We know that buy now pay later has enormous online shopper appeal, but Harvard researchers have identified what makes BNPL installment payments so popular.
Research by Harvard Business School professors Marco Di Maggio and Emily Williams highlights the risks of these financing services, especially for lower-income shoppers during tighter economic times and the holiday season.
BNPL payments will double by 2024
BNPL payments made up $97 billion—or 2.1%—of total US e-commerce sales in 2020, and that is expected to double by 2024, according to Worldpay.
The academics analyzed bank and credit card transaction data from more than 10 million consumers and investigated BNPL usage in a sample of over 400,000 consumers.
Concern for consumer debt
DiMaggio and Williams found that lower-income consumers spend more when using BNPL.
“Put yourself in the shoes of the consumer,” says Di Maggio, the Ogunlesi Family Associate Professor of Business Administration. “You see something you like, you put it in the shopping cart, and you start to checkout. Before, you were looking at $100 for the item, plus shipping plus taxes. Now, the bill [for the first installment] says $25. You say, ‘OK, now I’m going to buy it for sure.'”
Potential risks include overspending, overdraft and late fees, and possible credit report impact if payments are missed.
The flypaper effect
In their research abstract, the authors say that buy now pay later installments increase total spending level and the overall retail share in spending — something they call the “flypaper effect.
“Our findings are more consistent with a “liquidity flypaper effect” where additional retail liquidity through BNPL “sticks where it hits” than a standard lifecycle model with liquidity constraints,” the authors write.
The findings are consistent across financially-challenged lower income and higher liquidity shoppers.
What makes BNPL stick?
Three main features of BNPL appeal over credit cards include:
- A small down payment and lower individual payment amounts
- BNPL loans are offered through retailers for specific purchases
- BNPL companies offer easier lending terms, with no or limited credit checks, often zero interest, minimal fees, and limited negative reporting to credit bureaus.
A March 2021 survey of 2,000 US consumers found nearly 60% had used BNPL, up 50% over the previous year.
Motley Fool research shows many BNPL users have credit cards but prefer the more favorable terms, with 45% saying it helped them make a purchase outside their budget, while others used it to avoid high-interest fees (37%), or borrowing without a credit check (25%).
BNPL has obvious merchant appeal
BNPL companies earn revenue by charging merchants fees often as high as 55 to 8% of transaction amounts or more, substantially higher than the 2-3% charged by credit card companies.
These higher fees make business sense to merchants because nearly half of consumers spend from 10% to 40% more when BNPL options are available, according to research from Cardify in a Forbes article.
This ROI on merchant BNPL fees is consistent in sales impact claims and reports from numerous buy now pay later operators and retailers.
Buy now and pay later has “become table stakes” for retailers, said David Sykes, Klarna’s head of US, at a WWD virtual apparel and retail summit in November 2020. “It’s reached an inflection point,” he said at the conference.
Lower-income BNPL users penalized
The researchers found consumers earning between $25,000 and $45,000 a year use BNPL more on average than other income groups. As many as 20% incur overdraft fees, and 17% pay low-balance fees despite the initial appeal of zero or low interest.
Williams, an assistant professor of business administration in the Harvard Finance Unit, expresses concern for lower-income users of BNPL installment payments.
“Across all users—those who use credit cards, non-credit card users, everybody—the retail share of expenditures go up,” says Williams. “But the increase in total spending is only coming from non-credit card users. And it is only these users that are incurring the overdraft fees and low [savings] balances.”
She says some consumers may find tracking purchases more difficult if they use numerous buy now pay later lenders. This can lead to missed or late payment fees or simply overspending without realizing it and then using credit cards or other forms of credit to repay BNPL loans.
“The product was very popular [during the pandemic] because people were stuck at home. People were shopping, flush with cash. It feels like somebody is giving you free money. Why should that be bad, right? Especially if the alternative is paying 20% in interest on your credit card,” Di Maggio adds. Now, however, “the existing portfolio of these products is likely to be highly risky.”
More BNPL loan transparency needed
Merchants and buy now pay later operators must redouble their efforts to ensure consumers have full understanding and transparent information on ees, repayment terms, and interest rates.
With fast-growing inflation, the post-holiday shopping and spending hangover could be bigger than usual.
Looking for more BNPL research and resources?
Check out our BNPL Research library here.