Where is the Buy Now Pay Later Industry going in Europe?
Today, consumers have alternatives to buy those coveted sneakers without touching the money in their bank accounts or touching their credit card (if they have one). There are options that allow them to do this without ever having to walk into a bank and without paying any kind of interest (if they pay in time at least ☺!). Not too long ago this would have sounded far-fetched but thanks to embedded finance consumers can easily access this technology.
What is embedded finance and why is everyone in the fintech space raving about it?
Lending has likely existed in one form or another throughout civilized human history, with the earliest evidence found in the cradle of civilization itself, Mesopotamia. And although lending has been around for a long time, the nature, medium and way consumers access credit has changed many times.
Embedded lending is undergoing a transformation right now. Angela Strange’ famous quote: “every company will be a fintech company, as in the not-too-distant future” was prescient in how non-financial companies were going to integrate financial products or services in a seamless fashion.
Embedding financial services (from payments and lending to savings and insurance) allows new customer journeys to emerge that solve real-world problems for consumers. This creates enhanced value to customers, as they can easily mix and match services to best meet customers’ needs. Additionally, an improved experience for customers allows companies to strengthen customer stickiness and increase sales. In many instances, companies end up creating a completely new and superior value proposition.
Focusing on the consumer and financial trends of younger generations, Fintech's are re-engineering lending methods with the use of new technologies: APIs and automation and new business models: B2B2C and B2B2B distribution capabilities. A good example of the evolution is the embedded lending model of buy-now, pay-later “BNPL”.
“A lot of younger people don’t necessarily have a credit card, or they don’t want to have a credit card” Laurel Wolfe, Vice President of Marketing at Mambu
What is the market opportunity for embedded finance worldwide? Its Big!
It is estimated revenues for embedded finance services were US$16.1bn in 2020, but are anticipated to reach US$140.8bn in 2025, according to Forbes research. It is projected that the embedded finance addressable market opportunity worldwide is USD$7 trillion.
Addressing this market is not straightforward bearing in mind that regulation and payment systems are unique in every part of the globe, the necessities of each area are different and the development of startups in each area will have been specifically developed to help alleviate relevant issues.
For instance, Norway has the lowest proportion of cash payments at 3%, in the UK 34% of the population uses cash while in certain countries of Emerging Europe like Romania cash usage is 78%, this means that an additional layer for in-cash payments must be incorporated when delivering online payments solutions.
Particularly in Emerging Europe, comprised of 23 countries in Central, Eastern, and South-Eastern Europe and the South Caucasus, it is important to understand the market dynamics, the level of digital adoption, and even the PPP varies deeply from country to country. These countries, bare great potential as in many cases have a great unbanked population.
What are the pros and challenges of embedded finance?
What are the key drivers?
🔸 Open banking: tailor products according to customers’ needs. Need to earn trust.
🔸 Demand for innovative financial solutions: traditional models are becoming obsolete.
🔸 Customer solutions: frictionless, great customer experience, simple interface, and easy onboarding.
🔸 Open banking + high consumer acceptance + demand for easy and innovative financial solutions.
Buy-Now-Pay-Later
BNPL solutions permit consumers to skip paying at the point of sale and defer the cost of the purchase over several increments over time. They are offered directly by sellers or third-party services that pay merchants and collect consumers’ payments. BNPL also allows consumers to access the solution with little friction (signing up takes minutes or less).
• BNPL offerings are the fastest-growing online payment method in the US, Australia, Brazil, the UK and likely in other geographies. Market share is projected to expand at a compound annual growth rate (CAGR) between high teens and twenties percent over the next five years.
• BNPL providers can leverage access to more data to assess credit risk and integrate this into the retailer’s ecommerce platform.
• Consumers normally pay 0% interest, with late-fees (if any) charged at a flat-rate, and immediate service shut-off in the case of a missed payment.
• BNPL products make most of their profits from the merchants, instead of consumers in the case of credit cards. Merchants pay a fee in return for benefits like greater basket value and new customer traffic.
