How does the buy now pay later model work?

Updated:

October 31, 2022

INTRODUCTION

There is a growing number of retail business owners who are adopting the buy now, pay later (BNPL) payment models as part of their PoS system. The BNPL method has been progressing due to the changes imposed by COVID 19 measures and the rise in online shopping. Fintech companies are developing some pretty sleek apps that are simple and involve only minimal credit checks.

Some regulators are concerned that BNPL could lead to irresponsible lending, as consumers could view it as a painless form of borrowing and get a misconstrued sense that the spending is not real. In the UK, not all forms of BNLP products are regulated by the Financial Conduct Authority (FCA). However, the Government intends to do so in the future. In the meantime, there is the Consumer Rights Act (CRA) to assess the fairness and transparency of any BNPL terms.

With online purchases only going up, including the number of people buying more expensive goods like cars and furniture, BNPL is being used more frequently. As a result, there is an opportunity for business owners to use this alternative payment method to accelerate their profits. This article explores how the BNPL model works and how it could be used to attract a new type of customer.

WHAT IS BUY NOW, PAY LATER (BNPL)?

The BNPL method allows consumers to spread the cost of paying for goods or services over an agreed period in equal instalments. The length of time to pay back the money and the payment instalment amount can vary. From the outset, BNPL may look similar to that of using a credit card, but there is one significant difference – no interest. In addition, the retailer also requires the consumer to select payment options upfront. For example, a consumer may request six payments on a specific date, predetermined with the purchase.

The BNPL may not be to the liking of all retail owners or managers, but this shift in payment method should not be ignored. It offers financial inclusivity to those who need assistance spreading the cost of their payments without an interest penalty. Being able to provide this model can also help open businesses to a new line of customers.

Figures reported by Worldpay have shown that BNPL is currently the fastest growing online payment method. In 2020 the BNLP market tripled in size, with 5 million consumers using BNPL since the beginning of the pandemic. BNLP now accounts for over 5% of all eCommerce spending.

WHY HAS BNPL BECOME SO POPULAR?

To be able to understand why and how BNPL has become so popular, we need to look back at how it all started. In the past, there have been various similar options like layaway, which is when consumers pay by instalments and then receive the goods once the total price has been paid. However, Layaway plans are no longer a common preference as credit cards have increased in use.

Many large retailers have now adopted their own versions of credit cards with store credit cards. They are often offered at the point of sale and allow the retail business to have more control over the consumer experience and build on brand loyalty with additional purchases. The applicant needs to pass a hard credit check to qualify for a credit card or store credit card. Unfortunately, not all applicants are successful and end up walking away from a purchase they cannot pay outright.

The consumer payment trend was first pioneered by Swedish fintech Klarna and Australian firm Afterpay. Well-known software and PoS system provider Stripe then partnered with Klarna in 2021 to offer businesses BNPL options once Klarna had proven success following its launch into the consumer bank account market. Since then, other fintech giants have also jumped on the trend to stay up with the competition, with BNPL now offered by PayPal, Amazon and Apple.

BNPL has understandably become very popular with the everyday consumer, even with smaller purchase items. With BNPL, there is typically no hard credit check or underwriting required. The service providers also do not share any user data with credit agencies, resulting in the debt being unavailable to creditors. In addition, this payment method comes with no interest if payments are made on time. However, the purchaser is required to put a debit or credit card against the BNLP purchase and agree to automatic payments.

Businesses have been able to utilise BNPL services by removing the barrier to larger purchases. It allows customers to break up the payment over time – to fit within their budget. In addition, for businesses that sell lower-priced products and services, customers are more likely to buy additional things once they understand it is possible to spread the total cost over an amount over time.

HOW DOES BNPL WORK FOR BUSINESSES?

For businesses wanting to offer BNPL to their customers, they do not need to worry about becoming a fintech company themselves, as it is a service which a third party supplier can provide. They will set up the payment option and make it available for your customers at checkout, whether online or in-store.

A typical BNPL process looks like the following:

The customer purchasing will be required to pass a quick soft credit check.
The BNPL provider pays the retailer or business owner the total amount for the product.
The customer is required to pay the third-party BNPL provider back over time in a series of pre-agreed instalments.

