Inflation reduces the purchasing power of many households. The temptation to take advantage of interest-free loans from "buy now, pay later" providers such as Klarna or Affirm is growing. But the business model also has its pitfalls, and not only for customers.
During the corona pandemic, young consumers in particular liked the “buy now, pay later” (BNPL) hire purchase model when shopping online. The new handbag costs 500 euros and is actually far above the budget? No problem if the price can be paid in installments over several months.
Startups like Klarna, Afterpay, Affirm or Paypal, which do not do a credit check before granting a loan, have created a segment that, according to Globaldata, achieved a transaction volume of 120 billion dollars last year. Before the pandemic in 2019, it was just $33 billion. The business model benefited from the very low interest rate environment for a long time. According to Globaldata, BNPL transactions accounted for about 2 for every $100 spent in online commerce last year alone.
But the industry's gold rush could soon be over. The business model only works as long as interest rates are low and consumer spending is high. Because only then can the BNPL companies raise capital at relatively low cost and lend it to customers, who then pay off their purchases in a few installments and usually interest-free. BNPL companies, in turn, charge online merchants for each transaction.
The stress that the turnaround in interest rates brings for providers of installment payments is already noticeable with the European flagship of the industry, Klarna. The company recently laid off 700 employees, which is ten percent of the workforce. Klarna cited a change in consumer sentiment, inflation and the war in Ukraine as the reasons. And that's not all: For the Swedish payment provider, the ratings are going down again after the massive increase in the past two years.
The valuation that investors are still giving the company has recently fallen to $30 billion and then to $15 billion, they say. "That's funny," says investor Philipp Klöckner in an interview with ntv.de. Because Klarna would be rated higher than the US industry leader Affirm, although it is growing more slowly. The investor estimates that Klarna is only worth $10 billion.
The combination of low interest rates and low growth made it difficult to make money even under optimal conditions. Now that interest rates are rising, it is becoming more and more expensive for Klarna and Co. to provide customers with loans - in the hope that they will repay them on time. What Klöckner doubts. "With the looming recession, it's also becoming more and more likely that some of the loans that Klarna grants won't be able to be repaid in full. That's an additional risk." Ultimately, the BNPL providers would have to pay for such failures from their own margin.
In addition to the difficult economic environment, another provider is now entering the market with Apple, which is intensifying competition. While most of its competitors only act as intermediaries, the tech group intends to handle the lending itself. The necessary small change is available, Apple can lend money without a bank as a partner. Although the company does not have a banking license, it does have a payment authorization issued by Goldman Sachs.
"Apple Pay Later is becoming serious competition for Klarna, mainly because the company already has a very large customer base, including important data and a functioning payment system," says Klöckner. However, the investor sees another advantage that should not be neglected: While customers of established BNPL providers often have a bad credit profile and use Klarna and Co because they can no longer incur debt on their credit cards, Apple customers are particularly well off economically.
In the future, the tech group could only offer loans to customers it considers particularly solvent and thus take less risk. Users that Apple classifies as bad borrowers would be dependent on existing players, who in turn would be left with their customers' consumer debt.
Despite more and more providers on the market, according to Klöckner, consolidation will not happen any time soon. "Klarna and Affirm are both so unprofitable that a merger doesn't make sense." If valuations continue to fall, it's more likely that a large player like PayPal could jump in and seize the opportunity to expand its customer base and delve even deeper into the sector.
But first it has to be proven that the BNPL model really works. "At the moment the companies are all still burning a lot of money and spending more on marketing than they are taking in from dealers by arranging the financing solution," says Klöckner. The greatest weakness of the model, both from the point of view of retailers and consumers: sales or consumption are brought forward only once. As a retailer, this does not boost sales in the long term and users cannot spend more in the long term. "From a macroeconomic point of view, the question arises: Where does this model generate benefits at all?" says Klöckner.
The only benefit is likely being that one-off consumer spending can be made that customers think they couldn't otherwise afford. The US portal SFGate has determined that the BNPL services are indeed leading to larger purchases. While the average shopping cart was $100 in 2020, the average Affirm customer is now spending $365 on a single purchase - often with devastating personal consequences.
A survey by DebtHammer showed that 30 percent of users are struggling to make their BNPL payments. 32 percent said they even fail to pay rent, utilities or alimony to pay their BNPL bills. "In the USA we are observing that consumer credit is continuing to rise. At some point this will tip over," says Klöckner.
The investor is therefore in favor of regulating providers. Especially against the background that the BNPL companies are willing to give customers loans that are not considered creditworthy in the conventional banking system. This is why the industry is increasingly becoming the focus of regulatory authorities. For example, the UK Treasury has launched consultations on how BNPL firms should be regulated in the future. And in Australia, members of the government are pushing to regulate BNPL providers via credit laws.
