The Checkout as a Territory

Who is this for?

• Founders. The "Buy Now, Pay Later" (BNPL) movement is a lesson in how innovation is often a matter of reinvention. Though superficially similar to layaway purchasing, companies like Klarna alter the payment dynamics to benefit the consumer.
• Investors. Afterpay is publicly traded, while Affirm is headed to IPO. Before investing in these companies, it's worth understanding what they do, the competition, and potential defensibility.
• Learners. The checkout page is one of the most valuable territories on the internet. BNPL companies are leveraging behavioral science to extract maximum value from that terrain, incentivizing impulse purchases.

HJ. Paul Getty had a simple formula for success: “Rise early, work hard, strike oil.”

His life seemed to follow precisely that pattern. In 1914, his father gave a 22-year-old J.P. $10,000 to buy land and grow the family’s holdings. He picked a spot in Haskell, Oklahoma, and promptly hit oil. Within two years, he was a millionaire. That knack seemed to follow the younger Getty throughout his life — a nose for opportunity, a gift for sniffing out valuable terrain. By 1957, he was declared the richest living American, ascending to the spot of world’s richest citizen less than a decade later.

Max Levchin, founder of Affirm, seems to have a similar ability. Levchin was still in college when he teamed up with Luke Nosek and Scott Banister to start the business that would eventually become PayPal. That venture alone made Levchin a reported $34 million in his twenties before he went on to build Slide, a social media platform that sold to Google for $182 million. But it is his latest venture, Affirm, a financial services business heading toward IPO, that brings to mind the career of J. Paul Getty and other oil tycoons.

Affirm and its competitors, Klarna and Afterpay, are in the midst of a great land grab to rival the skirmish over the Permian Basin. Though bearing the appearance of financiers, these companies bear a closer resemblance to oil barons fighting over valuable terrain: the checkout page. In its proximity to generating revenue — the dividing line between a consumer’s wallet and corporate coffers — this page represents one of the most valuable destinations, one of the most lucrative territories on the internet.

It is a battle waged across the buying process and in our minds.

Buy now, pay later

Sebastian Siemiatkowski and Niklas Adalberth met at Burger King. Standing in the kitchen, watching frozen patties pass along a conveyor belt to be grilled, the two became friends. Years later, the pair would attend the Stockholm School of Economics, and along with two others, begin work on Klarna. In 2005, the company’s founders even pitched the concept at the university’s annual entrepreneurship event, receiving a decidedly tepid response and finishing among the very last entrants. Undeterred, Siemiatkowski and Co. have gone on to build a business reportedly worth $5.5 billion, pioneering a new category in financial services in the process: “buy now, pay later,” or BNPL.

Joined by Affirm in 2012 and Afterpay in 2014, BNPL businesses allow customers to smooth the cost of a purchase by splitting it into installments. Instead of shelling out nearly $2,000 for a Peloton bike, for example, consumers can pay $49 a month for 39 months. With 0% interest, it’s a no-brainer for buyers and a powerful conversion tool for the hardware manufacturer.

Though BNPL has been referred to as modern “layaway,” the assessment is somewhat disingenuous in the product’s particulars and the implied abusiveness of the practice. As noted, these companies often offer services at 0% interest, permit access to the product at the time of checkout (rather than after payments have been made), and cap late-fees.

BNPL businesses earn most revenue from merchants. Because of their effectiveness in improving conversion and increasing basket size — we’re more likely to buy and buy more when we know it won’t hit our pockets too hard — merchants are happy to pass on single-digit percentages of order value to BNPL providers.

The convenience of this offering has led to explosive growth. While the global BNPL market was pegged at just $7.3 billion in 2019, it is expected to reach $12.9 billion by 2022. Domestic reports show rapid US expansion, with a 197% GMV improvement, year over year.

The coronavirus has proven an unexpected boon. Unemployment has made delayed payment even more attractive and intensified fears over credit card debt. Stay-at-home orders have brought forward e-commerce adoption, for which BNPL is a native offering.

Assuming terms remain roughly equivalent and more purchases are made online, we should expect BNPL to comprise an increasing segment of global payments. Much of its ascendancy should be attributed to the greed and ineptitude of the credit-card industry.

The credit card killer

Whatever one’s political affiliations, Elizabeth Warren’s description of the credit card adeptly summarizes the fears shared by many: “My advice is to treat [credit cards] like what they are: little plastic grenades that must be handled very carefully.”

How did a modern convenience become a national bête noir?

The name may come from fiction. In his 1888 novel, Looking Backward, Edward Bellamy portrayed a utopian future in which citizens used “credit cards” to access stipends granted by an all-powerful government; they bore a closer resemblance to debit cards in their actual functionality.

