Buy Now, Pay Later: What Is It and How It Works

The "Buy Now, Pay Later" system, commonly known by its acronym BNPL, offers customers the option to receive a product or service immediately and pay for it in small installments over time, all without any additional fees or overcharges. This payment method has rapidly gained traction in recent times, effectively nudging customers to make a purchase even if they can't afford the full amount upfront.

For the past three years, BNPL transactions have seen a consistent doubling in growth annually. Services offering this payment format are sprouting up everywhere, much like mushrooms after a rain.

So, what's fueling the surge in BNPL's popularity within the e-commerce sector? Let's delve deeper to understand the driving forces behind this trend.

Picture this: A shopper browses through product listings on an online store, and they add an expensive item to their cart. It's something they truly desire, though not an absolute necessity. As they near the checkout process, hesitation strikes, primarily due to the immediate financial commitment of a significant sum. This often results in abandoned shopping carts.

But what if they didn't have to pay the full amount right away? That's where the BNPL service comes into play.

BNPL is a payment model that grants the buyer a short-term credit. This allows the purchase of a product by paying just an initial fraction of its full cost. The remaining balance is then spread out over a period, settled in installments.

Unlike traditional credit, BNPL offers distinct advantages. There's no need to secure a separate credit card. Instead, this payment option is either embedded within a bank's application or directly integrated into the online store's payment page. All the customer has to do is select BNPL at checkout, review the terms, and click a few buttons to agree.

However, don't expect to buy high-ticket items like homes or cars using BNPL. It's mainly tailored for products with lower to mid-range prices to minimize risks for credit institutions. In case of non-payment, the owed amount can usually be forcefully charged to the debtor's card.

In the West, BNPL is often referred to as "Pay in Four" since this payment method frequently involves four equal installments, be it monthly or bi-weekly.

Once a buyer opts for a BNPL payment plan on a site, they'll need to provide their debit or credit card details. The subsequent payments are then automatically charged until the complete amount, including any service-related fees, is settled in full.

There are several benefits of the Buy Now, Pay Later (BNPL) payment system:

1. Ease of Use: BNPL services require minimal effort from consumers. There's no need for excessive form-filling or tedious procedures that are common with traditional credit cards or loans.

2. No Interest Fees: Many BNPL providers offer zero interest on purchases, allowing shoppers to save on the costs typically associated with credit.

3. Payment Flexibility: BNPL options usually offer payment splits over several months, enabling consumers to spread out their expenses over an extended timeframe.

4. Low Transaction Fees: Many services in the BNPL space charge minimal transaction fees, leading to additional savings.

5. Credit History Boost: Regular use of BNPL can potentially enhance one's credit score, which may be advantageous when planning substantial future purchases or securing loans.

6. Immediate Product Access: With BNPL, consumers can instantly acquire the product they desire, without the wait to save up the full amount.

7. Broad Product Range: A vast number of e-commerce platforms and retailers support BNPL, granting consumers access to an expansive variety of products and services, unbounded by their immediate financial capability.

Presently, some of the leading international BNPL services include:

1. Klarna: A Swedish BNPL platform that allows consumers to break down payments into several portions, payable over multiple months. Klarna also offers an option to defer payment for 30 days.

2. Afterpay: An Australian service that lets users divide payments into four equal installments, without charging interest or additional fees for its usage.

3. Affirm: Based in the U.S., Affirm allows its users to split payments over several months. It offers fixed interest rates and doesn't impose extra fees on its customers.

4. QuadPay: Another U.S. service, QuadPay enables customers to break down payments into four equal segments, and like many others, doesn't charge interest or additional usage fees.

5. Splitit: Originating from Israel, Splitit allows users to divide payments into various parts using their existing credit cards. It doesn't levy any extra charges or interest on its users.

The "Buy Now, Pay Later" (BNPL) model typically involves three main participants:

- The customer,
- The e-commerce store owner, and
- The intermediary or service provider.

