The buy now, pay later (BNPL) boom began with an unassuming debut over a decade ago. In 2005, three Swedish entrepreneurs—Sebastian Siemiatkowski, Niklas Adalberth, and Victor Jacobsson—decided to test whether their installment loan service (then called Kreditor Europe, now known as Klarna) could attract investors' attention at a Stockholm competition similar to "Shark Tank." According to Klarna's website, Klarna finished last in the competition. One person in the audience (including King Carl XVI Gustaf of Sweden) approached Siemiatkowski and suggested he stick with the idea because banks would never do it. Klarna's website is still searching for this mysterious figure, hoping they will come forward so the founders can thank them in person.

In less than 20 years, BNPL has evolved from a novel payment method for shopping into a multi-billion-dollar industry spanning three continents. However, its explosive growth has come at a high cost: currently, major pure-play BNPL competitors including Klarna, Affirm, Afterpay, and Zip have not achieved profitability. Some merchant clients have begun to question whether the high fees they pay to BNPL fintech companies are worth sales that might have occurred naturally.

Meanwhile, regulators such as Rohit Chopra, director of the U.S. Consumer Financial Protection Bureau (CFPB), worry that consumers are becoming over-indebted from using installment payment services. Additionally, industry competition and consolidation are intensifying, with new entrants flooding the U.S. market—a region where installment financing service penetration is lower than in other parts of the world. However, achieving scale is not easy and is costly.

David Sykes, head of Klarna North America, said in an emailed statement: "We welcome competition because it drives innovation and ultimately benefits consumers. Equally important, as more players enter the BNPL space, regulation is needed to ensure transparency and to ensure that the high standards we have consistently upheld are followed and enforced."

The Rise of BNPL

BNPL is a new take on the decades-old traditional "layaway" plans, which are still offered by a few retailers such as Sears, Big Lots, and Burlington Stores. Unlike layaway customers, who cannot take goods until they are fully paid off, BNPL borrowers receive items after signing a short-term loan agreement, typically paying in four installments every two weeks, with the balance due within six weeks. If payments are made on time, consumers can avoid interest.

In the early 21st century, several key trends gave rise to the current BNPL consumption boom. The first was the financial crisis. Research from the U.S. Bureau of Labor Statistics shows that young workers were hit especially hard in that recession: the unemployment rate for those aged 20 to 24 rose to 11.3% in 2008, more than double the 4.8% rate for workers over 55. This created a generation of workers averse to debt and cautious about credit cards—exactly the demographic BNPL companies target, claiming their services are superior to credit cards.

Salman Syed, general manager at Marqeta, said in an interview: "There was widespread uncertainty at the time, even a latent distrust of 'who can I truly trust and build a good relationship with in my banking relationship.' So there was a huge opportunity in the market to say, 'Hey, let me offer you a technologically advanced credit tool that will be completely different from what you've been used to.'"

Shortly after Klarna got started, PayPal entered the BNPL business in 2008 through its acquisition of Bill Me Later. After the deal closed, the San Francisco-based company renamed the business PayPal Credit, offering a revolving credit line usable anywhere PayPal is accepted. Last year, PayPal also launched a "Pay in 4" service similar to those of BNPL competitors.

Technological advances have also made it easier to build financial products like BNPL. Libor Michalek, president of technology at Affirm, said the growth of machine learning and increased availability of consumer data were key. "These technologies created the possibility to rethink credit," Michalek said in an interview. "We firmly believe that when consumers have information and tools, they make informed decisions and want to do the right thing, and we see that in the data."

According to a March report from Worldpay, a division of payment processor Fidelity National Information Services, by 2025 BNPL financing is expected to account for 5.3% of global e-commerce transaction value (about $438 billion), up from 2.9% ($157 billion) in 2021. The report showed that in 2021, BNPL transactions accounted for 3.8% of North American e-commerce sales, up from 1.6% the previous year; in Europe, BNPL accounted for 8.1% of the region's e-commerce transaction value.

Growth Amid Losses

An academic paper from the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School noted: "Consumers' preference for BNPL is unsurprising, given an environment of high and constrained demand for new consumer credit, especially for lower-income Americans." The paper said: "Merchants' views are also extremely positive because merchants benefit significantly from the current business model of BNPL companies. By providing convenient access at the point of sale (especially online), BNPL products help merchants drive sales."

Many BNPL providers have had to pay a high price to keep up with surging consumer spending on new technology and employees. As a result, according to filings by public companies with the U.S. Securities and Exchange Commission and other securities regulators, their expenses have grown far faster than revenue, leading to losses with no signs of slowing in the near term.

Anil Goyal, president of Corserv, said: "Right now they are in growth mode, so losses are expected. Their costs will rise, and customer acquisition will become more difficult. It will be a tough battle for these companies to achieve both growth and profitability."

Take Affirm, for example. The San Francisco-based company reported net losses of approximately $430.9 million, $112.6 million, and $120.5 million in the fiscal years ended June 30, 2021, 2020, and 2019, respectively (according to the company's latest annual report). Its total operating expenses more than doubled in the fiscal year ended June 30, 2021, to $1.25 billion, up from $617.3 million in fiscal 2020. Sales and marketing costs surged from $25 million to $184 million, and technology and data analytics spending jumped from $122 million to $256 million. During the same period, Affirm's revenue grew about 70%, from $510 million to $870 million, helped by well-known clients such as Peloton (according to SEC filings).

