Why payout winners will need to go directly to the consumer
We have seen rapid growth in the Buy Now, Pay Later (BNPL) space in recent years, with reports citing that the global market size is expected to reach $39 billion by 2030. more companies are now offering consumers access to short-term, interest-free credit that can help spread the cost of relatively small purchases over several weeks or months.
The explosion of the BNPL shows that consumers view it as a fundamentally valuable commodity. It meets their longstanding demand for access to credit without the interest charges and barriers to entry associated with traditional lines of credit, such as credit cards.
In the UK alone, millions of people currently rely on expensive overdrafts and credit card products for discretionary spending and essential household expenses. The United States is no different – in this particular market, more than $140 billion in fees and interest are paid to credit card companies each year. Many other people cannot even access these traditional forms of credit due to a lack of credit history. In the UK and US combined, there are over 50 million people who fall into this category, known as ‘invisible credits’.
In this context, BNPL’s attractiveness to consumers should not be a mystery. When properly regulated and responsibly provided, no-cost credit that is also available to those with weak or no credit histories can promote financial inclusion and choice and save billions of pounds in unnecessary costs.
However, concerns arise when BNPL’s unregulated providers act without the appropriate safeguards for customers and accessibility controls in place. Meanwhile, the largest and best-known providers in the BNPL space have come under intense downward pressure on their valuations this year.
The ability of BNPL’s businesses to meet these two challenges – doing the right thing for their customers and for their investors – depends in large part on their adoption of the traditional “direct-to-merchant” model, called BNPL 1.0, or the more innovative “direct-to-consumer” approach – BNPL 2.0.
DTM versus DTC
In the “DTM” model, BNPL 1.0 providers offer point-of-sale financing through payment buttons on a merchant’s online storefront. In this business model, the customer is the merchant, not the consumer, and the service is presented as a payment option on the merchant’s checkout page by both the BNPL provider and the merchant. Today, it has become a highly standardized, low-margin business model choice and a highly competitive space in which to operate.
From a consumer protection perspective, this means meeting their borrowers for the first time at checkout. The provider is therefore much less able to form an informed picture of a borrower’s affordability limits, nor to gain insight into their behavior. Merchant demands and their pervasive pressure on conversion rates are putting increased lending pressure on these providers without regard to actual consumer affordability.
In the “DTC” model, known as BNPL 2.0, the supplier owns the relationship with the consumer. It is the one that is formed before any individual purchase decision is made. Basically, one defining difference is that they don’t provide point-of-sale financing. Instead, customers of DTC companies arrive at any merchant with a spending limit that suits them and their affordability profile. Naturally, this leads to a customer only being able to spend what they can afford to pay back.
Tellingly, it is this DTC approach that Apple, widely regarded as the world’s most innovative and successful consumer-focused technology company, has chosen to follow with its own recently announced entry into the credit card market. BNPL consumption.
The advantages of the new DTC model over the traditional DTM approach can also be seen from a business perspective. The sharp drop in valuations of companies like Affirm, Block (AfterPay) and Klarna is basically a symptom of the economy struggling to finally have a model that processes payments, especially in a recessionary environment.
If your product is a POS funding option that a merchant integrates into their checkout page, you get paid as a payment processor. You provide a highly standardized service, competing with other vendors to fund purchases made by the merchant’s own customers.
This is an unattractive supply-demand dynamic – an ever-increasing number of BNPL providers launching the same service, competing for a finite number of merchants. This means downward pressure on your margins. And that’s before the cost of living crisis and shrinking consumer discretionary spending started to bite.
On top of that, recent news from the Financial Conduct Authority (FCA) will see the regulator cracking down on merchants who work with these payment button providers by preventing them from talking about the button in promotional material. Anyone who does not respect this will be given a heavy penalty (even a prison sentence).
With this in mind, Meta and Google have made commitments to the FCA that they will not allow promotions from financial services companies unless they are regulated by the FCA. Since then, they have kept this commitment and recently discontinued these promotions on all platforms. This combination of factors has been a major contributor to the loss of investor confidence and appetite for these DTM business models.
In the long term, we see winners in the B2C payments industry as companies that can offer full ubiquity, a direct-to-consumer model that provides access to all merchants, not just some. It also allows you to offer a range of payment options on your own proprietary app or website – not just credit, but also debit and savings in the form of rewards that a customer might not otherwise get.
The Holy Grail is being able to combine payments and commerce on one platform. In this model, the payment provider is paid by merchants as a marketing channel to both put their products in front of consumers and convert a buyer’s intent when they next visit the online or offline store.
This creates a larger and more sustainable revenue pool to base your business model on. Retailer marketing budgets are expected to soar to around $1 trillion per year over the next two years. Plus, they’ll likely remain robust through a recession as retailers compete to boost sales.
There are parallels here with the Amazon marketplace and Amex’s business model. Investors are attracted by the unit economy, customers by the way retailers cover the cost of interest-free credit and cash back on debit payments.
The BNPL’s traditional model demonstrated consumers’ huge appetite for new ways to pay and, more specifically, for zero-cost credit. But it is the direct-to-consumer approach pioneered by new entrants to the payments space that has the most potential to create value for investors and merchants and, crucially, to change the lives of millions. of consumers looking for the most rewarding means of payment.
About Philippe Belamant