Supply chains are snarled and manufacturing is constrained. For weeks, headlines have been telegraphing a clear message to shoppers: This holiday season shop early.
In years past, early bird shoppers may have turned to layaway plans to reserve holiday gifts and pay for the purchases over time. But many retailers — including the nation’s largest, Walmart — have done away with or scaled back these programs. One reason is shoppers have new tools at their disposal to spread out payments.
A popular option for consumers are buy now, pay later plans. Retailers are big fans as well. The point-of-sale loans are easy for retailers to manage, and research shows these options lead to bigger baskets and greater customer loyalty. RBC Capital Markets estimates a BNPL option increases retail conversion rates 20% to 30%, and lifts the average ticket size between 30% and 50%.
Adding incremental sales
“It’s all about incrementality,” said Russell Isaacson, director of retail and automotive lending at Ally Lending, “getting that incremental sale or incremental consumer.”
Installment payments give consumers options and convenience when it comes to managing budgets and purchasing, according to Hemal Nagarsheth, associate partner in Kearney’s financial services practice. He said the option also increases trust between retailers and consumers, leading to “incremental sales, higher average purchase sizes, and higher frequency of purchase.”
Buy now pay later payment plans, offered by companies like Affirm, Australia-based Afterpay and Sweden’s Klarna, are particularly attractive to younger shoppers, like the much-desired Gen Z and millennial consumer. While each plan has differences — from the number of payments to the specific terms — the key similarity is the promise of a handful of equal payments spread over a relatively short period of time, with no hidden fees. Often, the plans are interest-free.
Installment payments are more popular among consumers that either do not have access to credit, or for a variety of reasons, do not want to purchase with a credit card. The option also makes a lot of sense for shoppers who don’t have the funds to cover the total purchase, but will over the next several paychecks, according to Ally Lending President Hans Zandhuis.
The average transaction value is about $200 for a buy now, pay later purchase, said Zandhuis. Often the checkout value for the retailer would have been around $100 had the ability to pay later not been available, he said. With it, that same consumer can spend $175 to $200, with 4 monthly payments of $50. The payments are meant to align with paycheck cycles.
Take apparel retailer Rue21, for example. Its key demographic is an 18- to 25-year-old female shopper, who often doesn’t use credit cards. With many low-priced items on its website, and waning mall traffic, increasing average order volume is a key priority.
When the pandemic shuttered stores, Rue21 had to figure out how to sell to its shoppers online without credit. Since Rue21 added Klarna as a payment option in-store and online, its average order volume is 73% greater than other payment methods, according to a case study Klarna published. Rue21 shoppers that transact with Klarna turn in the highest sales per customer with a 6% higher purchase frequency. As of May, Klarna purchases made up more than a quarter of rue21’s e-commerce sales.
A logo sign outside of a rue21 retail store location in Chambersburg, Pennsylvania on January 25, 2019.
Kristoffer Tripplaar | Sipa via AP Images
Affirm boasts that its merchant clients report a 85% increase in average order value when consumers opt to use its BNPL plan over other payment methods. Affirm approves installment payments for purchase totals as high as $17,500, which has proven to be very important for Peloton’s expensive workout equipment and services. FT Partners, an investment bank focused on the fintech space, estimated 30% of Affirm’s first-quarter 2021 revenue came from sales on Peloton’s website.
Klarna’s merchant base reports a 45% increase in average order value when a shopper pays over four payments. Shoppers can also opt to pay in full in 30 days interest-free, or for larger purchase, get financing with monthly payments from 6 to 36 months with an annual percentage rate of between 0% and 29.9%.
Attracting a customer a retailer might not have swayed otherwise is another benefit of offering a buy now, pay later options.
“We launched Klarna on the Macy’s website in October  and we’ve since scaled it across Macy’s, Bloomingdale’s and Bluemercury, both online and in stores,” he said. “With Klarna, we continue to see higher spend per visit and increased acquisition of new younger customers, 45% are under 40. Our goal is to convert all of these new customers to Macy’s loyal customers, who return for future purchases.”
Around 93% of Afterpay’s gross merchandise value in the most recent fiscal year comes from repeat users of the installment payment service, with the longest-tenured consumer making 30 more transactions per year.
Installment payments allow the retailer to “convert a [consumer’s] wish into a sale” according to Chris Ventry, vice president at global consultant group SSA & Co. “It eliminates the ability-to-pay roadblock” said Ventry. “For those using debit cards, the potential for an extended interest-free payment schedule through BNPL is enticing, ultimately enticing enough to drive conversion, which is the primary goal of all digital commerce sites.”
An analysis by Similarweb of the top 100 U.S. fashion and retail websites compared 50 merchants that offer a buy now, pay later option at checkout and 50 that do not. On average, sites with a BNPL option saw a conversion rate of 6% compared with 4% for those that do not.
Afterpay said it increases a retailer’s conversion rate and incremental sales 20% to 30% more than other payment options.
The incremental revenue and increased conversion makes the incremental transaction cost the retailer pays to the fintech companies worth it too. Zandhuis said while the retailer pays an additional 2% higher transaction fee to the BNPL company compared with transaction fees a traditional credit card company charges, “the math speaks for itself. The extra revenue is higher than the cost.”
Afterpay and Klarna charge merchants a 3% to 5% transaction fee, Affirm declined to disclose its transaction fees.
The programs also have advantages compared with traditional layaway, which requires retailers to store purchased items on site while customers make installment payments over time. Increasingly retailers are using stores as mini-fulfillment centers to service online orders. In this model, store space is at a premium.
Buy now, pay later is the fastest growing e-commerce payment method globally, with the growth of digital wallets second, according to FIS Worldpay. In 2019, the $60 billion BNPL market represented 2.6% of global e-commerce, excluding China.
Worldpay estimates that use of the option could grow at a compound annual growth rate of 28% to reach $166 billion by 2023. At that pace, it would make up about 5% of global e-commerce outside of China.
Right now, BNPL makes up less than 2% of North American sales, according to FIS WorldPay.
Coresight senior analyst John Harmon acknowledges the opportunity for retailers, but does not see it as a panacea.
“I don’t see BNPL as a magic solution, despite its booming acceptance, since it is just credit of a different sort,” Harmon said.