Buy Now Pay Later, the business models that are Challenging traditional lenders

Updated: Jun 24

Buy Now Pay Later (BNPL) is a term used to describe microcredit financing whereby a customer can pay just a fraction of the total price in order to receive a product or service. BNPL service providers cover the full costs at the moment of payment or shortly after, paying the merchant directly on behalf of the customer, who will later reimburse the provider. On the surface, this can seem like a pretty sweet deal to all parties involved.

The customer can buy a new pair of shoes for a downpayment four times less than the marked price, perfect for someone who wants to make the most of a sale but can’t wait until payday. The merchant is happy because the item sells, but not only for this reason.

Buy Now Pay Later services increase retail conversion rates by 20% to 30%, meaning more people are purchasing what used to sit dormant in their ‘basket’. The sale through BNPL is also larger than without, lifting the average ticket size between 30% and 50%, so instead of selling $100 worth of shoes, the merchant sells $130 (on a bad day).

The BNPL providers themselves are also raking in the cash, mainly from fees they charge merchants, late fees to customers, and interest on repayments. According to research from Global News Wire, the Gross Merchandise Value of BNPL is expected to skyrocket between now and 2028.

BNPL providers in Europe will be making the most money, followed closely by providers servicing Asia Pacific, including Australia. As explained by ProductMint, in the United States, Swedish BNPL FinTech Klarna charges merchants a $0.30 fixed transaction fee per purchase, on top of a variable fee ranging from 3.29% and 5.99%. Using the estimations for 2028, this will mean that European BNPL providers will be sharing a minimum of $28.3 billion between them (860 x 0.0329), not counting the fixed fees.

There is a growing prevalence of BNPL services in the Asia Pacific region, however even in Australia, its most mature market, they account for a mere 5% of all E-commerce transactions. In other words, BNPL trends are fairly new and there is still room for enormous growth and economic potential.

Traditional lenders are now competing with 5 main BNPL business models

As start-ups and traditional lenders catch on to the BNPL trend, they innovate to create their own unique models, as identified by McKinsey. Understanding these models gives a sense of the segments they target, the merchant and consumer needs they address, and business models banks and traditional lenders are competing with.

Integrated shopping apps

The leading BNPL providers, such as Klarna, afterpay, affirm and PayPal are building integrated shopping platforms that go beyond pure financing offerings and are looking to highly engage consumers through the entire purchase journey, with an aspiration to become “super apps” that offer shopping, payments, financing, and banking products all on a single platform.

  • Merchants partner with BNPL providers to maximise customer cart size and increase decisiveness at checkout

  • BNPL provider absorbs all credit risk in return for fees

  • Customer account with BNPL provider can be created automatically to establish repayments

  • On day of purchase, only ¼ (25%) of total value is due

Card-linked instalment offerings

Card-linked instalments are the prevalent form of financing at Point-of-sale across Asia and Latin America. This model has the potential to scale and expand to the US and Europe as providers can enable merchant-subsidised offers.

  • Customers pay for purchases in instalments through their issued debit cards

  1. Pre-purchase: A consumer plans for a purchase in advance and preemptively sets up an instalment plan

  2. During purchase: At checkout, the consumer selects payment through instalments

  3. Post-purchase: A consumer has already made the purchase and prefers to be reimbursed by the BNPL provider, then pay it off gradually through instalments

Off-card financing solutions

Typically, off-card financing solutions, such as Affirm and Uplift, offer financing on midsize purchases and require payment in monthly instalments. The average ticket size is close to USD$800, and the average tenure of the loans is about eight or nine months. Affirm, for example, has enabled upwards of $1 billion in consumer loans through Peloton, the company offering virtual, on-demand workouts.

Unlike Pay in 4 solutions, which are entirely merchant subsidised (0 percent annual percentage rate for consumers), off-card financing models also have originations where consumers are paying an APR—at times partially subsidised by the merchant—in the case of lower-margin industries, such as travel.

  • Similar to Integrated shopping apps, these solutions can be offered without the consumer owning a debit card

  • Point of difference: ability to serve consumers with higher credit scores, for larger payments (between $250 and $3,000) such as home appliances and fitness machines

  • Customers will pay APR on instalments, which are occasionally subsidised in part by merchants

  • About 80% of consumers who use this type of BNPL already own a credit card, but prefer this cheaper financing option or easier payment terms

  • Customers unlikely to use this option more than a few times a year

Virtual Rent-to-own models

Players, including AcceptanceNow and Progressive Leasing, are primarily targeting the subprime consumer base and have very high implied APRs. The model targets customers who lack the credit to qualify for other financing options.

Unlike other models, here the merchants are not heavily subsidising APRs, and instead larger merchants will receive rebates from providers. Categories are typically limited to goods that can, in theory, be repossessed. Originations are across two main categories: mattresses/furniture and electronics/appliances, but players are expanding into other products.

