Buy Now Pay Later: why it works

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The number of times I come across mentions of Buy Now Pay Later (BNPL) has dramatically increased and became ubiquitous in both brick and mortal businesses and the digital landscape in last 6 months. The BNPL concept is based on good repayment behaviour, in exchange for affordable purchases, through flexible payment plans. The market value of BNPL platforms such as  Klarna, Afterpay and Sezzle is projected to rise globally at a CAGR of 21.2% by 2027. 

Little bit of context for Southeast Asia. Out of the over 670 million people in the region, only 27% of the population have bank accounts. This sizable gap in banking penetration results in approximately 438 million unbanked individuals, with no bank account, credit or debit card or access to lines of credit. In parallel, there has been a shifting trend away from bank accounts and credit cards to services like BNPL, especially in younger consumers, due to debt aversion and ease of use. Hence, BNPL’s huge appeal.

The concept of BNPL is not new. Yet it is becoming increasingly popular and utilised due to a combination of factors, which include how humans are built as well as #COVID19 imposed restrictions (we have lot of spare time, are unable to travel and go shopping and feel the urge to online shop as a means of compensating), among others.

Here we review the main behavioural and psychological factors that drive BNPL:

1) Lose aversion

2) Present bias

Loss aversion

Research has found that spending money triggers areas of the brain associated with pain and disgust and that different forms of payment trigger different levels of discomfort. The pain of making a payment depends on the amount to be paid and on the method by which payment is made. Consumers who paid by credit cards rather than cash seem to experience less of a pain and hence were more willing to incur a given expense. As cash represents a physical representation of value, we feel more pain as people literally see themselves losing money.

Credit cards can be considered a prototype to BNPL as they use the same premise, albeit the only difference is paying the total price at a later date. Paying with credit cards provides a smooth transactional process, essentially decoupling the pain of losing their money in exchange for a product as there is no real money counting/giving process. An MIT study looking at purchasing tickets to a basketball game found that card-paying students were willing to pay twice as much as cash-paying students. Payment via credit cards is perceived as parting with a lower monetary value.

In both cases, the pain is linked to loss aversion, which is the tendency to prefer avoiding losses to acquiring equivalent gains. E-commerce companies are particularly adept at this, and constantly create urgency, offer deadlines for discounts and other ways of creating a psychological phenomenon of FOMO.

In brief, we are built to avoid pain by all means, which, in our daily lives, is recurrent phenomenon every time we pay via cash or credit cards. Perception of payment sometime later feels less painful.

Present bias

We humans are built to be focused/biased in present. We value $100 more today then tomorrow, less the day after and even less in future. In other words, present bias represent that fact that people place a greater value on goods/income achieved in the present moment – rather than receiving the same goods/income in the future. It suggests given a choice between a payoff today and a pay off in the future; we will choose to have the pay off now.

The timing of payments impacts the perceived value of a product. For example, people that pay for gym memberships monthly are more likely to exercise and renew their memberships compared to those that pay annually. These services provide a balance between pain and the perceived value/connection to the product. The focus shifts towards paying in future via smaller instalments, which are perceived as appealing and more affordable. As a result of tangible cash being abstracted away from us, it is harder to resist our impulse not to shop/consume via BNPL.

The BNPL business model is heavily relying on payment in future in various industries. Flexible options from ‘buy now, stay later‘ hotelier packages supporting Asian tourism, to car manufacturers’ deferred payment plans for boosting car sales, all the way to ‘fly now, pay later‘ air travel are increasingly popular.

You may ask what is the result of these two phenomena combined? Studies show that tourists (and pretty much any anyone) with high loss aversion and high present bias are more likely to overspend.

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