Following our regular weekly interview, the Finanser talks this week with one of Europe’s fastest growing unicorns, Klarna, in conversation with co-founder and Deputy CEO Niklas Adalberth,
To begin with, perhaps you can tell me how you and your colleagues came up with the idea of Klarna.
Sure. When we started this company, the entire idea was around safety. In Sweden, where we started, people were reluctant to use their credit card online because they didn't like the idea that their card number would be out on the Internet. They were also sceptical as to whether they would actually get the products they ordered. They would be worried they might receive a blue shirt instead of a red shirt or a size 43 shoe instead of the size 41 they ordered, for example.
In other words, the Internet and e-commerce in Sweden and the Nordics, was being hindered by this lack of safety. People didn't trust the card networks online basically, and that is where the idea came around for Klarna. We wanted to work out how to make consumers feel safe shopping online.
Early on we figured out that the only answer would be to create a company that is like a middleman, taking on the full risk for the merchant and for the consumer of paying and delivering online goods and services. That’s the basic idea of Klarna. We pay the merchant, no matter what happens, and the consumer can pay us up to fourteen days later, once they have received and are happy with the goods.
The key to being successful in this was to make an algorithm to calculate the risks involved. This is core to our model as to whether we should accept an order or not, as we must know the risk of the consumer not paying. We also knew that we could only take on this risk in the transaction if we made scale out of this, as you need thousands of transactions if you are to allow one to fail.
We also had one other big benefit, and that was that we had no previous banking or payment expertise. My expertise or experience came from flipping burgers at Burger King. That's all the knowledge I had when we started this business. This was a good thing because it made us rethink everything. For example, we knew immediately that we could not base this on the normal card scheme standards, as these had been designed from the 1970s or before. They do not work on the internet, and that was why we rebuilt everything and questioned everything, as we wanted to launch a company built for the internet and that could make the best customer experience there is.
So initially, Klarna was all about being a payment method. It meant that you could go to an e-commerce site as a consumer, select whatever you want, and then when you come to the checkout have the option to click on "Buy Now, Pay In Fourteen Days". When you did select that payment method, instead of Visa or MasterCard, you just entered your name, address and date of birth. That is all the information we needed. Based on that limited information we were able to take that data, perform the risk assessment and give a ‘yes’ or ‘no’ answer within a second. If the answer was ‘yes’, then the merchant was paid there and then, no matter what happened. This meant they could be confident to ship the goods right away to the consumer; who pays up to fourteen days later.
This worked because Sweden is a very open society and so you can get data, such as the exact income that someone makes, based upon your name, address and date of birth. The information even tells us your income based upon earnings and income from capital. All of this data is made publicly available in Sweden, and hence this kind of risk assessment is actually quite easy. As a result, we were able to start without significant losses per transaction, and this is how Klarna began.
I'm guessing from the experience of the founders, that you were just frustrated with the problem and wanted to solve it. Did you all have a technological background?
We did not. We were starting a Fintech business with no technical expertise, no financial expertise and no money. That was a quite tough start, but we were able to raise money and we were able to take in the technical expertise in exchange for equity.
And what was the real kick starter to the business?
We were just frustrated that we, the founders, didn't dare to shop online. We also discovered it was complex making a purchase online. You had to register an account; remember a username and password; answer questions like "What's your mother's maiden name?"; and all of these were very annoying steps you needed to do in order to proceed with your purchase. If you were to compare that to the physical world, it would be super strange to arrive at the checkout and then suddenly have the cashier asking you all of these questions. You would just leave without checking out.
So we started developing the idea of Klarna and when we launched this product, we got a great reaction. Typically, the feedback was something like: "Guys, you know what? This payment method is not only the safest because I don't need to pay until I get my stuff, but it's also the fastest because I don't need to take out my credit card and start filling out the details. It’s even easier, as I don’t have to enter all these numbers on this very small smartphone. I can just enter my zip code, and instantly you guys approve the transaction. Why don't you guys do this for the entire checkout, to make the entire checkout easier?”
