Buy Now Pay Later (BNPL) is a classic example of an old concept, installment payments, rapidly growing due to a digital renaissance. This trend has the potential to disrupt established payment providers due to BNPL’s ability to bypass the traditional payment “rails” provided by Mastercard and Visa (V). However, our analysis of Mastercard’s competitive advantages indicates that BNPL is unlikely to displace traditional credit card products.
The BNPL market is evolving, with industry pioneers Affirm, Afterpay, and Klarna competing alongside approximately 170 lesser-known rivals in an estimated $7.8 billion global market. More recently, established payments and technology firms, including Visa, Mastercard, and Apple (AAPL), entered the BNPL landscape with their own offerings. The BNPL concept has proven to be popular. In 2021, consumers spent $120 billion on purchases using BNPL programs, up from $60 billion in 2020—a 100% increase.
The BNPL business model is relatively simple. At purchase, consumers can opt to use a BNPL service to pay for a transaction. Typically, this results in an installment plan in which the first payment is required at the point of sale, followed by three to six subsequent payments over the next several months. If all payments are received on time, the consumer is not required to pay interest. BNPL firms generate revenue by receiving a percentage of the total purchase price.
The [Buy Now Pay Later] concept has proven to be popular. In 2021, consumers spent $120 billion on purchases using BNPL programs, up from $60 billion in 2020—a 100% increase.
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Mastercard ranks among the largest electronic payment providers in the world. The company benefits from powerful competitive advantages, including brand strength and a global acceptance network. It generates revenue by taking a small fraction of the total purchase volume that is processed on its network. As a result, revenue growth is a function of global consumer spending, and Mastercard benefits as electronic payments continue to displace cash payments around the world. Importantly, Mastercard does not assume consumer credit risk.
In late 2021, Mastercard launched its own BNPL service, Mastercard Installments. Consistent with past product innovations, the company leveraged the strength of its existing credit card user base, brand recognition, and acceptance network to create a seamless consumer BNPL experience. A key differentiator is Mastercard’s usage of its established “open loop” network, in which Mastercard facilitates transactions by connecting consumers, merchants, and third-party lenders.
There is a meaningful distinction between Mastercard’s BNPL model relative to the “closed loop” system employed by most pure-play BNPL companies. In a closed loop, the BNPL firm acts as facilitator and lender in consumer transactions. This framework effectively turns BNPL firms into small, unregulated banks with exposure to consumer credit risk. Additionally, BNPL firms must raise capital in order to maintain loan growth, thereby exposing them to the whims of capital market participants and rising interest rates.
Another important difference is in the size of acceptance networks. As of June 30, 2021, Affirm had approximately 29,000 merchants integrated into its platform. In contrast, Mastercard maintains a global acceptance network of more than 90 million merchants. As a result, Mastercard’s BNPL effort stands to benefit from scale, ease of use, and familiarity relative to standalone BNPL offerings.
Based on our analysis, we are skeptical about the long-term viability of the standalone BNPL business model due to questionable lending standards and higher borrowing costs.
In 2021, the Consumer Financial Protection Bureau launched an investigation into BNPL products based on concerns about consumer debt accumulation, murky regulation, and consumer data usage. The basis for this investigation is corroborated by real world experience. According to survey data from Citizen’s Advice, up to 42% of consumers use some form of borrowing in order to make BNPL repayments.
Reliance on capital markets among BNPL firms is another potential pitfall. BNPL firms fund a portion of new loan generation by securitizing existing loan portfolios and selling them to investors. The cost of these transactions has risen significantly over the past year. Back in February 2021, Affirm’s coupon rate for notes maturing in four years was 0.88%. Fast forward to May 2022, and the market required a 4.3% interest rate for a similar basket of loans with a five-year maturity.
Implications for Mastercard
We view the rise and potential demise of BNPL lending as roughly neutral to Mastercard’s long-term financial prospects. We believe Mastercard’s approach to enabling BNPL transactions on its existing platforms is sustainable and consistent with the company’s competitive strengths. Further, we believe Apple’s decision to use the Mastercard network to enable its own BNPL offering validates the strength of Mastercard’s market position.
On the margin, Mastercard could lose some portion of purchase volume for BNPL activity that bypasses the company’s transaction processing network. However, Mastercard stands to benefit indirectly from BNPL usage, as a portion of BNPL repayments are made via debit and credit card networks, including those operated by Mastercard. Further, BNPL firms are potential Mastercard customers for analytics offerings, including fraud detection and credit analysis.
We rely on our analysis of competitive advantages in order to understand evolving industry trends. This framework is especially helpful in the rapidly changing financial technology landscape. In our view, Mastercard’s unique business model, strong cash generation, and forward-looking business leaders should enable the company to offset potential disruption from BNPL competition and navigate future changes to the global payments marketplace.
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The discussion of the specific securities identified in this article is solely intended to illustrate the application of our investment approach. Our views expressed herein are subject to change and should not be construed as investment advice and are not designed or intended as a basis or determination for making any investment decision for any security. The specific securities identified are taken from a representative account of the Jensen Quality Growth Equity Composite and do not represent all of the securities purchased and sold for the Strategy. Our discussions should not be construed as an indication that an investment in a security has been or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of any security discussed herein. This information is current as of the date of this material and is subject to change at any time, based on the market and other conditions. Past performance is no guarantee of future results.
Certain information contained in this material represents or is based upon forward-looking statements, which can be identified by the use of terminology such as “may”, “will”, “should”, “expect”, “anticipate”, “target”, “project”, “estimate”, “intend”, “continue”, or “believe” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of a client account may differ materially from those reflected or contemplated in such forward-looking statements.
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