Buy now, pay later (BNPL) has quickly established itself as the go-to method of financing for a variety of purchases, particularly online.
This financing model has primarily been available to customers shopping online, but customers outside the U.S. have already dipped their toes into similar alternatives at brick-and-mortar stores. We’re likely to see BNPL offerings become more prevalent at points of sale for a manner of different purchases through 2022.
Investors in the space already see BNPL leaving the bounds of retail and entering sectors such as healthcare. “BNPL will become a more popular POS option in 2022, not only across brick-and-mortar stores, but also in sectors like healthcare, where installment payments already exist but have not yet crossed the chasm to digital,” said Frances Schwiep, partner at Two Sigma Ventures.
“Average ticket sizes for healthcare can range between $2,000 and $10,000, making it a perfect candidate for vertical-focused, larger-ticket BNPL solutions.”
Despite the popularity of the model, it appears there are a variety of applications for which BNPL is just being tapped, and smaller players are carving out a niche as the retail market grows crowded.
We believe BNPL adoption at the point of sale will accelerate rapidly given consumer familiarity. Jonathan Whittle
“Now that consumers have gotten comfortable with BNPL as a concept and are increasingly using it as an alternative to credit cards, we’re seeing opportunities for new BNPL products for recurring bills, such as rent, streaming service subscriptions, etc. We also see opportunities for new BNPL products for small businesses that are looking to reduce cash flow strains or avoid maxing out credit lines,” said Jason Brown, partner at Victory Park Capital.
It isn’t all smooth sailing, though. Smaller BNPL providers could struggle in markets where bigger players have already established a presence. In the U.S., Klarna, Afterpay and Affirm have managed to wrest the majority of the market share, leaving the rest with just a quarter of the market to compete over.
To get a better picture of where the BNPL market is at right now, we spoke with four active investors about their expectations for the space, upcoming regulation, scalability, default risk and more.
We spoke with:
- Frances Schwiep, partner, Two Sigma Ventures
- Melissa Guzy, co-founder and managing partner, Arbor Ventures
- Jonathan Whittle, co-founder and partner, Quona Capital
- Jason Brown, partner, Victory Park Capital
Klarna, Afterpay, Affirm and PayPal generated more than $3.2 billion in revenue last year. Is BNPL still an open market, or is it already dominated by entrenched players?
Frances Schwiep: BNPL, though crowded in established markets, is still ripe for innovation in new geographies like Latin America. Notably, unique local characteristics challenge a one-size-fits-all approach.
There’s a host of difficulties to overcome: from managing market-specific database integrations with APIs that don’t talk to one another to understanding nuanced risk dynamics that inform underwriting models, and geo-specific consumer behaviors that impact product roadmap.
For example, BNPL companies based in LATAM must weigh an array of variables included in the risk model differently based on consumer behaviors natively bound to the characteristics of the local market. For example, telecom variables and contact graph referrals are more heavily weighted features in the underwriting model in Mexico versus the U.S. Repayment collection methods also vary drastically by geography, and require local knowledge and know-how to execute at scale.
We believe building fintech products (versus other classes of products) with geo-specific dynamics in mind is key to their success. As Kyle [Miller], founder of Nelo (a LATAM-based BNPL) and former product manager at Uber, puts it, “I’ve found that the product gap I saw with Uber in established versus developing markets is MUCH wider for financial products, specifically credit and BNPL. Major differences I’ve seen include available underwriting data, repayment methods and general consumer behavior. The winner of BNPL in LATAM will have been built in LATAM for LATAM.
Melissa Guzy: The market for BNPL is maturing, and unless a new player has a differentiated approach and can offer additional services to both consumer and merchants, it will be tough for new entrants.
Three key areas for differentiation include:
- Checkout distribution (e.g., association with a scaled platform).
- Cost of funds (capital available for lending).
- Consumer proposition (consumer experience and repayment model).
What is clear today is that a new entrant will need a significant amount of capital from the start for marketing and winning a position on the checkout page.
Jonathan Whittle: It depends on the market. In most emerging markets where Quona invests — including Latin America, the region I lead for the firm — BNPL remains relatively open, with a few market leaders beginning to emerge, such as ADDI in Brazil and Colombia, and Zest Money in India.