  • Rent-to-own/Lease-to-own allows consumers to rent a product (eg. furniture and electronics like fridges and microwaves) paying high rates of interest for about 12 months

  • Usually 20-30% of customers will pay off the item’s full value within 90 days, at minimal charges

  • Most (95 percent) of the consumers have a credit score below 700; about 70 percent have a score below 600

  • From the moment the customer cannot continue to pay, item must be returned

Vertical-focused larger-ticket plays

A model very similar to the way sales financing has worked historically is vertical-focused larger-ticket plays. This model usually has category specialists such as CareCredit (healthcare) and GreenSky (home improvement).

  • Targets high-value purchases between $2,000 and $50,000 in sectors such as healthcare, veterinary, and home improvement

  • Major competition to banks who traditionally are the only outlet for larger personal loans of this value

BNPL is classified as embedded finance, as the retailer doesn’t finance the purchase themselves, but rather redirects the consumer to a third-party finance company.

Comparing the unique features of each type of BNPL infrastructure shows us that Integrated shopping apps such as Klarna rely on income from lots of small loans over a large customer base (long tail model), which in practice works as selling a wide variety of niche products, which individually sell very little, but which in total generate high sales volume. By enabling brands to offer innovative credit solutions at the point of purchase, for example by paying in instalments, Klarna has grown into a $45bn company.

Alternatively, companies like BrightePay and Humm provide loans up to USD$21,000 (AUD$30,000). They count on large amounts to generate revenue, making up for the fact that people only take out loans of this size a couple of times a year, if that.

BNPL for business - the next playing field

The B2B deferred payment market is booming globally and the BNPL B2B opportunity is much larger and growing rapidly. The opportunity to succeed is incredibly lucrative, but innovation in the space has lagged behind. Until now, at least.

The market landscape is changing. Outdated offerings such as invoice factoring are being revisited and re-packaged. Providers such as Hokodo in the UK, Alma in France and Billie (German Start-up where Klarna has invested and partnered) are rapidly gaining traction due to their innovative propositions and fixation on superior customer experiences.

mymuesli is now the first company to use Billie’s BNPL solution directly integrated via Klarna in their B2B checkout. Business customers placing orders in mymuesli’s online shop can now benefit from the same flexibility as consumers using Klarna. They can buy their favourite mymuesli products for the entire office and pay later. Billie offers shopping limits of up to €100,000 and boasts a 90% conversion rate.

Square, with a different approach, offers business loans in the UK through which businesses can make their repayments with a percentage of daily sales made through card sales. Square also announced the acquisition of AfterPay, the transaction is expected to close in the first quarter of 2022, which could give access to the BNPL market too for businesses.

In France, players have launched or are in the process of launching BNPL for businesses. Hokodo, founded in 2018, and Hero, are the best positioned in the market, but other start-ups aren’t far behind. Finexkap and defacto have widened their offerings from financing to BNPL solutions.

Amazon, the e-commerce marketplace giant, is not lagging behind the trend. The Amazon Business American Express, offers companies to optimise their cash flow with deferred payments, giving them an additional 60 days to pay for their purchases on, which is part of Amazon’s core strategic goal - increasing participation in the Amazon ecosystem and solving inefficiencies for both customer and merchants.

The Dark side of BNPL

According to the FCA, the financial watchdog in the UK, 84% of financial counsellors report that half, more or all of their clients had BNPL debts, compared to only 31% in 2020. As mentioned at the beginning of this article, customers fall into the trap of believing that paying in instalments is more financially viable or easier than following age-old advice to simply…save up. They often over spend, or simply forget to make a repayment, incurring hefty late fees.

In 2019, the National Retail Association of Australia said that 55.9% of BNPL users were under the age of 35, and in 2022, Mozo reported that 67% of Afterpay’s sales came from Gen Z and Millennials. An article written by Sheila Bair, chair of the FDIC from 2006 to 2011, explains that BNPL targets a financially fragile population, often young twenty-somethings who already have crippling student debts without a stable, permanent job. They also struggle to resist the pervasive marketing tactics of BNPL companies, with their sleek logos, minimalist slogans and fun, colourful advertisements. What’s more, at a young age, many don’t have a credit history, preventing them from receiving loans from banks, resulting in their attraction to more flexible alternatives.

Currently, BNPL providers are not regulated under the same framework as credit unions or banks. In the case for Australia, Treasurer Josh Frydenberg mentions that such a framework has been largely unchanged in the country for 25 years. The country’s National Credit Act does not cover BNPL providers, and it is through this loophole that so many companies have attracted customers looking for small, low-interest loans in droves.

The Australian Finance Industry Association (AFIA) requires all BNPL providers to operate according to its Code of Conduct. The document stipulates that for a new customer to be granted any credit amount under AUD$2,000, they must not be considered as “vulnerable”, yet claims that such circumstances may only be known to AFIA if the customer chooses to reveal the information. What’s more, some elements of the document’s definition of a vulnerable person are ambiguous; someone whose “cultural assumptions or attitudes about money” are different, or who’s age may affect their decision making. This is problematic because individuals in these categories are unlikely to self-identify as vulnerable, let alone declare it, and many slip through the cracks.