• There is better alignment of interests between consumers and the BNPL providers.
• BNPL increase access to loans, including for populations that likely do not have access to it
Generational Shift
BNPL products have grown in popularity thanks to their use by younger generations that are digitally native, ecommerce driven and have a well-established aversion to debt (particularly with credit cards, which have the highest interest rates of all debt)
• According to statistics in the US, only 33% of millennials carry credit cards, for example. For this reason, it is no surprise that millennials and Generation Z are the largest BNPL users.
• Afterpay has reported that its average customer age is 33.
• Millennials and members of Gen Z represent a growing portion of the world’s consumers. Retailers that do not embrace BNPL offerings thus risk missing out on significant profits.
The generational shift in use of credit cards by younger generations is more striking when we consider that in emerging markets credit cards are a lot more difficult to access and have higher interest rates that in developed markets. Here the prevalence of debit cards is much greater and BNPL solutions could be the first access to deferring payments that many consumers have easy access to.
BNPL in the UK and EU
Worldpay estimates that in the UK, the world’s third-biggest e-commerce market in approximation at US$266 bn transacted in 2020, it is estimated that BNPL will account for 10% of all sales by 2024, when the overall e-commerce market will be worth US$366 bn. Europe as a market is likely to make up as much as 50% of buy now, pay later spend in the coming years with the vast majority of users being under the age of 35.
BNPL is gaining market share quickly and as a consequence numerous start-ups in the space are successfully raising funds from investors. Investment in European BNPL players grew 118% YoY in 2020 to €1.08B. Over €930M was raised in Q1 2021 alone.
It is estimated that the European eCommerce market to be US$1.1 trillion!
Basics of the BNPL model
Business model for Merchants:
The merchant is incentivized to pay for the fees in the BNPL model since they get more value than a traditional credit card, with a boost in customer acquisition (depending on which BNPL) and in customer retention. The effect of both changes the unit economics of each customer that originates through the BNPL channel with an impact in the following metrics:
₋ better retention with more repeat purchases
₋ higher Average Order Values
₋ higher conversion rates
It is important to consider, that according to Payments’ latest research shows that 48% of customers who use BNPL will use it at POS and if the merchant does not recommend it, the customer will not buy from that merchant.
According to Hayden Capital, this makes the business model have a virtuous cycle:
↑ merchants = more use cases (+ categories) = + customers & ↑ usage frequency = FOMO to get BNPL = + merchants = higher BNPL profits (invested in marketing) = ↑ merchants
Only when BNPL providers have enough merchants, great market share, and brand ubiquity BNPL companies will be able to raise their take-rate!
Business model for BNPL Providers:
In general merchants integrate BNPL solutions into their buying process at checkout, and they pay 3% — 6% of merchandise value. Consumers receive the service for free and pay off their purchases over a 6week period. Payments are then made in 2-week intervals across four equal instalments, normally in a 6-week time frame. This implies a high capital velocity business.
• Assuming total loan maturity of 6 weeks, and average duration could be lower. BNPL providers can recycle their capital between 10–15x per year.
• Assuming a ~5% take-rate and ~30% pre-tax margin Returns on Capital of up to ~23% ($100 GMV x 5% take-rate x 30% margin x 15x capital recycle per year = $22.5).
Importantly, companies are bearing the credit risk. It can be estimated that the loses for companies such as Klarna, Twisto, and Zilch can be lower in terms of magnitude versus legacy lending products companies. So, how are they able to mitigate the risks associated with defaults? As these companies will use data to deliver the product needed by the customer.
Part of their advantage is the innovation side of their business models which mitigates risk. For instance, loan limits are relatively low vs credit cards which reach a maximum of US$1K -US$1.5K. Customers’ ticket size per transaction can range from US$80 — US$150. So outstanding values are low. Additionally, underwrites are done through both previous financial information and real time data which is usually locked within an individual or business.
