By Michael Pierce, Commercial Director, Banking – Western Europe at FintechOS

Buy now, pay later (BNPL) is, by definition, a challenger’s business model. It redefines aspects of both payments and lending, without being reliant on traditional definitions of either. While the concepts of store credit and paying by instalments have existed for decades, the current growth of both BNPL uptake and market competition can be attributed to rapid and permanent shifts in consumer expectations.

Pioneered by Klarna and a growing crowd of competing start-ups, key aspects of BNPL include:

• no-money-down and sliced payment options
• interest-free periods
• simplified eligibility and application requirements compared to traditional payment cards or credit qualifications, translating into availability for a wider range of customers
• close integration in a point-of-sale user experience context
• a digital-native approach to customer self-service.

BNPL is still growing at an exponential rate. According to Bank of America analysts, the industry is “estimated to grow by 10 to 15 times its current size by 2025, representing $650 billion to $1 trillion by 2025 globally”.  In the UK, almost one in four consumers have used a BNPL service, with 9.5 million shoppers saying they avoided retailers without a BNPL finance solution at checkout.

With the impressive expansion of BNPL and its consequent impact on the established payments and lending markets, the entire established financial services industry is currently at a strategic crossroads: players can defend against yet another consumer fintech challenge they didn’t entirely anticipate, or they can “lean in” – learn from what has happened so far and join this new competitive space.

There are three contrasting business models by which banking, and lending incumbents could choose to tackle BNPL, depending on strategic appetite, revenue aims, and the time they are willing to take to build new solutions and bring them to market.

1. Direct plays or indirect partnerships 

A highly consumer-focused and digitally ambitious bank or lender may choose to fast-follow Klarna and other challengers directly. In essence this business model is to reverse-engineer the Klarna product and roadmap and set up a competing BNPL solution with consumer-facing app, universal ecommerce checkout integrations via virtual cards, and smart methods of providing instant credit risk evaluation at the point of sale.

This approach is not necessarily limited to large banks with a global market, since tier-two banks and lenders may be more digitally agile or possess niche advantages, such as regional or vertical specialisations.

2. Embedded lending 

As BNPL becomes more standardised and the number of customer-facing BNPL competitors increases, competition will shift to the design and availability of the consumer lending product itself. This will be to the advantage of the established players, who are in a position to innovate in order to accommodate higher purchase (lending) values, different risk profiles, and overall higher volumes of lending.

Lenders will use new-generation product platforms to build “headless” lending products that promise new revenue channels via retail and checkout partnerships. The key design hurdle is to package product risk and eligibility criteria in a way that can be offered and instantly approved during the end-consumers’ checkout process, in order to set up “pay later” and instalment options. While the financial fundamentals of lending remain the same, product builders will have to adopt new ways of thinking about risk that prioritise acceptance and a seamless user experience, while still retaining an ethical, compliant, and scalable model.

The BNPL space is already changing lenders’ product design ideas to incorporate greater flexibility and dynamic logic compared to traditional lending. For example, new loans can be purpose-built to embed in point-of-sale user experiences, with drastically simplified application and onboarding processes, and a direct connection between loan cash and merchant settlement based on fulfilment statuses. Lenders who innovate on embedded lending will see benefits within their own channels, since BNPL means achieving greater automation, the ability to handle a higher volume of transactions, a greater emphasis on the quality of digital self-service, and more flexible, customer-friendly repayment terms.

3. BaaS 3.0   

Banks with a focus on the BNPL space – or existing relationships with checkouts, ecommerce merchants, or retail brands – will see an opportunity to provide credit and liquidity for the B2B side of BNPL, at the aggregated level, without having to become highly integrated into consumer-facing applications.

Not all financial institutions will want to create their own consumer-facing BNPL propositions, and those creating embeddable lending products for BNPL partnerships may find the partnership-based approach too limiting. Banking-as-a-Service (BaaS) provides a more ambitious model of scalable growth where established financial institutions can license out their capabilities to a wider range of both co-operating fintechs and non-financial businesses, with reduced case-by-case adaptation and integration each time a merchant or other non-financial business seeks to integrate their BNPL (or other embedded lending) offers.

As BNPL becomes more constrained by maturing regulation, BaaS models could become more important. Consumer-facing innovators will prefer to focus on differentiation and brand-building through digital experience design, while preferring to leverage proven underlying technology and regulatory status offered by trusted lending providers.

Don’t pass on BNPL

According to recent consumer research by FintechOS, half of consumers are open to BNPL being part of their regular shopping habits, with BNPL uptake even more pronounced among younger people: BNPL is first choice for payments for one in five Millennials. Financial brands seeking to remain relevant with rising Gen-Z and Millennial consumers – and indeed digital users in all generations – need to add BNPL to their product and growth strategy. BNPL will increasingly become a growth engine for other lending and banking products, as well as being a profitable source of revenue in its own right.

As the industry matures, regulation will create moats around BNPL business models. At the same time, business models will be proven and crystallize into more defined zones of competition that are resistant to brands who arrive late and have to fight to pry customers away from competitors rather than growing by attracting early adopters more cheaply. In BNPL, early movers will reap hefty rewards, while more cautious financial brands may find that they have left it too late to join the new wave.