It would take seventy years for a recognizable credit card to emerge. In 1950, Diners Club released a “charge card” that allowed consumers to delay payment until the end of the month; in 1958, Bank of America introduced the revolving credit line. Though rewards and terms changed, the lines were drawn — a card that allowed the consumer to spend beyond immediate means.

While that provided a popular premise in the decades that followed, the Global Financial Crisis catalyzed a change in opinion. Millennials, many of who began careers or watched family members suffer through the recession, developed an aversion to credit cards, with just 33% using them, per a 2016 survey. This represents a departure from prior generations, in which the majority of the population held them.

This pattern seems to hold for Gen Z: while Baby Boomers have an average of 3.5 cards per person, and Millennials have an average of 2.5, Gen Z has just 1.4. Age differences play a role, certainly, as do contrasting preferences and values. While only 32% of Americans feel they would be judged for having credit card debt, that worry rises to 55% among Millennials.

BNPL capitalizes on this growing disinclination, offering a convenient solution with a capped downside. Compared to the classic credit card, BNPL solutions present considerably less risk. Let’s imagine that two consumers want to buy a $1,000 treadmill. Consumer A purchases the treadmill with their credit card; Consumer B uses a BNPL product. At the time of the purchase, Consumer A charges $1,000 to their card, while Consumer B promises to pay four installments of $250 over four weeks.

Both default.

Consumer A incurs a late fee of $36 (the current average), while the remaining balance appreciates at an APR as high as 29.99%. Consumer B, meanwhile, pays a late fee of $24 (Afterpay’s pricing, as an example), with 0% interest on the outstanding balance. While Consumer A would continue to accrue late-fees at the same rate, Consumer B’s penalties would stop at 25% of the total price, or $250.

There are downsides. BNPL users cannot build their credit score by using the product (though they also protect it from damage), and it is not nearly as universally available as paying by credit card. There are signs that this is changing, though. Affirm, Afterpay, and Klarna all have “virtual card” systems that allow paying in installments for almost any product online, without the merchant having adopted a BNPL solution. While this is a relatively inconvenient process now, you can imagine these companies issuing a physical card to the same end.

The clear benefits of the BNPL model may explain why adverse selection is less of an issue for BNPL providers than initially believed. While some customers may leverage the service because they struggle to access capital elsewhere (a fear raised about Afterpay by Bronte Capital in 2018), more than 75% of surveyed BNPL users report having the funds to pay in full. Indeed, a recent analysis of BNPL providers Klarna and Afterpay suggested the percentage of their loans that are either high-risk or in default is lower than traditional banks like Lloyds and Barclays, and neobanks like Monzo.

The model works, the product is in demand, and market tailwinds are pushing BNPL adoption. Perhaps, in time, companies like Afterpay will eclipse American Express. And yet, even that prize may miss something in its relative smallness, a metaphor in minor-key.

BNPL businesses are at the start of a turf war, fighting to win the checkout. And like real combat, their success depends on winning hearts and minds.

The battle for the checkout

Companies build value differently. Some might do it on the strength of their technology, others on the network they develop. BNPL businesses do so by focusing on the territory they occupy: the checkout page. How can they exert control, extract greater value, and increase their landholdings? Existing players are doing so by cultivating “upstream” relationships, focusing on specific categories, and architecting the checkout experience to incentivize impulse purchases.

Moving upstream

How do you win the checkout? Increasingly, the answer is to move upstream. BNPL companies are engaging in a range of tactics to ensure that customers have already made their selection when it comes time to pay.

The primary method BNPL companies use is to make their site a destination in and of itself. The positioning of Affirm, Afterpay, Klarna, Quadpay, and Sezzle, per their websites, is remarkably similar. They present as a shopping website, allowing customers to browse by category before redirecting to a merchant page. Whether they realize it or not, the consumer has selected their method of purchase. When it comes time to pay, the site defaults to offering the BNPL provider-in-question.

Virtual cards represent another proxy war for the checkout page. Again, the payment method is made in advance: customers add money to their card, then navigate to the merchant page. This represents a reasonable tactic to capture spend with merchants that don't provide BNPL service but is rendered obsolete as soon as one or more offering is in place. Given the similarity of terms, consumers are unlikely to go through the extra steps of topping up a virtual card on Affirm if they can check out directly with Klarna.

Quadpay has sought to control the customer differently. In addition to focusing on mobile (its CTAs are directed towards users downloading its app), the company recently released a Chrome Extension. Once installed, the extension allows the user to pay by installment anywhere online, providing the same value as a virtual card without the onus on the user to top up first. We should expect other providers to follow suit.

