The big changes coming to buy now, pay later

In the space of a decade, buy now, pay later (BNPL) has become ubiquitous in Australian retail.

From the payment system's initial use mainly for fashion and beauty products, BNPL services such as Afterpay, Klarna, Zip Pay, Sezzle and Humm are being used to buy holidays, homewares and electronics as well as services such as dental treatments and education.

Such is the popularity of the service that it will face tougher regulation from the middle of this year as the Federal government introduces more consumer protections.

BNPL allows customers to pay for goods and services in instalments instead of paying the full amount upfront. They repay the money in regular amounts in the subsequent weeks - for example, four repayments every two weeks for Afterpay and Klarna.

Customers might be charged an account fee, although this can sometimes be waived if they have a zero balance owing. They are also charged a late fee if they miss a repayment.

Along with the ease of applying, people are attracted to BNPL services because they don't charge interest. However, they do charge merchants a fee, typically 2% to 4% of the purchase price, which is their main source of revenue.

More than 50% of Australians have used a BNPL service in the past 12 months, according to data from Afterpay. While the service is thought of as appealing to consumers in their teens and 20s, the average age of an Afterpay customer is 37 and for Zip Pay it's 39.

The biggest cohort of users is Millennials, although Afterpay says there is strong growth among Gen X and older consumers as they also shy away from credit cards.

Their popularity has been driven by a growing number of consumers who don't want credit cards, particularly among younger generations. Faster approval for loans - almost instant in many cases - is also more appealing to consumers rather than having to wait a few days for a bank to approve a credit card or a personal loan.

Bricks-and-mortar and online retailers have adopted the services as a way of attracting customers who might not otherwise have the ready cash to pay for their products.

BNPL providers also offer businesses the chance to attract more customers by showcasing their goods and services on the BNPL apps.

The payment method is an Australian invention, with Afterpay the world's first BNPL service, launching to consumers in 2015.

The business famously started when investor Anthony Eisen noticed there was always a light burning late into the night in the house across the road in Sydney's affluent Rose Bay.

It turned out to be e-commerce entrepreneur Nick Molnar, who was selling jewellery online via eBay and packaging his orders overnight. He shared his idea for letting young consumers pay for goods in instalments rather than via credit card and so the pair went on to create Afterpay.

The company boomed - it hit $1 billion in monthly sales in November 2019 and expanded to the US, attracting nearly four million active US customers by the start of 2020.

The huge success of Afterpay and the potential scale of the BNPL opportunity were demonstrated in 2022, when US payments giant Square (now Block) acquired Afterpay for $39 billion, the largest mergers and acquisitions deal in Australia's history.

Hard to make a profit

The huge sale price notwithstanding, profits in the BNPL sector have been slow in coming. In a report on the sector at the end of 2023, the Bank for International Settlements said major BNPL platforms face profitability challenges.

"High operating costs, for marketing, administrative and technology expenses, among others, have prevented these platforms from breaking even since 2018," it said.

Afterpay didn't make a profit before it was taken over by Square, and its standalone profits have not been reported since then.

However, the tide might be turning for the sector. Zip Pay recorded a loss of $330 million in the 2023 financial year, before swinging to a $5.7 million after-tax profit last year, from revenue of $868 million, and Humm made a $27.3 million profit in the first half of the current financial year.

The BNPL sector has rationalised over the past couple of years as some players succumbed to intense competition and investors starting demanding a return on capital once interest rates started rising from record lows.

Only four or five global players of any significant size remain.

"There were two or three years where these guys had to get their margins and make some money in order to pass through the other side. We're now on the other side of that, so industry structure and dynamics are really quite positive at the moment," says Jonathon Higgins, head of research at stockbroker Unified Capital Partners.

"They're not competing heavily at the checkout; they're not doing massive loss-making marketing campaigns. There's obviously a lot of growth in the US, north of 25% a year at very low penetration compared with Australia."

Banks enter the fray

Australia's major banks have entered the market with their own BNPL offerings over the past few years, but Higgins doesn't expect this to change the competitive dynamic.

A key feature of BNPL products is that they provide a good buying experience and readily attract customers. Zip Pay, for instance, has about 2 million Australian users, about 10% of the adult population.

Banks, by contrast, are terrible at dealing with customers, says Higgins, so they'll likely stick to their core retail banking expertise of providing home loans. Despite having their own BNPL products, they are more likely to look to partner with existing players, he says.

There were around seven million active BNPL accounts in Australia in 2023, Assistant Treasurer Stephen Jones said in a speech on responsible lending.

The average BNPL consumer uses it for 18.2 transactions a year, with an average transaction amount of $136. Overall, the value of BNPL transactions was about $20 billion, which is equivalent to around 2% of Australian card purchases.