Jason Brown: It’s true that the large BNPL players that are focused on point-of-sale financing for consumers have dominated the market — they have strong brand recognition and customer bases. Because the market is crowded and it’s expensive to acquire customers, it is difficult for new BNPL entrants in the traditional consumer point-of-sale space.
However, now that consumers have grown comfortable with BNPL as a concept and are increasingly using it as an alternative to credit cards, we’re seeing opportunities for new BNPL products for recurring bills, such as rent or streaming service subscriptions.
We also see opportunities for new BNPL products for small businesses that are looking to reduce cash flow strains or avoid maxing out credit lines.
What kinds of opportunities are you looking for right now, and how do you like to be approached by founding teams?
Frances Schwiep: We’re on the lookout for companies both enabling and distributing next generation financial products. We continue to be bullish on platforms that are selling embeddable financial products, such as payments, insurance and lending.
We are seeing an exciting class of companies providing “OS systems” for specific verticals and professionals (from Glossgenius for stylists and Altruists for financial advisers, to Side for real estate agents), and believe financial offerings will be key pillars of these platforms.
We also see a compelling opportunity for fintechs to unlock more value within marketplaces — whether it’s retail, restaurants or B2B inventory — and attracting wallets by offering the financing and checkout experience consumers want. I believe the next Alibaba will start as a fintech play.
Beyond embeddable fintech products, we’re excited about companies that are disrupting traditional payment rails with more efficient models. As complexity and average processing fees at checkout have increased for merchants in recent years, there has been mounting pressure to innovate and regain control over costs.
We are also excited about companies building modern software for both financial institutions — who are under pressure to compete with digital native competitors — and for financial teams within enterprises who are trying to modernize their management of cash.
Last but not least, we think financial health and wellness is being redefined, with alternative asset classes, including crypto, becoming more mainstream. Consumers’ financial footprint is getting increasingly complex, and we’re eager to invest in tooling that helps with consumer on-ramps, consumer access and management of new financial investment opportunities.
Melissa Guzy: We like founding teams who think differently about opportunities and winning market share. They need to be realistic while being visionaries, which is hard to find. Also, founding teams need to demonstrate that they can build a team and attract talent.
We also believe there are opportunities to develop BNPL expertise in a segment (e.g., medical expenses) or a geographic region/country that has less competition and more growth potential.
Jonathan Whittle: We’ve already backed the company that we believe will dominate the B2C BNPL space, and perhaps B2C/M2C payments in general, in Latin America, and it’s ADDI. There are also opportunities in the B2B-focused BNPL arena on the back of growth in B2B e-commerce marketplaces and as M2B businesses come online. Many early-stage companies are attempting to tackle this opportunity, too: Slope, Dinie, R2 and Kontempo, to name a few.
Jason Brown: We are always looking for opportunities to partner with new entrants that have a differentiated and cost-effective customer acquisition channel, either through partnerships or product innovation.
As a lender, we work closely with VC firms that have significant expertise and vision in the space to identify innovative companies with strong management teams that need credit financing to unlock their next stage of growth.
Do BNPL offerings run the risk of appearing too similar? Which products or services are innovating? What can startups do to stand out?
Frances Schwiep: Yes, and to overcome this risk, we’ll see a bifurcation of companies — those who will pursue a B2B strategy with merchant integrations and merchant services at one end of the spectrum, and those who will prioritize a direct-to-consumer acquisition strategy and own the consumer relationship via their “super app” on the other.
The latter is a relatively new development and involves focusing on customer repeat engagement, loyalty and creating a marketplace of products with the financing solutions customers want. And that’s where Nelo fits in. They moved from a direct-to-merchant integration strategy to a direct-to-consumer approach, winning the hearts and minds of consumers with their slick, easy-to-use app.
Finally, we believe vertical-specific BNPL solutions will emerge with ancillary services tailored to address a particular sector’s need (e.g., healthcare, home construction, etc.)
