Invest now, win later: Inside the ‘buy now, pay later’ gold rush

This story is part of Protocol's special report, "Buy now. Pay later. Win the future." Read more here .

"Buy now, pay later" is a tiny slice of the consumer credit market: At $97 billion in volume, it accounted for 2% of global consumer credit in 2020. But short- and long-term payment plans are experiencing explosive growth and heavy venture capital investment. They are also becoming a must-have feature for ecommerce — and even threatening to displace those ubiquitous store-card offers at cash registers.

At stake are massive revenues and market value. Visa, Mastercard and PayPal together are worth more than $1.1 trillion. And McKinsey estimates that "buy now, pay later" fintechs have already pulled away between $8 billion and $10 billion in annual revenue from banks.

Ultimately, "buy now, pay later" could threaten the lock of the traditional credit card on consumer spending. Consumers, particularly younger ones burned by the 2008 financial crisis and piles of student-loan debt, have shown a shift to debit cards. Credit-card balances, which have grown in most years for decades, took a hit last year and dropped to their lowest level since 2017.

It's shaping up to be a brawl, with control of global payments as the long-term prize. Pure-play "buy now, pay later" companies now face growing competition from payments processors and established card issuers, who don't want credit cards to become obsolete but want to be prepared if it happens.

But the fierce competition only makes untangling what "buy now, pay later" is more complex. Is it a reinvention of the venerable installment plan, a new form of consumer credit, a payments feature or an ecommerce marketing tool? It's all of the above: The way it crosses financial sectors is clear by how many large companies have jumped in with offerings.

Affirm, Klarna and Afterpay offer the purest forms of "buy now, pay later" plans. PayPal, which bought Bill Me Later in 2008, is embedding its Pay in 4 service into its standard checkout. Amazon, Shopify and a host of other ecommerce marketplaces see "buy now, pay later" as a way to increase conversion rates and avoid discounting. Even Apple is reportedly eyeing "buy now, pay later" as a way to broaden the appeal of Apple Pay beyond a convenience play.

Offering pay-later has become "table stakes" for any ecommerce operation or payments company, says Tom Seo, a fintech venture capitalist at Dash Fund. "Something is wrong if you don't have it."

But there are many ways to offer "buy now, pay later" — and the details make a big difference to consumers and merchants, as well as the companies offering the deals. To win in this sector requires a combination of merchant reach, consumer adoption, powerful AI underwriting and ecommerce marketing savvy. That doesn't come cheap. So the industry's mantra is becoming clear: invest now, win later.

The war for merchants

To date, merchants have been the real customers for "buy now, pay later." If you're not baked into a checkout page, it's hard (though not impossible) to become part of the sale. For retailers, "buy now, pay later" companies promise bigger purchases and higher conversion rates. And pay-later companies know consumers are creatures of habit: Until shoppers encounter a "buy now, pay later" offer, they're inclined to keep whipping out a card to spend, making merchant placement deals a crucial pipeline of new customers.

Accepting pay-later isn't cheap compared to typical card-processing rates. "Buy now, pay later" merchant fees are relatively opaque, but retailers reportedly pay between 3% and 8% of the value of the transaction. PayPal is the exception — it includes pay-later purchases in its standard rates.

Affirm has been scoring the biggest wins here, with partnerships with Amazon, the ultimate "buy now, pay later" trophy deal, and Shopify, which had more than 1.7 million merchants as of June. Square has agreed to buy Afterpay, which will put the Australian "buy now, pay later" service in front of the many businesses that use it for payments.

As competition for merchant placement tightens, the "buy now, pay later" companies don't want to get commodified, which would leave them with little choice but to cut rates. So they're catering to merchants with more and more features.

Affirm sees itself as "fundamentally a marketing device for merchants," CEO Max Levchin said on a recent earnings call. Affirm and other pay-later providers can get away with charging more than typical credit-card fees by helping retailers avoid dropping prices, particularly with cost-sensitive consumers. Even an 8% rate is better than having to slap on a 25% discount to move a product.

Affirm recently bought Returnly, which offers return services for merchants, and touts the data it provides to merchants to help drive sales, down to the item SKU and individual purchase patterns. Geoff Kott, chief revenue officer at Affirm, says merchants can't really get that data elsewhere: "That is so powerful and effective when it comes to how to effectively retain and convert that consumer."

Klarna has been aggressively striking deals with established retailers like H&M, Walmart and Sephora. It also bought several companies recently , including Toplooks, which helps merchants create customized marketing images and messaging, and HERO, which helps merchants communicate with customers through text messages, video and online chat rooms.

A key part of the Square-Afterpay deal is Square's popular Cash App, which will become the way to manage installment loans and find new deals. That could make Afterpay less dependent on acquiring customers through merchants, on top of the access it will get to Square's existing base of sellers.

PayPal's Pay in 4 has a key selling point: It's already built into its checkout button and doesn't require any additional merchant integration, said Greg Lisiewski, general manager of PayPal's Pay Later business. All PayPal merchants in the U.S., Australia, U.K., France and Germany automatically have "buy now, pay later" through PayPal.

PayPal is happy to let "buy now, pay later" generate more volume for its core payments business. "We don't have to make all of our money by charging a premium" for pay-later shopping, Lisiewski said. "For us it's helping merchants sell more using our products and that pulls more volume to our platform."