The credit check performed by the BNPL provider is not in-depth and does not affect the purchaser's credit score. The third-party service provider determines the time frame and percentage of the instalments which the customer pays. For example, some providers will allow customers to choose how much they want to pay over three to twelve months, whereas others will set out a set number of payments.

In addition to the benefits BNLP offers to consumers, it also has plenty of advantages for businesses that implement it too. Here are the top ten benefits for the business owners:

The third-party BNPL provider is responsible for any chargebacks instead of the merchant.
BNPL providers take on the liability of any fraud in the purchases.
There are some fantastic sales dashboards which allow for complete transparency between the BNPL provider and the business owner.
BNPL payment options can open your business to a fresh customer base who may not have been able to afford the product/service in one payment, resulting in more sales and improved customer retention.
A way to allow businesses to accommodate customers with unexpected or emergency purchases without being out of pocket.
Offers a new way to purchase goods and services which can enhance a business' brand and overall customer experience.
BNPL is great for targeting a specific, younger, and modern customer demographic.
A higher purchase rate conversion due to shoppers being less hesitant with a convenient payment option available.
Consumers have the convenience of applying and managing the BNPL agreement online, through the store and often via a mobile app.
Retailers can offer a well-rounded, branded shopping experience for their customers.

It is worth noting that the BNPL is not just for public customer transactions – it can also be a beneficial tool for B2B payments. For example, a small business may not have the cash flow available to purchase inventory for a busy season, such as Christmas or Summer. Using the BNPL model will allow the company to stock up for the projected busy period with the confidence it can pay off the loan following the boost in sales.

Before implementing BNPL, merchants will need to carefully consider the following:

Will BNPL likely increase sales?
Will BNPL reduce customer friction and improve conversion rates for their business?
Is BNPL a cost-effective way to better customer experiences while strengthening the bottom line?

There is a large and growing number of merchants who are answering “yes” to the above, but it may not be the case for all. If a company does choose to adopt a BNPL into their PoS system, then communicating the principle of BNPL to customers is crucial to promoting the alternate payment method. How this communication takes place is up to the merchant. There is a requirement to balance the desire to inform customers about BNPL while maintaining a streamlined checkout experience. One practical approach is simply notifying at checkout that a purchase can be made in instalments via a BNPL option.

WHAT ARE THE DIFFERENT BNPL REPAYMENT OPTIONS?

There are currently two types of BNPL service options available to business owners: merchant transaction fee loans and consumer interest loans. With the merchant transaction fee loan, the consumer is not charged any interest on their overall purchase, as long as they make their payments on time. Instead, the merchant incurs a single transaction fee of 2% 8%. Although this fee can put off some retailers, the option of having BNPL as a payment option has the potential to lead to customer acquisition, retention, and higher purchase amount.

In contrast, the consumer interest loan involves an interest rate being applied to the purchase at the point of transaction, resulting in the business owner being saved from the additional fees. Although this is more appealing to the retailers, it can be less attractive to the consumer.

In addition to the two BNPL service options, there are also many providers for business owners to choose from. The booming finance industry has attracted many fintech providers to offer BNPL payment services. With so many providers entering the market, it can be challenging for a business to choose the best option for their needs. Below are some examples of the offerings by popular BNPL companies:

Klarna – This provider is currently the UK's most used BNLP service. They offer shoppers three payment plans. These include pay in 30 days, three interest-free instalments, and finance.
Clearpay – Australia's Afterpay sister company targets millennial consumers who prefer debit to credit. They offer flexible payments of four equally split amounts which are paid back in two-week intervals.
Laybuy – Offers shoppers the opportunity to take goods on the day with no sign-up fee or interest, so they are paying the original price. The full amount is paid back in six payments every two weeks.

The majority of providers offer apps that consumers can download on their mobile phones or tablets to make it an easy-to-access payment option. This is another benefit retailers can offer and advertise to their customers to help boost their own sales.

There are now a couple of banks in the UK that offer BNPL schemes. HSBC and Monzo are currently providing BNPL with NatWest following suite in the summer of 2022. One of the benefits of consumers using BNPL with their bank rather than an independent provider is that banks have a more extensive view of spending habits, allowing them to better judge affordability limits.