And that's when we discovered the Klarna Checkout, which is a product that we have launched in the UK and are about to launch in the US. It works well. For example, in Sweden, we've been able to convert more than 50% of all our transactions into this new payment solution. The way it works is that, when you come into the checkout, you only need to enter your email address and zip code, and that's it. The only thing you need to do before pressing the "Buy Now" button or "Place Order" button. You just place that order. You just press that button. You come to the confirmation page instantly, and the order is approved. You also have the option, on that confirmation page, to decide if you want to change the payment method but, if you don't, you can just close down your smartphone and you will get your goods. You can then decide when you want to pay, up to fourteen days later. That’s the essence of Klarna and what we've really done is separated the buying from the paying, where the paying is often the more complex part.
Heavy-weight players like Google and PayPal are focused on the same issue, and yet they didn't solve it. Why have you been successful at solving it, when they haven't?
Because they base it on Visa and MasterCard. The old traditional card scheme standards that go fifty years back in time. When you read about all of these fantastic startups on TechCrunch or whatever, and you look into them more closely, you will see the same. They're all based on the old card schemes. So you could question: how innovative are these new companies in reality? Sure, if you look at Stripe for example, I think they're very good in terms of providing credit card solutions in an easier way for the merchant. They simplify the sign up of a merchant that wants to sell online. That's good. If you look at Square, same thing. But it's all still based on old systems or old standards and you still need to pull out that credit card.
I was going to ask you about Stripe, because they're going to go head-to-head against you. Is that a concern?
Not really. All competition is good, and I think that they've done a really good signup process, but we provide something completely different. We provide a separation from buying and paying. We make it super easy to checkout for the consumer.
In terms of how you see Klarna growing, you’re developing across Europe right now. What challenges have you found there?
So we've separated the buying from paying. The buying should be super easy and the paying should also be super easy, but every country is different and has different views and needs. In fact, many markets have payments that are super localized. In Germany for example, the consumer could actually settle in the end with the Visa or MasterCard or they might do it through a direct transfer to the bank or through the domestic Elektronisches Lastschriftverfahren (ELV) system, which is very popular in Germany and works like a direct debit.
Now we know that we cannot force consumers to use our option only, so all those options are still there. We don't force the consumer to go through a cumbersome process before they are accepted and before the merchant gets the order completed. The challenge then is to make all of this local. We need to have all of these local payment methods supported in every geography where we operate, to provide a great experience because, in each market, it's very different.
In the UK for example, there is now Zapp and Paym. If Zapp takes off, as is likely, then it should be included in the Klarna Checkout as a way of settling in the end. The same with Apple Pay, Google Pay, Ali Pay or whatever method people prefer in the end, when they are ready to make the actual purchase. That puts a lot of efforts on us to continually develop and incorporate all of these options, and that is why we employ more than 350 people in our engineering department.
We are constantly developing and constantly making it more and more localized. On top of this, as with any payments company, we also have all the KYC requirements that are slightly different dependent upon which markets you operate in. These legal requirements needs to be 100% compliant with all of the different regulations in the different markets and, once again, that creates a lot of work for us to still make it very easy and also 100% compliant.
When I talk about the Klarna model, some people say to me -- "How can they solve the credit risk if you don't have the data?" You mentioned you had access to all this data in Sweden but, in some countries, they don't have any data.
That would be trickier for sure and, once again, I think that if we had started this business in the UK, where you don't have as much data, maybe we would never have succeeded. The thing that we have discovered over each expansion -- just taking this business idea to Norway for example – is that people said: "Oh, you will never be able to do this in Norway because we don't have this Social Security Number that everyone uses, so you can't identify the customer as easily. Also, you don't have access to income data so how will you be able to assess the risk?"
What we did is recognise that we had to work with less data, but we were still quite data-rich. We were able to get the losses down to lower than any other bank would have because we discovered that behavioural data is very, very powerful. Behavioural data means that we take in the data and analyse the risk from that data. If you shop at three o'clock in the morning, we see that as higher risk than if you shop at three o'clock in the afternoon. Our risk models recognise that a transaction is higher risk in the middle of the night than during the day.
Other examples are that we also take in the line item data so that, if you buy a book about champagne, we see that as lower risk than a book about beer. We take that data into our models. We also take in, for example, if you write in upper case or lower case. If you write with capital letters, we see that as higher risk than if you write with normal letters. So all of this is almost the same whether we are approving a transaction in the UK, Spain or in Sweden.
In addition to this, we have a lot of external data. We are plugged into over 25 external data providers, depending on what geography they cover. All of this – the data and our algorithms – helps us to assess the risk.
