Mercator Blog

BNPL Gets Bigger and Better with Afterpay and Square
Date: August 5, 2021
Brian Riley
Director, Credit Advisory Service

As retailers begin preparing for the winter holidays and Buy Now, Pay Later (BNPL) players such as Mastercard, PayPal, and Visa roll out their point of sale solutions, Square entered the market with a splash. Square, founded by Twitter's microblogging entrepreneur, Jack Dorsey, provides a range of integrated merchant payment services. The firm recently acquired BNPL giant Afterpay.

Square, founded in 2009, helps small merchants compete in e-commerce. The firm began as a solution to help Jack Dorsey's friend, Jim McKelvey, sell his crafted blown glass at a business called Third Degree Glass Factory

The story goes like this. McKelvey, a friend of Jack's, had a $3,000 order for an artisanal glass faucet. The buyer, a woman in Panama, wanted to use her American Express, and Jim could only process a Mastercard or Visa payment; he lost the sale. Jim lamented: "So I said, 'What we ought to do is build a payment system to prevent little businesses from getting screwed the way they've been getting screwed because it's really tough if you're a small businessman to accept payment cards. You pay a ton of money…2 or 3 percent is the beginning of it, and then you've got all these fees, and you've got these PCI [security] compliance requirements."

And, as they say, the rest is history. Square now trades on the NYSE, with a market cap of $126 billion, with almost 6,000 employees and $10 billion in revenue. Square's 2020 10-K filing with the Securities and Exchange Commission indicates:

"In the year ended December 31, 2020, we processed $103.7 billion of Seller
Gross Payment Volume (GPV), which was In the year ended December 31, 2020, we processed more than 2 billion card payments, more than from 405 million payment cards. At the End of 2020, our Square point of sale ecosystem had over 210 million buyer profiles, and approximately 284 items were listed on Square by sellers."

The Afterpay acquisition will fit right into Square's merchant-facing seller infrastructure. Square's software platform centers on four point-of-sale products. First, Square POS is available for iOS and Android and pre-installed on Square Register and Square terminals. Second, Square Appointments is a free online booking tool. Third, Square for Retail is an advanced platform that includes barcode scanning, inventory management, and supply chain management. The fourth component, Square for Restaurants, provides table, order, and course management tools with back-of-house functionality and cost reporting.

The four channels integrate with various services, including Square Online, which helps build websites that integrate into Instagram and Facebook and an ordering system, Square Online Checkout, Square Invoices, and Square Virtual Terminal. There are also staff management tools, contract management, loyalty, and gift cards.

Square acts as a merchant of record for transactions, which means they settle, clear, and manage transaction risk. Functionality includes Managed Payments and Risk Manager.

The firm also provides suitable cash management tools for merchants, including instant transfers, Square Pre-paid card, and Square Capital. Since its recent founding, Square Capital underwrote more than $8.1 billion in loans in 1.2 million transactions. In March 2021, the firm launched an industrial loan bank "to expand access to financial tools for underbanked populations and marks the beginnings of the company's journey to provide more banking solutions to small businesses." Initial offerings for small business owners are Square Savings, Square Checking, and of course, Square Loans.

This new institution is a perfect setting to integrate Afterpay's Buy Now, Pay Later business. Afterpay will likely operate as a separate subsidiary, but it will likely be "Square 'Something." The ability to cross-sell and integrate both buyer and seller options is exceptional.

What this Means to the BNPL Industry

Fintech BNPL firms clutter the market as the installment loan function becomes revitalized. In Australia alone, a market one-tenth the size of the U.S., we identified a dozen firms, ranging from Afterpay to Zebit, with market caps spanning from $28 million to $28 billion. Square enters the BNPL lending space in a big way and will likely shake out the BNPL field. In addition, some existing players indicate a shift in focus, no longer offering financing for $100 specialty retail products but now moving into large-ticket items, healthcare, and the auto-aftermarket.

PayPal's Pay-In-Four model amped up the game in several markets. Its model fits into their ecosystem nicely. In direct competition, Square addresses the market with Afterpay. Expect to see compression at smaller BNPL offerings. At the same time, keep an eye on Mastercard and Visa BNPL options because the merchant space is core to their business. One thing is for sure: BNPL is no longer just for fintechs.

What this Means to the Payments Industry

Keep an eye on whether PayPal will counter with a banking model similar to Square's recent entree. While PayPal has done exceptionally well by relying on financial partners or banking alternatives, an insured institution would add value to the firm's operational configuration.  

With Square's banking entity, there are many options to address consumer and small business depository and lending functions. In addition, PayPal and Square have enough ballast to each launch their payment networks, which would be an extreme challenge to current credit and debit card functions.

Will either PayPal or Square have the critical mass to run their payment network? Absolutely. They already do. Think about your own PayPal account today. You can settle directly to the PayPal account, inside or outside the traditional branded payment rails. Square works in a similar fashion, and now with their industrial bank and their new BNPL firm, they can tie many financial transactions together. Forget about BNPL for a minute. Think about the broader topic of installment lending,

What this Means to Retailers

Options, options, options. Pick one financing channel, or maybe two. You will most likely always need to accept American Express, Discover, Mastercard, or Visa, but it should be pretty apparent by now that people want installment options. BNPL is not for consumers to buy staples such as milk and eggs; it is (currently) for small ticket items in a retail context under $200 or so.

What this Means to Consumers

Just don't get lost on the word "no interest." Lending is a business-a massive business. No one runs a successful business on the premise of "no interchange or interest." But you can get financing, and BNPL is undoubtedly an option.