BNPLs: Businesses Needing Provided Legibility
The relatively new payment method - Buy Now, Pay Later or BNPLs have caught a lot of attention recently, not to mention payment volume 😉
Before you dismiss BNPLs as a "debt trap", you must first understand the economics behind it. Let's dig in!
How BNPL present to a user
- When a new user for a BNPL is engaged in a transaction, they're presented with an endorsed third-party offer of credit
- The offering in the BNPL space is usually "pay in 4" - the first one is drawn immediately with the other ones being drawn 2 weeks, 4 weeks and 6 weeks after the transaction
- Basically the user is using someone's fund for a few weeks, for free
How BNPL presents to business
- The payments industry charges a fee to business owners for two main reasons: i) facilitate the orderly movement of money and data ii) marketing
- Businesses have three goals of marketing: increasing customer's tendency to use them, increasing the frequency at which they come back, and increasing the amount spent
- BNPL pitch itself as more of a marketing effort and less of a payment rail. They charged 300 bps more than the conventional credit cards
- Clearly BNPL need something to justify charging twice as much as credit cards right? Well they claim they could increase conversion rates, basket sizes and repurchase frequency significantly
The economics behind BNPL
- Most BNPL loans start with a bank and not the BNPL provider
- BNPL providers are just software companies, they don't have the capital efficiency to be in the business of borrowing and lending
- The bank themselves also don't desire to own the loans. They retain a small piece and sell the rest to someone who has agreed in advance to purchase it
- So the BNPL provider looks for capital partners, someone who seeks attractive yields at low but non-zero risk
- Here how it works: Let's say a $100 pay in four transaction needs $75 of backing in 6 weeks. Due to repayment, the average amount of capital required over the term of the loan is usually half of that. If the BNPL was willing to pay 2% of the original transaction to the capital provider in lieu of interest, the capital provider would receive $77 in repayments for their committed capital for 6 weeks, representing about 2.67% yield on $37.50 over 6 weeks. This works out to 25% annualized, give or take
- Where are you going to get low-risk 25% APR debt in the current interest rate environment?
Bam! You have just invented a relatively high-interest consumer loan out of nothing, without charging the customer a penny more than their purchase naturally costs. Of course, it is not out of nothing; the business is paying for it, as a marketing expense.
There are only two mistakes you can make about lending. The first is making loans that don't get paid back, and the second is thinking that the only thing that matters for a loan's economics is whether or not it gets paid back.