Wise merchants will select their BNPL partnerships strategically and judiciously. Some studies have indicated that too many BNPL options at checkout can cause confusion, leading to shoppers abandoning their purchases. As competition stiffens among BNPL providers, they will be working hard to make their merchant experience as positive as possible.

CLOSING THOUGHTS

BNPL offers convenience and choice to consumers. It is a means to having more control over their spending while avoiding unmanageable debt. Most importantly, they want to do this as efficiently as possible, wherever and however, they shop. BNPL options can satisfy consumers across multiple generations and geographies – by flexibly accommodating their ever-evolving purchasing behaviours.

Customers ought to be aware that the BNPL method is not yet financially regulated by the FCA. This means they have little protection should there be a financial dispute between them and the BNPL provider. However, the industry in the UK is pretty well established, and regulations are due to be imposed on the BNPL industry in the near future.

Currently, for businesses, merchants have a reasonably safe opportunity to gain new, younger customers and increase their sales with BNPL services. However, as this payment method grows, so do the threats of fraud connected to it. As a result, business owners will need to stay up to date on anti-fraud prevention tools and news surrounding the industry to avoid being caught off guard and continue to enjoy offering customers the opportunities to spend more and leave satisfied.

FREQUENTLY ASKED QUESTIONS (FAQS)

What is a PoS system? A point of sale (PoS) is a system that businesses use to manage sales transactions. In the past, a PoS in a shop would have been a big cash register and a ledger to record purchases and sales. However, PoS systems have moved on quite a bit in recent years, making it easier than ever for businesses to sell their goods and services. For example, there is now the opportunity to run a PoS system via your mobile phone, tablet, and online. Cash registers are still used where relevant but are being replaced by terminal PoS systems that run off cloud-based software. In addition, BNPL service providers can integrate their software with PoS systems to make the transactions seamless.

What is the difference between a soft credit check and a hard credit check? A credit check is when you or a company look into your credit report to view your financial history. A credit report contains things like your name, address, borrowing history and details of anyone linked to you financially. There are two different forms of credit checks – soft credit checks and hard credit checks. The main difference between the two is a hard credit check will leave a visible footprint on your credit report, which other lenders will be able to see. If you have multiple hard credit checks completed over a short space of time, it can have an impact on your credit score.

How do BNPL providers make money? Instead of charging the shopper interest, BNPL providers make money by taking a percentage from anything they help the retailer sell. One of the main motives for businesses to sign-up for BNPL payment options for their customers is the potential for a significant increase in sales. Many shoppers now prefer the BNPL method as it helps them manage their monthly budget and afford goods they would not be able to pay for in one lump sum.

What happens if a customer does not pay back the BNPL provider? Although each BNPL provider will have its own terms and conditions, the majority will charge late fees to the shopper if payments are not made on time. Missed payments can also lead to the lender freezing the shopper's account, so they are unable to make further purchases using the BNPL method. If the charges are not paid within an agreed period, the BNPL company will likely turn the debt over to a debt collector, which can be troublesome for the customer.

What is the Consumer Rights Act UK? The Consumer Rights Act in the UK aims to protect consumers against poor-quality products and unfair business practices. This includes contract terms with regards to transactions, repairs, refunds and delivery. Although the FCA does not currently regulate the BNPL model, shoppers that do sign-up for a BNPL payment plan still have their consumer rights protected under the Act. In addition, consumers can contact Citizens Advice to report any problems they have experienced and get advice on what can be done.

Why do merchants like BNLP? Merchants like BNLP as it has the potential to increase sales and attract a new customer base. It acts as an excellent alternative for customers wanting a flexible way to pay for goods without incurring credit card interest. The generation primarily using BNLP are generation Z and millennials. It is estimated that 4 in 10 consumers in Britain have used BNLP, so it could open some enormous opportunities for merchants if they choose to include it as a payment option.

How Do BNPL Services Affect Chargebacks? In a BNPL transaction, the customer is directly paying the third-party provider, not the merchant – meaning any chargeback the customer might file will not affect the merchant. The customer may try disputing any payments they made directly to the merchant. Still, the BNPL company would have made the customer agree to terms and conditions that would invalidate the chargeback. Businesses must make sure customers take some form of action to show they have understood their agreement to the BNPL terms and conditions, such as ticking a box so that they can not make the claim they were never informed about them.

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