Similarly in the UK, in February this year Britain’s regulatory watchdog, the Financial Conduct Authority (FCA), told Clearpay, Klarna, Laybuy and Openpay to modify their contracts, identifying “potential harms” to customers. The FCA has no control over the regulation of each company, but can enforce increased transparency of fees in accordance with Britain’s consumer rights laws. For now, this is the extent of regulation, however Britain's finance ministry promises to introduce legislation “when parliamentary time allowed”, whatever that means.

When it comes to the US, a number of states have commended the Consumer Financial Protection Bureau on its inquiry, launched on the 16th of December last year, into new fringe lenders in a letter to the organisation’s director, Rohit Chopra. An Australian organisation, Consumer Action, has made a submission to the inquiry urging US regulators not to make the same mistakes as their Australian counterparts.

In 2021 the European Commission also put forward a proposal for credit regulations, claiming that some lending, often under the amount of EUR 200, has been left out by the previous Directive of 2008. Some Member States are now calling for the Directive to extend its scope to include “potentially detrimental products”; consumer credit that entails high fees from missed payments. The changes to the Directive, last updated in 2008, would lead to better consumer protection and higher consumer confidence. If BNPL firms are included within the regulatory scope, they will be obliged to provide more information about their fees and services, regardless of whether their ad is on a small phone screen (with limited space), or not.

Many governments around the world are scrambling to reform their digital payments regulations in fear that tech giants from Silicon Valley and foreign enterprises will determine their countries’ payment systems and economic prosperity. The BNPL market is likely to feel the effects of these policy complaints mid-2022, and new FinTechs or Banks that are looking to integrate BNPL services to their offering will have to be mindful of their approach. Well established players like Klarna, Affirm, Zip and Afterpay will have to decide whether to make adjustments to their business models and marketing strategies in all regions as soon as one country’s policy changes, or to adapt little by little. Questions remain about what this will mean for merchants selling to customers overseas, where different policies apply.

What does this mean for Buy Now Pay Later firms?

The dilemma for BNPL firms is, effectively, higher regulation that will benefit customers in the long-term has the potential to reduce how many people can use the services due to poor credit history. This in turn will reduce the value of BNPL sales for merchants, making them second-guess their need for BNPL services for which they pay a high price (usually between 3% and 6% of each sale), and eventually prevent BNPL firms from cashing in on this commission when a merchant no longer justifies the costs involved.

On the other hand, increased regulation for BNPL firms has the potential to vastly improve their financial outlook. For the 2021FY, Klarna reported losses of $748 million, over 400% what they were a year prior. Afterpay’s losses looked similar, at $240 million, a YoY increase of over 330%, and are attributed to its receivable impairment expenses, in other words, the value of repayments that the firm is pending to claim from its customers.


In any case, Buy Now Pay Later services are making it easier and faster to receive credit. The rise of BNPL has had a positive effect on the evolution of financial institutions, both Start-ups and traditional banks alike, as they are forced to innovate in order to keep up with customer demand. This is reflected by numerous acquisitions such as that of PayBright, a Canadian provider founded in 2009, by Affirm, GreenSky by Goldman Sachs, and Billie by Klarna. This is without mentioning all of the High street banks vying to imitate BNPL services by FinTechs and partnerships taking place between players, such as that of Raisin and Mondu.

An increase in regulation may slow the boom, but could also give way to new models not-yet-seen on the market. With an increase in credit checks, we might see a rise in FinTechs partnering with companies that offer alternative credit scores, like Zopa and CreditLadder which have collaborated to use rent payments to help calculate a customer’s score, or Esusu, which reports rent to major credit bureaus. These companies have the potential to become the key bridge between regulators and BNPL providers.

In another scenario, increased regulations may mean that credit risk is so reduced for merchants that some build their own Pay in 4 model, making intermediary providers like Klarna and Affirm, who used to cover this risk for a fee, redundant. Larger merchants have already explored this option, like Alipay which created its own Credit Pay Instalment product, and only time will tell whether this will one day be commonplace for every retailer and coffee shop on the block.

For companies offering B2B BNPL, the opportunity to succeed is incredibly lucrative, however there are many challenges, as it is far more complex than consumer BNPL. Payment volumes tend to be much higher, and more detailed, quality customer data is required. Providers must negotiate this with the fast pace of the business industry, whereby owners expect rapid decisions. Business expertise is necessary to avoid compromising revenue or jeopardising the risk model.

If you are interested in how the banking industry is changing and what everyone should know about digital banking, take a look at our latest research Ins and Outs of Digital Banks.

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We would like to acknowledge the following sources that were indispensable to writing this article:

  • Buy-now Pay-later: Business Models and Market Overview. Master Thesis in Management Engineering at Politecnico Milano. Andres Santiago Garcia Alvarez

  • Buy now, pay later: Five business models to compete. Article.McKinsey & Company

  • The Economics of Self-Destructive Choices. Study as part of the Advances in Japanese Business and Economics. book series. Shinsuke Ikeda

  • Choices, values, and frames. Study as part of the American Psychologist journal. Daniel Kahneman and Amos Tversky

  • How our primal instincts fuel Afterpay’s buy now, pay later juggernaut. Article in The Sydney Morning Herald. Colin Kruger