The emerging financial technology of "buy now, pay later" (BNPL) has attracted investor attention for its popularity with young shoppers who spend an increasing amount of money online. The recent IPO of BNPL fintech company Affirm (AFRM 1.31%) was met with some initial excitement, but since the spirited opening rally, the stock has fallen over 50% from its all-time high.

There are some lessons to be learned from a country like Australia, a global hub for this specific offering that is now saturated with BNPL hopefuls. It's becoming increasingly evident that most of these companies will struggle to ever make money, and they face competitive headwinds from giants like PayPal entering the race. Put simply, BNPL is a technology with almost no barriers to entry and very little proprietary value.

Man and women worried, looking at bills

Image source: Getty Images. 

The point of saturation

If BNPL were comparable to an existing concept, it would probably be microfinance -- on steroids -- for the developed and sophisticated consumer. Services like Affirm integrate with online e-commerce stores and give customers the opportunity to finance their purchases directly from the website they're shopping on. Depending on the amount spent and loan duration (usually three, six, or 12 months), the customer pays somewhere between a 0% and 15% average annual interest rate.  

A key problem for Affirm is that integrating with an endless stream of online stores is incredibly laborious. The challenge was overcome by the Australian BNPL provider Zip, which partnered with Visa to give customers a digital card they can use anywhere. It's effectively a credit card, except with a low maximum limit of $1,500 plus all the BNPL benefits like low (or zero) interest charges. Affirm will similarly offer an Affirm Card, slated for release later in 2021, that will deliver more flexibility to the company's customer base. 

The drawback, though, is how easily competition can subvert these efforts. In response to Zip, for example, major Australian banks issued low-interest credit cards with much higher credit limits. Payments giant PayPal is rolling out a "Pay in 4" BNPL service in June to its nine million Australian customers, at no extra cost to merchants or consumers. 

Zip is not the only company with a twist on the BNPL model. The $34 billion Australian giant Afterpay operates similarly to Affirm, except it charges the merchant a percentage fee based on the transaction value, and the consumer only pays fees if they're late on their payments.

If it sounds like there's a lot of competition in this space, that's because there is. Since Afterpay launched in 2015, Australia has seen at least 18 other players enter the space, and none of them are consistently profitable from this business alone.

Absent earnings 

Like many technology start-ups, Affirm isn't making money. The difference here is that practically none of Affirm's competitors are, either. It's increasingly difficult to generate earnings in this business as competition ramps up, and the concept grows somewhat stale. And it's really hard to adapt the model to other forms of lending, because it relies on low credit limits and therefore limited customer verification for maximum convenience. Changing this just makes BNPL players like any other lender.

For the six months ended Dec. 31, 2020, Affirm generated a $76 million operating loss on $378 million of revenue. Remarkably, this was 73% more revenue than the same period in 2019, yet the company lost 16% more money on an operating basis. 

  For the six months ended Dec. 31, 2020 For the six months ended Dec. 31, 2021
(in millions) Revenue Net Loss Revenue Net Loss
Afterpay $220.3 ($31.6) $417.2 ($79.2)
Zip $69.6 ($30.3) $160.0 ($147.5)*

Data source: Company filings. All figures reported in Australian dollars. *Adjusted for QuadPay acquisition.

So, Affirm is not alone. Australian market leaders Afterpay and Zip are also suffering from significantly greater losses for each extra dollar of revenue they generate as higher interest rates and strong competition squeeze margins.

Interestingly, Afterpay and Zip are both eyeing the U.S. market with the former planning a listing there at the time of this writing.

As the BNPL concept matures and bigger players continue entering the market, Affirm may find it difficult to arrest its decline. Positive earnings could save the company, but it's difficult to predict whether that's feasible given the consistent losses across the sector.