Recent interest in the “buy now, pay later” (BNPL) space is rising to a fevered pitch.
Investors are not only getting giddy over US-based BNPL player Affirm’s IPO filing and its strong growth…but investors have also been captivated by the strong performance of Australia-based BNPL player, Afterpay.
Unlike other BNPL players, Afterpay has been public for a couple of years already, and early investors have been handsomely rewarded with shares rising from ~AUD$3 to ~AUD$95 in the last 3.5 years. That strong performance has pushed Afterpay’s market cap to ~USD$20 billion, turning it from a less than USD$1 billion micro-cap company to solidly one of the largest companies in the world.
The incredibly smart Fred Liu at Hayden Capital recently published a deep dive into Afterpay that is worth reading in order to understand the opportunity and potential of not only Afterpay’s business but similarly positioned BNPL players around the world as well.
Like Capital Flywheels, Fred Liu has been an early investor in Sea…but Fred Liu has a much longer and more impressive performance track record, one that is deeply worth admiring.
As a reminder, BNPL is an alternative form of credit. Instead of paying for something with cash / debit or a credit card, BNPL gives consumers an interest free loan at the point of sale (e.g. at the checkout screen) that can be repaid over several months via installments. Since BNPL borrowings can be repaid over time, it allows consumers to buy more upfront. However, unlike credit cards, the cost to the consumer is low (usually no interest / fees if the installments are paid on time)…revenues for the BNPL player is almost entirely paid for by the merchant (3-6% take rate on merchant sales in the case of Afterpay).
Source: Hayden Capital
The excitement in this space is understandable. Fintech is exciting and highly dynamic, and BNPL is one of the newest areas of fintech.
However, I won’t beat the dead horse here on why the BNPL space is worth studying.
There are plenty of analysts and investors out there already writing about the opportunity in this space.
And the opportunity should be intuitively large even without doing much analysis because BNPL is a form of credit, and we live in a world where the demand for credit can never be satisfied. If you offer credit, someone will take it…Hence, discussing the demand for credit seems not particularly interesting or useful to Capital Flywheels because of course there is / will be demand for credit.
What I think is worth speaking more about is how the BNPL space may potentially evolve in the future, and why I believe BNPL players will need to evolve in order to remain relevant.
As Capital Flywheels wrote recently in Square, Fintechs, and Our Changing Economy, banks and traditional credit channels are being dis-intermediated. While all fintechs are currently benefiting from this dis-intermediation, the long-term changing structure of our economy will not lead all fintechs to success. Capital Flywheels firmly believes that the realm and domain of credit will solidly belong to the digital players that control the verticals.
For example, Square’s control over restaurants and SMEs mean they will be better positioned to offer credit to these merchants than any standalone fintech player. For example, Shopify’s control over e-commerce SMEs mean they will be better positioned to offer credit to their merchants as well.
How do I know this?
Fintech players are already whispering this if you watch what they do instead of what they say. And you can see this in how they approach their markets and the actions they take…including BNPL players trying to move up the funnel to be closer to their consumers, and hence trying to become platforms / aggregators themselves…including BNPL players (and merchant acquirers) paying the companies that control the verticals an access fee.
That’s interesting, Capital Flywheels, but it seems quite hypothetical?
And here is the core of what this post is all about – While BNPL and installment payments may seem like a new industry, it’s actually not new at all. It’s only new in western markets…but has been the de facto standard form of payments in Brazil for more than two decades.
We do not have to deal with hypotheticals…we can simply look at how the Brazilian market is evolving to understand how the western BNPL market may evolve as well.
When Capital Flywheels started studying the Chinese fintech market 5-6 years ago, Capital Flywheels understood that what China was doing would very likely eventually become the future for other markets, including the western markets. Hence studying the Chinese fintech market allowed Capital Flywheels to in some sense predict the future of the western fintech market. The western markets did not recognize it at the time because few people paid attention to China’s fintech market until very recently (and with interest further juiced by Ant Group’s now-cancelled IPO).
In a similar vein, many western market investors may not know that Brazil has had something very similar to BNPL for decades…and we do not have to reinvent the wheel to understand how BNPL may need to evolve. And it mostly points in the direction that Capital Flywheels argued above.
Years ago, when Capital Flywheels first visited Brazil and learned about the local financial markets, Brazilians were adamant that installments were a uniquely Brazilian payment feature. Installments had been a fixture in the market since the 1990s because Brazil went through a period of hyperinflation in the 80s and early 90s. We are talking about truly hyperinflation. Inflation reached more than 6000% by the late 80s…with such high inflation, normal commercial activity is very hard to maintain.
It is in this environment that Brazil evolved installment payments in order to allow commerce to somewhat function. By allowing consumers to spread out payments instead of paying upfront, consumers were much more likely to transact (and be able to afford) their purchases since the loans can be paid off with highly inflated future money. Even while inflation declined in the subsequent decades, installments remain a dominant feature of the market, with the majority of online and offline purchases involving installments today.
According to Adyen, 80% of Brazilian e-commerce transactions involve installments:
Payments in installments are very common in Brazil, accounting for 80% of ecommerce payments for businesses with a typically high average transaction value. These are interest-free for the buyer and are collected month-by-month by the merchant (ranging from two to 12 months).Source: Adyen
Brazilians believe installments only took off because of hyperinflation, but Capital Flywheels believes Brazilians are underestimating the universal nature of credit demand…hyperinflation made installments necessary in Brazil, but credit demand will eventually make installments a desireable option in all markets.
