The TechCrunch Exchange - Protect me from what I want

Saturday, January 21, 2023

Welcome to the TechCrunch Exchange, a weekly startups-and-markets newsletter. It's inspired by the daily TechCrunch+ column where it gets its name.

Buy now, pay later is an alluring option for consumers, perhaps even more so in a recession. But with rising debt and inflation, perhaps the focus should be on companies that help protect borrowers from digging themselves into a hole. — Anna

Image Credits: Nigel Sussman

The enduring appeal of buy now, pay later

I thought that tougher economic times would create immediate headwinds for the buy now, pay later trend. I was wrong.

“BNPL is a form of credit that allows a consumer to split a retail transaction into smaller, interest-free installments and repay over time,” and it is “in the midst of rapid growth,” a September Consumer Financial Protection Bureau report stated.

More recently, the Financial Times reported that “demand for BNPL boomed during the pandemic and has continued to grow, according to data from U.K. open banking fintech Snoop.”

This isn’t just a Gen Z trend, the FT added: Demand “has surged among all age groups in the U.K., including older people, who find themselves squeezed by the cost of living crisis and in need of short-term credit.”

The rise of consumer-focused BNPL is also global and arguably makes even more sense in markets where credit cards aren’t as widespread.

Earlier this week, we learned that MENA-based BNPL startup Tabby had raised $58 million in a round led by Sequoia Capital India and STV, with notable participation from PayPal Ventures.

Tabby’s year-on-year growth likely helped it convince investors: Last March, the Dubai-based company “had a little over 1 million active users who shopped with more than 3,000 brands yearly. Now, Tabby says more than 3 million users shop from 10,000+ brands, including nine out of MENA's 10 largest retail groups,” TechCrunch’s Tage Kene-Okafor wrote.

However, it would be wrong to think that BNPL only appeals to customers who can’t access other forms of credit, whether that’s in emerging or developed markets. In its 2022 Consumer Lookback report, VC firm Battery Ventures found out that convenience, size of purchase and the ability to manage finances were the primary drivers for Americans to use BNPL.

Quoting data from polling firm Morning Consult, Battery also noted that U.S. adults “from households with annual income between $50,000 and $99,999, as well as those with annual income of $100,000 or more, [were] even more likely to have used BNPL (21% and 20% in June, respectively).”

Talking to TechCrunch, Battery vice president Courtney Chow called this finding surprising, as she and her colleagues had hypothesized that BNPL would primarily appeal to “folks from lower socioeconomic background and not being able to have access to traditional credit.”

The broader-than-expected target audience of BNPL may explain why European player Klarna is, in the words of its co-founder and CEO Sebastian Siemiatkowski, seeing “tremendous growth despite challenging macro.” In a tweet, the entrepreneur revealed that the U.S. was “finally Klarna’s largest market by revenue, followed by Germany.”

That’s welcome news for the Swedish BNPL company, which saw its valuation slashed last year and whose competitors in the U.S. include Block-owned Afterpay and public company Affirm.

But on second thought, consumers still wanting loans in a recession is not that surprising. The more important question is what will prevent delinquency rates — the percentages of repayments that are past due — from continuing to rise.

Preventing delinquency

Battery’s report includes a warning that delinquency rates today may rise in the short-term given rising interest rates and inflationary pressures. Another source shares this view: TransUnion's 2023 Consumer Credit Forecast projects delinquency rates for credit card and personal loans to rise to levels not seen since 2010.

High delinquency rates would be a concern in a traditional finance environment, but the rise of BNPL adds another layer to it: There are virtually no guardrails that can prevent it from becoming a slippery slope for consumers.

Regulating BNPL is part of the answer, and that’s already underway in Europe, the U.K. and the U.S. But solutions to protect customers from debts they can’t repay will also come from other startups.

One of the things that caught my eye in Battery’s report is that the “companies to watch out for” featured in the firm’s BNPL section were not consumer-facing. Instead, it chose companies that help lenders up their game, and Chow explained why:

“I think a big part of the opportunity around lending is enabling the underwriters to have more data to have more accurate lending so that theoretically, you can increase and widen the top of funnel for the consumers that you’re able to service but at the same time, deliver superior outcomes for both borrowers and lenders.”

For instance, the VC firm highlighted API-centric startups Codat and Railz in the “alternative data” category.

“Alternative data is financial data that usually isn't collected by credit reporting agencies or typically provided when customers are seeking financial products such as a loan,” Railz wrote in a blog post. “In this essence, alternative data is a variety of sources including bank account cash flow analysis, usage of credit cards and other financial touch points such as rent or utility bills.

“This data also contains non-financial health checks such as education and employment records and can even include an individual's social media accounts,” it continued. “Financial institutions in turn can look at this alternative data to prove the good history and reliability of an individual, for example, paying rent and bills on time can demonstrate a good track record, or having a job shows an individual has a reliable income.”

With alternative data, Chow said, “you’re not just relying on a snapshot of traditional systems; you’re able to have more comprehensive profiles of consumers.”

In adjacent categories, there are also companies like Alloy, which helps banks and fintechs fight fraud, or Taktile, which lets fintechs “adjust their risk selection in a data-driven way and ensure they only underwrite the risks that match their strategy.”

If I had to choose, I’d be a lot more bullish about this type of startup than about consumer-focused BNPL companies, especially until we know what kind of regulation is coming their way — and whether the rocky macroeconomic environment changes consumers’ behavior. But of course, Tabby’s funding round shows that major VCs are still willing to invest in consumer-focused BNPL. Though if delinquencies continue to rise, will investors shift their focus away from consumers and toward “alternative-data” and B2B BNPL? That’s a story for another day, but one I’m keen to explore too.