BNPL products have been lightly regulated until now, with the providers arguing they're not a credit product and so shouldn't be regulated as such.

However, following several government inquiries, they will now be regulated under the National Credit Code in an effort to provide better protection for consumers.

From June 10, BNPL providers will have to have a credit licence from the Australian Securities & Investments Commission and become a member of the Australian Financial Complaints Authority.

They will be classified as low-cost credit, a new designation created for BNPL. As such they will have to comply with a less stringent version of responsible lending obligations, which require them to take reasonable steps to verify a consumer's financial situation and assess their needs and goals.

"The old BNPL model that Afterpay pioneered was to give everyone credit and, if they stuff up, we won't give them anymore," says Unified Capital's Higgins.

"That's just not going to fly anymore. So, that means you're probably likely to write less loans because even though it's a small balance, some people shouldn't have it."

However, Afterpay says it is unlikely to be significantly impacted by the changes.

"It is a proportionate regulatory framework. What we're seeing is actually that the product can continue to exist in the way that it always has," says Michael Saadat, international head of policy at Block. "There will be some changes to customer onboarding processes, and credit checking will be part of our upfront process going forward, but we don't really see that it's going to significantly impact customers."

Zip Pay says it will be business as usual under the new regulations, as it already holds an Australian credit licence and has been conducting credit and affordability checks on customers since inception.

The reforms were introduced to meet concerns that BNPL was putting people in debt.

Good Shepherd - a charity that works to overcome economic insecurity among women, girls and families - said its clients' BNPL debts were growing.

"Good Shepherd frequently sees financial stress and hardship among clients using BNPL. More than three in four financial counselling and capability practitioners report that clients with BNPL debt struggle to make payments on time," it said in a 2022 report.

Spending limits imposed

However, Afterpay's Saadat says the product has built-in guardrails that stop people getting into financial difficulties.

While customers previously started with a $600 spending limit, these limits now start low and are determined on a case by case basis once a credit check is conducted during the application process.

If customers meet all of their repayments over the ensuing months the limit can eventually rise to $3000 - significantly lower than many credit card limits.

If they fail to meet a repayment, they are stopped from spending any more until they are back on track.

"The risk to a consumer from using our product is very low," he says.

Zip Pay declined an interview, but said in a statement that it has 10 years' experience in credit decisioning and matches customers with "appropriate purchasing power".

"Our business model is built on being a responsible lender, and doing what's right by our customers, merchants and other stakeholders. Less than 1% of our customers are on hardship plans."

The Reserve Bank (RBA) noted last year that BNPL is an expensive way for merchants to accept payments, with an average cost of 3.5% of the value of the purchase, "well above" the cost of card transactions.

Most BNPL services don't allow merchants to pass on the cost to consumers through surcharging.

"Surcharges could be used by merchants to signal to consumers that they are using a relatively expensive payment method," said the RBA.

The central bank believes merchants should be able to pass on surcharges and plans to revisit the issue.

However, BNPL providers are opposed to the idea, arguing that retailers gain a service from using a BNPL service - more customers, sales they wouldn't otherwise make and the chance to showcase their wares in BNPL apps - and so should pay for that.

For and against

Sydney-headquartered Success Tutoring charges parents $800 for one of its courses to help students win a place at a selective high school and accepts payments via Afterpay.

"Because it's a large amount, families would much rather receive the service and pay later," says founder Michael Black. "The benefit for us is that we get the money straightaway."

Around 10% of its courses are paid via Afterpay and Black believes he would lose business if he didn't offer BNPL.

Success Tutoring pays a merchant fee of around 5% to Afterpay and Black says he would pass it on to customers if Afterpay allowed it. "The shoppers are receiving a service and getting a benefit, so if they have to pay a little bit extra, I think that's okay," he says.

But The Best Backyard, which makes outdoor furniture and children's play equipment, stopped offering BNPL about 18 months ago.

"When we started looking at the [merchant] fees, it was hard to justify with everything increasing in price," says director Tom White. "We were looking at doing a price increase just to cover the fees and it just didn't seem to make sense."

White estimates that 20% to 30% of the sales had been made with BNPL, but believes The Best Backyard has probably only lost a handful of sales since withdrawing the BNPL option.

"We've had very few requests from customers saying, 'Do you have Afterpay or do you have Zip Pay available?' " he says. "They still want to purchase the products, and so they either use PayPal or a credit card."

If payments regulation changed and the BNPL providers were forced to allow merchants to pass on their fees, then White says he would consider reintroducing the services and that the business could benefit from the platforms for the product discovery that many providers offer.

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