Melissa Guzy: BNPL companies vary by geography to fit the local market. Tabby is a great example in MENA, Akulaku in Indonesia, and so is Paidy in Japan. They are all in the BNPL category, but they have developed an expertise in regional distribution channels, non-traditional customer segments and product variations.
Jonathan Whittle: Installment payments can quickly become a fairly standardized and easily commoditized offering. What will differentiate BNPL solutions is tech architecture, underwriting ability and UX, coupled with seamless integration of other synergistic products, such as one-click checkout and payment management solutions across payment methods.
Other forms of differentiation will stem from additional value-add merchant and/or consumer products, like a consumer app tied to a line of credit that can be used across multiple merchants. That strengthens stickiness and reduces churn while fueling client acquisition and conversion.
Jason Brown: Consumer point-of-sale BNPL products are very similar, though some are differentiating by offering longer payment options for products that are more expensive or more nuanced.
Another area where we’re seeing innovation is with white-label BNPL products that can be embedded into a merchant’s checkout process. With a crowded market, it’s important for startups to differentiate themselves by acquiring customers in a cost-effective way.
Will we start to see more consolidation this year? If so, which types of BNPL startups will be likely acquisition targets in 2022?
Frances Schwiep: Acquisition targets will be considered for their relevance in their users’ everyday lives as well as their granular (i.e., item level) longitudinal data ownership.
For larger fintech players, the most attractive BNPL startups will be those that see high engagement and repurchase rates. Item-level data is particularly attractive to banks, which lack insight around SKUs today and could help them drive value back to merchants.
Melissa Guzy: I believe all BNPL companies can be acquisition targets once they achieve some scale. Three million customers appears to be the benchmark.
BNPL platforms that are successfully embedded in large-scale platforms are likely to be more desirable acquisition targets than providers in the early stages of merchant distribution. The ability to touch a large percentage of transactions coming across a network — and the limited balance sheet — may create an opportunity for a large traditional bank to step in and expand their loan book.
BNPL players without scale or platform distribution deals are more likely to be consolidated by larger industry peers or suffer attrition over time.
Jonathan Whittle: I could see smaller platforms that are struggling to compete with emerging leaders being likely acquisition targets. But acquirers aren’t limited to legacy banks and credit card companies. We’re seeing interest from BNPL platforms themselves — like Zip’s acquisition of Sezzle, where a larger player is looking to consolidate market share and pocket synergies via economies of scale.
Jason Brown: We’re already seeing consolidation in the BNPL space and expect the trend to continue. There are a lot of smaller entrants that we believe could eventually be acquisition targets for larger players seeking to acquire additional customers or enter a new market.
For example, BNPL products focused on small businesses could be viable targets for some of the consumer-focused BNPL players that want to expand into that offering and cross-sell it to their existing merchant customers.
How closely are you watching the U.S. Consumer Finance Protection Bureau’s probe into BNPL? Are you advising your portfolio companies to expect a regulatory clampdown? How might that affect smaller fintechs’ ability to enter the market?
Frances Schwiep: The key dimensions I’m keeping an eye on related to the CFPB’s probe into BNPL include: (1) potential impact on consumer sign-up experience, which could lead to increased friction in the underwriting process, and (2) how BNPL firms gather data and assess consumers’ ability to repay using the installment mechanism.
Mandated consumer protections for fair lending (including requirements for marketing and communications) are inevitable. However, I believe they will be a positive enabler for greater consumer trust in BNPL products overall.
Melissa Guzy: BNPL regulation is being contemplated or introduced in most countries today. The rapid expansion of a new consumer lending vehicle, paired with potential concerns about systemic risk factors, is driving this activity.
Regulation so far has not been intended to inhibit BNPL but to make it more transparent. In the U.S., for example, discussion focuses on credit bureau reporting, consumer T&C and late fee/collection standards.
We believe that viable BNPL providers need to possess a regulatory IQ and be prepared to conform and evolve as regulation is introduced. Watching and learning from other markets is one way to stay prepared and ahead of the curve on regulation.
Jonathan Whittle: Quona is an investor focused on financial inclusion in emerging markets, so while we keep an eye on what the U.S.-based CFPB is doing, it’s less relevant for our markets generally. However, it is useful anecdotally with regard to how regulators see the space.
