Beyond the BNPL Frenzy

A quick background on the BNPL business model if you are not already aware – BNPL (buy-now-pay-later) is a way for customers to purchase goods now and pay later in installments, at a 0% interest rate (yes, that’s correct – 0%!!!). BNPL companies generate revenue by charging a fee to e-commerce merchants on the transactions. BNPL credits are usually underwritten through some soft credit / fraud checks and serve a broad range of the population, including individuals that usually don’t qualify for traditional bank financing. Moreover, these are seamless, flexible, plug-and-play solutions to offer Point-of-sale credit.

What was the BNPL frenzy?

Not too long ago, BNPL (Buy Now Pay Later) businesses would pop-up in every conversation in the start-up world. This industry experienced huge traction in 2020 and BNPL was considered to be one of the fastest-growing segments, not just in consumer-finance, but in the entire FinTech sector. According to GlobalData, BNPL transaction volumes had hit $120 billion in 2021 globally, up from just $33 billion in 2019. The same report had forecasted the industry to reach $595 billion by 2026 at a CAGR of 33%. In that BNPL “frenzy”, Klarna had become the most valued start-up of Europe after raising capital at a whopping valuation of $45.6 billion in Jun-22. To understand the exponentially increased interest in this industry, let us first understand how the growth story evolved.

What brought about the frenzy?

The growth of this sector sustained an acceleration during the COVID-19 pandemic, when e-commerce trades saw a huge boost. As per this Forbes Report, e-commerce sales jumped 55% during COVID-19 to hit $1.7 trillion. During the period of this e-commerce boost, merchants were trying to maximize their basket sizes. Emerging BNPL start-ups offered these merchants a convenient way to increase their sales by targeting small 0% interest credit lines towards a low-savings and moderate/high-income generation (Gen Z and Millennials). As per a report by Charged Retail, 61% of BNPL-accepting retailers indicated that it had improved their access to new customer, thus, driving growth in revenues for 67% of them and profits for 37%. As a result, e-commerce storefronts aggressively started adopting BNPL solutions. These tailwinds drove immense capital into the BNPL market and BNPL start-ups ended up raising a combined funding of $11bn in 2021 alone.

How did the hype start to fade?

The BNPL hype started to fade when the broader capital markets underwent a turmoil. Tech stocks started to witness dramatic plunge in Q2-2022. During this period, Klarna – once the most valued start-up of Europe, raised a down round at a valuation of $6.7 billion, an 85% decline over its most recent round. Klarna, along with many other BNPL players such as Affirm and Zip, have seen massive drops in valuation since the “BNPL hype” started to fade.

There are some concerns which have regularly popped up about the sustainability of this industry. Fundamentally, we can segregate the concerns of markets into three broad categories:

• Regulatory: As previously mentioned, BNPL operates on soft credit checks and loans are targeted towards individuals who might usually not qualify for traditional credit alternatives. These are often individuals with low financial resilience – putting them at the risk of an unmanageable debt burden. There is, thus, a threat of regulatory intervention – perhaps imposition of stricter regulations on this market in order to ensure financial wellbeing of the population.

• Profitability: BNPL models popped up when access to capital was easier. BNPL players raised credit lines for onward lending at cheap rates. As markets tightened, the interest rates naturally went up. At the same time, strategies aimed at a rapid increase in merchant-onboarding led to more aggressive pricing, with a negative impact on unit economics.

• Competition: Since the widespread adoption of BNPL across e-commerce channels, several BigTech players, with the likes of Apple, Revolut, Monzo, PayPal and Mastercard, have either already launched their BNPL products or have expressed interests in doing so. Following the trend, traditional banks, including Barclays, NatWest, HSBC and Deutsche have also launched their BNPL offerings. The competitive pressure has narrowed margins even more, raising the question of whether BNPL is to be seen as a standalone product, or just a feature.

How are BNPL companies responding to these concerns?

Certainly, these concerns are also understood, and accepted, by most of the founders in the BNPL industry and BNPL companies have been trying to respond to these in their own innovative ways in the past year. Some of the trends we have observed in the industry are:

• Mitigating Regulatory Risks: Responsible BNPL companies have avoided necessity-driven marketplaces such as groceries, rental etc. Steering away from certain specific markets ensure that BNPL offerings do not hamper the financial well-being of a particular target audience by making them dependent on this product for their day-to-day purchases. Additionally, we have also seen BNPL players adopt higher standards of transparencies, stricter limitations to usage and a more limited reliance on late fees as a source of revenue.

• Improving Unit Economics: Gone are the days when new unicorns were minted on a daily basis – and BNPL founders probably understand this the best. Most of the start-ups have significantly reduced their cash-burn in the last two quarters. We have seen new streams of revenue pop-up apart from the usual take rates (which were typically charged from merchants), including Virtual card and SaaS Fee etc. Business Models are being redesigned as we see several B2B, B2B2C and B2B2B plays coming up. Most of these efforts in the industry have been directed towards improving the Unit Economics and reaching breakeven at the earliest.

• Addressing Competitive Pressures: Certainly, competition has escalated in the recent past as explained above and this has also pushed companies with unsustainable revenue models out of markets. We believe that as the market matures and develops, the sector will consolidate, and only the fittest companies with resilient business models will survive.

There are three major pillars to this business model – sourcing of customers, underwriting of loans and collections – and these pillars must be grown in synergy with a smooth and seamless user experience, for a player to emerge out as a winner in this space. While new BigTech entrants might have existing advantage over one, or even two of these pillars, they still have a lot of ground to cover in a new and rather mature market. Specialist BNPL players have been in this space and developed their product over the years for this specific market opportunity. BNPL is not a winner-takes-all market and we have seen different players emerge in different geographies and marketplaces. We can certainly look forward to seeing some healthy competition and consolidation in this space in the near future.

What do we think is the way ahead?

Fasanara has been very closely involved with the BNPL industry since the industry’s nascent stages – while it was still taking shape. Some of our early-stage portfolio companies have emerged as front-runners in this space with highly resilient business models. There is certainly merit in the concerns that have been expressed by the markets in the recent past and we have always anticipated the unrealistic and inorganic hype of 2021 to eventually fade away. However, we also believe in the long-term sustainability of the business model and our conviction is further reinstated by the healthy growth displayed by BNPL companies in our portfolio in the recent past. We often come across other BNPL companies with healthy revenue streams which are sustainably optimizing their scale, well on their way to reach profitability in the very near future. For instance, Bumper – a car-repair BNPL claimed to be profitable in Dec-2021 and had raised a fresh round of funding from a major corporate VC in this sector.

We have continuously partnered with our portfolio companies to develop resilient strategies for both sides of the BNPL coin – customers and merchants, while also taking into account the trickier credit conditions in this market. Our integrated credit and equity strategy at Fasanara positions us well in this market to offer our companies an ecosystem of support – credit market outlooks, industry perspectives, and necessary shifts in business strategies. This is a market where we expect our exceptionally talented founders to be focussed and skilfully build a BNPL business which will survive these market conditions and emerge out into the future leading the FinTech Lending space.