Now that we’ve defined BNPL and evaluated the benefits and challenges experienced by consumers and merchants, we’ll explore how the market could evolve in the future. Digital wallet providers, banks, card schemes, and big technology firms are all looking to offer BNPL services, so the exact contours of competition are uncertain. However, the key components of a healthy industry in the future have already become evident.
How fintech has developed
The first wave of fintech companies radically improved the customer experience. Banks historically sold banking products such as checking (current) accounts, credit cards, and loans. In the UK, early digital challenger banks including Monzo, Starling, and Revolut created digital services that operated in real time and helped customers get a handle on their finances. Today, the bar has risen, even if some banks are catching up. Financial services businesses that design mobile experiences around addressing customer needs and priorities will succeed in the long term.
However, the shift to digital banking has coincided with a low interest rate environment and stronger regulation on fees. This has made it much harder for banks to turn a profit on two major revenue lines: net interest margin (NIM) on lending and interchange fees via card payments. UK consumers are not accustomed to paying for everyday banking, so fintechs that offer subscriptions (the most popular technology business model) for banking services have struggled to make this a primary revenue stream.
The fintechs scaling up faster are those offering financial services at a largely free entry point, or at least a much lower cost than competitors. Examples include Wise (formerly Transferwise) in remittances, Robinhood in wealth, a variety of digital wallets for peer-to-peer payments, and of course, BNPL providers for lending on consumer spending.
The second fintech wave consists of embedded finance, enabled by infrastructure companies that offer banking-as-a-service to customer-facing banks and non-banks. Here, examples include US-based Marqeta, whose valuation reached more than $15 billion after its IPO in June; PPS (a leading processor and issuer powering many of the UK fintechs such as NatWest’s Mettle, Tide, and Monese;) and Stripe, the world’s most valuable privately owned fintech.
Bill Gates famously said: “Banking is necessary, banks are not.” Angela Strange from a16z argues that “Every company will be a fintech company.” And Bain Capital’s Matthew Harris contends that “Fintech is the fourth platform (on top of the internet, cloud and mobile).” The common thread in these assertions is that banking products will soon come to be distributed through a wider variety of businesses, and the direct relationship with the customer will not reside only with banks. Instead, banking will become invisible and embedded within the services we use every day.
As the Covid-19 pandemic hit last year, much of life shifted online and accelerated the use of embedded finance products, especially in e-commerce. Consumers and businesses had to adapt quickly and the two waves of fintech collided as online e-commerce and digital payments boomed. BNPL services, which had made good progress before the pandemic, found themselves in the middle of a shift to digital payments, embedded lending, and e-commerce. Many retailers that relied heavily on in-store sales had to quickly increase their online sales volumes. BNPL helped retailers improve the consumer’s checkout experience, and helped customers manage payments over several installments. BNPL providers are digitally native and their checkout APIs are easy to integrate. What’s more, retailers could minimize the risk of capital management during a period of huge economic uncertainty, worldwide lockdowns, and the temporary closure of non-essential physical stores.
Where payments, lending, and e-commerce trends converge
BNPL providers blend the frictionless user experience of the first wave of fintech products with the embeddable nature of the second wave. This report has offered strong evidence that BNPL now has mass-market appeal and covers multiple use cases for consumers and merchants. Born in fashion and electronics, it has spread to furniture, housewares, and other categories. It is used mostly for physical goods, though there are signs of it expanding into services such as event tickets and vacations. It also follows behavioral patterns similar to credit cards, typically being used for low-value purchases.
BNPL solved a central problem for online shoppers, who wanted to try items before they paid for them. It has since evolved into a digital user experience that fulfills a number of customer Jobs to Be Done. For a long time, making online purchases involved a lot of friction compared to in-store purchases where, regardless of whether they were contactless or chip and pin, card payments were comparatively easy. Today, however, much of the innovation in payments is taking place in the digital realm, and customers expect to see those experiences replicated across channels.
BNPL providers have been quick to innovate in both the products they offer and the experience they create across several touchpoints. From their initial embedded BNPL checkout product, they’ve expanded into in-store payments and personalized shopping recommendations via their apps.
The inventiveness of BNPL providers, the mass-market adoption by consumers, and the benefits to merchants has led to many types of companies looking to enter the market. One of the most commercially attractive aspects of BNPL products is that they build direct relationships with consumers and merchants (see Figure 24). Bringing the two together can activate network effects and become integral to the exchange of value on both sides of the market, as PayPal and Amazon have done over the years.