Under this model, customers can purchase products without any upfront markup, and repay the cost in equal installments. No formal credit agreement is needed. Meanwhile, the service provider promptly transfers the entire purchase amount to the retailer on the following day, minus their own commission.

The BNPL payment method generally follows a four-step procedure:

• Product selection,
• Order placement, choosing the "BNPL" payment option,
• Making an initial down payment, and
• Completing the remaining payments in equal installments over a specified period (typically, up to 4 months).

Here's a typical scenario when leveraging this payment model:

1. When a customer is finalizing an online order, they'll encounter a BNPL payment offer from the service provider.

2. Opting for this method requires the customer to fill out a short application. This usually asks for their full name, contact information, banking details, and possibly some additional data. Using this information, the BNPL provider swiftly assesses the customer's creditworthiness. Approvals or denials from the service are almost immediate, ensuring a smooth shopping experience.

3. Once approved, the customer will be presented with a payment plan, often spread across four equal installments. This might entail monthly payments or bi-weekly installments, with an immediate first payment. For instance, for a $100 purchase, they'd pay $20 upfront, followed by four additional $20 payments. These installments don't carry interest, and subsequent payments are usually automated, debiting the customer's specified card.

Retailers offering BNPL services pay a commission to these providers. Generally, the BNPL provider retains a small percentage of each transaction and transfers the rest to the retailer. While retailers might lose a minor amount on each sale due to this commission, the likelihood of increased sales volume can compensate. This is because offering BNPL often empowers customers to make larger purchases than they might have been able to afford using other payment methods.

Historically, shoppers had three primary methods for settling their purchases: they could pay in cash, use a credit card, or tap into installment plans provided by certain retailers.

The BNPL system has revolutionized shopping experiences, especially for those whose needs may outpace their financial means. Consider the difficulty some might face when asked to pay $200 upfront for a new winter jacket. However, the proposition of receiving that jacket at the onset of winter and then making monthly payments of $50 seems much more manageable, even on a tight budget.

The benefits of this payment model for consumers are evident:

● Enhanced purchasing power,
● Flexible payment options,
● Convenience,
● Better expenditure and budget management, and
● Clear and straightforward payment plans.

Such a payment structure undoubtedly enhances the overall customer experience, which can naturally boost sales. Data from Afterpay suggests that retailers experience an 11% rise in profits after integrating their service.

Another similar service, Klarna, has reported a 41% increase in average order value and a 30% boost in conversion rates after retailers incorporate their system.

As with the introduction of any innovative service, there are certain potential risks to consider when integrating BNPL services.

As previously mentioned, retailers choosing to offer their customers the BNPL feature will have to part with a percentage of each sale to the service provider. These fees can climb as high as 8%, which is steeper than traditional payment methods, such as debit or credit cards.

Moreover, if a consumer decides to return an item purchased through a BNPL plan, the retailer won't recoup the fee given to the service provider. Such situations can be financially detrimental for businesses.

Depending on the BNPL provider, integrating and maintaining this new payment method on an e-commerce platform can be intricate. Introducing another feature can potentially complicate your business operations or create potential complexities for consumers.

A widespread ethical concern among those offering BNPL payments revolves around inadvertently encouraging consumers to spend money they might not truly have. BNPL services can be particularly appealing to those with limited incomes, potentially prompting unnecessary expenditures from lower-income shoppers.

Given that these providers typically only conduct a brief credit check before approving the installment plan, there's a risk that a shopper might overextend themselves financially. This could lead to potential issues for the consumer down the line.

Before deciding whether to implement the "Buy Now, Pay Later" system, it's crucial to weigh the pros and cons of such a move. BNPL can lead to increased sales, a higher conversion rate, and even an enhanced shopping experience if you're willing to assume potential risks.

For some retailers, the fees charged by providers and integration costs are justified by the benefits. For others, traditional payment methods like debit and credit cards remain sufficient.

However, there's no doubt that expanding payment options signifies a progressive step in the evolution of e-commerce and the enhancement of customer service.