Buy now, pay later startups are 'having a moment' - here's why retailers like Walmart and Target are betting on installment payments to keep consumers spending

• Buy now, pay later startups are seeing a surge in demand from merchants looking for new ways to get consumers to shop.
• Buy now, pay later startups charge merchants a fee for each transaction, but argue that their ability to drive sales and increase shopping cart values are worth it.
• While AfterPay and Splitit are both publicly traded in Australia, Affirm, Klarna and Sezzle have together raised over $2 billion in funding from investors like Ashton Kutcher, Snoop Dogg, and Visa.
• We spoke to execs at Affirm, AfterPay, Klarna, Sezzle, and Splitit about the rise in merchants offering installment plans at checkout.
• Click here for more BI Prime stories.

There's a lot of buzz about what consumers' new spending habits will look like as the country recovers from the coronavirus pandemic.

And while today, shoppers are reducing non-essential spending on things like fashion and travel, startups offering buy now, pay later solutions are hopeful that during the recovery from the coronavirus pandemic, their products will be in high demand.

These startups give consumers the option to purchase an item now and pay for it over time, usually in two-week installments. Often marketed as an alternative to credit cards, spreading payments over several weeks can give shoppers more flexibility than the monthly billing cycle of a credit card.

And amid the coronavirus pandemic and tough market conditions, executives at these buy now, pay later startups are already seeing an increase in demand for their products, both from consumers and merchants.

Merchants are looking to buy now, pay later products as a way to entice shoppers to keep spending. And these buzzy startups have seen a surge in inbounds from merchants across all industries, including fashion, home goods, and airlines.

Business Insider spoke with execs at Affirm, AfterPay, Klarna, Sezzle, and Splitit about this rise in merchant demand.

Affirm, Klarna and Sezzle have together raised over $2 billion in funding from investors like Ashton Kutcher, Snoop Dogg, and Visa. AfterPay and Splitit are both publicly traded in Australia.

A tipping point in adoption

"As a concept and as an industry, this is probably a tipping point in terms of adoption," said Brad Peterson, CEO of buy now, pay later startup Splitit.

While their payment schedules vary, all of these startups offer consumers the ability to split a purchase into several installment payments. While Affirm charges interest (between 0 and 30%), AfterPay, Klarna, Sezzle, and Splitit do not, instead offering interest-free installments, typically with no fees unless a consumer fails to pay on time.

Over the past few weeks, these startups have seen consumer spending in industries like fashion and travel decline. In-store spending has been hit the hardest, as non-essential shops have been closing. And online, consumers are spending less on non-essentials, too.

"Aspirational spend, or splurging, has decreased significantly," said Peterson.

But consumers are still spending, shifting dollars toward the essentials, he said.

"People are spending in categories that you could argue are more necessities," Peterson said. And necessities means more than food.

Affirm, for one, has seen spikes in online spending at big-box retailers like Walmart and Target. It also saw a 92% spike in home office sales at merchants like standing desk retailer Uplift Desk, and a 40% spike for home appliance sales at retailers like Dyson.

And consumers who are tight on cash due to temporary job loss, furlough, or reduced wages, are turning to these installment options to finance those purchases.

"I think certainly the demand for credit, in general, is going to go up and for consumer-friendly credit, like interest-free installments. I think all trends are in our favor now," said Paul Paradis, chief revenue officer of Sezzle.

Surges in merchant demand

Over the past few weeks, buy now, pay later players have seen a surge in demand from online retailers. Offering one of these installment options at checkout can help increase the cart conversion (the number of shopping carts started that end up as purchases) and average order values, the startups say.

"Inbound merchant interest in AfterPay continues to exceed expectations," said Ben Pressley, executive vice president of strategy and sales operations at AfterPay.

"I think the buy now, pay later market is definitely having a moment," said Pressley.

Klarna, too, is seeing retailers expedite their onboarding conversations, said Sebastian Siemiatkowski, the company's CEO.

"Their focus on online sales right now has increased quite a lot, considering the physical stores being closed," said Siemiatkowski.

And it's not only fashion and home goods that are looking for buy now, pay later solutions.

"We're talking to everyone from airlines to fitness brands," said Greg Fisher, chief marketing officer of Affirm.

