Emily Bishop, a 26-year-old digital strategist in Washington, D.C., wanted a Peloton in 2020. She thought it was out of her reach at nearly $2,000, particularly because she was wary of credit card debt and uncertain about her job prospects. But then, when browsing Peloton’s website, she saw a deal: $63 a month for 36 months, a financing option through a company called Affirm.
“I would have never been able to purchase a bike outright,” she told Grid. “I kinda just stumbled across it by accident.” She estimates she’s actually saving money by dropping her $180-per-month spin class membership and — with the help of stimulus checks — has paid off her bike early.
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Peloton, struggling to consistently move product in the fits and starts of covid waves, is counting on customers like Bishop to keep sales moving. The company even dropped its prices; these days a brand-new bike will cost just $1,500 — and an increasing number of people are opting to buy one on a $39-a-month-for-39-months payment plan, all at an extremely tempting zero-percent interest rate.
Affirm, founded by PayPal co-founder Max Levchin and which has been working with Peloton since at least 2018, is a venture capital-backed newcomer to the consumer credit market. Its name might be familiar, along with those of Swedish company Klarna and Australian company Afterpay (which was recently purchased by Jack Dorsey-founded Block).
These companies offer “buy now, pay later” (BNPL) financing that lets consumers get the items they want now and keep paying for them for months or years to come. They’re also experiencing explosive growth — with estimates of $100 billion in buy now, pay later spending in the U.S. in 2021, up from around $24 billion in 2020. By some estimates, 1 in 5 consumers uses some type of buy now, pay later company.
But like all consumer financial products, taking out small loans to pay for goods comes with some major potential downsides. For one, it seems like customers who use payment plans tend to buy a lot more than customers who simply use credit cards. The dispute and resolution systems are also less clear, and users are not always aware of what the implications for their credit will be by taking out the loans (although that may soon be changing).
And, like any automated payment, if borrowers don’t manage their funds carefully, they can be hit with overdraft or non-sufficient funds fees. These are just a few of the concerns flagged by Marisabel Torres, the California policy director of the Center for Responsible Lending, one of several advocacy groups that have called for more oversight of the sector. “It’s taken off very quickly, we’re flooding the market with credit and not looking at what the consequences might be,” Torres said.
“Buy now, pay later is the new version of the old layaway plan, but with modern, faster twists where the consumer gets the product immediately but gets the debt immediately too,” Consumer Financial Protection Bureau Director Rohit Chopra said in a recent statement.
How buy now, pay later works
The way buy now, pay later works is that these services do a “soft pull” of a buyer’s credit file, which does not affect the credit score, and in some cases, these services don’t require credit scores at all. Like credit cards, retailers also pay a fee to the creditor to handle the transaction; it’s often higher than the one credit cards offer, but it’s perhaps worth it to the retailer to make a sale they might not otherwise get. Customers can often end up paying less than they would with revolving credit card balances, although if they fall behind on payments, they can be hit with late fees and cut off from the service.
“Buy now, pay later is like an extended line of credit for high-ticket items. The low-income community is attracted to BNPL,” said Suresh Dakshina, president of Chargeback Gurus, which consults with merchants to prevent reversed charges. While the product is often associated with lower-income consumers who may have trouble accessing the credit they want, there’s evidence that consumers with higher credit scores are starting to use it more, according to McKinsey.
While in the U.S. these loans are associated with big-ticket items, the typical use case in Europe, where the market is more advanced, is in apparel, explained Ohad Samet, the founder of TrueAccord, a collections service used by the industry: “when you look at Klarna and Afterpay, where they competed and found traction was in fashion.” Samet pointed specifically to using the services to “order different sizes and colors in one item and return a bunch of stuff.”
Walmart partners with Affirm, Bed Bath and Beyond with Klarna, and Forever 21 with Afterpay. While many customers encounter buy now, pay later as just another option for online checkout, the companies have also developed apps that let customers find items from associated brands through them.
“If they know you are a regular customer and regularly using buy now, pay later through one company, they are going to let you use that option over and over. You might have a $5,000 credit card limit, but once they know you’re a healthy customer, they might extend you $20,000,” said Dakshina.
While any given loan may be safer than a revolving line of credit because it’s smaller, over time, buy now, pay later will enable customers to, well, buy more. “With buy now, pay later, I am going to extend a line of credit so you keep buying as much you want, that is going to put more debt on the average American,” Dakshina said.
Regulators have begun to take notice, as they tend to do when a new form of consumer debt is taking off. The CFPB announced last month that it was ordering five big players in the market — Affirm, Afterpay, Klarna, PayPal and Zip — “to submit information so that we can report to the public about industry practices and risks.” The bureau’s announcement flagged potential areas of concern, including increased consumer debt; regulators not having a clear view of buy now, pay later companies’ activities; and the use of consumer data.
Consumer advocates have called both for more data collection and federal oversight of the industry that would come with new rules written by the CFPB.
Peloton is hoping it can still be a luxury product with discount pricing
Peloton is by far Affirm’s highest-profile partnership. When the company went public, Affirm revealed that Peloton sales amounted to 30 percent of its total revenue. In its most recent quarterly filing, that portion had gone down to 10 percent. The relationship will continue at least through September 2023, with options to renew it.
For the merchants, the deal is pretty simple: “higher approval rates and higher basket size than using credit cards,” Samet told Grid. In other words, customers are able to buy more easily, and they’re able to buy more. Afterpay claims that it has led to some $8 billion a year in additional sales for U.S. merchants, with some $2.7 billion coming in the form of larger “baskets” of purchases. TrueAccord estimates that buy now, pay later services lead to an “average order value increase of 20% to 35% and cart conversion [making the sale once a customer puts something in their online cart] increase of 20% to 85%.”
In exchange, they pay fees to the lenders that are typically larger than what credit card companies charge, although, as Samet pointed out, this has become a very competitive market: “I see the full rate sheets, there’s a lot of discounting in the background that makes them more competitive with credit cards.” The CFPB has pegged the fees buy now, pay later companies charge merchants as “3 to 6 percent.”
Affirm said, “While merchant fees depend on the individual arrangement between us and each merchant and vary based on the terms of the product offering, we generally earn larger merchant fees on 0% APR financing products,” implying that Peloton is sending back a healthy payment for every bike Affirm finances.
“Where others have proved it’s worked with low balances,” Samet told Grid, “Affirm has shown at least with Peloton that low-friction, high-value, zero-APR product can work as well.”
And it seems like the greater risk belongs to Peloton. The company’s stock nose-dived in November after it drastically lowered its projections for revenue. In response, the company cut the price of its base-level bike. The reason was simple: It needed to sell more.
As for Affirm, when asked in a call with analysts for its own specific numbers for what the company has garnered from Peloton, CFO Michael Linford would say only that “results for us on Peloton did exceed our internal estimates, and there’s certainly nothing that we’ve seen to suggest that we should be changing our outlook overall in light of where that business is at.”
“We continue to believe price remains a barrier to purchase for many consumers and this is our latest step to improve the accessibility of our platform. We are pleased with the consumer response to our new price, which quickly converted many consumers already in our purchase funnel and is helping to generate a significant number of new leads,” the company said in a letter to investors.
“Younger and less affluent consumers continue to represent our fastest growing demographic, yet among non-Members, there remains a lingering perception that Peloton is a luxury item,” the letter continued.
Peloton and other online retailers are making a bet that cheap financing can change that.