Is BNPL Disruptive or Sustaining Innovation?
Ozhan Orge
Transforming Financial Institutions Through AI & Digital Innovation | Digital Banking & Growth Strategist
Harvard Business School Professor?Clayton Christensen, Deloitte USA Managing Director Michael E.?Raynor?and Harvard Business School Associate Professor Rory McDonald wrote a HBR article [1] on disruptive innovation in December 2015 and it is one of the HBR classics already. They explain what is disruptive innovation and what it is not:
?“First, a quick recap of the idea: “Disruption” describes a process whereby a smaller company with fewer resources is able to successfully challenge established incumbent businesses. Specifically, as incumbents focus on?improving their products?and services for their most demanding (and usually most profitable) customers, they exceed the needs of some segments and ignore the needs of others. Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable functionality—frequently at a lower price. Incumbents, chasing higher profitability in more-demanding segments, tend not to respond vigorously. Entrants then move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred.”
?In the article the writers say that Uber is not a disruptive innovation because of the above mentioned definition of disruptive innovation. They continue:
?“Disruptive innovations are made possible because they get started in two types of markets that incumbents overlook.?Low-end footholds?exist because incumbents typically try to provide their most profitable and demanding customers with ever-improving products and services, and they pay less attention to less-demanding customers.”
??Disruption theory differentiates disruptive innovations from what are called “sustaining innovations.” The latter make good products better in the eyes of an incumbent’s existing customers: the fifth blade in a razor, the clearer TV picture, better mobile phone reception. These improvements can be incremental advances or major breakthroughs, but they all enable firms to sell more products to their most profitable customers. Disruptive innovations, on the other hand, are initially considered inferior by most of an incumbent’s customers. Typically,?customers are not willing to switch?to the new offering merely because it is less expensive. Instead, they wait until its quality rises enough to satisfy them. Once that’s happened, they adopt the new product and happily accept its lower price. (This is how disruption drives prices down in a market.)“
In today’s article I want to ask the question whether you see BNPL as a disruptive innovation in the payments area or is it a sustaining innovation?
I am not an expert on disruptive innovation but reading the above definition and comments, I find BNPL to be closer to disruptive rather than a sustaining innovation.
BNPL started with focusing on low end footholds.
BNPL was adopted first by Gen Z and Millennials [2] as a solution for their financial pain points and needs. At the beginning, the ones who do not have ample credit score for high credit cards limits or loans liked the BNPL most. Moreover, they do not have high level of savings. So, this segment is generally ignored by banks. But they would like to buy new personal electronic gadgets, new clothing etc and they represent a strong group of consumers. Paying in installments or deferring payments is a good option for them.?
?BNPL started with very low ticket sizes. The average ticket size for BNPL is on average around EUR 100-150. Average personal loan in European Banks is more than EUR 3,000. Average Micro loans are above EUR 7,000. This level of lending needs a thorough risk assessment. For small ticket sizes, BNPL companies do a softer, cheaper risk assessment which is a nightmare for the banks. If they would like to do the full assessment for these ticket sizes it will be a loss bearing business due to the high-cost base of banks.
?BNPL companies are providing an interesting product that is practical, useful and easy both for consumers and merchants. They happen to be more practical than the credit cards for the consumers:
?·???????With the credit cards payments, the purchase blocks the card limit. If you have a EUR 1.000 card limit and bought something for EUR 100, the available limit is going to be EUR 900 for any other purchase. In BNPL there is no total limit for the consumers. You can buy 15 different items that are all EUR 100 and these purchases are all independent. They do not add up to a customer level limit.
·???????With the credit card, the payment is set for the same date of the month. If you are paying your credit card at the 1st of every month, pay later period for your purchase you made on 15th of the previous month is 16 days only and for the items bought on 21st the pay later period is 10 days only. In BNPL the ‘pay later’ period is not related to the date of purchase. If it is 40 days, you pay back in 40 days.
·???????When you return the goods, you will have to wait for the bank / credit card company to return the amount to your credit card.?And if the payment date of the credit card is immediate, then you must pay for the purchase already before returning the goods. In the case of BNPL, the users can return items until the agreed payment date, and they do not pay anything or wait for a payment return from the BNPL provider.
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?Ease of use, simpler application and stress-free approval process makes BNPL more and more appealing to other customer segments and for higher ticket sizes[3]. Moreover, BNPL creates engagement in the customers and repeat purchase is more common than the credit cards.
?McKinsey article “Buy now, pay later: Five business models to compete”[4] refers to a survey that was done in July 2020: “nearly 56 percent of American consumers have used a BNPL service—compared with 38 percent the year prior”. Article continues: “Unlike with other POS installment loans, consumers have a very high affinity and engagement, resulting in significant repeat usage. More mature consumer cohorts are using these financing products about 15 to 20 times a year and logging into these apps ten to 15 times a month to browse or shop.”
?If we remember what Christensen, Raynor and McDonald said in their HBR article: “Entrants that prove disruptive begin by successfully targeting those overlooked segments, gaining a foothold by delivering more-suitable functionality—frequently at a lower price. Incumbents, chasing higher profitability in more-demanding segments, tend not to respond vigorously. Entrants then move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success”
BNPL is gaining foothold in the upper segments and growing. But as they grow, the problems are also arising. Profitability, regulation, competition topics are coming. Next week I will touch the topics and problems BNPL providers are facing and trying to solve.
[4] https://www.mckinsey.com/industries/financial-services/our-insights/buy-now-pay-later-five-business-models-to-compete
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