"In the travel and ticketing space, we're actually seeing acceleration because they're looking past this and saying, people are going to be more cognizant of how they're spending their money," said Fisher.

Proving their value to merchants

Offering a buy now, pay later option at checkout can help merchants increase sales, but it comes at a cost.

Where processing a credit or debit card transaction means paying interchange fees set by card networks - usually between 1% and 2% - the buy now, pay later business model costs more for merchants.

When a consumer makes a purchase using one of these startups at checkout, merchants pay a fee for the sale which ranges between 3% and 6% of the purchase value.

"Merchants want to do all they can to convert people that are browsing," said Peterson.

Especially for retailers that have both a physical and online presence, boosting online sales can help them stay afloat while their brick-and-mortar stores are closed. And merchants signing on with these buy now, pay later solutions are starting to weigh the costs of traditional marketing versus the installment options at checkout.

"If you were a merchant today, you might say, well this is an increase in my payments costs," Siemiatkowski said.

But some merchants think about it differently, Siemiatkowski said. Merchants are thinking about buy now, pay later as not just a payment method but a customer conversion tool.

While offering a buy now, pay later option costs more than credit card sales, affiliate marketing through digital outlets and influencers can cost merchants anywhere from 5% to 20% of a sale, Business Insider has reported.

And in recent weeks, retailers have started to suspend their affiliate marketing programs that work with influencers and digital publications to reach shoppers.

"We improve conversion, which helps the business case to justify the cost of doing so," said Peterson.

On average, Splitit has seen a 78% increase in cart conversion, and a 20% increase in order value. AfterPay partners see a 22% increase in conversion and a 20% to 30% increase in average order value. Affirm says it increases average order values by 85%, according to its website. Klarna says it has seen a 45% increase in order values for its installment product.

"If you're going to pay more for something, you want to make sure that that actually has a meaningful impact on your average order value, on your purchase frequency, on your promotion rate, the number of new customers," said Klarna's Siemiatkowski.

And many of the buy now, pay later players drive sales for merchants not only at checkout but on their own websites. Their store directories, which list all the retailers that accept the product, is a key way the startup funnels shoppers to its merchant partners.

"We end up being one of, if not the largest affiliates for lead flow that most of our retail partners have," AfterPay's Pressley said. "And those leads convert at an extremely high rate."

And Affirm says it drove $500 million sales to its 4,000 merchants via its app and website in the last year.

Managing risk and consumer credit

When a shopper uses a buy now, pay later option at checkout, merchants typically get paid in full by the installment plan provider. Shoppers then pay back the installments to the buy now, pay later company. So these startups take on the risk if a consumer can't pay.

"I think the area that differentiates the players in our space the most is kind of how they go about determining what to give to who and when," said Sezzle's Paradis.

"We have to be more conscious of our risk, because there are a lot of people that are losing their jobs for the time being, or may have to experience pay cuts," Paradis said.

While each company assesses credit in different ways - be it through soft credit checks or other data - if a consumer misses a payment on an installment plan, they aren't able to transact again until the balance is paid.

When a customer is declined for a buy now, pay later solution, it's usually because they are new to the service, the order value is too high, or they have outstanding balances with the installment provider.

And for these free installment products like AfterPay, Klarna, and Sezzle, there are also late fees (around $7 to $10) if a consumer doesn't pay back installments on time. Though these providers offer grace periods before fees are charged.

Splitit uses a customer's existing spending power on a credit card to determine how much they can spend through their installments.

And Affirm, which offers installments in the form of loans with an interest rate between 0 and 30%, doesn't charge late fees.

"We only do pay-over-time for those people who we think responsibly can buy that item," said Affirm's Fisher. "The reason we hold to that principle is that we don't charge late fees."

And while most of the buy now, pay later players offer non-loan installments that are paid over a period of six weeks from the purchase date, Affirm's loans typically are issued in three, six, or 12 month terms.

"The unfortunate fact is that a lot of Americans are seeing a rapid deterioration of their personal financial situation," said Siemiatkowski.

"You have to take that into consideration as well and be very mindful of that in how you think of doing this and presenting these options and who do you actually accept to use these solutions as well," said Siemiatkowski.