The challenge for consumers and merchants alike is to understand where the value and costs lie in each of these systems.
For example, a traditional home loan is a classic pay-later credit product - the lender funds the purchase and the borrower pays it back over some years. Because of the size of the purchase most people don’t have the funds on hand to “pay now” even if they wanted to. In return the lender charges an interest rate for making the loan available and to cover the risk the money might not be paid back.
For a much smaller value purchase like the high-tech television, maybe we do have the funds available. Or maybe we’ve been given a gift card or have enough reward points from an airline frequent flyer program.
When we do have such choice it becomes a case-by-case decision whether to pay before, now or later. That’s why it’s worth understanding where the costs and revenues are in each system.
Burden of choice
While pay-before is typically free to use, the cost comes from pre-committing your funds. If you have paid for a gift card that means funds are no longer in a term deposit earning interest or are not being used to make an extra payment on the home loan. That’s a cost.
It’s easy to forget that cost applies to cash too. Cash in your purse is actually dormant, it’s not earning anything, paying off anything or buying anything when it’s “just cash”. (Indeed any inflation will actually erode its value.)
The issuers of gift cards also enjoy two key sources of revenue: they earn interest on the money sitting on the card before it is used (the “float”); and they never have to pay the amount, estimated at around 10 per cent of the face value of cards, which is never used - either because someone forgot there was money left on the card or they lost it (known as “breakage”).
There is also the risk the pre-paid card or voucher might expire or - unfortunately not uncommon - the business which sold the card goes bankrupt and the cards are no longer honoured. (Legally, as the owner of the gift card you are an “unsecured creditor”.)
Those who operate pay-now schemes like eftpos or NPP make their money from various fees. These may be network fees or usage charges or what are known as “interchange” fees.
Because payments are network-based they typically involve an institution issuing a payment instrument on behalf of the customer (maybe a card or NPP account), a network provider (like NPP or Visa or MasterCard or Alipay) and an institution processing the transaction on behalf of the merchant.
That all of these parties have costs and receive benefits makes the pricing of transactions so complex no one has ever agreed on what they should be. At some point, however, they will be built into product prices and other fees.
“Pay later” is in essence unsecured personal lending. A credit card is a guarantee you can borrow money to buy things up to a limit and you don’t have to get special approval each time. The issuer of the card - the lender - makes money from either fees or interest rates or both. Fees are also charged to merchants who accept the cards, usually between 1 and 2 percentage points.
The increasingly popular pay later schemes, like Afterpay in Australia, are a variation on unsecured lending. Each transaction is discrete and the provider makes money mainly from the merchant – charges are more than double credit card merchant fees – and there are also charges to consumers if the loan is not paid back in the agreed time and sometimes other charges like establishment fees.