This post by Leonardo Romano provides a nice overview of how the installments feature is experienced by the average Brazilian consumer.
For example, it is embedded straight into merchant advertising (the ad below shows cash retail price as well as 10x installment payment plans for all items advertised):
Unlike BNPL in western markets, the installments are overlaid directly on top of credit and debit purchases. Brazilians still pay for the item with debit or credit cards (whereas BNPL in western markets replace debit or credit cards), but the payments are spread out over a pre-agreed schedule as determined by the merchant.
From the user’s perspective, the impact on their credit limit and repayment schedule could look like 1 of 2 ways:
1/ Full purchase amount is reserved within the credit card limit but is released as the loan is paid down
2/ Only the installment amount is reserved against available credit limit, allowing the consumer to continue to make further purchases with available credit limit.
How it reflects on the credit limit is up to the issuing bank to decide.
In many ways, Brazilians have been living with “BNPL” for a very long time already. While the implementation is similar, there are some differences to pay attention to:
1/ Brazilian installments do not replace debit or credit cards, whereas BNPL in western markets do.
2/ Brazilian installments is a market feature and hence work with all credit cards and effectively all merchants, whereas western BNPL players operate more of a closed ecosystem where only partnered merchants within the network can offer / accept it.
3/ Since Brazilian installments run on top of the debit and credit system, merchants receive payments in installments as well (as it is paid), whereas western BNPL players pay merchants upfront. In western markets, the BNPL player essentially takes on timing risk and funds working capital on behalf of the merchant. In Brazil, if a merchant wants the money upfront, they can pay the debit / credit card merchant acquirer (like Cielo, Stone, or Pagseguro) a prepayment fee to receive installment payments upfront.
What is most interesting is not the differences, but the similarities and what we can potentially learn about the evolution of this market.
Because Brazilian installments have been a market feature for so long, installments have largely become a commodity on the merchant side of the equation. There are no standalone “installment” players…instead, installments are folded into the existing payment value chain as just another feature with merchant acquirers and banks capturing the bulk of the value.
Merchants have lots of options for offering installments to their consumers and largely receive it as commoditized offering bundled into the POS system via their merchant acquirer or bank.
Since installments are commoditized, merchant acquirers and banks compete largely on the basis of who can offer merchants better service as well as other financial services (e.g. checking and savings accounts, working capital loans) as well as value-added software.
You know what that sounds like? Sounds a lot like Square!
Currently, in western markets, you have to partner with a BNPL player to offer consumers BNPL payment options. However, it’s not inconceivable that BNPL will also eventually be offered as an option by western merchant acquirers since they ultimately control the point of checkout.
For example, in Brazil, one of the leading merchant acquirers, Stone, offers installments + prepayments alongside a host of other services…and it is these other services that keep merchants engaged even though the vast majority of revenues and earnings come from installment + prepayments:
And to close the circle, Stone has periodically referred to themselves as the “Square of Brazil”.
The most interesting evolution of the Brazilian installments payment market is actually not on the merchant side. The most interesting evolution is actually on the consumer side.
This is important because while BNPL players are mostly fighting to lock-up merchants, the most important battle is actually to lock up the consumer. While merchants can choose to offer installments or not, the choice is ultimately up to the consumer. Hence controlling the consumer decision is monumentally more important than controlling the merchant.
Western BNPL players have not talked much about this, but you can see them whispering it through what they do. For example, Afterpay and others are trying to create shopping portals that insert themselves much earlier into the consumer buying decision process. And Affirm has given Shopify a 5% stake, effectively as an access fee to become the BNPL option for Shopify merchants.
But Brazil is starting to show why this is a challenging position and provides strong evidence that the power ultimately rests with the players that control the verticals and the platforms.
One of the clearest examples is to consider what the leading e-commerce platform in the region, Mercadolibre, is doing.
Mercadolibre controls the consumer. Through this control of the consumer, Mercadolibre has significant influence over consumer decisions and how they pay.
One of Mercadolibre’s fastest growing offering is Mercado Credito (translated below using Google):
Mercadolibre has effectively allowed their consumers to do installment payments regardless of what options the merchant offers.
And this is doubly more problematic for merchant acquirers that only control the merchant side of the equation because Mercadolibre also controls the most dominant e-wallet in the region, MercadoPago.
This means that Mercadolibre not only influences consumer decisions on its e-commerce platform in a way that merchant acquirers may struggle to match, MercadoPago e-wallet extends that influence and control to effectively every merchant in the region, online and offline.
Sea is already quickly executing on a similar strategy in Southeast Asia. And platforms like Shopify already have similar power as well even if their positioning in the value chain is slightly different, but still more powerful than the credit / BNPL player all the same. This is a power that Square’s Cash App will eventually have as well.
While BNPL is fairly nascent in western markets, you can actually see some of these changes if you squint…
Paypal recently launched BNPL within their wallet, which touches over 300 million consumers. This enables BNPL regardless of whether a merchant offers it or not.
Even traditional banks like Chase is enabling it for their credit cards:
Capital Flywheel firmly believes the long-term opportunity in credit belongs with the platforms and those that control the verticals.
But the long-term future can take a while to materialize.
In the meantime, BNPL is likely to do well because our collective demand for credit is insatiable and BNPL has created a new avenue for credit.
As the Indian guru, Swami Vivekananda affirms, “Desire is infinite, its fulfillment is limited”.
And so it goes with credit and BNPL.