By now, pay later companies now have over half a trillion dollars worth of debt on their books according to estimates from industry groups. The exact number is harder to track than something like total credit card debt because these companies are not required to record their lending practices in the same way. Either way, this is an especially concerning amount of money because by design, buy now pay later loans should only last 8 weeks before they are paid off in a predictable installment plan.
But new research and company confessions have revealed what you probably already knew. People aren't really paying off their CLA account. They are just using it as a new way to make their month go a little bit further at the end of their money.
Most of the largest buy now pay later companies are barely 10 years old now. But in that time, they have been able to scale rapidly thanks to a combination of generous investor funding, a techro attitude towards regulations, and a service that was appealing to people who didn't want to go through a formal credit application process for whatever reason. The argument was that these companies weren't giving out loans.
They were just letting people split up their purchase into smaller payments made over a set time period. And if everything was done properly, the users wouldn't even need to pay interest. But now, after giving out quick, easy not loans to anybody who could download an app, the companies are pulling a shocked Pikachu that they're not debt is not getting paid back.
Now, consumer debt defaults are on the rise everywhere. But BNPL has its own risks that can make this a whole lot worse than people not being able to split up their Costco hot dog into four easy payments. Why is paying for so addictive?
I'm using CLA to pay for these Chris Brown tickets. I don't care what nobody says. Being under financial stress takes a lot of time, a lot of planning.
I am Afterpay's number one consumer, number one fan. I don't know what it is about a paying for, but I can just never resist. I will afterpay it cuz I feel less guilt.
On the surface, buy now pay later services are not a drastically different financial product to a credit card. Both let you make purchases now and let you pay it off later. Both offer interestf free periods if you make your payments on time.
And both have been embraced by companies that want to sell you because they make it easier to spend money you don't have. Now, it's true that both of these financing options have extremely high interest rates and fees if you don't make your payments on time. And while buy now pay later companies tend to try to hide these risks, I hope it isn't shocking to you that delinquent unsecured consumer debt is considered very risky and therefore attracts a high interest rate.
But for financial tools that seem so similar at face value, there is one big difference that people tend to overlook. According to data collected by the Fed, credit cards are some of the most profitable products that banks offer to their customers. Even including their interest free purchase periods, the banks still make returns four times higher on credit card lending than other products like mortgages, commercial lending, and traditional personal loans.
By now, pay later companies, on the other hand, have struggled to turn a profit at all. In fact, most of them have been making spectacular losses. According to public financials, a firm lost nearly half a billion dollars last year, which was actually an improvement on the year before where they lost nearly a full billion dollars.
Other companies like Afterpay, CLA, and PayPal's paying for are harder to get data on because they are either private companies that don't have to publicly disclose their financials or they were acquired by other companies which mixes in their losses with profits from other parts of the business. CLA has raised a lot of capital from the ever reliable SoftBank to scale its business operations. The company did claim to have some quarters of profitability thanks to their creative use of AI to cut down on customer support expenses, but a lot of that was actually thanks to low borrowing costs, a generous interpretation of how reliably their customers would repay their installments, and ignoring everything else that it takes to run the business.
The company's actual profit for the quarter was a nearly $und00 million loss, doubling from the same time last year. In the supposed golden age of buy now pay later, the industry leader has had to put off its IPO because it's not clear if the business is even viable. These losses are occurring across the industry despite the fact that these companies typically take a larger cut of sales for merchants and charge higher effective interest rates on delinquencies because oh yeah, even if you don't personally use any of these services, you are still paying the price for them.
So, it's time to learn how money works to find out how a predatory business undermining the finances of hundreds of millions of users across the globe can't even make money for themselves. This week's video is sponsored by ODU. ODU is a powerful business management platform that brings everything together.
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The way that buy now pay later companies were supposed to make their money was by charging a higher than normal merchant fee from the retailers that use them as a payment option. Mass market credit card processors like Square, Stripe, Shopify, or PayPal usually charge merchants around 1 and a half to 3 1/2% on sales to take credit card payments according to data from Nerd Wallet and the company's own information portals. By now, pay later companies have started charging as much as 8% on sales to average retailers, according to a report by merchant cost consulting.
Larger companies like Walmart, Amazon, and Door Dash can negotiate these rates individually, but those agreements are largely kept private. For many retailers, 8% represents their entire profit margin after costs and expenses on a sale. So, paying that much to a buy now pay later company is untenable.
The problem is that the merchant agreement to buy now pay later companies forbids retailers from passing along these fees to customers. So they have an option. Either make no profit on sales through platforms like CLA or raise prices for everybody to cover this new expense.
Now the third option would be to not offer these payment options at all. But companies don't want to do that for three simple reasons. The first is that by now pay later customers are the perfect kind of customers.
According to industry data, they are much younger than formal credit card users, spend more impulsively, and have purchasing power thanks to being able to split up their payments. A report published by the Harvard Business Review found that after consumers started using buy now pay later services, they were 17 to 26% more likely to make a purchase. Not only that, but their average purchase was 10% larger than it was with normal payment methods, leading to an overall increase of 30% in discretionary spending.
