Why is the “buy now pay later” popular all over Europe and the US?

Buy now pay later, that is, buy now, pay later, is very popular in the European and American markets. The leading company Affirm, also known as the “American version of the price”, skyrocketed in 2021, starting to rise from a low point of less than $50. After confirming the cooperation with Amazon, the stock price skyrocketed and directly took off. The highest stock price reached 176 US dollars, an increase of more than 250%.

Source: Tradingview

Although Affirm's stock price has dropped sharply since November 2021, the popularity of buying first and then paying later in Europe and the US has not abated. Some agencies predict that the size of the buy-and-pay later market will rise from US$125.09 billion in 2021 to US$3.268 trillion in 2030, with a compound annual growth rate of 43.8%.

Source: Precedence Research

To be honest, it's hard to find a segment with such good growth prospects in the financial industry right now, but it is inaccurate to equate the “US version of HuaBi” Affirm with Huabei. Let's first take a look at the buy now pay later model.

Affirm's model is slightly more complicated; we used Affirm's competitor Afterpay as an example to illustrate the buy-and-pay later business model. Whether it's Affirm or Afterpay, buy now pay later is both a payment method and an e-commerce platform. Merchants need to deploy it on the platform first, and users can see a variety of products when they enter their platform.

Source: Affirm

Source: Afterpay's official website

The most attractive thing about shopping on Buy Now Pay Later platforms is that you can instalment without interest, so how do buy now pay later platforms make money? Take Afterpay as an example. After a customer purchases a product on the platform, Afterpay will first pay the full payment to the merchant. Of course, 3% to 6% of the transaction fee will be deducted here, which is also the main source of revenue for Afterpay. Another revenue is late payment fees (late payment fees) charged when customers are overdue.

Source: Supplied website

However, for Afterpay, this model causes a mismatch between cash inflows and outflows. For example, a user buys a product worth $1,000 on Afterpay in four installments. After deducting 6% of the transaction fee, Afterpay immediately needs to pay the merchant $940. At this point, Afterpay only received the first payment of $250 from the customer, and there was a difference of $690 here, and the 690 dollars needed to be paid in advance by Afterpay. In the future, customers can simply return the money directly to Afterpay.

Source: Supplied website

Well, we can see that although Afterpay does not charge customer interest, it does earn merchant transaction fees. Sure enough, it's internet thinking; wool comes from pigs. Affirm's model is similar to Afterpay, except that when making payments to merchants, they go through a third-party partner bank and ask the bank to pay the full amount first. Thus, the bank forms a loan, and Affirm buys this loan in a few days.

Whether it's the Afterpay or Affirm model, they ultimately have to bear the customer's credit risk, earn merchant transaction fees, and occasionally earn penalty fees for overdue customers. But don't forget what I just mentioned. In the buy-first-pay model, the platform will cause a mismatch between cash inflows and outflows. Even customers will pay back their money. As the platform's transaction volume increases, the platform requires more capital to be paid to merchants in advance to make up for this mismatch. What's more, will the customer default and cause bad debts?

Buy-first-pay platforms basically make up for cash flow mismatches through borrowing. For Afterpay, they supplement capital by issuing interest-free convertible bonds. Although Afterpay is not required to pay interest, future convertible bonds will dilute existing shareholders' equity when converted to common stock. This seems like sacrificing shareholders' rights to earn interest spreads.

According to information disclosed by Afterpay, Afterpay earns 4.2% of transaction fees, reduces 1.2% of execution costs, reduces 1.1% of bad debts, and finally earns 1.9%. However, if future borrowing requires interest payments, I'm afraid this 1.9% will not be profitable.

Source: Afterpay on Block Investors Day Documents

However, like all new things, the profit prospects were unclear at first, even more so for the Internet industry.