Buy now, pay later helps financial services firms build relationships with UK merchants and consumers
The rise of BNPL may seem like a threat to incumbent companies in the payments, lending, and e-commerce markets, but in fact it creates opportunities for all when one views the product as sitting within a larger financial and retail proposition. BNPL providers already offer more than a checkout payment option and deferred repayment plans; many offer interest-bearing financing and over-the-top payments with any merchant via their smartphone apps, QR codes, and virtual cards.
Most of the UK BNPL providers’ smartphone apps have become points of discovery for retail. All offer retailer directories, with features extending to product wish lists and deal or discount trackers. These providers sit a level above the retailers, operating as a shopping assistant. True, they’re building strong brands and customer relationships, but with the intent of driving traffic to their retail partners and building non-financial revenue streams in affiliate and advertising fees.
Their next moves are uncertain. In the current low-interest-rate environment, capital is cheap, but if rates rise in the coming years, that will increase the cost of funding for BNPL products. Providers would then have to reduce the cost of funding by, for example, taking customers' deposits as Klarna has begun doing in Germany and Sweden. They might also need to diversify their revenue streams, which for BNPL firms typically means new services for merchants.
Designing propositions that solve more merchant Jobs to Be Done, such as managing their cash flow and linking that to sales and marketing metrics, could be promising growth areas. For example, Square’s purchase of Afterpay (Clearpay in the UK) marks another step in strengthening consumer relationships built with their Cash App. The acquisition also strengthens Square’s portfolio of payment options for small businesses, exemplifying BNPL as part of a broader proposition to merchants and consumers.
An extension of digital and mobile wallets
Mobile and digital wallets as a form of payment have shown sharp, sustained growth because of their convenience in-store and online. Consumers connect their credit and debit cards to mobile and digital wallets, which then reduces the hassle of paying for things. Providers of mobile and digital wallets thus have quickly added BNPL functionality. They offer increasingly flexible payment mechanisms, in order to capture a greater share of the customer’s payment methods. Curve, for instance, announced that users will be able to choose to make a purchase using BNPL or Apple Pay Later.
Indeed, PayPal, the original digital wallet and with a market cap larger than most large US banks, introduced a Pay Later functionality in November 2020. PayPal also signaled its intent to become a “super app” combining financial services for both consumers and merchants with shopping tools, integrating its $4 billion purchase of Honey and more recent acquisition of Happy Returns, and peer-to-peer messaging. PayPal’s ability to connect shoppers and retailers in product discovery and financial services could quickly blur category lines.
Similarly, Shopify, an e-commerce and financial services infrastructure provider, is helping its merchants build stronger consumer relationships to complement its strong relationships with merchants. To that end, the company has deployed its Shop Pay digital wallet, and has partnered with Affirm to offer BNPL products. Various levels of embedded financial services come into play here. Like PayPal, Shop Pay is a digital wallet that can be used across any e-commerce store offering BNPL (even non-Shopify stores, it recently announced). The only difference is the partnership with Affirm.
What’s clear is that having a clear fintech strategy has become essential for outsized growth, especially when consumer preferences on payments and lending are changing.
Generational changes threaten existing business models
A Capital Economics report notes evidence in the UK and internationally that younger generations are more reluctant to use credit cards and other forms of debt. The same report shows that debit card payment volumes have grown threefold since 2009, much faster than credit cards. One of the most striking findings from Bain’s survey of online shoppers is that among respondents age 18–24, more used BNPL (42%) than credit cards (31%). If this trend continues as the younger generation ages, we could see further shifts in payment and lending behavior.
In response to this trend, we are already seeing innovation in cards. Tymit aims to reinvent credit cards by offering BNPL repayment functionality and help customers avoid interest charges. Visa offers credit card issuers BNPL application programming interfaces to add new functionality to credit card payments. Consumers clearly benefit from access to no-interest deferred repayment plans. However, card providers depend on consumer interest charges and fees as a key revenue source, so offering BNPL repayment features without the merchant services (and associated fees) could threaten their business model.
Can banks quickly follow BNPL providers?