Jason Brown: We are always keeping an eye on developments that can have an impact on our portfolio companies, including legislation. We support regulation that ensures consumer protection and expect that fintech companies comply accordingly, whether in our portfolio or otherwise.
Klarna Checkout is available in 170 countries, but it’s a market leader that can afford to hire teams to comply with a patchwork of regulations across countries. Can smaller entrants compete internationally, or does regulatory uncertainty limit them to their native markets?
Frances Schwiep: Klarna has gone after developed markets, where high card penetration already exists. There is still a ton of untapped TAM for BNPL in markets where access to credit is low, and whose economies are rapidly moving away from cash-based transactions.
This presents a huge opportunity to leapfrog credit cards entirely as the predominant method of digital payments in those markets. For example, in Mexico, less than 15% of the adult population has access to a credit card, and the use of cash is expected to drop dramatically to just 2.6% over the next two years.
Melissa Guzy: New entrants can compete if they understand customer needs and distribution channels and have assembled the right team for the geographical focus area. Generally, as lending companies get more global, their target consumer/risk appetite narrows.
Providers willing to develop local operations will always have an opportunity to compete against multinational lenders.
Jonathan Whittle: BNPL is highly region specific, and the levels of regulatory complexity can vary widely and depend on the country. This being said, international expansion is not only possible, but very attractive for BNPL platforms looking to scale (particularly for companies with smaller home markets), assuming the right regulatory “leg lifting” has preemptively been completed and that local know-how has been internalized.
When international expansion is warranted, a selective approach tends to work best with deep analysis of market differences and similarities, and with sufficient focus and traction in each market before launching in a new one.
Jason Brown: We don’t view patchwork regulations across borders as a disadvantage; smaller entrants can typically navigate regulatory complexities in any market. The larger challenge for a smaller entrant is acquiring customers versus moving into and navigating the regulatory requirements of a new market.
Blue-chip financial services companies are expanding their corporate venture capital operations so they can find the next Afterpay. What advantages do traditional VCs have over CVCs for bringing fintech startups to market?
Frances Schwiep: Ultimately, traditional VCs are unbiased and have a clear-eyed ambition to help fintech startups become as successful as possible. CVCs may be incentivized to align the focus of the fintech startup with their own models and synergies they want to create, which could theoretically impact the guidance they give.
Melissa Guzy: VCs are willing to take early-stage risk and help a company grow to materiality. Seed and early-stage investments are less common for CVCs. In addition, VCs have the ability to help a portfolio company advance and grow through multiple years of “non-material” revenue as they attempt to develop product-market fit.
A CVC may have an interest in a category but could find it hard to provide hands-on support to an early-stage company without distracting corporate divisions with more pressing and material revenue objectives. CVCs tend to blossom at the point that brand and commercial partnership can accelerate a portfolio company’s growth, which is often a growth or later stage investment.
Jonathan Whittle: It tends to be easier for traditional VCs to attract entrepreneurs who are hesitant to limit their exit options or to bring strategic interest — even if at arm’s length — into their cap tables too early on in their trajectories.
Jason Brown: Both traditional VCs and CVCs have highly talented investors with expertise in their respective areas — whether it’s in fintech, enterprise software, consumer digital health or other areas. It really comes down to the startup and what they are looking for in an investment partner.
From our work with traditional VCs, we have seen their ability to be nimble and creative, and CVCs, of course, have deep sector and product development expertise. Depending on the company and its goals, they may choose to partner with either a traditional VC or a CVC, or a mix of both.
Are online merchants becoming more open to BNPL solutions than brick-and-mortar stores? Outside of the U.S., customers can use deferred payments at point of sale. It seems like online merchants are willing to subsidize interest costs if BNPL drives enough sales. Will BNPL become a more popular POS option in 2022?
Frances Schwiep: BNPL will become a more popular POS option in 2022, not only across brick-and-mortar stores, but also in sectors like healthcare, where installment payments already exist but have not yet crossed the chasm to digital. Average ticket sizes for healthcare can range between $2,000 and $10,000, making it a perfect candidate for vertical-focused, larger-ticket BNPL solutions.
