Signals: The biggest winner of BNPL is... Mastercard?

Hey fintech friends,

The largest Buy Now, Pay Later platforms may have lost anywhere from 13% to 95% in market value since their 2021 peaks, but that hasn't stopped business from booming:

It turns out that BNPL adoption is still on the rise, now accounting for 2.8% of all retail eCommerce payments. The BNPL market is forecasted to grow to $3.7 trillion by 2030 as shoppers ditch credit cards for lower-interest payment methods, as 15% of consumers report already having done in the past few months.

Apple joined the BNPL chat with Apple Pay Later because it's Apple, and duh. Apple Pay made up only half a percent of Apple's total revenues last year and Pay Later isn't designed to be much more profitable; it does, however, position Apple to take a major stake in BNPL's growing adoption and steer this inertia towards core Apple products.

There's a silent winner in this launch who will gain core product adoption and net a higher profit: Mastercard.

The major card networks are making a move into BNPL, and now the race is on for these players to capture BNPL payment volumes on their own schemas– and reap the higher fees that come with them.

Let's dive into Apple Pay Later, and the emerging role that card networks are playing in BNPL's future.

Credit is about processing fees: BNPLs take a roughly 2%-8% cut on each purchase they facilitate in fees from the underlying merchant. In return, merchants see a demonstrable boost in sales, with BNPL increasing the likelihood of purchase by 20%-30% and growing average cart sizes by ~50%.

Apple's Pay Later feature gives users the option to split payments into 4 installments with no interest or fees (for now?) at any of the 85% of merchants accepting Apple Pay, all within the Apple Pay experience and funded from Apple's own balance sheet.

From a merchant's perspective, Apple Pay Later kicks ass.

Apple Pay Later conceptually grows top-line sales as much as other BNPL solutions do, but at a cost incremental to Apple Pay's typical processing fees– and one that's far lower than BNPLs' standard rates. Apple Pay transactions are also generally less prone to fraud and chargebacks (iOS 2-factor authentication, card tokenization, etc.) and merchants are enrolled for Pay Later on an opt-out basis via their payment processor so, no installation required!

This could be a head-turning moment for BNPLs that so far have been negotiating their way into checkout experiences on a merchant-to-merchant basis.

From Apple's perspective, Pay Later is part of a bigger lifestyle platform play. Apple Pay is a major wedge into the financial lives of iPhone users who've adopted it, and BNPL particularly resonates with younger, credit-constrained customers who haven't quite embraced Apple Wallet yet. The users also may not qualify for the Apple Credit Card, and Pay Later could be their stepping stone.

On an operational level, BNPL is a really tricky product to offer. Imagine having to instantly (read: instantly) underwrite a buyer at the final stages of checkout, immediately swap their payment method out for one that you can fund to cover the purchase, maintain a ledger to service all of their liabilities, arbitrate any payment disputes, defend against fraud– and do all of it within the dark, scary confines of the consumer credit regulatory regime.

Apple instead chose to launch Pay Later on top of Mastercard Installments, a service launched in 2022 to facilitate BNPL transactions through Mastercard's network. Mastercard Installments is already in-market via solutions like SoFi’s Pay in 4 feature and Visa has a competing offering called– you guessed it– Visa Installments.

Why do card networks care so much about BNPL?

Just as BNPL platforms are competing to fund buyers' purchases at checkout, Visa and Mastercard are scrambling to route the underlying payments onto their own networks.

At a first pass, the card networks are worried that BNPL payments may get routed to non-card rails altogether, as Mastercard's 2022 10-K stresses:

So Mastercard and Visa launched BNPL support in a bid to coax BNPL payments onto card rails from, say, ACH. But that's not the end of the story.

Mastercard Installments is basically routing all Apple Pay Later purchases onto Mastercard.

If an Apple user opts to split a purchase with Pay Later and cover payments with a Visa debit card, Apple can't just run the Visa directly with the merchant. Instead, Apple issues a Mastercard-branded virtual card through Goldman Sachs, adds funds to cover the up-front transaction, and has the merchant process the newly-issued card on Mastercard's network. Apple will collect installments from the user's original Visa debit card as per usual, and Mastercard pockets the network fee for the initial purchase (all the better if the original card is also a Mastercard, 4x the fixed network fees amirite?).

I'd be remiss in not pointing out the ironic timing given Mastercard and Visa were recently in hot water with the FTC for using security tokens to gatekeep card numbers from competing regional networks. Regulators since leveled the playing field by making merchants route more traffic to smaller networks, and this product obviously differs from Mastercard's TokenGate move (but if we're being drama, in principle it's similar).

Either way, the additional payment volumes that Mastercard generates here are an even bigger deal considering...

Merchants give up about 2.2% of each consumer debit card transaction in processing fees that are split between 1. Their acquiring processor, 2. The buyer's issuing bank, 3. The issuing processor, and of course, 4. The card network. Mastercard Installments, however, carry a processing fee of 3%.

It's unclear what exactly goes into this higher fee, but Apple Pay Later's product design suggests that Mastercard is taking on a larger role in these transaction than it would in a normal payments scenario. By default, Mastercard earns around 0.1375% in network fees on card payments. In an Apple Pay Later transaction, though, Mastercard seemingly also acts as Apple's issuer processor (i.e. setting & communicating authorization rules based on the buyer's Pay Later arrangement with Apple). Mastercard is layering billed "value-added" services on top of all of this, like wallet tokenization, potentially fraud scoring, and almost certainly some kind of BNPL mark-up.

As with everything in the payments world, these are trivial figures that could quickly add up for Mastercard. Apple Pay accounts for 4.3% of of eCommerce payments today, and getting embedded in Pay Later puts Mastercard Installments in a position to compete head-to-head for any BNPL traffic that gets surfaced on an iPhone.

Stepping back, the BNPL world is way too big for any single player to swallow. The concept is gaining traction across age cohorts and in particular among Gen Zers, 61% of whom have already used it to make a purchase. BNPL products still has plenty of room to grow from here– by deploying financing for new products, building out new distribution channels like Affirm’s Debit+ card and Klarna's shopping app, and in the B2B space rolling out reverse factoring– aka ✨BNPL for business✨– offerings to meet businesses' growing need for short-term working capital.

Solutions like Mastercard and Visa Installments are accelerating competition by enabling platforms to scale faster, but regardless of which companies emerge as winners, one thing has become clear: Demand for BNPL is significant, and it's here to stay.