Big banks have all the right ingredients to turn the BNPL threat into an opportunity. They have a huge base of retail customers with a variety of credit products, and many of the established banking providers have merchant acquiring services. Those with direct consumer and merchant relationships could theoretically move into the top right of Figure 24. But can they operationally align their retail and commercial capabilities to create a compelling proposition that resonates with generational shifts around payments and lending? Structurally, this will be a challenge because their consumer credit businesses own P&Ls separate from their commercial banking businesses. If they can overcome organizational and technology challenges, they’ll be well placed to compete with new BNPL services and do so at scale.
White-labeled credit products for retailers
While the most prominent BNPL products have been fintech branded, an alternative approach, more aligned to their core capabilities, is to create white-labeled credit and BNPL products for retailers. One high-profile example is Barclays’ partnership with Amazon in the US (coming soon to the UK) to offer BNPL at checkout for qualifying Amazon purchases. A BNPL checkout option would provide more choice for customers and could create a lucrative business line for Barclays.
Retailers partner heavily to offer their credit products. In the UK, Amazon partners with NewDay to offer its branded credit cards. NewDay’s white-labeled credit products are well positioned because, while not a household consumer brand, they provide financial products to many companies that are. NewDay offers a range of co-branded credit cards, POS financing products, and digital BNPL 1.0 products to high-profile retailers. It recently launched NewPay for retailers in the UK enabling BNPL, installment loans, and no-interest financing. A sister company, Deko, provides the same products to smaller merchants and also offers software to enable the right financing offer to be shown on the product page as well as at checkout. In addition, NewDay administers its own credit cards targeted at specific customer segments; Aqua, for instance, helps customers improve their credit scores.
Many merchants value a branded BNPL checkout option, as customers often are more likely to use a payment method they recognize. Companies such as NewDay offer an alternative, with white-labeled lending products enabling retailers to deepen their customer relationships through financial services. Other banks are considering this space. HSBC, for instance, recently led an investment round in the white-labeled, multi-lender, and multi-product provider Divido.
The crossover of financial services and retail presents a broad opportunity, because so many types of businesses could execute different strategies. At the moment, BNPL sits at the center of much of the product innovation and growth. It allows brands (financial or not) to strengthen their customer and merchant relationships, which positions them favorably in the developing digital-first economy. How this opportunity pans out will hinge in part on the shape of upcoming regulation.
BNPL as a regulated product
BNPL products in the UK will soon become regulated. Earlier this year, the Woolard Review identified areas of focus ranging from disclosure requirements to affordability assessments to ensuring that regulation is proportionate given the typical size and low-cost nature of BNPL debts.
To be sure, the industry has a stake in adequately protecting consumers, but regulation should also allow innovation to flourish. As noted earlier, consumers generally give higher ratings to their experience of BNPL products than to other forms of unsecured lending (Figure 11). As usage grows and more companies enter the market, we believe regulation should focus on consumer outcomes such as driving low levels of missed payments and default rates—which can negatively affect both BNPL providers and users—and pushing for even higher levels of customer satisfaction.
Based on our research and the recommendations from the Woolard Review, we propose three areas for business leaders to emphasize in planning for BNPL regulation.
1. Education and clear communication. Lending helps people spread the cost of purchases to align with their income and ability to pay. When taking on debt, though, people need to be fully aware that they are entering into credit agreements with repayment implications. Even BNPL products that are free of interest and late fees are a form of credit that must be repaid.
Compared to other forms of unsecured credit, BNPL 2.0 is relatively new. Educational initiatives and clear communication thus should play a role in helping consumers understand how BNPL works and how to use it responsibly.
Effective education requires a long-term commitment. We’re encouraged by a number of initiatives to date. In late 2020, the Advertising Standards Authority (ASA) published guidance on advertising BNPL products, which took full effect in March 2021. That guidance calls for all advertising to clearly state that BNPL services are a form of credit. This message bears repeating every time a consumer uses the product, which currently does not happen when consumers pay with credit cards.
BNPL providers have taken visible steps on this issue. Klarna, for example, launched the KlarnaSense campaign to encourage customers to ask themselves, “Do I love it? Will I use it? Is it worth it?” As people increasingly turn to social media for financial advice, Klarna created the Influencer Council to promote better standards for promoting financial services on social media.
These positive steps are just the start. Financial education doesn’t create awareness or change perceptions overnight, as our survey shows that 44% of all BNPL users either strongly or somewhat agreed that “BNPL services do not qualify as debt because they don’t charge interest.” This sentiment was especially strong among younger respondents. Changing perceptions requires a sustained effort by all providers of BNPL services in their various forms.
