The rise and evolution of buy now pay later

BUY NOW PAY LATER (BNPL) has experienced exponential growth over the last 36 months - and with this growth we have seen major shifts in business models within the financial service sector. This leads to the question- Where does this (R)evolution of payment experience lead to and what are the critical factors that will determine the future of how we shop, pay and exchange value?

Key changes over the last 12 months

The only constant in life is change and the pace of change in the BNPL industry has reached new levels. While 2019 and 2020 have been dominated by ‘land grab’ strategies of BNPL providers to gain market share in ‘established’ consumer segments and attractive industries like fashion, retail and home improvements, we have seen a new era of evolution in the BNPL sector and a broader impact within the financial services industry in 2021.

Evolution 1: Internal Disruption - Shift to open loop systems.

The success of BNPL has been traditionally in closed loop systems — merchants and customers are connected through the BNPL provider and value exchange only happens within the boundaries set by the BNPL provider. In other words, merchants need to enter a contractual agreement with the BNPL provider, and only customers who are signed up with the BNPL provider can use the BNPL service at those merchants. In return for higher conversion rates, increased basket sizes and data insights, merchants pay a service fee (typically 2–8% depending on size and industry) to the BNPL provider.Over the last year though we have seen more BNPL providers (e.g. Humm – bundll, and Zip – Tap & Zip) as well as established payment giants (e.g. PayPal - Pay in 4 and Amex - Plan It) offering BNPL services to customers at any merchants where the underlying network (e.g. Mastercard, Visa, Amex or PayPal) is accepted. While this provides more choice for customers, this low margin model creates internal competition between the closed loop and open loop systems.

Evolution 2: Competition - The empire strikes back

For a long time, banks have watched the phenomenon of BNPL from the sideline — with a mix of scepticism and admiration. But as the popularity and usage of BNPL started to increase dramatically, with more than  7m active accounts today in Australia (noting that most people use 2 or more accounts in parallel), financial incumbents finally saw the threat that was emerging: Not just the decline in credit card usage/revenues but more importantly the high customer engagement and trust building with those new BNPL players. The fear of losing influence and control over the customer has pushed banks to strike back with similar products including no interest credit cards (e.g. NAB StraightUp card or CBA StepPay). With more announcements by Citi, Suncorp, ANZ in recent weeks, activity levels are reaching fever pitch in Australia and the commoditisation of instalment- based payments has become inevitable. The key question is who will be the ones to wrap their value-add propositions, such as product recommendations, order tracking, loyalty programs for customers and insight services for merchants to deliver the best shopping experience?

Evolution 3: Segments and Specialisation

With saturation in core industries, BNPL providers have been on the pursuit for new categories (e.g. health, travel, government payments) and customer segments in which to grow — not only from a consumer but also from a business perspective. Small and medium businesses have been one of the key focus segments over the last months with the launch of new B2B products (e.g. Openpay – OpyPro and Zip – Business Trade). In parallel, BNPL providers have adopted specialisation strategies with category specific value propositions and a focus on becoming the preferred payment option/category leader (e.g. Openpay for Automotive, Humm for home improvements).

Evolution 4: Ecosystem play - from product to platform

The need to diversify not only product and services but also to access new revenue streams and increase their future relevance has led to various partnering models being adopted. Example of ones with a focus on customer retention are the partnerships between Klarna and Flybuys or Humm/bundll and Velocity Frequent Flyer to drive loyalty and purchase frequency. Others have chosen to move from a product to a platform play, a shift that has been re-defined by the acquisition of Afterpay by Square along with Afterpay's partnership with Westpac (Money by Afterpay will launch later this year).

The underlying aspiration of these partnerships is to find sustainable and, most importantly, profitable growth. This is going to be key.

Brace for next wave of disruption

The evolution of BNPL will continue. We are yet to see how the success in a hypergrowth phase paired with a low interest rate environment will stack up in a different economic environment.

Two key dimensions will shape the future of BNPL over the coming months:

• Adoption – what will be the acceptance of BNPL across industries/merchants and customers?
• Regulation – what will be the regulatory intervention to protect customers and merchants?

Depending on how those dimensions play out, four different futures are possible (see graphic below), spanning from staying an alternative payment method for some, through to a new ubiquitous way to buy.

One thing is certain: The BNPL experience is here to stay even though its various forms and flavours will continue to evolve at a rapid pace for consumers, merchants and BNPL service providers (the specialists or the incumbents) alike. It has already rattled the traditional consumer banking experience in Australia, especially for incoming generations, and the longstanding dominance of the big four banks in this space has never been more challenged. The question is: Can BNPL continue to be one of the biggest Australian financial innovation success stories in redefining whole industries while at the same time doing the right things to protect consumers and businesses?