Klarna takes the leadership of the total BNPL market later followed by Afterpay/Clearpay. On the other hand, an interesting advantage that a player like Twisto (know Zip), is the predominance it has in CEE which is a market that is ripe for disruption and that its population needs completely different products. BNPL services will have to adapt to challenges such as underbanked and unbanked population. It is important to understand that right now, there is a war for market share, with likely consolidation. Winners will most likely be determined by customer stickiness and who dominates the number of merchants.
Overview: Founded in 2005 in Sweden and is Europe’s most valuable fintech startup. Klarna’s offering to consumers and retailers includes payments (BNPL), social shopping, and personal finances.
Brands pay 4%-6% fee to Klarna for the service (processing fees included). For this, brands receive 1) customer stickiness 2) higher conversion rates 3) lower return rates 4) larger ticket sizes on average 20% — 30% 5) Klarna takes upfront risk with brand being paid upfront.
Team: company was founded by Sebastian Siemiatkowski, CEO, Niklas Adalberth and Victor Jacobsson whom participated in the Stockholm School of Economics annual entrepreneurship award in 2005 with their idea on how
to provide consumers and merchants with safer and simpler online shopping payment methods. However, their idea did not receive enthusiasm and their entry was among the last in the competition.
Today the company has more than 3,000 employees, most of them working at the headquarters in Stockholm.
Latest round: US$635 mm, led by SoftBank’s Vision Fund 2
Valuation: US$45.6 bn (+47.3% increase from post money valuation @ US$31 bn in March 2021);
Financials: 1Q21 @ US$18.1 bn volume vs US$9.9 bn in 1Q20. In 2020, it processed $53 billion in volume.
Exit Plan: The route would be and IPO via a SPAC or direct listing. Founder in its that the company ill remain private as it already behaves as a public company in its reports.
Target audience: Gen Z + Millennials
How do they deliver a differentiated GTM:
₋ Online merchants: 1–1 bilateral partnerships with merchants.
₋ Its branding is the antithesis of the corporate, sterile image of most banks.
₋ Social media: UK Instagram account has +141K followers, more than the combined of all the UK’s Big Four banks.
Traction:
o Presence in 20 markets, expanded to 6 new ones in 2021, including France, New Zealand, and CEE.
o US growth @ 18 M shoppers today.
o +90 mm global active users and + 2mm transactions/a day; partnerships with +250k retailers worldwide.
o Notable partnerships: Macys, H&M, IKEA, Expedia Group, Samsung, ASOS, Peloton, Abercrombie & Fitch, Nike & AliExpress, have enabled Klarna’s innovative shopping experience online and in-store.
o 85M social media impressions every month, marketing campaigns tap into pop culture. o 3.6M active users monthly on the shopping app (most downloaded BNPL app in the world.
Value proposition: offer innovative solutions at point of sales (POS); Has a bank license in Sweden.
- Merchant-centric:
a) Easy API integration at checkout.
b) Help reach new shoppers.
c) Increase the basket sale value.
d) Creates shopper stickiness.
- Customers:
a) Can access quickly to buy more.
b) Offers payment flexibility to pay for items between 30 days and 6 months.
c) Taps in the psychology of credit card aversion.
d) Conducts soft credit checks, with defaults credit score will be affected.
e) Is cheaper for consumers than traditional credit.
Overview: is a payment app for the mobile-first era. Twisto is a cashflow management and payment app that enables customers to pay for their online purchases with just one click. Connected with Mastercard and Apple Pay-compatible, the Twisto account enables customers to pay for their online purchases with just one click, deal with bills and invoices by taking a photo of them within the app, and pay just about anywhere else with the card, a special payment bracelet or ApplePay. On top of that, the account comes with the best exchange rate possible for international payments. Twisto aggregates the payments in a neatly designed mobile app, and customers pay them all at once at the end of each month.
Team: founded in 2013 by Michal Smida which will remain part of the Board of Directors after sale. The founder had over 10 years of international exposure and worked for four years in investment banking. He imported the solution from BNPL companies in eastern countries and adapted to solution to fulfill the specific needs of his operating markets.