Melissa Guzy: All of Arbor’s BNPL investments are outside the U.S. The UI/UX associated with online payments can be easily configured to accommodate multiple payment scenarios based on the capability of the merchant and interest of the buyer.
Brick-and-mortar stores have been historically limited by the capability of the POS system. As we move into 2022, we are beginning to see the introduction of BNPL/installments at the physical POS due to three things: updated POS infrastructure, merchant desire to offer payment options beyond credit cards and general consumer awareness of BNPL products.
It is likely that the premium margins subsidized by merchants will become less desirable over time as product adoption increases, so we should expect downward pressure on margin and interest rates.
Jonathan Whittle: As you note, many consumers in Brazil and other markets are familiar with installment payments at the point of sale. However, these have traditionally been limited to consumers with credit cards or at large retail chains.
We believe BNPL adoption at the point of sale will accelerate rapidly given consumer familiarity, tapping into consumer segments with no credit cards or with low limits, and small and mid-sized merchants.
Jason Brown: We are definitely seeing brick-and-mortar BNPL solutions growing outside of the U.S. Online purchasing is a very meaningful part of overall consumer purchasing in the U.S., and we expect it to continue dominating. However, in areas where online purchasing and credit card adoption are low, the in-store BNPL option is a beneficial enhancement for both consumers and merchants.
How are you advising your portfolio companies in managing default risk? How prominent an issue has this been so far with regard to your thesis for startups in this subsector?
Frances Schwiep: We are guiding companies to set up practical checks and balances to avoid wipeout risk. We also recommend they only allow small loans at first until credibility is established or capture data around customers’ income flows to determine how well equipped they are to pay back loans (similar to the Nubank credit strategy).
For example, Nelo’s initial loan size can be as low as $10, and they require that customers pay the first installment for some purchases, reducing default risk.
Other best practices include clear marketing and communication, and best practices around repayment collections (e.g., methods used, reminders, etc.), and making repayment as frictionless as possible.
Melissa Guzy: Mitigating default risk is necessary for all fintech companies. Default risk is endemic to lending models, and the ability to intelligently address it is one of the key criteria for backing a management team in the BNPL space.
A BNPL startup will typically launch services using its balance sheet or a credit facility secured on “average” terms. It is the responsibility of the platform to acquire new customers and expand its loan book while understanding and controlling for default and fraud metrics.
Most platforms will make limited bets in new channels or categories until they can optimize their risk algorithms and expand in a predictable manner. Arbor has interesting insight into the opposite side of BNPL default rates, as we have also invested in TrueAccord, an AI/ML-based debt recovery platform that services major BNPL providers, including Affirm and Klarna.
Jonathan Whittle: There are many creative ways to minimize fraud and default risk, including the requirement for the first installment to be paid at the time of completion, as well as increasing credit available to users as they individually demonstrate their repayment behaviors.
Jason Brown: From our years of experience underwriting fintech businesses, we have strong risk management systems in place that we assess potential borrowers against before proceeding with an investment. Because of our expertise, our portfolio companies are also able to leverage our insights to improve their credit analytics and better manage their default risk.
BNPL clearly gives consumers more flexibility, but more than 50% of Americans couldn’t raise $1,000 if they had a sudden emergency. Do startups need to educate their customers about the risks of short-term debt?
Frances Schwiep: The promise of embedded finance is greater transparency, accessibility and support in helping people manage their finances. Realizing this hinges on startups (and everybody involved) engaging in responsible lending practices through clear language, setting unambiguous expectations to reduce potential consumer exposure to fines and late fees, and making sure that people understand what they’re buying.
We see an opportunity for BNPL in categories that are for essential, non-discretionary spending, including for essential services. For example, Nelo has been quite active in helping consumers better manage payments for utilities, phone plans, appliances and other goods that are not purchased impulsively just because installment options exist.
Melissa Guzy: Countries contemplating BNPL regulation are focused on consumer terms and debt transparency as their primary control factors. Any BNPL provider (existing or starting out today) needs to invest time and energy into understanding their consumer and preventing negative outcomes.