I was told that all I need to do if I'm using Klarna is just to give my ZIP code or post code and that's it. Is it really as simple as that then?
Klarna Checkout is very dynamic, flexible and interactive, in terms of working to make it super easy for you regardless of who you are and what market you are in, and what transaction it is. For example, in Sweden, the email and zip code could be enough data for us, if it is for a lower transaction amount. This is because we recognize the IP address and the zip code, and can check that they are geographically aligned. That is enough if it's a lower risk item that you are buying. It all comes back to that very easy experience, especially if you're a returning customer. It may be different for a first time user, where we may need slightly more data, especially if you’re buying something more expensive. Let's say that you're a completely new customer and you want to buy two iPads at the same time at three o'clock in the morning. Let’s say you want to do this through a hotmail.com email address. Of course, with those risks, we would then ask you a few more questions. It might even be that we want you to enter the credit card details in advance.
But what's important here is that only 1% of the transactions are risky or will cause a loss. We don't want to punish the other 99% of the population for that 1%. Banks, because they only focus upon risk, force us to enter all these cumbersome details because they distrust 100% of buyers, rather than the 1%. We do the opposite. We give 85% of the customers in the population a very nice experience, because we think the risk is actually quite low. As long as the transaction makes sense; the IP address makes sense; you write with normal letters in lower case; it’s a daytime purchase; it’s a low cost item; and so on. As long as all of these variables are right then, for 85% of transactions, we deliver a fantastic purchasing experience. The remaining 15% that we're not sure of, then we start asking more questions in the checkout process, but it’s still super easy and very dynamic in that sense.
Ultimately, it’s all about a much nicer experience for the majority of the people.
A lot of the TechFin or FinTech new companies are addressing issues that the banks don't deal with and, when I talk about Klarna, you are honey for the merchant bees, if I can put it that way. This is because the merchants are looking at conversion, they want more business, but the banks are prohibitive because of their risk mitigation and they make it difficult. You've solved the issue both for the merchant and the consumers.
Absolutely. And if you look at the normal credit card payment, what players are involved in making that transaction possible? Well, first you have the technical standards, which is either Visa or MasterCard, who have their way of working for what they need for data to make the transaction. Then you have the issuing bank. They are the ones that have the consumer risk. Then you have the acquirers, who take the merchant risk and approve the merchant: the online shop in this case. The issuers and acquirers are usually very traditional and, most of the time, come from very old systems with banks that were using mainframe computers from the 1970s. Then you have the gateway, which is yet another player in this transaction.
That is four different players involved in a payment. In order to make all of these different players work together, to make them innovate and change, is difficult. To get all of these different players in the payment system to work together requires a lot of coordination, a lot of time, a lot of agreement. That's why we see most of the payment schemes being based on old components that are slow to change.
That is why we have rediscovered the process, and are doing all of these four things in one payment system. We are our own issuer. We do our own underwriting for the consumer. That is our system. We do our own acquiring. We are the acquiring player in this transaction. We hold our own brand, our own technical standards and we own our own gateway. If you do all of these four things in one player, one company, one innovation and one technical platform, then you can innovate like no one else. It is far easier to innovate if you control the whole transaction than just a fourth of the transaction.
Where do you see yourselves going as a business?
We believe that there is a need all over the world to make payments much, much easier. There is a strong need for a one click system that covers the risk that you will actually receive what you order, and that you don't need to send the money in advance if you don't want to. We think there is a strong need for that all over the world, and we think that the e-commerce boom has now really started. If we can simplify the entire process around the checkout into one click, I think there is a great need for that, and hence I think there’s a great need for Klarna all over the world.
About Niklas Adalberth
Niklas Adalberth is Klarna’s third founding member. Niklas has a Master in Economics from the Stockholm School of Economics and experience in being an entrepreneur within the IT sector.
Klarna was founded in Stockholm in 2005 with the idea to simplify buying. Today, Klarna is one of Europe’s fastest growing companies and, after joining forces with SOFORT in 2014 to form Klarna Group, claims to be the leading European online payment provider. Klarna Group has over 1,200 employees and is active in 18 markets, serving 35 million consumers and working with 50,000 merchants. You can find out more here. http://thefinanser.co.uk/fsclub/2015/06/klarna-chameleon-you-know-something-works-when-its-copied
Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, TheFinanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal's Financial News. To learn more click here...