“Buy Now, Pay Later” (BNPL) : Optimizing Customer Targeting Decisions Using Payment Default and Product Return Option Values

Consumers’ option to default when purchasing retail goods is a pervasive and difficult problem for retailers to manage, especially with the growing popularity of “Buy Now, Pay Later” (BNPL) payment methods. The difficulty arises because constructing optimal targeting policies requires balancing demand and cost aspects, as well as accounting for the consumer return option. In this paper we develop a structural model with both default and return options included, that nests related discrete choice models as special cases. The model enables a firm to measure the option value of both defaults and returns, and to balance their costs and benefits. We find considerable heterogeneity in the value of defaults and returns, across consumers and categories; higher values of these options leads to increases in demand. We find that the firm will infer that customers have lower price sensitivity and higher transaction fit uncertainty if we ignore defaults, and show how these results can help optimize return policy. We simulate response to firm decisions regarding default and returns where actual return cost exceeds default cost to the firm, which is an understudied but quite common problem in relatively small ticket (per unit) items sales through BNPL and credit payments payment mechanisms