Even its harshest critics call Klarna a “genius” business model. The firm, which lets shoppers buy now and pay later, crucially without fees or interest, has grown fast in the UK – it has almost 10 million customers there and is opening 95,000 accounts a week.
Interest among tech investors has reached fever pitch, with Klarna recently valued at $10.6bn (£7.8bn). It bills itself as offering a “healthier, simpler and smarter alternative to credit cards” and has 85 million customers globally, with an average age (in the UK) of 33.
But is it luring its young customers into unsustainable debt, letting them buy more than they can afford? Or is it just an electronic version of the credit offered by old-style catalogue shopping?
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The retailer picks up the tab
You can’t miss Klarna at the checkouts of scores of big online retailers. “Don’t wait until payday hon, Boohoo accepts Klarna,” says the fast-fashion retailer targeting young online shoppers. “Cop it now, pay in 30 days with Klarna,” JD Sports says. Asos, H&M, Superdry, Pretty Little Thing, Schuh, New Look and hundreds of other retailers have also linked with the payments firm.
In the UK, Klarna lets shoppers pay in either 30 days’ time, with a debit or credit card, or split the cost into three equal payments, the first taken immediately and the next two 30 and 60 days later.
It boldly promises there is “always” no interest, no fees and no late payment charges. There is no complicated account sign-up, and no credit check appears on the shopper’s credit record. It has a separate service called “financing”, which it says is only a small part of its business that acts more like a traditional loan, charged at up to 18.9%, for which hard credit checks are made.
The company makes its money by charging the retailer rather than the customer. Small retailers pay as much as 5.4% plus 20p for each sale, although big companies pay less.
Buy now, pay later (if you can)
If sellers are bearing the burden, should we really care about the way Klarna operates? For Martyn James of Resolver, a dispute resolution service that has received a number of complaints about Klarna, the main concern is that it encourages overspending. “Its business is to say ‘come on, spend, buy it now, go for it’. It’s not really that far removed from payday lending.”
Klarna allows shoppers to order multiple items at once, safe in the knowledge that their card won’t be debited with the full amount immediately. It means they can order the same item in several different sizes, returning the ones that don’t fit, and pay any outstanding money later for those they keep.
“They are now monetising the simple act of trying on something to see if it fits,” James says. He worries that retailers are enabling customers to order multiple items in expectation that some won’t return them in the 14- or 28-day window – and are then stuck with the bill. There is also a risk that delays in returning goods mean extra payments are taken.
The debt charity StepChange says it has an increasing number of clients who have money owing on “buy now, pay later” (BNPL) among their debts when they turn to it for help. Klarna is easily the largest BNPL player in the UK market, although there are others, including Clearpay, used by Marks & Spencer.
“BNPL services paint themselves as simply the new convenient way to pay for goods you want. But along with convenience there’s a more worrying aspect: by encouraging you to defer the reality of paying precisely at the moment you are focused on the goods you wish to buy, there’s a risk that when the time to pay does come, it might not be affordable,” says Sue Anderson of StepChange.
Will shoppers be able to repay?
Klarna rejects suggestions it is encouraging reckless spending, pointing to its low rates of missed payments. “The ultimate test of our ability to ensure that consumers are only buying what they can afford is our default rates,” it says.
“Fewer than 1% default on a payment with us and that number has stayed constant throughout the lockdown period. The fact that this number is so low, and without the threat of late fees or interest accumulating, suggest to us that the vast majority of consumers are using our service to better manage their shopping within their means.”
But it is in the sights of financial regulators. The Financial Conduct Authority is examining Klarna and other BNPL operators as part of an inquiry into the unsecured credit market that began in September.
One worry voiced by some bankers is Klarna’s boast that it does not perform credit checks, and even if the shopper fails to pay, it won’t show up on their credit record. In that case, they ask, how can other financial providers of loans and credit properly check a new applicant’s ability to repay?
What if the algorithm says ‘no’?
A report by the financial advice site Money.co.uk, “Shop now, stress later”, suggests that 18- to 24-year-olds on BNPL schemes such as Klarna, Clearpay, Zilch and Laybuy owe about £225 each.
It analysed 10 fast-fashion brands based on how many times “buy now, pay later” is mentioned during the shopping process, with Nasty Gal, Boohoo and Pretty Little Thing “the worst offenders when it comes to promoting them”.
Money.co.uk said: “BNPL is encouraging young consumers to spend more than they can afford. These stores are all fostering a smash-and-grab mentality among young shoppers today.”
So what happens if you buy on Klarna but fail to pay? The company says: “As a last resort, Klarna will refer unpaid debts to a debt collection agency.” But some customers who contacted Resolver said they were chased by an agency relatively soon after failing to pay, even as they were disputing a returned item.
Klarna says it assesses a shopper each time they make a purchase
What may surprise some shoppers is that even if they do fall behind on payments to the extent that they are referred, the unpaid debts won’t register on their credit record. Klarna says it works with “specially selected debt collection agencies that do not impact a consumer’s credit score … Ultimately, Klarna assumes 100% of the risk of non-payment.”
According to the Financial Times, some analysts worry about Klarna’s rising credit losses – which almost doubled in the first half of 2020 compared with a year earlier, leading to a nine-fold increase in operating losses.
Klarna says it assesses a shopper each time they make a purchase. “The affordability check conducted by your credit card provider to determine your credit limit may have been performed many years ago. At Klarna we are performing a check every time you make a purchase.”
This can be frustrating for some customers who are accepted one month and may find they are rejected the next. They will never find out why, as the algorithm that determines acceptance is never revealed.
We asked Klarna what goes into its algorithm. “We conduct a soft credit check. Alongside this, we review multiple data points which are combined to create an internal ‘score’ which we use to determine the creditworthiness.” It did not elaborate on the multiple data points used but it is understood they range from your home address to your IP address and the data that reveals about you.
On Trustpilot, Klarna generally scores well – apart from a recent bust-up over pre-orders for the new Xbox All Access – and being rebuffed is about the most common complaint. This was one recent posting: “Klarna have blacklisted me. I pay on time, have a good credit score, nothing outstanding. I get the same reply each time. It’s worked out by an algorithm. They can’t tell me why.”
Klarna responded: “We cannot provide specific reasons to why a consumer’s order has been denied. Each purchase decision is made by an automated algorithm.”