(Bloomberg) -- From Apple iPhones to Adidas shoes and Uber Eats takeaways, Britons are using buy-now, pay-later like never before to fund their lifestyles.
This model, allowing customers to spread out payments without interest or credit checks, has become the darling of retailers and is drawing a growing menagerie of fintech companies. That’s increasing the competition and risks squeezing industry margins, just as the government gets ready to regulate the sector.
Activity rose nearly a fifth to about $27 billion last year, putting it at 7.7% of the UK’s total e-commerce market, according to GlobalData Plc. The boom is being driven by international firms like Klarna Bank AB, PayPal Holdings Inc. and Afterpay Ltd. More are coming, such as US startup Affirm Holdings Inc.
“Affirm is stepping into a competitive landscape,” said Sameer Pethe, a partner at consultant Kearney. “Merchants who haven’t plugged in a point-of-sale solution aren’t many.”
Retailers such as Sports Direct Ltd and e-commerce marketplace Very have already started their own BNPL offering, while banks like HSBC Holdings Plc are also getting in on the act. A key selling point is the ease — it can typically be done with a tap of a mobile phone.
“The UK is one of the world’s leading BNPL markets, with a high level of maturity, penetration, and competitiveness,” said Matt Purnell, an analyst at Juniper Research, adding it has now overtaken former leader Sweden in terms of volumes.
The risk for new entrants is that they are joining a retail market facing a bleaker outlook. Shares in Britain’s top shopping chains have tumbled this month after disappointing sales over the Christmas period and as investors dump UK assets over concerns about debt sustainability.
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Thin Margins
The UK’s BNPL market has already jumped tenfold from 2019. That’s been fueled by a cost-of-living crisis in the aftermath of the pandemic, higher interest rates on other types of credit, and the disappearance of alternative “payday lenders.” Klarna now has 10 million active customers, with top items in the UK’s recent Black Friday sales including the latest smartphones, sports shoes and gaming systems.
One BNPL business model — such as that used by Zilch Technology Ltd — offers consumers a virtual payment card, and earns revenue from commissions and advertising. But many of the emerging BNPL companies — including Sezzle Inc., DivideBuy and PayL8r — typically make money on interest-free loans by charging merchants a fee, usually around 3% of the transaction cost. This means they operate on thin margins.
When interest rates were close to zero, BNPL firms were collecting these fees while paying next to nothing in funding costs, but now they are having to adapt their business. Many of them have moved toward a securitization model, where they package up these short-term loans and sell them on to credit investors.
Klarna, for example, has been focusing on cutting costs following a massive down round in 2022, but is yet to return to profitability. The sector is being backstopped by some major financiers, such as hedge fund Elliott Investment Management for Klarna and KKR & Co.’s private credit arm for PayPal’s European business.
Affirm sees “significant opportunities” in the UK, and expects last year’s growth to continue in 2025, according to its country manager Ruth Spratt. It’s aiming to beat the competition and tap “a gap in the market” by offering wider payment options and no late or hidden fees.
Growing Scrutiny
With growth, comes scrutiny. The UK’s top financial regulator is drafting rules that will come into force by 2026 after the new Labour government last year promised measures that would “prevent people building up unmanageable debt” and ensure they were treated fairly by providers.
It’s taking action as consumer credit in the UK has been growing steadily in recent years, hitting a high of £232.6 billion in November, according to the Bank of England.
The new proposals would see the Financial Conduct Authority authorize and supervise BNPL firms, requiring them to carry out the same affordability checks as traditional lenders and offer customers the same kinds of redress.
Affirm’s Spratt said the firm supported regulation that promotes consumer choice and transparency. Affirm is a standout in BNPL circles for not charging late fees, though it does pass loans to collection agencies once they are more than 120 days late, and that may impact the consumer’s credit score.
Law firm Hogan Lovells expects BNPL firms to end up having much the same requirements as other consumer credit firms. Those include holding capital to deal with potential redress measures and losses.
Consolidation Risk
“There is almost certainly going to be consolidation,” said Jonathan Chertkow, a Hogan Lovells partner on the financial regulation side. “Big players have seen this coming, they’ve ramped up and are becoming compliant ahead of times. Smaller players who don’t want to do that will leave the market.”
Rob Pasco, general manager of credit for digital wallet Curve, which offers installment plans with typical interest rates of 12%, said it is planning to heavily invest in the UK market as the looming regulation would deliver a more “level playing field” between its business and BNPL.
Consolidation could also spell opportunity for larger BNPL firms, but they will have to shoulder the higher costs that come with regulation. One particular concern is redress cases being referred to a financial ombudsman, which would charge firms £650 ($790) for each adjudication after their first three visits. That’s a hefty fee in the context of BNPL, where the average value of UK transactions stands at around £70, according to research from Juniper.
“PayPal is doing this to gain market share for their core business,” Kearney’s Pethe said. “Klarna is trying to get more people into its ecosystem.”
PayPal and Klarna said they were in favor of regulating the market. Zilch said it has been regulated by the FCA since April 2020. Spokespeople for Sezzle Inc., DivideBuy and PayL8r didn’t immediately respond to requests for comment.
Still, the extra checks and balances could prove problematic for consumers used to smooth and fast transactions. That’s hard to square with the retailer establishing affordability and displaying mandatory consumer protection information.
Some BNPL players have already pulled back as market dynamics weaken. NatWest Group Plc axed its offering in March, less than two years after launching it, while Laybuy went into administration in June after failing to find a rescue buyer.
“If the customer journey becomes disrupted, some of them won’t want to do it anymore,” said Cherktow. “That’s a big tension.”
(Updates to add detail on Zilch business model 9th paragraph and comments from Zilch and PayPal in 22nd paragraph. A previous version corrected line in paragraph 16 to clarify there are no charges for Affirm customers’ delinquent loans.)