PayPal has 650,000 merchants and 7 million consumers that have used "buy now, pay later," for $3.5 billion in total payment volume since launch, but it doesn't offer pay-later in stores yet.

The struggle for consumers

If "buy now, pay later" is a payments Trojan horse, merchants are merely the gate it's getting wheeled through. The real goal is becoming top of wallet for consumers, an everyday spending tool like plastic cards have been for the past half-century, and a familiar brand associated with shopping.

That's why so many in the space are trying to build super apps that combine discovery and special offers with tools for tracking payments. "We don't believe that just dividing into four is, over time, enough for them to click our button," said David Sykes, head of Klarna US. Klarna's customers like a number of other features such as tracking packages, wish lists, price-drop notifications and try-before-you-buy, he said.

In Europe, where it is licensed as a bank, Klarna gives an indication of how it wants to own the customer relationship: It launched bank accounts in Germany, with debit cards and savings. It doesn't have immediate plans for banking in the U.S., Sykes says, but it's not hard to imagine Klarna making those moves eventually. He sees Klarna as at the intersection of "shopping, payments and banking."

About 30% of Affirm's transactions in its most recent quarter were direct from its app, indicating that the company is driving customers to merchants, not just serving as a button on their websites. Affirm is even offering savings accounts and recently announced it would let customers buy and sell crypto.

PayPal has similar aims with its super app, which could soon include payments, shopping and investing. And it could expand its core app into discovery with its recent acquisition of Honey, a deal-seeking tool.

In all the major pay-later apps, consumers can search for a range of merchants. If the provider doesn't have a relationship with a given store, the app produces a one-time virtual card at the point of sale. This virtual card can also be used with Apple Pay or Google Pay at brick-and-mortar stores. Those transactions generally aren't as profitable as direct merchant deals, but they help cement the pay-later service's utility.

There's another company that seems to share these super-app ambitions: Apple is reportedly planning with Goldman Sachs to offer its own version of "buy now, pay later" that will work with Apple Pay. Apple executives have made no secret of their desire to build the company's services revenue, and with a built-in audience of hundreds of millions of iPhone users, they could create a serious contender.

A global battlefield

Klarna was born in Sweden, Affirm in San Francisco, and Afterpay in Australia, each with a different initial goal. But the sheer size of the global "buy now, pay later" opportunity is sending them into each other's geographies and attacking each other's strongholds. To win, companies must straddle continents and categories, which will require a ferocious pace of dealmaking, acquisitions and country launches in the years ahead. It won't be a winner-takes-all market, but go ask Discover what it's like to be a second-tier payments network.

Affirm, which is just now contemplating expanding beyond the U.S., sees itself as handling large and small purchases alike — "the totality of transactions," said Kott. Like exercise bikes, for example. When it went public, Affirm's dependence on Peloton sales caused some alarm. But Peloton's share of Affirm's gross merchandise volume has been steadily falling as it diversifies. Its Shopify and Amazon partnerships could drive more small-ticket purchases, too.

Larger purchases may be where the competition becomes clearest. The "buy now, pay later" market is crowded, but an advantage in big-ticket items with longer-term loans stands out, according to Andrew Jeffrey, analyst at Truist. Small-ticket items paid in four installments are probably the most commoditized type of purchase, he said.

Klarna's average U.S. order size is about $140, according to Sykes. He said Klarna typically enters a market focusing on fashion, cosmetics, apparel and accessories — low-price, high-margin businesses that are popular with younger consumers and where merchants are eager to move products quickly. Over time, he added, Klarna moves to bigger-ticket purchases like travel and home.

It might seem puzzling to sign up for a new payment tool to buy a T-shirt, when your wallet and smartphone already have a host of established payment options. That's where the psychology of "buy now, pay later" comes in. Because it's a new option, consumers don't have the negative associations they might have with other purchasing tools. It's being embraced by "a bunch of consumers who are younger and have decided that they just don't want to embrace traditional credit cards," Sykes said.

That could change. "Buy now, pay later" debt collection is a growth market, too. A fundamental aspect of pay-later plans is that they entice consumers into spending more — they wouldn't appeal to merchants otherwise. It may well be that "buy now, pay later" gets the same bad rap as credit-card debt. It also might attract the eyes of regulators, who are scrutinizing innovation in consumer credit more closely these days.

For now, those risks seem small to executives compared to the possible rewards. The current architecture of payments, brilliantly conceived by Dee Hock , the founder of what became Visa, in the 1950s, seems spaghetti-like today. A single payment must pass from an issuing bank through a payments gateway, a card network and a merchant bank. The cardholder's bank has no real idea what they're buying beyond a store name.

"Buy now, pay later" collapses that into a single transaction with complete transparency that promises to connect shoppers, merchants and even manufacturers, with instant credit lubricating the wheels of commerce. No wonder money is pouring in.

Though companies came to the market differently, ultimately "buy now, pay later" is about owning the customer relationship, not just facilitating a one-off transaction. The new form of credit is just pay-later's shiny face. Behind it lie ambitions to dominate the future of shopping with a virtuous circle of data and transactions that renders other financial intermediaries irrelevant.