The team is being professionalized and new hires have been made both at the CMO and COO level. These is crucial, when looking to execute new markets and integrate the Company under Zip Money.
Latest round: US$15.7 m Series B, led by Australian fintech company Zip Co and the early-stage VC for fintechs Elevator Ventures.
Valuation: US$106 m
Exit Plan: In May 2021, the company was acquired by Zip Co for about €89 million. Zip Co. had invested in Twisto in earlier rounds. The acquisition deal is expected to conclude in 4Q21, and founder and CEO Michal Smida, as well as most of the Twisto team, will stay on board. The acquisition will enable Zip to expand its global footprints into Central and Eastern Europe.
The acquisition will also help Zip to tap into the rapidly accelerating global BNPL opportunity.
Target audience: Gen Z + Millennials
How do they deliver a differentiated GTM:
D2C: They deliver their product through online merchants, which is a similar strategy to Klarna. Nonetheless, they can capture additional clients through their service bill payments.
B2B: Nikita in house credit score that can be used by third parties such as retailers and digital banks.
Traction: — 3 markets, Czech Republic, Poland, and Romania.
- Focused on CEE with 1.6mm users
- Increased by 2x the average transaction of credit card usage from 5 times/monthly to 10 times/monthly.
Value proposition: they offer flexibility to make daily payments go as easy and secure as possible, through its secure one-click online payments and its BNPL system. Through a payment app that is connected to Mastercard and is Apple Pay-compatible, customers can pay for online purchases instantly and to take care of all bills and invoices by taking a photo of them within the app. For credits users can receive money with a 45-day maturity and the option to defer their payments. It offers a unique omnichannel payments, which acts more like a digital wallet, instead of a credit card.
One of the differentiating factors about Twisto, is that its strategy is based on its local knowledge of CEE, where the market is still fresh and in development, where BNPL represents less than 5% of the overall ecommerce market. In Western EU, this can be as much as 30–40% of all e-commerce volumes.
- Merchant-centric:
a) Easy API integration at checkout.
b) Help reach new shoppers.
c) Increase the basket sale value.
d) Creates shopper stickiness.
- Customers:
a) Can access quickly to buy more.
b) Offers payment flexibility to pay for items.
c) Taps in the psychology of credit card aversion.
d) Conducts a differentiated credit scoring through soft credit checks, but if payments defaulted credit score will be affected.
e) Is cheaper for consumers than traditional credit.
f) Digital wallet enables customer to have other uses such as paying service bills.
Target audience: CEE Gen Z + Millennials + Gen X; usually higher- risk profile vs. western European countries.
Unique Market Opportunity: existing operations in Central Europe (purchases with BNPL solutions are still under 5% of all payments; Twisto estimates it will grow between 20% -30% of all online payments within 5 years, and feel that they are in a uniquely positioned. Being part of Zip’s global platform will accelerate their growth, expand to new markets, win global merchants operating in Europe, while leveraging global partnerships already in place and broaden their product offering.
Overview: London startup that has built an “over the top” buy now, pay later (BNPL) business out of cutting deals directly with consumers bypassing the need for integrating anything new into an ecommerce site’s check-out process, as many of the leading providers have done. It offers an online virtual card designed to allow its customers to pay overtime, anywhere. The company’s online card is done in conjunction with MasterCard and allows the customer to buy whenever and whatever they want splitting the purchase into multiple payments with no interest charged, enabling individuals to buy the goods and pay later. Zilch charges a 4% interchange fees to Mastercard. The company has won the consumer credit license from the UK regulator, the FCA.
Team: Founded in 2020 by Philip Belamant, CEO. Philip is a native of South Africa with over 16 years of experience in the payments and technology industries, Belamant has rapidly grown Zilch’s investment and consumer base. Before starting Zilch, Belamant founded, developed, and sold a variety of other fin-tech ventures. Belamant has launched value-added and mobile payment services in 15 different countries across India, Africa, and Europe and was the founder of a Top 40 fin-tech company in Africa. The services he launched in India, Africa, and Europe reached more than 20 million users and partnered with Airtel, MTN, Orange, TNM, and Vodafone.
