Buy Now, Pray Later: Solving for Commercial Sustainability in Asia Pacific’s BNPL Industry
- Release Date: Apr, 2022
- Authors: 2022, Alison Hu, Benjamin Quinlan, Hugo Cheng
- Category: Reports
Table of Contents
HUGO CHENG
CFA Engagement Manager
MA (Cantab), University of Cambridge MSc, Imperial College London CFA
Executive Summery
Buoyed by years of robust economic growth and booming household consumption, the AsiaPacific (“APAC”) region has seen rapid growth in the consumer finance market, with total consumer finance loan volumes reaching USD 5.4 trillion in 2021.
Despite strong demand, traditional consumer finance products – such as personal loans and credit cards – have faced heightened criticism from consumers and merchants alike, exhibiting problems such as high interest charges / fees and static conversion rates, respectively. Recognising these pain points, numerous alternative consumer finance solutions have emerged in recent years – the most notable one being Buy Now Pay Later (“BNPL”).
Unlike traditional consumer finance products that monetise consumers through fees and interest charges, BNPL firms primarily monetise merchant partners by charging them a merchant discount rate (“MDR”) to facilitate credit-enabled transactions. In doing so, consumers are given access to better financing and repayment terms without the need to pay interest. And regional demand for BNPL solutions is skyrocketing as a result, with total gross merchandise value (“GMV”) forecast to grow by a CAGR of over 39% from 2022-25, reaching USD 361 billion.
Nonetheless, BNPL firms currently face a plethora of challenges on several fronts, including unsustainable customer / merchant acquisition costs, NPLs, and funding costs, as well as low user retention rates. As such, most BNPLs are struggling to turn a profit, with even the largest players in developed markets (both in APAC and the West) making sizeable losses.
In fact, we estimate that the largest BNPL firms are currently running average profit margins of -15% p.a., with more nascent players operating in emerging markets suffering from profit margins of -100% p.a. Investors are voting with their feet, with share prices of listed BNPL firms being battered in 2021.
We believe that the BNPL model, as it stands today, is in need of a fundamental rethink, and see three key routes that firms must explore to carve out a path to long-term profitability: (1) optimisation (i.e. enhancing processes across the user journey and adopting alternative funding models); (2) integration (i.e. expanding vertically across the consumer value chain to enhance user retention and drive profitability); and (3) expansion (i.e. leveraging existing credit capabilities to tap into additional revenue streams, including alternative credit products and/or B2B technology solutions).
We see significant upside potential for BNPL firms that can successfully transform their strategies and operating models. For BNPLs operating in developed APAC markets, we see a 30% uplift in revenue and 20% reduction in costs as achievable targets within a three-year timeframe. For BNPLs operating in emerging Asia, we see a corresponding revenue uplift and cost reduction of 45% and 15% respectively, over the same period.
Unless major changes are made, we anticipate that most BNPL providers in the region will continue wearing losses indefinitely and forecast combined market losses to reach USD 5.2 billion by the end of 2025, based on the industry’s current P&L trajectory.
While we envisage a more sanguine future ahead for BNPL firms that can rapidly adapt their business models, it is going to be a case of Buy Now, Pray Later, for those who fail to get it right.
SECTION 1:
APAC consumer finance dynamics
Overview
The APAC consumer finance market has grown rapidly in recent years, with total consumer finance loan volumes increasing at a CAGR of 12% from USD 2.7 trillion in 2015 to USD 5.4 trillion in 2021 (see Figure 1).
Figure 1: APAC Consumer Finance Market Size (USD Billion)
Economic Growth
Rapid economic growth results in a more confident population that is willing to purchase on credit
Growing Middle Class
Individuals with rising status borrow to finance purchases to align with higher living standards
Rising Internet Penetration
Strong internet coverage enables delivery of credit products in a scalable manner
New Product Development
Credit providers are developing new products to address nuanced needs of the local populace
From a geographic perspective, much of this growth has been fuelled by China and ASEAN, reflecting: (1) strong economic growth; (2) a booming middle-class; (3) rapidly rising internet penetration rates; and (4) the launch of new consumer finance products.
Consumer & Merchant Pain Points
Despite strong historical demand, traditional consumer finance products, including unsecured personal loans and credit cards, have drawn increased criticism and negative publicity in recent years. The two key stakeholder groups – consumers (especially the younger generation) and merchants – have expressed discontent towards existing consumer finance products for a variety of reasons (see Figure 2).
Figure 2: Consumer & Merchant Pain Points
For consumers, adoption barriers start at the application stage, which typically requires individuals to visit physical branches to submit a range of documents (e.g. employment, income, and address proof, etc.). The review of these largely paper-based documents is extremely inefficient and may take days, if not weeks, to complete. Rejection rates are also high, especially amongst less affluent customers, given their riskier credit profiles. Even if / when applications are approved, consumers must contend with high interest rates and a range of hidden fees and charges, which worsen considerably if they are unable to meet their monthly repayment obligations.
On the merchant front, traditional consumer finance products rarely lead to revenue uplift, as many of these credit products are designed to drive neither conversion rates nor order values. Given the absence of meaningful revenue enhancement, the option to pay through traditional consumer finance products represents a cost burden for many merchants. Without concrete partnerships in place, merchants are also unable to access the large consumer base held by consumer finance companies, lowering the value proposition of such products.