An ironic specter haunts these efforts. PayPal, Max Levchin’s old company, announced BNPL offerings in August of this year. Not only does it have much more downstream distribution (checkout), but perhaps the best tool for upstream distribution.

The company’s $4 billion purchase of Honey, a Chrome extension that automatically searches for discounts, may be the perfect BNPL Trojan Horse. Honey’s clear value proposition (install to save money) allows them to capture users outside of the transaction cycle. Whether you’re planning on making a big purchase or not, it’s worth having on your browser. You can imagine a future in which Honey not only offers discounts but payment terms. Save 20% at checkout and pay with installments, all via the same interface.

It will be interesting to see if BNPL insurgents seek to replicate that strategy by adding discounts of their own, or acquiring a company like Drop. They may have better luck by focusing on a particular sector.

Category focus

As competition heats up, BNPL companies are picking lanes. A report from Hayden Capital details how this trend is manifesting at Afterpay. The Australian business is increasingly focusing on fashion and beauty, a sharp pick given that many of these purchases are impulsive. Moreover, merchants are brand-sensitive, meaning that they’re likely to work with the BNPL provider that feels most fashion-conscious. In this respect, success with one retailer begets success elsewhere; once you sign Glossier, Fenty Beauty is more likely to follow. This allows the company to accumulate territory within the category more easily. It also clarifies marketing messaging and allows Afterpay to develop a stronger relationship with a subset of customers. Finally, it also helps create a destination. As customers associate Afterpay with beauty and fashion, more buyers may begin their search on the site.

While Afterpay is the most explicit exponent of this strategy, there are echoes of it with Affirm. Rather than focusing on a specific segment, Affirm has made a name specializing in larger purchases. Along with links to apparel brands, Affirm’s website emphasizes automotive purchases, home decor, and luxury items, including jewelry. This may prove a savvy specialization, too: customers preparing for a significant outlay may think of Affirm first.

Increasing impulsivity

An understanding of human emotion is critical to BNPL extracting value from consumers. In researching this briefing, I reviewed several academic papers on impulse control and online purchasing.

One that particularly caught my attention appeared in Frontiers in Psychology and was titled, “Motivational and Affective Factors Underlying Consumer Dropout and Transactional Success in eCommerce.” It offers an overview of academic literature on the subject of online buying, motivation, and self-control. It is full of unsettling sounding passages like this one:

In contrast to the classic model of buying behavior, we assume that the motivation to buy can be installed even when it was not the original motivation, such as when a consumer who only planned to browse is presented with attractive offers.

Or this one:

Reduced levels of self-control have been posited as a likely predictor of spontaneous purchase. Self-control lapses are often explained by missing capacity to exert control due to continuously or momentarily impaired ability to engage in self-control. However, self-control can also be hampered by situational factors, especially when the costs of indulging in temptation are blurred.

Beneath a declaration stating that authors worked “in the absence of any commercial or financial relationships that could be construed as a potential conflict of interest” is a telling line.

“This work was supported by Klarna UK Ltd.”

Just as Edward Bernays, the nephew of Sigmund Freud, used his uncle’s understanding of the human psyche to help sell bacon and cigarettes, modern BNPL providers are not just financial businesses, but behavioral ones. Within the checkout page terrain, they are architects of experience, tasked with optimizing every aspect toward a particular end: the purchase. As they move outside of this territory to upstream competitors, their influence may grow.

When viewed through this lens, the future of these companies may look somewhat surprising. Less like the 21st-century’s Bank of America and more like today’s social media behemoths. With an app on our phone, an extension in our browser, and a card in our wallet, BNPL may attain ubiquity, which, in turn, provides the basis for constant commercial manipulation. Site visits, payment history, and location tracking could be used to strategically serve discounts, upsells, and installment payment offers, designed to provoke purchases. Though existing financial businesses have similar tools at their disposal, BNPL companies’ incentives directly align with this future: they justify themselves only so much as they increase conversion above the status quo. Spurred by competition, that mission may lead exponents to pursue a more invasive relationship and dig deeper.

To capture the checkout page and maximize its value, companies like Affirm, Afterpay, and Klarna are extending the theatre of war and bringing their functionality to new places. In doing so, they may hasten the decline of the credit card and usher in an era in which consumers treat every purchase as a pseudo-subscription, smoothing their costs and limiting the downside of defaults.

But as large payment processors like PayPal enter the arena and use their distribution to surpass the reach of insurgents, success may depend on other factors.

“Oil is like a wild animal,” J. Paul Getty once said. “Whoever captures it has it.”

The tycoon could just as well have been speaking about human desire as oil. The fight is shifting. As BNPL becomes more of a commodity, it may be those that understand emotion, those able to control impulse, that are best poised.