Latest round: US$80 mm in a Series B, led by Gauss Ventures and M&F Fund,Ventures.
Latest Valuation: +US$500 mm
Exit: Potential M&A or future private fundraising rounds to enable them to grow and expand to other geographies such as the US and other countries in Europe.
“If Zilch succeeds, it could eat into the profits of both BNPL providers and traditional credit cards”
Target audience: Gen Z + Millennials.
How do they deliver a differentiated GTM:
Part of the innovative value proposition is that they deliver their services through a Mastercard card. That does not limit customers to shop on an application, but anywhere they can shop online and in person with a Mastercard.
Traction:
₋ 1 market, UK; expansion to US & other European markets.
₋ +500 K users; 4k new UK sign-ups per day.
₋ 4.66% weekly rate growth
₋ Twitter followers @ 676
Value proposition: consumer centric vs. retail centric. Zilch integrates with a user’s bank account, through open banking, to assess their credit situation and if they can afford a particular purchase. The transactions are then carried out with virtual cards issued by Mastercard. It earns revenue through commissions and interchange fees.
₋ Customer-centric:
o Can access quickly to buy more, as it offers a digital card. o Offers payment flexibility to pay for items in installments. First installment always @25%. o Taps in the psychology of credit card aversion. o Conducts a differentiated credit scoring through soft credit affordability vs. credit risk.
o Is cheaper for consumers than other types of credit because users are generally not charged interest and there are limits on the fees that can be charged.
₋ Gateway providers:
o Business is created directly with Mastercard. o Tapping into the worldwide interchange fees market @US$30 bn.
o Help reach new clients and increase number of transactions.
₋ Merchants:
o Business is not conducted with merchants but with Mastercard.
o Do not need API integration at checkout.
GTM: The use of “Fin-fluencers” is crucial, as they aim to - “only use Zilch ambassadors. Those who know and love products.” Zilchs’ CEO, Philip Belamant
Unique Market Opportunity: first BNPL fintech to secure a Financial Conduct Authority (FCA) license.
To conclude, I carried an analysis of all the three companies to better understand their differences, similarities and where are the opportunities for each one of them!
Business Model Comparison:
Expansion Plans and Market Opportunities:
• On the international expansion plans of the three start-ups the repercussions are the same what happens when you enter new markets with leaders?
o Zilch: How will the competition react in the US and other markets like Germany in the EU, with the new market entries? Already there is a great presence of Klarna, Affirm, and Afterpay, as well as incumbents such as Amazon and Paypal.
▪ Will Zylch’s differentiated approach be enough to capture remaining white spaces, especially as the BNPL industry finds itself at more mature stages in developed markets such as the US.
▪ Is it planning to grow through acquisitions or is the company open to M&A?
o Twisto: will be able to compete at a better pace as it was acquired by a larger company that dominates emerging markets in the Middle East. A competitive edge that they might have been that they offer an integrated solution that is basically a digital wallet. According to Pymnts.com and Pay Pals’ latest report on BNPL, 34% of Millennials will be more willing to try BNPL solutions if they were integrated to digital wallets. This is great news as they already offer invoice payments and that’s where players should move to, and they start embedding more banking services in their offering.
o Klarna: leader in many markets but will still need to continue to deliver innovative solutions and will have to continue to defend its position in the market, especially as incumbents with large followings launch similar solutions.
▪ Will continue to grow via M&A and will most likely look for ways to integrate local competitors into their portfolio. Klarna, has made 8 acquisitions and 3 investments. The company has spent over $ 375M for the acquisitions. The company has invested in multiple sectors such as Payments, Alternative Lending, Banking Tech and more. The founder explained that the next acquisitions will likely be acquihires.
• BNPL is still ripe for disruption and all the companies will have to move fast to continue conquering white spaces, especially as the market becomes more mature. The companies will need to continue delivering innovative solutions that are comprehensive and that address the comprehensive needs of its customers.
