Buy-now-pay-later firms brace for financial storm
With economic conditions tightening, and investors becoming increasingly wary of risk, the buy-now-pay-later bubble could be on the verge of bursting. Market leader Klarna has made one-tenth of its workforce redundant, as it looks to cut costs – something which may bode poorly for the fledgeling segment.
In recent decades, the continued trend of heightened inflation and suppressed wages has seen Britain’s consumers left with less and less of their paycheque after rent, utilities and food bills. The growth of the UK’s consumption-based economy depends on being able to get customers to part with cash they don’t have. At the same time, despite apparently facing a ‘talent shortage,’ employers remain resistant to giving their staff a pay-rise that could fill this void.
Over the last three decades, credit has become an essential element of this equation – enabling underpaid workers to continue in their function as consumers, and so keeping the economy ‘growing’. However, the 2008 financial collapse – which was underwritten by the subprime mortgage crisis – left traditional banks unwilling or unable to service this space. Stepping into the role in the following economic cycles, a number of entrepreneurs have tries to exploit this ‘gap in the market,’ with different forms of so-called alternative finance.
In the early 2010s, for example, pay day lenders were regularly used as a means for lower-income households to make ends meet. The problem was that many lenders charged extortionate rates of interest for this service, placing huge numbers of people in ever-increasing debt – and many consumers unable to access other forms of credit felt they had no other choice but to agree to those conditions. When economic conditions worsened, those customers were unable to service their debts, and the pay day lenders inevitably faced the same market forces as predatory lenders from banks had in the previous decade.
Following the downfall of firms like Wonga, however, another form of alternative finance stepped into this position: the phenomenon of Buy Now Pay Later (BNPL). Using a BNPL option to spread out payments on a big buy resembles a personal loan in that your payments are split up into equal instalments over time, typically just a few months. Such deals have exploded during the pandemic, gaining a foothold among the under-30s and those with tight finances, who have welcomed the ability to delay payment for goods, typically without interest.
During the pandemic, this mechanism boomed. With online shopping suddenly the only way to obtain non-essentials for many consumers, vendors were well positioned to profit. They faced a problem, though: their captive audience was existing on an even lower budget than usual – as many were on furlough schemes or reduced salaries while employers weathered the storm. Quick, easy credit was seen as the way to enable them to continue consuming – so merchants allowing BNPL providers onto their sits in ever growing numbers.
A poll from Bain & Company found that the nature of buying now, paying later meant many people felt able to purchase items they would otherwise have saved for. As a result, by mid-2021, 57% of merchants questioned said they had benefitted from increased checkout or basket conversion on their website, due to BNPL. A further 47% said the order value had been boosted – while more than half felt their brand had accessed new customers due to BNPL involvement. Meanwhile, BNPL providers received typically around 4% of the sales price – with retailers feeling it was well worth it, having received a boost in sales and left someone else holding the debt incurred.
Bleak outlook
BNPL firms operate on thin profit margins, though, and while this is not necessarily a problem in ‘boom times’, it has proven to be a ticking time bomb in the months since. Illustrating this, FinTech Klarna – which offers online shoppers the option to spread the cost of their purchases over instalments, at a zero headline rate of interest – has announced a 10% cut of its 7,000 staff, as it bids to reduce costs.
Founded in 2005, Klarna became Europe’s most valuable private company last year, valued at $46.5 billion, with ambitious plans for cracking the US market and a hotly anticipated IPO. However, as households face huge inflation rates, and the cost of basic goods like fuel, energy and food spiral, the customers of Klarna and other BNPLs are pulling back on non-essential spending. While this impacts the firm’s ability to bring in profits from vendor commissions, it is also putting increasing pressure on its need to recoup amounts it has lent.
This is an even bigger problem for BNPLs. As they depend on lending to marginal borrowers, many BNPLs spend far less on risk assessment and credit checks on customers than traditional lenders. As of November 2021, the Woolard Review was informed by one major bank that of its customers using BNPL, one-tenth had already exceeded their overdraft allowance that month. These borrowers would likely have been pushed into arrears and default – and with the cost of living crisis exacerbating things, they have likely been joined by many more.
Indeed, the study cited by Bain earlier found that only 21% of consumers said they “strongly agree” they could easily afford BNPL payments. The situation may well have deepened – especially as, due to its low level of checks, BNPL has obtained a number of customers who are unaware of what they are signed up for. A Citizens Advice Bureau report in 2021 found that 39% of the 14 million people who used BNPL in the UK in 2021 “used it without realising” due to vendors including it on payment pages. A further 40% did not think it constituted “proper borrowing”, while 42% did not “fully understand” what they had agreed to.
Looking at this, many economic experts are getting a distinct feeling of déjà vu. Lending to negate stagnant wages ultimately led to a bust for banks, and pay day lenders. As storm clouds gather on the horizon, the situation looks “unsustainable” for BNPL.
