where credit cards and Buy Now Pay Later options are. As Dana was saying, we have a different side to the business. We make larger loans. They're longer. Depending on the consumer's credit, there can be consumer interest involved, but there is still a merchant processing fee. A merchant gets a ton of value out of being able to increase sales and provide a better option, so that works similarly to other payment options they offer.
Sheel, from your perspective as a seed fintech investor, do you think BNPL is mostly done? There are at least three big companies in the space already.
SHEEL: It's hard for me to get excited about a new ecommerce focused BNPL provider because we have some pretty good ones. What we've seen more recently is a lot of international and B2B services. Like Bobby, we’re seeing movement in the offline world.
Is there something about BNPL that lends itself to one solution per country?
DANA: I don't think so. The way I would cut it is not by country but by payment norm. For the Western card-dominant market, there's a good chance these same three players dominating the U.S. market are going to roll up all of Europe. That competition is already underway. Klarna and Afterpay are aggressively expanding in Europe right now.
The merchant value prop and the consumer value prop are very consistent in these bank-card-dominant markets. It is similar to what we were doing with early international expansion at PayPal in those markets, but when we go to China or Latin America, we're going to have some differences.
Are we finally in a world where fintech companies are going to quickly follow every good idea? Is that the level of maturity that fintech has now?
DANA: In payments and credit, I think so. It's not unlike social media, where Twitter and Facebook have their Clubhouse copycats. Afterpay went from $0 to $10 billion in three years in the U.S. in terms of payment volume. That should get everybody paying attention.
Dana, didn’t PayPal already have BNPL when it acquired Bill Me Later 15 years ago?
DANA: No. In my mind, I separate unsecured consumer credit lines from what Afterpay is doing. Afterpay is a no interest, no ability-to-revolve-debt, always free to consumer product. Bill Me Later was built as a consumer credit company with aspirations to build a big revenue base by charging consumer interest. Those are very different businesses.
What caught Affirm off guard was how fast Afterpay grew with this no-interest model. It quickly followed Afterpay once it saw how quickly it was growing. Affirm and Bill Me Later were about high average order value financing, such as Peloton bicycles and Casper mattresses.
Afterpay was started in fashion and beauty with $100 AOV. It was a very different approach to the market in terms of building out an acceptance network and a very different value prop to the consumer.
I just went to both Afterpay and Affirm’s websites, and all of them are trying to become destinations for shopping. Do you think that is going to work, Dana?
DANA: I think this is one of the least understood things happening in these payment networks: their ability to drive leads and traffic back to retailers. Afterpay was started in Australia and is the clear market leader there. It is the largest referral source to all ecommerce, second only to Google, and we're seeing the same trends emerge here.
Afterpay users have a strong affinity for the platform. They like the ability to get that “credit-like” feature on their debit card. Debit card users are approaching 90% of the top-of-wallet card, so they are using the platform to discover retailers that accept it.
They are also dominating categories where discovery is more essential. In fashion and beauty retail, there is a serendipity to the shopping experience that matters. That also plays well to the model they're building. They are driving a surprising amount of incremental volume to retailers. This generation of payment companies is going to be the first that realizes the value of consumer data.
This has been an opportunity for the incumbents—the Mastercards and Visas—but they've been unable to use data in an effective way because they have a multi-tier distribution. It's Visa to issuing banks to consumers or Visa to merchant-acquiring banks to merchants. They haven't had an effective distribution scheme to do that.
If you look at the data that these modern payment networks have, they own the integration with the merchant. They're seeing SKU (stock keeping unit) information in the cart. They have the consumer spend data. They're on every page on every retailer. They have the ability to create incredibly personalized shopping experiences for consumers. This will be an important trend over the next several years.
IMMAD: The biggest thing is they're actually seeing the SKU data. They know what you're buying. Even PayPal, which is at the checkout, doesn't really know what you're buying.
DANA: That's right. And they're seeing browse-level data too, because they're integrated throughout the site, not just in the back end of the checkout flow.
What are the differences in economics between finding Afterpay on the merchant’s site versus if I go from Afterpay's site? What does it look like to Afterpay?
DANA: For the most part, there is no difference, but they are early in starting to collect affiliate fees from those merchants. Over time—and I think Klarna has been the most aggressive about this in the U.S. market—merchant discount rates will come down and be offset by marketing referral fees from retailers.
Another interesting thing is that people are sick of Amazon and no one else has put together all the SMB (small and medium-sized businesses) ecommerce merchants. That's one of the reasons these websites do so well. Bobby, do you think you're going to put together all the home service businesses into a Wisetack consumer experience?
BOBBY: Maybe. It will take us having a bit more scale. Currently, we're more focused on being the underlying technology provider. In home services, there are fewer repeat purchases. It's one thing to shop for fashion and buy some stuff every couple of months. There's more repeatability in the Afterpay fashion model than if I'm getting my plumbing repaired.
We have had people say, “I had such an amazing experience with Wisetack. Can I use you for other things I'm doing around the house?" It's common. Even with old-school financing providers, they have directories of their merchant providers for that reason.
BOBBY: I would expect something like that to happen. Again, it's less of an immediate need for what we do, and we're more focused on the technology and being an incredible payment option for both the business and the consumer. We’ve got plenty to do on that front.
LAWRENCE: What Dana was saying about putting more data into consumer purchasing is super interesting for business owners because when you look at people like my parents, usually what they have is a salesperson who works for the factory, for the supplier, and then they're telling them, "Here's what's selling this season."
If you look at how small business owners run their businesses, it’s not data-driven at all, and they pay for reports from companies like Nielsen. Collecting that data and helping people create more insight into what's selling is also super relevant to the business side of things.
Dana, you mentioned that you saw untapped opportunities for BNPL outside of ecommerce. Can you speak more on that?
DANA: I'll give you two examples of what I've seen. Even in the U.S. market, where the field is crowded, some innovative things are going on. One is a New York-based company, Flex Finance, that does recurring consumer payments. They're starting with rent as their focus and are building out a distribution network through property management companies.
The second is other categories like medical where there may be smaller medical or elective medical expenses. This format can be of high value to both the merchant and the consumer, but it's a very different playbook to execute than retail.
As you're seeing more BNPL-style opportunities in international markets, what is that going to look like? In international markets, credit is not very common, and default rates tend to be much higher than they are in large markets.
SHEEL: On the international side, we're looking for markets that have large and growing retail ecommerce businesses and functioning credit markets. Those two things combined make for a good opportunity for BNPL, and we're starting to see that in many markets around the world now.
It took a while for that to happen. I think the success of Afterpay, Affirm, and Klarna has meant that there are now a bunch of companies in every market going after the same space.
A lot of companies still charge customers a late fee, which can be very annoying and also hurt customer trust. Do you think that there's innovation in those areas that can improve the consumer experience?
DANA: Pricing—whether it's late fees, merchant discount rates, or APRs—these businesses will always use those knobs to figure out how to drive marginal returns in their business.
What I referred to before—using the payment network as a means to drive traffic back to retailers—is very interesting. Incumbent payment networks are the unmet opportunity where we have the potential to see the most interesting innovation over the next several years.
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