January 20, 2022

January has the reputation of being the most disliked month. In many parts of the world, it’s a long, cold period without any festivities and not much to look forward to. And in the aftermath of Christmas, it’s also a month of financial reckoning. For a lot of people, money stresses are high as the credit card bills from December begin to roll in.

All the exuberant spending on Christmas and New Year’s comes due in January, adding an extra bite to an already frosty month. But not to worry. A brand new business model has emerged to help consumers keep on spending, despite the post-Christmas budget crunch.

We’re talking about a new generation of Buy Now, Pay Later (BNPL) services, which are “helping” consumers push that age-old IOU even further down the road. The tantalizing draw of instant gratification and delayed payment have helped BNPL companies flourish in recent years, but at what cost? While the BNPL industry is indeed growing quickly, high user fees, ballooning consumer debt, and lack of collateral, point to another financial crisis – and an unviable business model for the long term.

What is BNPL?

BNPL is simply a spin on the lay-away plan, wrapped in the latest technology and artificial intelligence to make it sound more appealing to young online shoppers. In a traditional lay-away plan, you have to finish making all the payments before you get the item. With the new BNPL model, consumers get their items right away, and make the payments later. The basic concept is the same: lure and nudge consumers to spend more on things they can’t immediately afford today, with the promise to pay in the future.

The big difference? In the past, lay-away was used to purchase mostly bigger ticket, tangible items, such as washing machines. Nowadays, online shoppers can use BNPL to pay for almost anything, from massages to t-shirts.

Source: Urban Outfitters

Who are the main BNPL players?

Four companies in the BNPL industry have built scale: Afterpay, Klarna, Affirm and Zip. Many other small players are more focused on a geography (e.g. Sezzle in the United States) and/or verticals (Brighte in home improvement).

The business model

In the BNPL world, there are no credit checks on customers. The merchant is paid upfront and the BNPL company collects the installment payments.

Cost can be incurred in three ways when using BNPL products:

  1. Interest payments (if all payments are not made by specified deadlines);
  2. Late fees; or
  3. Account fees.

Costs differ for each provider. For example, Afterpay and Klarna don’t charge account keeping fees, whereas Zip collects a monthly account fee.

The maximum amount of purchases one can make varies depending on the company. On paper, credit loss is mitigated as the book turns anywhere from nine to 15 times a year, depending on the terms and loan balances.

What is driving BNPL industry growth?


The massive shift to online shopping has naturally led to a growing increase in online transaction volume. There is also a structural shift away from credit cards to online payment methods, like BNPL. Penetration of BNPL is merely 1% of United States (U.S.) e-commerce and 1-3% in most parts of Europe, compared to 10% in Australia or 25% in Sweden, so there is a strong secular tailwind.

At a combined 140 million, Gen Z and Millennials now comprise the largest portion of the U.S. population. They are the driving force in e-commerce growth, and the primary target customers for BNPL operators. This is because many of them do not have credit cards, with a major concern being the fees and penalties associated with having one. Interest-free instalment payments offer an appealing alternative, and have quickly gained traction among younger consumers. Even older Generation X adults are starting to adopt BNPL products.


There is an obvious value proposition for merchants, namely access to a large, engaged, and rapidly expanding online customer base. BNPL provides higher conversion from leads to sales, increased average order value, and improved online and in-store traffic. Many BNPL companies also provide customer insights and benchmarking data to retailers. The average merchant fee can range anywhere from 2-6%, depending on the provider and the services rendered.

The looming risks of the BNPL industry

Historically, recessions are almost always triggered by problems in the credit market. BNPL could very well be that trigger. For now, the consumer balance sheet is in great shape, but the question is for how long? What happens when government handouts stop, and all these installment payments come due? We could be setting ourselves up for the next global financial crisis.

Take credit scores, for example. As BNPL in most cases is not considered conventional credit, it does not show up on credit scores. This in turn paints a distorted picture of the consumer’s true financial health. 

Where is the collateral in case of default? Many consumers are using BNPL to pay for clothes, vacations or other services which do not have any resale value as they are not tangible. How will the lenders recover the unpaid debts?

There is also regulatory risk. The rules differ from country to country. In Australia, the BNPL industry is allowed to self-regulate. In the U.S., regulations are lax and differ by states. For example, the State of California requires BNPL providers to obtain a license from the Department of Business Oversight (DBO). But this is not the case in other parts of the country. In the United Kingdom (UK), the Financial Conduct Authority (UK) is currently reviewing the regulation of unsecured credit, including BNPL arrangements.

At some point, customers will have to come up with the funds to pay their loan, and if they don’t, they will be on the hook for late payment fees and/or high interest payments. Many customers might even default. One thing seems certain: BNPL loans will make the collective debt burden worse.

Portfolio impact

At Global Alpha, we do not invest in BNPL. Our focus is on finding high-quality companies with defensible business models and strong balance sheets that should outperform the small-cap benchmark.

However, one of our holdings, ACI Worldwide (ACIW), is benefitting from increased transactions online. Every time a customer uses a credit or debit card, a number of systems are involved, including the merchant processor: Visa, Mastercard, or the ATM and the card issuer systems. ACIW software essentially provides the “electronic handshake” that connects these systems.

Every second a purchase is made using BNPL, we can rest assured in some way or another that ACIW is benefiting from it without the inherent risk of the “buy now, pay later” industry. As the saying goes, ACIW is enjoying both the cake and the cherry.

Have a nice day.

The Global Alpha team

Global Alpha Capital Management Ltd.
January 20th, 2022