BNPL
Recognising the limitations of incumbent solutions in addressing persistent consumer and merchant pain points, various alternative consumer finance solutions have emerged in recent years – the most notable of them being Buy Now Pay Later (“BNPL”).
The key difference between BNPL and traditional consumer finance products lies in their revenue model – unlike consumer finance companies that derive revenue from charging interest (and associated fees) to consumers, BNPL firms focus on monetising their merchant partnerships by charging a merchant discount rate (“MDR”) for processing new transactions (see Figure 3).
Figure 3: Business Model Differentiators
The BNPL model was established to provide consumers with faster and easier access to credit while allowing for more flexible repayment terms without charging interest. As such, it was seen as an ideal solution in addressing the consumer pain points associated with traditional consumer lending products. In addition, BNPL firms run extensive marketing campaigns with many of their partner merchants to drive awareness and visibility of merchant products, increasing conversion rates and average order values (“AOVs”). In exchange for these new revenue streams, BNPL firms charge merchants an MDR – a commission for facilitating transactions.
SECTION 2:
The BNPL landscape
The BNPL model was established to provide consumers with faster and easier access to credit while allowing for more flexible repayment terms without charging interest. As such, it was seen as an ideal solution in addressing the consumer pain points associated with traditional consumer lending products. In addition, BNPL firms run extensive marketing campaigns with many of their partner merchants to drive awareness and visibility of merchant products, increasing conversion rates and average order values (“AOVs”). In exchange for these new revenue streams, BNPL firms charge merchants an MDR – a commission for facilitating transactions.
APAC Landscape
Recognising the explosive growth of the APAC consumer finance market and potential for competitive disruption, a flurry of new BNPL players have set up operations in the region in recent years. It is worth noting from the outset that the dynamics of the credit industry are markedly different across the region, especially when comparing developed and developing APAC markets. For example, only 2% of the Indonesian population currently holds credit cards, compared with 68% of the populace of Japan (see Figure 4).
Figure 4: APAC Credit Card Ownership (2020)
Such discrepancies reflect the differences in both the proportion of the banked population and the level of financial sophistication across each market, which have been a driving force in shaping the makeup of the BNPL competitive landscape in the region.
User Focus
Due to the heterogenous nature of the APAC market, BNPL providers operating in the region offer very distinct value propositions, largely reflecting the markets in which they operate. Taking target users and merchant dimensions into consideration, BNPL players in APAC can be broadly categorised into three key competitive clusters (see Figure 5), namely: 1. Developed market players; 2. Emerging market specialists; and 3. Supra-regional players.
Figure 5: APAC BNPL Landscape
1. Developed Market Players
Developed market players operate in countries where the population is highly banked, with larger disposable incomes. They also typically partner with middle- or high-end merchants. These BNPL players position themselves similarly to leading Western BNPL firms, with an extensive user base and wide merchant coverage. Launching the earliest in APAC, Australia’s Afterpay and Japan’s Paidy are prime examples of BNPLs operating in this space.
2. Emerging Market Specialists
Emerging market specialists operate primarily in ASEAN countries, where most of the population is unbanked, with lower disposable incomes. These BNPL players focus on servicing the unbanked population by partnering with low-end merchants (i.e. consumer staples). Akulaku and Kredivo, both from Indonesia, fall into this category.
3. Supra-Regional Players
Lying in the middle are supra-regional players, typically operating in more developed Asian markets, such as Singapore and Malaysia. These firms focus predominantly on low-tomiddle income consumers, targeting merchants offering consumer durables. Examples include Atome and Hoolah, both headquartered in Singapore.
Service Offerings
These three BNPL player groups can be further differentiated across several key dimensions (see Figure 6), namely: 1. Service model; 2. Merchant offering; and 3. Investors / funding source.1
Figure 6: BNPL Player Differentiation
Developed Market Players
Backed by a sizeable user base, developed market and supra-regional players charge merchants relatively high MDRs when compared to emerging market specialists. Given their better-established position in the market, many are looking to enhance the experience for their end users by incorporating browsing and purchasing functions into their BNPL applications, as well as integrating with large payment services companies to provide a seamless purchase solution.
Developed market players are typically funded by established financial institutions. For example, Paidy’s investors include Mitsubishi UFJ Financial Group (“MUFG”), Goldman Sachs, and PayPal. Some have also chosen to go public, such as Afterpay (which is listed on the ASX), enabling them to raise capital from public markets.
Emerging Market Specialists
DUE TO THE HETEROGENOUS NATURE OF THE APAC MARKET, BNPL PROVIDERS OPERATING IN THE REGION OFFER VERY DISTINCT VALUE PROPOSITIONS, LARGELY REFLECTING THE MARKETS IN WHICH THEY OPERATE.
Industry Outlook
Presenting an attractive alternative channel for consumers to access credit, the APAC BNPL industry is expected to grow rapidly in coming years, particularly as regional economies continue to recover from the Covid-19 pandemic and domestic household consumption power continues to rise (see Figure 7).
Figure 7: APAC BNPL Gross Merchandise Value (USD Billion)
With eCommerce sales expected to rise significantly in an increasingly digitalised world, we estimate the total gross merchandise value (“GMV”) of transactions processed by APAC BNPL firms to grow by a CAGR of 39.3% over the next three years, reaching USD 361 billion by 2025.
SECTION 3:
