FINANCIAL FRESHMAN #050
TL;DR → One of the main ways that BNPL services make money is by charging retailers as much as an 8% fee every time their payment terms are selected at checkout. Retailers are willing to pay this fee because they know you will spend more than you otherwise would. The popularity of these services can be partially attributed to the psychological burden that they remove from making a large purchase.
BNPL, Continued
In our post last week, we highlighted the current state of “Buy Now, Pay Later” (BNPL) services in the United States. These services have exploded in popularity over the last few years, and it’s the 18-24 year old demographic that is predominately driving that increase in business. Whether you fit into that demographic or not, every reader is going to fit into one of these four buckets.
For the remainder of this post, I want to talk to those of you in bucket #2 or #3. To make sure you make the right decision for your personal finances going forward, you need to understand both the literal and psychological costs of BNPL services. That is, how much money it may cost you, as well as how it may trick your brain into spending money you otherwise wouldn’t. Let’s start with the former.
The Literal Costs
Several BNPL providers, including Klarna, PayPal, and Afterpay, will let you “Pay in 4” when you complete your purchase. If you’re even a little bit familiar with BNPL, you’ve probably heard of these types of payment terms before. Simple, right? Your $400 concert tickets become four payments of $100 each, paid on whatever interval the servicer tells you. But wait—without interest, how do they make money? From four places, as it turns out.
- Selling User Data. Check the terms of use of your servicer of choice if you want, as some are certainly better than others. It’s common for these companies to state that they don’t sell your user data, but then they’ll say openly that they may “share” it with third party companies to “improve your shopping experience.” Right.
- Late Fees. Back to those concert tickets. What do you think would happen if you were to miss one of your $100 payments? A fee is tacked on to your next installment. Easy.
- Interest-Bearing Plans. What if instead of four payments of $100, those concert tickets could only cost you $14.99 per month? Depending on what servicer you’re using, as well as how much you’re borrowing, sometimes you may be offered (upsold) literal debt. These debts will charge you interest in the same way that a personal loan or credit card would.
- Charging Retailers. Every time you check out with a BNPL option, the merchant will pay a fee of around 2-8% of your purchase amount. This is a massive price to pay, and it makes a 1.5-3.5% credit card fee feel like a bargain. Why would merchants accept this steep of a fee?
Well, because you’ll spend more money. This is where the psychology comes into play.
The Psychological Costs
Below, I outlined five psychological principles or cognitive biases that BNPL providers are exploiting to make you spend more money than you otherwise would.
Instant Gratification. Obviously, we had to start here. This represents our desire to satisfy our needs or wants as quickly as we can. BNPL enables you to have what you want right now, so there’s no need to save money or wait. BNPL sells us speed and satisfaction, in the hopes that you’ll figure out the details later.
Loss Aversion. This is a cognitive bias that suggests that humans feel the pain of loss more strongly than the pleasure of gain. So, how can a BNPL service exploit that? Make it so you’re not losing $400 at once to go to that concert. Breaking up the cost tricks your brain into thinking that you’re losing less, since you’ve spread out the psychological (and literal) losses.
Anchoring. Say you’re in the market for a new TV, but money is a little bit tight at the moment. You come across the above listing on Best Buy’s website, and you immediately see that you can own the TV for only $25 today. You now see the purchase as more attainable, since your mind has been anchored to the available (& lower) price.
Mental Accounting. Have you ever gotten a gift card to a store that you never shop at, but you found yourself blowing it immediately anyway on something trivial? This is mental accounting at work—the fact that people treat money differently based on how it’s categorized in their minds. Using a BNPL service exploits the same idea, making you categorize your large discretionary expenses into manageable weekly buckets. The timing may also work against you here, as you may file money away in the “future me will deal with it” bucket.
Pain of Paying. There’s a negative feeling associated with losing some amount of your financial resources, and this is largely regarded as the pain of paying. Reducing that pain is not only going to make you spend more today, but it may also make you more likely to leverage BNPL services again in the future.
When it comes to making a potentially poor financial decision, each of these has a small component in shaping your way of thinking.
Final Thoughts
There’s some complex psychology at play when you’re presented with a BNPL option at check out.
Our human desire for instant gratification gets you in the door, and loss aversion makes the big up-front price feel scary. Once you’re anchored towards the available lower price, mental accounting helps you justify it. After the sale, the reduced pain of paying keeps you from feeling bad about it. Will the cycle continue? That depends on your financial picture, as well as your willpower.
I’m not here to tell you to stay away from these services like the plague. Personal finance is personal, but make sure you’re always making the right decision for present (& future) you.
