By Anubhav Jain
Note: This piece was originally published in Tech Crunch on September 10, 2021. You can read the original post here.
“Buy Now, Pay Later.” The term has become mainstream in the past few years and rightly so. BNPL as a product stands for easy credit, linked directly to the consumption of goods or services. Today, BNPL exists in various forms, from the simplest small-ticket ones offered by fintechs on consumer checkout platforms and marketplaces by companies like Lazypay, to the closed-loop ones offered by marketplaces themselves such as Amazon Pay Later (which they are now extending for outside use as well), to the ones offered by companies specializing in expanding the scope of consumption and consumer credit, such as those offered by ZestMoney.
Most of the global growth in BNPL has been around the consumer segment and has predictably driven retail consumption and retail lending over the past few years. Consumer BNPL is a good alternative to credit cards, especially for the large segment of consumers who do not have a credit history and thus are unable to obtain credit from financial institutions. However, there is another vertical of BNPL products that is now becoming increasingly important: the one targeted towards small and medium enterprises (SME), also known as “SME BNPL.”
Evolution of B2B Commerce in India
E-commerce has seen tremendous growth in India over the past decade. While 2010–2020 has largely belonged to consumer technology companies, with the likes of Flipkart, Ola, Zomato, Pharmeasy, Makemytrip, and others completely redefining how Indian consumers shopped or consumed products and services online. Penetration of smartphones and availability of low-cost internet and mobile data led to rapid growth in retail commerce in India, not just in the larger metro markets, but in what are known as “tier 2” and “tier 3” towns.
With the growth of digital e-commerce came parallel growth in consumer credit in the country. Just as consumer durable goods loans by Bajaj Finance had driven increasing consumption in the offline world, so did credit cards and digital lending in various forms lead to credit-based consumption in the Indian retail segment, both offline and online.
Yet it must be noted that the robust Indian retail market is enabled by a large B2B supply chain. This supply chain was broken at various points due to multiple intermediaries and bottlenecks created by the inefficiencies of each of those. With increasing pressure from end consumers, there was a need for disruption through the use of technology. A number of players responded by using technology to revamp the B2B e-commerce space. They began organizing the previously disorganized B2B commerce market at various touchpoints, inserting convenience, pricing, and easier product access through technology-led logistics and a modernized supply chain.
Since 2020, there has been rapid development in the B2B e-commerce space. With small businesses transitioning to smartphones for running a significant part of their day-to-day business using mobile apps, and the penetration of low-cost Internet across India, there is widespread disruption in how businesses transact today.
Industry reports have also clearly highlighted the expected growth in the eB2B or digital B2B space in the coming years.
Source: Redseer B2B Narrative Report
Timing for a BNPL product for SMEs
Not only has smartphone and internet penetration driven technology adoption among SMEs, but the recent COVID-19 pandemic amplified the adoption of digital B2B commerce. Small businesses, which were earlier using physical means to procure goods and services, were now forced to try new and online models for their day-to-day business.
Also, with UPI (Unified Payments Interface, an instant payments system) completely disrupting P2P (person-to-person) and P2M (person-to-merchant) Transactions, a number of innovative solutions have evolved which find relevance in the B2B transaction space. QR Codes and UPI payments have now become more common in the B2B space, especially among smaller businesses, even though their share is still significantly low. The very next step towards solving the digital B2B puzzle is embedding credit inside every transaction and every invoice. There’s never been a better time for businesses to do this.
As it happens, a number of government initiatives in India clearly highlight how India is moving towards digitizing B2B transactions: mandatory GST e-Invoicing, use of account aggregators for financial data collection, Digital KYC and NACH (National Automated Clearing House, a form of auto-debit from bank account), and acceptance of Digitally Signed Agreements are all initiatives which would push B2B transactions and B2B credit to a completely different level.
If we compare B2B transactions in the digital space to the offline world, there is only one missing link, and it is terms offered to a small business by their supplier/distributor or vendor. Businesses, unlike consumers, are purchasing goods and services to eventually trade them or add value and further sell to consumers or others down the value chain. This process is not immediate and has a certain time cycle attached to it. As a result of the longer sales cycle, most small businesses require credit payment terms while making their inventory purchases. As B2B commerce scales and grows through digital means, a BNPL product for SMEs is the right solution to support the growth of SMEs in India.
So What’s the Difference Between BNPL and SME BNPL?
An SME BNPL product is nothing but a purchase financing product offered to small businesses who are making the purchase of a good or service from their suppliers, which could be a distributor, an aggregator platform, or a digital B2B Marketplace (like Udaan, Hyperpure or Jumbotail). It is a financing option provided to any business transacting on a digital B2B platform that seeks terms at the time of their purchase transaction.
Here’s how it works. Let’s say a Rice Trader buys 50 kg of rice from a distributor (or digital B2B marketplace) every week and has done that (on average) for the past few months. By providing a credit line to the Rice Trader sufficient for purchase of 100 kg of Rice with a 14-day credit Cycle, the SME BNPL provider would ensure the Rice Trader gets sufficient support in managing working capital without worrying about the need for liquidity for purchases, and the expected risk would also be lower since the Rice Trader would not delay payments, because that would result in a block in supply by the distributor in the event of non-payment. Compare this to the traditional approach where the same Rice Trader was provided a certain credit limit purely based on their bank statement or Financials, which they could use for any purchase or business expense, without any control on the end-use.
