Klarna: Solving the Most Fundamental Challenges of eCommerce

Earlier this week, a mate told me about a Swedish payments company that is funded by Sequoia Capital, the venture firm that invested in Google, Paypal and more recently Square.  To learn more about the Klarna, I thought I’d do a post on them.

First, some background.  Klarna was established by three students at the Stockholm School of Economics in 2005, when they took part in the school’s incubator programme and received EUR 60K of angel investment.  The background for their business idea can be summarised with two simple facts:

·      70% of online shoppers would prefer to pay by invoice

·      29% of those who don’t shop online do so because of security

The entrepreneurs behind Klarna therefore decided to develop a convenient, secure and flexible solution to enable online payments by invoice.  The customer simply selects Klarna Invoice as payment method at check-out, enter its national ID number and Klarna will underwrite the payment.  The merchant sends the order, along with an invoice, to the customer, who settles the invoice with Klarna within 14 days. 

By implementing Klarna Invoice, and better catering to customers who are uncomfortable with using credit cards for online purchases, merchants increase sales by an average 25%.  Klarna charges the merchant a set-up fee of EUR 330, an annual membership fee of EUR 330 and a transaction fee of 2.95% plus EUR 1.7.  This is clearly not cheap, but with few competitors offering a similar service, most merchants will probably see the value of Klarna.

In addition to their basic Invoice solution, Klarna has launched two other products; Klarna Account and Mobile.  Klarna Account is an instalment service that allows customers to break up their repayments over several months.  All purchases that are made through Klarna are consolidated to a single account, which provides additional simplicity.  This service has half million users, who on average make 5 times more purchases than other online customers.  

Klarna Mobile is the most the most recent Klarna product and is currently only available in Sweden.  With this solution the customer enters his mobile phone number at check-out and receives a PIN-code by SMS, which is used to verify the purchase.  The customer is automatically set up with Klarna Account, which provides one monthly account that aggregates all purchases and enables the customer to split the payment in instalments.  Although this service initially targets online payments, there is clearly potential to expand it to brick-and-mortar purchases.

The numbers certainly demonstrate that Klarna has hit on a very attractive opportunity and show why Sequoia chose to invest.  Five years after being set up, Klarna is now present in 6 northern European markets, Sweden, Finland, Norway, Denmark, Germany and the Netherlands, and is accepted at more than 8,000 merchants.  4 million customers have made a purchase through Klarna to the value of more than EUR 500 million.

The beauty of this model is that Klarna is not dependent on building a network, as customers can use the service without already being registered users.  Although customers may be more inclined to use the service as it becomes more familiar and they begin to consolidate their services with Klarna Account, at its core, the service is as relevant to the first merchant as it is to the millionth.  

Still, there are a number of challenges ahead.  The credit card networks are continuously improving their security features, slowly alleviating customers’ concerns with security.  Furthermore, every week a new player seems to enter the online payments space with new, more convenient and secure technology.  These trends may eventually put pressure Klarna to reduce their merchant fees.

Moreover, Klarna’s Mobile solution does not seem like a viable competitor in the bricks-and-mortar space.  Customers are more comfortable with using credit cards for physical transactions, cancelling out Klarna’s proposition to brick-and-mortar merchants.  With this in mind, physical merchants are unlikely to accept the relatively high implementation, membership and transaction fees that come with Klarna’s service.  Finally, the scale of sales and implementation resources that would be required for Klarna to expand their service among physical merchants would probably see them overreaching.

Despite these challenges, by developing a secure and convenient method for customers to shop online, Klarna has solved two of the fundamental challenges associated with ecommerce.  With little competition in this space in Europe, Klarna will likely to continue growing for many years to come, certainly justifying Sequoia’s EUR7M investment.