BNPL Profitability from a Risk Perspective

Author: Joydip Gupta

The future is digital. Whatever doubts surrounded this statement vanished with the pandemic. The pandemic has forced consumers to consider numerous steps to ensure their safety, and this has contributed significantly to the accelerated adoption of digital payments.

And there can be no prize for guessing the payment platforms that registered the highest growthpost the pandemic. Buy Now Pay Later.

Given its massive addressable population, the Indian BNPL market is poised to become the world's largest. Goldman Sachs estimates that BNPL will account for nearly 7% of total retail GMV (Gross Merchandise Value) by the end of FY26. The current GMV of $3 Bn is estimated to go up to $35 Bn by 2026. BNPL's current use cases focus on e-commerce, and consumers use it primarily for shopping online, ordering food, paying bills, booking travel, paying bills, and using eHealth or EdTech services.

But that’s just one side of the story.

BNPL can be challenging

Every week, we hear about a new company in the banking or payments sector entering or launching a BNPL product. Although there is still some debate about whether it is a boom or a bubble, this segment has some serious challenges.

1. BNPL is a game of high volumes and large customer acquisitions. Scaling up requires significant upfront marketing investment and funding. Consumers often use BNPL, use it well, and pay on time. Nevertheless, there are some areas that need to be fixed to drive higher ARPU (average revenue per user)/customer lifetime value (LTV).

2. In a perfect world, a BNPL player makes money from both sellers and consumers. A fee of 2% to 8% is charged to merchants. Based on the credit score and repayment period, customers pay interest between 10% and 30%. If repaid on time, no interest is charged, and lenders offer BNPL credit limits of up to 5 lakhs. However, there is little money to make with small ticket-sized loans. BNPL loan profits are always lower than customer acquisition costs and processing fees, even at high interest rates.

3. In comparison to credit cards, one may say that BNPL loans are so much simpler as it is not mandatory to have a credit history and there are ‘easier’ approvals. But a lack of credit history also makes it difficult to assess the credit risk of buyers which might lead to more defaults. Even if credit was made mandatory, asking for a bank statement or a salary slip for a small loan may discourage users from availing of this payment option altogether.

Why does everyone still want a piece of the BNPL pie?

BNPL players see a massive opportunity of pivoting into other banking products. There may be other more profitable financial products they want to cross-sell, such as credit cards, higher AOV loans, insurance, etc. Furthermore, players expect the current expense mix to be lowered in the future. They expect to scale economies, better funding costs, and lower customer acquisition costs.

Currently, the industry is struggling to turn a profit, with its average industry profit margin sitting at -2.6 %. But some analysts (Credit Suisse) are forecasting the BNPL model to show positive operating margins by FY 2023-2024 and achieve 20-30% of operating margin by ~2026-2027. BNPL providers are expected to continue increasing competition, shift to larger enterprise customers, and economic-sharing agreements with partners. These factors could limit upside to contribution profit margin beyond FY 2021.

How do you make BNPL profitable?

1. BNPL needs to be viewed from a customer lifecycle profitability lens, not from a profitability lens. The first BNPL loan is a marketing investment followed by which players should look at the most efficient way to drive large volume of customer acquisitions at the lowest unit cost (CAC).

2. Drive profits by getting the customer to make repeat purchases. That’s where the acquisition cost drops, and profits start to build up. If you are offering term loans, look at cross-sell or upsell to larger EMI-based products. If you are offering a line of credit (or credit card) find ways to drive usage.

3. It is critical to manage early risk. High-risk customers borrow money for small ticket purchases. Further, lack of documentation makes it difficult to assess risk comprehensively. Small loans upfront and close monitoring of customer payments are the keys. Using multiple data points, AI-powered models assess customers better. Customers who pay up are rewarded by gradually getting larger loans, while non-paying customers are penalized by being blocked.

Self-learning AI models and a strong, portfolio analytics engine can play a crucial role in monitoring borrower activity and making sharper decisions. Many BNPL players use AI powered solutions to build risk scorecards, test and make credit decisions based on risk assessment.

Scienaptic is helping several BNPL clients globally and has a plug-and-play solution that performs instant underwriting of new BNPL loans, as well as portfolio monitoring of BNPL customers to cautiously scale up your book by growing good customers and weeding out risky customers.