We believe that any provider involved in this space should position their offering as a form of debt and prioritize transparent T&C. One of the main issues with short-term debt is the accumulation of small payment obligations that add up to an unsustainable obligation.
The ability to modernize credit bureau reporting — or an industry alternative — for a more fulsome picture of consumer debt is ultimately likely to be part of the solution.
Jonathan Whittle: Absolutely. Transparency in pricing and repayment timelines are key and should be understood by consumers ahead of purchase. Another way to promote responsible consumer lending practices is for BNPL platforms to be cautious about the types of merchants they partner with and the types of products they allow to be purchased via installments.
Jason Brown: Our mission is to invest in companies that are dedicated to helping build a more inclusive financial system, and a natural part of that is financial education. We’re passionate about partnering with founders who are working to provide not only products that meet consumers’ financial needs, but also educate them about the risks and rewards of the various solutions that are available.
Gen Z and millennials are the primary users of BNPL. What needs to be done to expand adoption across other demographics?
Frances Schwiep: More segment-specific marketing needs to be done, in addition to expansion into new product categories that may be more relevant to other demographics (e.g., travel, home design, healthcare, etc.), as well as partnerships with financing methods currently heavily used by those demographics.
Melissa Guzy: More people will become comfortable with a virtual credit card, and for some, BNPL is linked to their debit account but allows them to use it in the same manner as a credit card. The market will expand over time as this approach becomes more prevalent.
Early BNPL adoption rose in online environments and was often fueled by specific categories (e.g., fast fashion). In addition, millennial and Gen Z consumers categorize indebtedness differently than their parents. For example, breaking a large purchase into three scheduled payments is viewed as “smart budgeting,” whereas adding a large purpose to a revolving credit line with interest payments and no pay-off plan is viewed as “bad debt.”
If we take the long view, we can follow three trends that will expand demography:
- Online to offline movement of BNPL as the physical POS becomes more capable.
- The general aging of the millennial population and increasing purchase power.
- The adoption/inclusion of BNPL by traditional banks and payment networks.
Jason Brown: Gen Z and millennials have grown up with BNPL options and don’t want to have credit card debt, so they are more inclined to use BNPL as a budgeting mechanism than other generations are. We’re starting to see BNPL businesses target other consumer demographics by focusing their efforts on merchants that are more likely to have different demographics purchase their products.
What have we missed? Do you have any general advice for someone who’s starting up in this space?
Frances Schwiep: The massive opportunity for BNPLs is the rich data unlock. Traditional credit networks lack infrastructure to extract and send rich, item-level merchant data. Thus, my bank only knows me at a surface level — how much I spent and where (a wide, but not deep view). A merchant knows my detailed purchase behaviors, but it’s a single-view perspective (a deep, but not wide view).
BNPLs, on the other hand, because they bypass credit networks (and their broken systems), get access to detailed, SKU-level data for customer purchases across merchants — a deep and wide view.
I believe this rich data unlock is foundational for the future of commerce. It enables a whole host of new products and services to be crafted. For BNPLs, the insights derived from these datasets not only create advantages from an underwriting perspective, they also open the door for next generation shopping experiences to be built.
Companies like Klarna (in developed markets) and Nelo (in LATAM) have already started capitalizing on this dynamic, pioneering a new strategy of going up-funnel by directly connecting consumers and merchants via their “super app,” and getting consumers to start their personalized shopping journey there.
But this is just the beginning. Rich, SKU-level data has been a hot topic across fintech use cases — from payments to fraud prevention. Longer term, I could see this data shake-up caused by BNPLs catalyzing the creation of a globally recognized data sharing protocol to be written for commerce.
Melissa Guzy: If you are going to enter this space, you need to have a differentiated product for the merchants and for the consumers. One should not assume that new entrants will have the same opportunity as their older peers just because it has been a great success for startups that were early. The incumbents are experienced, seasoned and well capitalized.
We believe it is important to understand how to distribute or embed services in a differentiated manner, and that focus on a complex or less developed commerce or payment channel may provide an entry point.