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AfterPay, a mastery of behavioural design

Erica Hall  |  03 Aug 2021Text size  Decrease  Increase  |  
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Afterpay, the Aussie invention that created a new market segment called Buy Now Pay Later, has announced a merger with US payments market leader Square. Founded by tech royalty Jack Dorsey, who also co-founded Twitter, Square will pay $39 billion to buy Afterpay. Should it go ahead it will be the largest merger and acquisition deal in Australian history.

What is so special about Afterpay?

Afterpay (ASX: APT) offers consumers an alternative payment option. Its works by charging retailers to offer customers interest-free instalment plans by splitting a purchase amount over four fortnightly instalments, available both online and in-store. The service is free to customers who pay on time, with no interest and no contracts. The alternative payments platform has resonated with both consumers and merchants alike capturing hefty growth figures across both sectors.

Afterpay's success is due to a deep understanding of the behavioural needs of their target client base, Millennials. Co-founder Nick Molnar noticed this generation were actively eschewing credit cards, having seen their parents struggle with debt during the Global Financial Crisis. They had vowed not to put themselves into the same situation. Whilst they still wanted to consume, Millennials didn't want to go into debt to do so. As a result, debit cards were de rigueur, substantially preferred over credit cards. According to research undertaken by Afterpay, millennials ownership of credit cards is approximately 25% lower than older generations.

Millennials are more cautious than previous generations, tend to distrust banks, budget more and seek to use more of their own money to fund their lifestyles. Use of debit cards is a way to help keep their spending in check. Molner understood this and believed the timing was right to deliver a new solution to market.

Buy now, pay later. Not credit…

Afterpay provides instant access to goods via a structure which is a cross between a lay-buy and a credit card. Afterpay's approach is different to the traditional lay-buy service of yesteryear which only relinquished the goods once the payment was completed in full. In contrast, when purchasing via Afterpay, customers pay a quarter of the purchase price as a down payment. The remainder of the purchase is paid in instalments. This plays to a behavioural economics concept of mental accounting discovered by Nobel Laureate Richard Thaler. Thaler found when you buy goods on credit it provides a payment uncoupling effect. The joy of spending today is separated from the pain of the future payment.

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An consequence of payment uncoupling is consumers tend to spend more when they don't have to pay upfront with cash. Cost becomes less important when payment is a future consideration. However, this can become an issue when the payment requirement catches up with you; ASIC’s own research found approximately 20% of BNPL customers are not keeping up with their instalment payments and incurring late fees. Financial Counselling Australia Fiona Guthrie has expressed concerns that BNPL risks are not being properly accounted for, “People think they are harmless but the reality is they are a form of credit and should be treated that way.”

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No interest charges.

If a customer misses making their Afterpay payment they will have to pay a fee. However, the language Afterpay uses is psychologically important; the fee charged is called a late payment fee, it's not interest. Given Millennials reluctance to go into debt and to pay interest costs, language and positioning matters. Whilst Shakespeare penned "A rose by any other name would smell as sweet," behavioural finance disagrees. Essentially how you "frame" something matters, your words and positioning matters, impacting the decisions that will be made. Afterpay seems to understand this and delivers the right framing to their clients.

Frictionless set up.

Signing up to become a customer seems to be a breeze. I witnessed the process personally whilst shopping in a clothing store. A young lady wanted to buy some clothes but didn't have enough cash to fund the purchase. The shop assistant suggested she sign up to Afterpay. Minutes later she was a fully-fledged Afterpay customer, bounding out of the store in a euphoric glow, thrilled with her new impulse purchases. Had the process not been so simple chances are this young lady would have walked out of the store and the odds are better than even she would not have come back. Key behavioural intervention here - you need your product or service to be available at the right time, when the customer is willing to try something new or when self-control is wavering.

Automatic payments via regular instalments.

Structuring repayments in instalments over time further helps to minimise the pain of the repayment. By paying in part via fortnightly intervals makes it feel like less of an outlay. Do you want to pay $100 now or 4 payments of $25 spread over 6 weeks? You anchor around the $25 which feels like a bargain.

What's more, instalment payments are deducted automatically from the customers nominated account. Consumers don't even have to think about the payment, let alone do anything about it aside from making sure they have enough funds in their account, further reducing any potential payment pain.

When people are making decisions each time a friction point is raised in the decision-making process, the risk of derailment rises. Automation is an effective way to mitigate that risk. Afterpay's payment automation is a frictionless process to capture payment.

The structure of the Afterpay service has resonated with consumers and retailers alike, successfully filling a gap in the market. After its success in its local market, Afterpay has gone global with US and UK expansions. Now that it is being acquired by Square (SQ), Afterpay can accelerate US growth by leveraging Squares existing merchant client base. How Afterpay works in neatly with the way humans think about money is likely a major contributor to their success to date.

is Senior Manager, Adviser Solutions, Asia-Pacific for Morningstar Investment Management

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