Installment Payments: Should Merchants Offer Their Customers A New Way to Pay?

What are installment payments?

Installment payments refer to a transaction that is split into a series of payments that a consumer pays overtime rather than paying one lump sum at the time of purchase. Many financial technology companies (Afterpay, Klarna, etc.) are partnering with merchants to provide them with installment payment plan options, allowing that merchant’s customers to pay in a series of installments at no interest.

How does it work?

Let’s look at an eCommerce example. A consumer is browsing through a merchant’s website and sees a product that they are interested in. The consumer clicks on the product and is taken to the details page, where they can add the product to their cart. Underneath the product details, a banner says “Pay with 4 interest-free installments of $20” instead of the full $80 price tag. If chosen, the consumer can enter previously existing credentials for that installments payment provider or create a new account with the provider at checkout. Customer credentials reside with the installments payment provider, and those credentials can be used across many merchants. Their account will be charged the first installment, and the installments provider will charge subsequent payments until the product is paid off. While there are no interest charges, many providers will charge late fees if a consumer is unable to make a payment in the required time. Late fees vary by provider, some imposing fixed fees while others imposing fees that are a percentage of the order total.    

From a merchant perspective, the merchant is paid the total amount of the product at the time of purchase even though the customer is paying in installments. The installments payment provider assumes the risk should the consumer default on a payment. Of course, this comes at a cost. Like any other payment method, installment payments providers typically charge a fixed fee per transaction and may even charge a percentage fee of the total order amount. For example, Klarna’s website lists their pricing model estimate as up to $0.30 USD + 5.99% per transaction.

How are installment payments different than a credit card?

A common question when talking about these new installment payments providers is how this payment method is different from a typical credit card transaction. With a credit card, the consumer is charged the total order amount at the time of purchase and the merchant receives the total amount. The consumer is not required to pay off the total amount on their credit card at that time; however, they are responsible for managing payments against the total and ensuring it is paid off before their next statement in order to avoid any interest charges.

Installment payments providers manage the installment plan on behalf of the consumer and do not charge interest at any time. That is not to say that there is no risk to the consumer. As mentioned above, a consumer can incur late fees if a payment is not made on time. The allure of these installment payments is that it provides a semblance of credit without requiring the consumer to apply for a credit card, be approved based on past credit, and worry about how their payment schedule will affect a credit score. Enrolling in an installment provider’s offering does require a light screening of past credit history and a fraud check, but it does not affect a consumer’s credit score [3]. As younger generations become more concerned with taking on debt, they do not see the same value of a credit card that older generations did. According to Sezzle, an installment payments provider, 30% of millennials do not have a credit card and 87% of consumers want a way to pay for goods over a period of time that is not a credit card. Furthermore, a study conducted by financial-advice website Credible found that young consumers are more afraid of credit card debt (33.2%) than of death (20.4%).  

As younger generations become more wary of debt and less trusting of large financial institutions, consumers have looked towards these new methods of achieving the same goal of Buy Now, Pay Later.

Are installment payments right for your business?

It’s important to look at installment payments from a few different viewpoints in order to evaluate whether this payment model makes sense for your business.

Industry

It should come as no surprise that installment payments make more sense for a merchant offering high ticket items than for merchants with inexpensive goods. It is unlikely that a customer would choose to pay for their morning coffee with 4 easy installments of $0.50. However, if a merchant is dealing with a low conversion rate with items sitting in a checkout cart only to be abandoned, offering to pay for that item in installments may entice the consumer to continue the checkout process all the way through to purchase.

Customer Experience

There are both costs and benefits to the customer experience when using installment payments. In a best-case scenario, a customer who prefers installment payments can use their chosen method of payment. If the customer has used an installments service before, there is likely very little friction in entering their credentials and completing their order. As mentioned above, installments payments can increase a customer’s purchasing power by making an expensive order more financially manageable.

Conversely, any negative experience the customer has with the installments provider will likely be attributed to the merchant as well. While installments providers tout interest-free payments and an alternative to credit, there are still consequences for a failure to make payment. Installment providers charge late fees based on a certain payment plan and will even send a customer to collections if they fail to pay multiple times. This customer will likely confer a negative experience onto the merchant. It is important to consider how using a third-party payment provider will influence the customer experience both positively and negatively to decide which outweighs the other.

Cost

Perhaps one of the most important aspects to consider if the cost of accepting installment payments versus additional revenue to be gained. A merchant should conduct an analysis to determine if accepting installment payments could increase the ticket amount, number of orders, or increase repeat customers. A comparison of the benefits to be realized against the costs incurred will help determine the value of installments payments to a merchant. 

There are many facets to consider when it comes to accepting installment payments. To explore your options and considerations, please contact Leah Ehler at lehler@wcapra.com.