I was recently talking with a few payments folks, and a hot debate began between two folks about banks having the wrong focus. The banker disagreed, of course, but the debate went something like this:
“You make things too difficult and complex”, said the protagonist.
“We have to do that, as we are a regulated industry”, said the banker.
“No you don’t”, answered P. “You just do this because you’ve built a complex business. It’s nothing to do with regulation.”
“Of course it is”, said B. “We have a global business that has to deal with international regulators and act as financial police. Of course, that’s complicated because we have to do checks and balances. You only need to look at the fines hitting the industry for anti-money laundering and related issues to realise how complex this is. You cannot simplify this, but have to balance the complexity with the user experience.”
“Bollards”, said P. “Just look at Klarna”.
“Klarna?” said B. He’d never heard of them.
“Yes, Klarna”, said P. “Klarna focus upon what the customer needs, which is sales for merchants in their case. You focus upon what the bank needs, which is risk mitigation. Your focus is wrong. You focus upon internal risk and avoiding regulatory sanctions, rather than regulatory opportunities and what the customer needs. Klarna clearly demonstrates this.”
So I decided to take a closer look at Klarna and, sure enough, they’ve created an interesting business based upon conversion of online interest into sales – what merchants need – rather than dealing with the regulatory risk concerns. In fact, they’ve been created through regulation as a business that competes with PayPal, iDEAL and the payments system, thanks to the opportunities created by the PSD (Payment Services Directive).
For example, they now hold a European passport to provide credit finance to merchants. Their license is as a credit market company – a credit financing firm for businesses – and their model is based upon order fulfilment.
Here’s a few words from their website:
Klarna was founded in Stockholm in 2005 with the idea to simplify buying. Today, we are one of Europe’s fastest growing companies. In 2014 we joined forces with SOFORT and formed Klarna Group, the leading European payment provider.
Klarna Group has more than 1200 employees and is active on 18 markets. We serve 35 million consumers and work with 50 000 merchants. Our goal is to become the world’s favourite way to buy.
And they are well on their way to achieving this.
The model is a simple one. Customers get the goods without having to pay upfront. They pay upon invoice. Founded in Sweden in 2005, they expanded across the Nordic region in 2008. In 2010, the company moved into German and the Netherlands, then Austria, France and Italy and, more recently, the UK. The company is now active in 18 markets across Europe.
The model is incredibly simple and effective by allowing users to make purchases online without providing their payment details to the merchants.
It originally worked by asking for your national identification number at checkout (Social Security Number, SSN, in USA terminology). Klarna’s technologies then make a micro-credit check in real-time using the ID number and, if clear, pays the merchant of the goods. The process has now evolved to purely asking for your zip code and email address.
This means the purchaser need make no complex registration or provide any sensitive data when ordering. They just pay the Klarna invoice when they’re ready within fourteen days using a credit card, cheque or bank transfer. In other words, Klarna has removed the online payment piece from online buying.
This is why Klarna has the strapline simplifying buying as their whole focus is to encourage sales conversions online, which merchants love, and make buying easy, which customers love. According to their deputy CEO and co-founder Niklas Adalberth, the company has “increased the sales conversion rate to 50% on mobile devices, from an average of 3% when the company’s services were not used.”
This is because the system makes it easy to buy. For example like Amazon checkout, by using the post code Klarna can pre-fill the user’s address for checkout purposes and make the checkout experience even easier. This also reduces fraud, as the goods can only be shipped to the registered address with any defaults reported to the credit bureau.
Klarna then makes money by owning the entire payment experience end-to-end. Klarna issues the credit to the buyer and can encourage reduced payment costs by getting the payee to use a bank transfer rather than a credit card. In other words, Klarna's revenues are made from merchant fees, user fees and interest charged to users (see end note for more on this).
As mentioned, Klarna was founded in 2005 and is valued at over $1.4 billion today – a unicorn in Fintech start-up terminology – increasing its employee numbers by a third last year to 1,200 staff, and has its foundations in behavioural data. Two of the three founders researched a Masters dissertation on how to use behavioural data for risk. Their findings were that behavioural data is four times more powerful than financial data, and this is why Klarna are happy to accept all of the risk of default payments because they use information from 250,000 transactions every day in their data models. It is also why Klarna does not sell its customer analyses to other companies.
In summary, Klarna simplifed the buying process and has massively changed the Northern European online landscape, and you know something works when it is copied, e.g. Qliro has now launced in Sweden, a Klarna style lookalike.
This is just one of several interesting new Fintech payments startups that I’ll focus upon in the next few weeks, Adyen being the next and any other recommendations welcome.
End note: More details on Klarna's revenue streams
Note: Fees vary with the specific products and countries. Some of these numbers may be out-of-date but should be indicative.
1. Fees to merchants
Set up fee:
- Certain products like the new Klarna Checkout has a set-up fee of 3995 SEK (613.59 USD), which is currently being waived in the UK, e.g. it's free.
- 599 SEK (92 USD) per month for Klarna Checkout
Per transaction fee:
- 1.5% – 3% per transaction
2. Fees to users:
- Late fee / reminder fee:
- 60 SEK (9 USD) in Sweden. 135 SEK for larger outstanding balances.
- 4.95 EUR (5.50 USD) in Germany
- Fees for their instalment product:
- 29 SEK (4.50 USD) one-time fee in Sweden
- 0.45 EUR (0.50 USD) per month in Germany
- Per transaction invoice fee: Klarna doesn't actually charge users this fee, but it is not uncommon for merchants to pass the fee on to users. Typically 29 SEK (4.50 USD).
3. Interest charged to users on instalment plans or late payments:
Effective interest rates are pretty similar to credit card rates:
- 25-30% in Sweden
- 15% to low 20+% in Germany