Advertising has a role, but other digital realms do as well. The more financial services become embedded into lifestyle services, the more “invisible” they become. Over time, every payment innovation (credit cards included) has moved users away from physical cash, which reduces friction and makes spending money (and the associated borrowing) easier. Hence the “denomination effect”: People tend to spend more when using a credit card than they do when using cash. Recent technologies such as digital wallets and BNPL further minimize this psychological barrier. As money continues to turn invisible, payment service providers need to design products in ways that help users to spend and borrow responsibly.
Some BNPL providers are taking on these challenges. Clearpay’s guiding design principles include the realization that “late payments are bad business.” The company has backed up this principle by launching flexible money management features to help customers repay on time or early, and through Pulse Rewards that motivate responsible spending. Instead of offering reward points to encourage spending, it offers points for payments made on time. Rewards are a classic behavioral design technique that could counterbalance frictionless, invisible payment experiences.
Besides advertising, communication, and behavioral design changes, BNPL services have controls built into them on every purchase. Each provider assesses the credit risk for a purchase and freezes accounts if payments are missed. Again, this is a positive step, but making such missed payments visible to other lenders and BNPL providers remains an issue.
2. Integration and sharing of credit information. Addressing two connected needs will improve outcomes for BNPL customers and providers alike. The first is the need for providers and other lenders to accurately assess a customer’s overall indebtedness and credit risk across products. Current data sharing and credit scoring mechanisms were not designed for the frequent underwriting of low-value purchases that are repaid in short-term installments. Redesigning data-sharing frameworks that incorporate affordability assessments will be central to better underwriting. This broader view of BNPL debt will also promote equitable treatment of consumers when they engage with other financial services. As the BNPL providers take on the credit risk, many already have been working with CRAs to find a solution, although these may take a few years to formally implement.
The second need involves a central place for users to track their spending and borrowing, a need not unique to BNPL. Digital consumption forces people to pay in new ways, such as subscribing to services rather than paying once up front or on credit. People might have multiple subscriptions and credit purchases simultaneously across different platforms. This complicates management of their financial lives, so solutions that incorporate open banking can make a difference.
Regulation will play a pivotal role in integrating the credit information ecosystem. Working more closely with CRAs will allow BNPL companies to assess credit comprehensively. BNPL companies can further reduce risks by helping customers manage their finances centrally through open banking platforms. Such platforms can also give customers control over their financial data, allowing them to share it directly with CRAs and lenders. CreditLadder, for example, allows users to share rent payment information with CRAs.
3. Empowerment of small and medium-sized merchants. Regulation should ensure that BNPL products remain accessible to merchants of all types. Given the typical economics of enabling products like BNPL, larger merchants often can negotiate lower merchant service fees and marketing commissions. That said, smaller merchants have come to find such services highly valuable as well, especially over the past year or so. Offering BNPL lends credibility, drives conversion, opens up co-marketing opportunities, and supports customer acquisition.
Regulatory compliance, if made applicable to merchants, can be proportionately more burdensome and costly for smaller firms than larger ones. Interventions should therefore seek to ensure that the cost of compliance does not unduly affect small firms, or worse, lock some of them out of the market. As BNPL companies move closer to the customer by becoming e-commerce aggregators, keeping their platforms open and democratic will be critical to fostering a vibrant, inclusive e-commerce ecosystem in the UK.
More essential, more strategic
For businesses in financial services, over the past few years it has been essential to have a fintech strategy. Now it’s also essential for businesses that intersect payments, lending, and e-commerce to formulate a BNPL strategy.
As with all innovation, social and customer-level challenges have surfaced. Regulation will help protect consumers by creating standards for BNPL providers to follow. Yet just as important is the willingness of BNPL companies to actively put customers’ welfare and priorities front and center. Companies will thrive by combining the conveniences of new digital experiences with active measures to promote healthy financial management and debt repayment. Fortunately, we have already seen numerous positive steps along these lines.
Looking ahead, we expect to see some big strides in how credit referencing data is shared across the industry. Here, the maturing of open banking offers inventive ways to share data.
We also expect to see more banks, lenders, fintechs, and retailers add BNPL to their mix of payment and lending options. Digital payments, once seen as a complex feature, has become a more strategic area for companies aiming to deepen customer relationships. The next few years thus hold great promise for digital payments and embedded finance in the UK, as well as across the globe.