Special Considerations Needed
There are a few points to note as we talk about SME BNPL. As the end customer for this type of BNPL product is a Small Business — often characterized by volatile cash flows, seasonality, and working capital problems — it is critical to provide the BNPL option with flexibility in terms of usage and repayment. Ideal BNPL options for SMEs are those where SMEs can repay their transactions as and when they want and are charged interest only on the amount used and the number of days for which the credit is utilized (almost like an Overdraft facility). This flexibility ensures that the SME using the BNPL option does not feel the burden of any monthly obligation or EMI (Equated Monthly Instalment) and can plan their funds/cash flow accordingly. This is one of the most important differences between consumer BNPL and SME BNPL, and rightly so; a salaried individual or retail consumer can pay her debts on a monthly basis due to a fixed expected income (or salary) at the beginning/end of every month, but an SME needs to be given flexibility owing to the inherent nature of their business.
Another important characteristic for an SME BNPL product is control around usage. Most consumer BNPL companies evaluate their customers in terms of their risk and ability to pay, irrespective of the merchant where the customer is making their purchase or using the BNPL product. But an SME BNPL product can be offered both in closed-loop and open-ended variants. An open-ended variant would require the SME BNPL provider to assess the SME as a whole in terms of their risk and ability to pay, while the closed-loop variant would more likely assess the transactions of the SME with a particular supplier/distributor/B2B marketplace to establish the likelihood of repayment.
In terms of tenure, different consumer BNPL products offer different terms to the same customer depending on the nature of the purchase. For example, a retail customer can get 15 days of credit by a BNPL provider on Swiggy or Dunzo, and the same retail customer is provided 3 or 6 months payment options when making a purchase on Amazon or Flipkart. This is contrary to SME BNPL, where the small business using the BNPL product is typically offered the same credit term across providers and merchants, which is typically governed by the industry to which the SME belongs.
Finally, in terms of pricing, an SME BNPL product is mostly characterized by subvention (or an interest-free grace period) provided by the merchant (similar to the offline world, where the retailer typically gets a certain “free credit” period provided by the distributor before inventory must be paid for), which may not always be the case for consumer BNPL (though in most consumer BNPL scenarios, the merchant or the brand subvents the interest cost as the cost of converting a sale, and the consumer is able to enjoy an interest-free purchase).
Here’s a quick chart that defines the differences between BNPL and SME BNPL:
SME BNPL and Cash Flow -Based Underwriting
One of the biggest problems facing the SME credit Industry is the fact that most incumbents follow balance sheet-based underwriting models when offering any lending product to Small Businesses. More than two-thirds of Indian SMEs are underserved in terms of access to formal credit for this reason; they either do not have a balance sheet (since most Indian SMEs don’t prepare financials or get them audited) or even if they have one, their revenues are under-reported since the majority of their income is in cash. In both scenarios, traditional underwriting does not work. Thus there is a need for a different approach to enable credit for SMEs.
SME BNPL is the solution when flow-based underwriting or transaction-based underwriting can be used to offer credit to SMEs. Since the SME BNPL use case is that of a purchase of goods by a business, instead of assessing the overall net worth of the business for a larger credit line, credit can be offered to the SME purely based on their short-term cash flow projections and underwriting for the same.
The OCEN Framework (Open Credit Enablement Network, which lays the rails for standardization of credit) also highlights how cash flow-based underwriting can be used at scale to enable small ticket and short term, sachet-sized lending for SMEs. By underwriting the upcoming invoices for an SME using historical transactions, an SME BNPL product can be built which avoids the heavy documentation process in terms of collecting financial statements or banking transactions from the SME, thereby reducing friction and increasing adoption, at the same time assessing transactions would ensure that the limits provided are in line with the business cash flows.
Rupifi has developed a strong cash flow-based underwriting model which it uses in its SME Buy Now Pay Flexibly product and simplifies the journey for the SME by reducing the need for collecting any bank statements or financial information. This SME BNPL product is also closed loop, thereby ensuring that the SME is able to use this feature only on the platform or marketplace from which the historical transaction data is obtained, thus reducing the risk of default.
Sector-Specific SME BNPL
With SME BNPL, the Industry Segment of the SME is a critical consideration. For example, most fast-moving consumer goods (FMCG) or grocery retailers sell their products in a 7 or 14-day cycle and thus require a maximum 14-day credit period when offered a BNPL product. Similarly, in the Pharma/Medical segment, the retailers typically expect up to a 30-day credit cycle. Extending this to fashion or electronics segments, the credit requirements extend to around 45 or 60 days, and on the other extreme, in Agriculture, the credit requirements are even longer, owing to the seasonality of the crop cycles, at around 90 or 120 days.
Not only is the credit term the sector-specific input in designing an SME BNPL product, but there are other sector-specific nuances to consider. For example, margins in different sectors also determine the credit terms offered (in terms of subvention by the merchant). Similarly, depending on SKU level margins, merchants use credit to buy certain SKUs using the BNPL product while the SME buys certain other SKUs using cash payment upfront. All these factors make SME BNPL both a complicated and interesting opportunity.
Growth and the Future of SME BNPL
As B2B transactions continue to get digitized, credit products for SMEs need disruption using technology and better product design. SME BNPL is the most obvious step towards helping SMEs, especially in the post-COVID world, where credit has dried up even more for the smaller businesses. Globally we are going to see multiple companies in the digital B2B space in the future, and expect that SME BNPL will become central to doing business.
Anubhav Jain is co-founder and CEO of Quona Capital portfolio company Rupifi, India’s first embedded lending fintech. Anubhav has more than a decade of experience in Credit Risk, Analytics, Customer Management and Portfolio Development. At Rupifi, Anubhav and his team are building embedded lending products for Indian SMEs, with their flagship product being a flexible SME BNPL.