• It is important to take into consideration that there will continue to be more disruptors in the industry as it appears to be that Credit cards and traditional loans will continue to be disrupted, but more players in specialized categories like healthcare and airfares will continue to appear, as entry barriers will probably remain low.
Regulation:
• How will regulation affect these companies in the next 5–10 years? Especially, as tighter regulation may be coming, as today in most markets “buy now pay later” providers do not need a banking license or a credit license. The problem is that over-regulation might affect innovation at the product level and might decrease the growth of the category.
o Zilch: was recently granted a FCA license, and this might give them a competitive edge versus the other companies.
o Twisto: CEE is a highly regulated environment already, still potentially could wave having a banking license through its partnerships.
o Klarna: credit and regulation risks will vary depending on each country’s performance and associated risks. The great advantage is that Klarna has deep pockets to continue expanding and that they have a banking license in Sweden.
Demographics:
• Klarna, Twisto, and Zilch all target Gen Z and Millennials. I believe that they will need to expand to newer categories such as teenagers and Generation X. In that regard they will have to expand to other categories offerings like gamming and specialized categories where there is a higher spend.
• Zilch might have an advantage there, as they might be able to offer debit cards to teenagers based on their parent’s credit score. This might be an innovative solution that might help teenagers manage their money and build early on their credit scores.
GTM strategy:
• While Twisto and Klarna offer a similar distribution strategy which is via online merchants, which limits their capability to scale.
• On the other hand, Zilch innovative is the fact that it opens a virtual Mastercard that allows the customer to have the flexibility to shop at their place of preference. On the other hand, through affiliated marketing, Klarna enables anyone that has the app to access its marketplace and shop for anything they wish for with a ghost card, even if they do not have a bilateral agreement. The customer gets an initial amount of US$1k and additional credit limit is untapped depending on the customer behavior. Nonetheless, this limits the amount of people that use Klarna to the number of customers that have downloaded the application.
Data :
Will continue to be king. BNPL players will start moving from the referrer mechanism to the traffic owner through a deeper integration of its partners into their applications.
• Klarna: launched “Account Insights” a solution that turn into unique insights bank statements into through data categorization and enrichment. These incredible insights can facilitate a range of use cases including personalized budget plans, insurance checks, loan applications, credit- & risk assessments, personal finance management applications, and many more, all through a simple API integration. This will allow Klarna to move from BNPL to an aggregated solution that promotes more engagement.
• Twisto: Nikita credit score system in conjunction to all data collected from service bills on its digital wallet could give them a competitive edge.
• Zilch: it still on a very early stage and there is limited information to analyze the potential of its data collected. Nonetheless, if they can quickly collect data from users across geographies, shopping categories, and demographics they will be able to use it to roll out new products that create further customer stickiness.
Open Banking:
• Open banking will continue to be crucial to define the primary the guidelines to BNPL and it also helps in terms of cybersecurity.
• Apification is crucial as it allows the rapid massification, especially as it creates simplicity in the onboarding experience.
• A way that all three applications might be able to create more user stickiness, is by allowing the user to pay in the number of instalments of their preference (limited within the app). This makes the experience much more personalized. As the risk premium is higher, additional fees should be charged to the customer (this model works spectacularly well in Colombia).
Collaborations with Banks:
• We will see more cross-collaborations between banks and FinTech's in the next ten years, servicing clients together. The main reason is that they can be complementary to each other, as BNPL companies need banks for funding, might operate through the bank without ever needing a bank license, and banks can make profit from interchange fees.
And finally, as Athemis group states, “the future state of financial services is embedded, augmented, and ubiquitous.”
For this, we are beginning to challenge traditional financial business models and seeing new frameworks that are an intersection between financial services and every other industry, such as healthcare, energy, logistics and trade. We will probably move more towards a world where their solutions become increasingly interconnected and customizable, with innovative components that can be inserted into all types of companies across sectors. Consequently, this will create deep changes in society and ultimately propel economic growth.