A 30% increase in spending on non-essentials is not something that the average household can reasonably afford right now, especially amongst the groups attracted to BNPL. For people who can get access to them and use them responsibly, credit cards are an overall better value proposition. They have more flexible terms, they have better reward programs, and they can help users build up their credit.
They are also more strictly regulated because they are officially classified as a debt. by now pay later companies have so far dodged that official classification which means they are not as tightly regulated which means they can give credit to people who would otherwise struggle to get it. Now this is not to say that credit cards are some flawless financial product.
They too can easily let people spend money they don't have on they don't need but there are more rules about responsible lending since BNO applications don't show up on official credit reporting records. It also lets particularly self-destructive users pull some impressive financial maneuvers. People can get a credit card and apply for BNPL loans at the same time without each of the lenders knowing about the others.
They can then use their credit card to make their BNPL payments, stretching out the period between purchase and actually needing money by more than 4 months. Now, maybe there is a finance bro justification about the time value of money here. But let's be honest, people are either doing this because they are incredibly financially irresponsible or because they have no other choice.
The cost of living has outpaced most people's incomes. Eventually, this is going to catch up with us, but for now, people are stretching things out for as long as they can using financial gymnastics like this. Buy now, pay later has become just another tool to delay the inevitable.
According to an industry survey conducted by Lendingree, one of the fastest growing purchase markets for these services is in groceries. So, yeah, it's easy to characterize people using services like Afterpay as reckless consumers. And there certainly are people being irresponsible.
But a lot of this excess spending is really just people who couldn't afford to keep up. Even back in the good old days of 2023, a study conducted by the Fed found that more than half of BNPL users took on these loans because it was the only way they could afford it. So yeah, people spending money that they shouldn't or couldn't spend is a powerful incentive for businesses to accept the massive commission that these companies charge for their services.
Jesus, is this uh is this stuff regulated or are you guys What are you doing here? Uh, sort of. Sort of.
Jesus Christ, the spread on these is huge. 50% commission. Help for what?
It's our markup for our services. Anyway, if all of that wasn't good enough, these services collect a lot of data on their customers and act as a sales platform for brand partners, pushing deals and special time offers directly to individual consumers at specifically tailored times. In the early days of companies like Afterpay, they started out almost entirely as a sales platform running events like Afterpay Day where partner retailers could run sales in a big online event.
This has become less of a priority as the companies are now first and foremost a payment provider. But they still use it as a way to justify their business as a sales driver instead of just a fee generator. CLA was once valued at over $45 billion and investors didn't care as much about profitability problems because there was the potential for incredible profit if they became the default payment choice for a new generation.
But that hasn't happened. The money these companies raised was primarily used to fund research and development, server hosting, salaries, and fancy offices with ping pong tables. But by now hopefully you are seeing the problem.
The money that actually got lent to people didn't come from investors in the business. It was borrowed from institutional lenders and then loaned out to customers. Now, this isn't unusual.
It's the fundamental system behind all banking. But good middlemen should be able to get more from this group than they need to pay back to this group. The problem is these services suck at lending.
Picking on CLA again because they are one of the few companies that have had to publicly release their financials so far. They have made $182 million in interest income in the first quarter of this year coming from people who missed payments and had to pay penalties. In exchange, they had to pay $130 million in financing costs, which sounds like they should have made more than $50 million in gross profit just from lending.
Except that people who are paying interest on late BMPL loans are not exactly the best borrowers. The company also lost an additional $136 million in loans that it considers unreoverable. This means they actually lost about $85 million in one quarter with a generous interpretation of their consumer losses.
Credit cards aren't perfect by comparison, but banks are slightly more careful with who they will lend to. Banks can also raise cash at lower interest rates from individual depositors, and they can make money off people who aren't delinquent by definition. For a business this predatory, they kind of suck at being predatory.
For particularly desperate consumers, these businesses have become an alternative to payday lenders, who also have similarly low lending standards. The only difference is that payday lenders charge exorbitant interest rates that made up for the risks and then some. by now pay later companies can't really do that because that would further tarnish their reputation as a fun little alternative to # treat yourself and think about the problems later.
With such huge losses from the lending side, it means BMPL companies are even more reliant on their merchant fees to keep them afloat. But companies are starting to push back on that. In order to be the exclusive provider to companies like Walmart and Door Dash, Clara had to arrange sweetheart deals with much lower fees to these big companies.
This might be a good play for taking market share. But even total domination of an unfeasible market doesn't mean much. Investors are likely to keep throwing money at these companies because if they can be the last one standing, there is the possibility of increasing margins.
But that's going to come with some trade-offs for everybody else. The same way that Uber started out as a great alternative to taxis, Airbnb an alternative to hotels, and Netflix an alternative to cable, BMPL are still in the take market share phase. Eventually, these companies will need to make their service worse and take in more revenue if they want to continue existing.
For businesses, that will mean more fees for the privilege of accommodating BNPL services. And for customers, it will most likely mean more hidden ways to be forced into paying more than you really wanted to. There are really no winners here.
But nobody wants to be the biggest loser holding the bag if it all falls apart. A tragically common occurrence with a lot of new business trends. In fact, buy now pay later is just the latest symptom of a bigger investment sickness.
So, go and watch this video to find out why common sense is so hard to profit off. And make sure to like and subscribe to keep on learning how money works.