Klarna is in a similar situation. According to its 2021 annual report, as it expanded in the U.S. last year, Klarna's U.S. customer base grew 71% to 25 million as of January. Its workforce also expanded by about 50%, from 3,238 employees in 2020 to 4,789 full-time equivalent employees at the end of last year. Meanwhile, Klarna's total operating expenses rose 70% last year to 15.7 billion Swedish kronor (about $1.6 billion), but total operating income grew only 38% to 13.8 billion kronor (about $1.4 billion). The company said in its annual report: "In 2021, we accelerated our ambitious market and product expansion plans, entering five new markets and extending our products to the shopping app in 18 markets." However, Klarna's operating loss for the 2021 calendar year widened from 1.63 billion kronor in 2020 to 6.58 billion kronor (about $688.85 million), according to Reuters.

Similarly, Australia's Afterpay (acquired last year by Block, Square's parent company, for $29 billion) posted a loss of A$159 million (about $112.8 million) in fiscal 2021 ended June last year, compared with a loss of A$22.9 million the previous year. Meanwhile, Zip reported a loss of A$653 million in the fiscal year ended June 30, 2021, versus a loss of A$20 million the prior year. Zip's revenue surged 150% last year to A$403 million, but marketing expenses soared from A$9.5 million in fiscal 2020 to A$71.2 million in fiscal 2021 (according to company filings). Information technology and payroll benefit expenses both more than doubled. Zip officials declined to comment for this article.

PayPal is profitable overall but does not separately disclose the financial performance of its BNPL business. Syed believes that, given PayPal's mature computer network, it may not face the same losses as its competitors. "When you have such a large base, you can find multiple ways to monetize different services," Syed said. "You can bundle existing products, and the opportunities for them will be very abundant." A PayPal spokesperson declined to comment on the profitability of the BNPL business.

Intensifying Competition

Increasing competition may be linked to the losses. According to data from New York market research firm Yipitdata, by payment volume, Affirm dominates the U.S. market with a 40% share, Klarna holds 19.6%, Afterpay 16.4%, PayPal's Pay in 4 11%, and Zip 4.2%. Other smaller players (including Sezzle, acquired by Zip this year) make up the remainder. Yipitdata ranks by individual installment transaction counts.

In contrast, BofA analysts ranked by global consumer app downloads, yielding a very different picture: as of the first quarter of this year, Klarna accounted for 60%, Afterpay was second at 19%, Affirm 16%, and Zip 5% (PayPal was not included).

Consumers' acceptance of BNPL is growing, with some even using it to manage everyday household expenses like groceries, attracting more competitors to the space. Specialized services have also emerged in segments such as healthcare and education, further promoting BNPL. David Morris, financial services and payments analyst at Insider Intelligence, said: "The point-of-sale financing market you're seeing is changing, which will bring more competition and may compress the profit margins of these buy now, pay later fintech companies." Morris noted that Mastercard and Visa have now launched their own BNPL services, which will intensify competitive pressure in the industry and may also make BNPL less profitable as a standalone product.

Regulation Is Another Hurdle

As BNPL penetrates different shopping segments, critics' concerns are also growing. In December last year, after concerns were raised by a group of Democratic senators and consumer activists, the CFPB began an inquiry into the BNPL industry. A spokesperson for the federal agency did not respond to a request for comment, but Chopra has shown a willingness to take a tough stance on the payments industry.

Marshall Lux, an adviser at Boston Consulting Group, believes the CFPB should accelerate its regulatory pace on BNPL. "This is the area taking on the most risk in the economy," he said. Lux (also a fellow at the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School) noted that most BNPL borrowers are subprime. "This should be higher on the CFPB's agenda." Lux supports BNPL reforms, including requiring disclosure of all fees and rights at the point of sale to help consumers understand the "true cost" of BNPL financing; establishing related credit reporting standards; and data privacy standards and dispute resolution procedures.

Chopra, along with his congressional Democratic allies and consumer groups, accuses the BNPL industry of potentially piling debt onto consumers who cannot afford to repay it. The CFPB said in a December statement: "The CFPB is concerned about debt accumulation, regulatory arbitrage, and data collection issues in a consumer credit market undergoing rapid technological change." That same month, Chopra sent letters to major BNPL operators including Affirm, Afterpay, Klarna, PayPal, and Zip, requesting detailed information about their business practices and protections for consumers' confidential information.

Lucy Morris, former deputy enforcement director at the CFPB (now a partner at law firm Hudson Cook), said in an interview that the bureau is working to ensure consumers do not get into trouble because of BNPL. "That doesn't mean companies are breaking the law," Morris said. "It may just be that the bureau wants to use its influence to improve conditions for consumers."

Can the Industry Sustain?

Mark Flamme, managing director at consulting firm AlixPartners, acknowledged the industry's challenges and questioned the long-term viability of the BNPL industry. He suspects that consumer late payment issues will worsen over time. "The risk of consumers overextending themselves is real," Flamme said. "I can visit 15 different websites and get 15 short-term loans from multiple different players."

In fact, the BNPL industry has already begun to slow. BofA data shows that global BNPL app download growth slowed from 36.2% in the fourth quarter to 21.4% in the first quarter of this year. Affirm performed best that quarter, with average daily downloads up 61.8% year over year, but down from 93.7% in the fourth quarter. Meanwhile, Zip has seen negative annual growth for nine consecutive months, and the first quarter was its lowest quarter for app downloads since the third quarter of 2020 (according to BofA).

As growth slows, BNPL providers will find it harder to become profitable, partly because meeting the demands of customers seeking the best deals will become more difficult, making it harder to meet investors' expectations for returns. None of these efforts will be easy or cheap.