Fintech/Analysis/

Can Klarna and its rivals survive an economic downturn?

Europe’s most valuable startup is laying off its staff — but will we see worse collateral damage for its smaller competitors?

By Amy O'Brien

Sebastian Siemiatkowski, CEO of Klarna

Public markets are down, and banks and economists are grappling with the possibility of an economic downturn. In these uncertain times, even Europe’s best-funded startup is not immune.

Yesterday buy now, pay later (BNPL) giant Klarna’s CEO and cofounder Sebastian Siemiatkowski said that the company will lay off 10% of its workforce. The company also quietly announced that pre-tax losses tripled to $250m in the first three months of the year, up from $80m in the same period last year. 

“What we are seeing now in the world is not temporary or short-lived, and hence we need to act,” Siemiatkowski said in a prerecorded video message to his “Klarnauts”. 

“More than ever, we need to be laser-focused on what really will make us successful going forward.”

It’s a stark reminder of how exposed one of investors’ — and consumers’ — most beloved innovations of the past decade is to macroeconomic headwinds. Since 2019, investors have poured $3.9bn into Klarna and its European rivals like Scalapay, Zilch, Alma and Zilch — more than half of the total investment into European payments startups in that time.

A staggering 49% of millennials (25 to 34-year-olds) in the UK used BNPL in 2020, according to Bain & Company, using these credit arrangements to splash the cash on everything from CBD oil to Shein bikini bulk buys.

So what does the future hold for the BNPL industry in an era when consumer wallets are pinched and capital is scarce? 

At the mercy of interest rates

The first blow that macroeconomic shifts have dealt to BNPL companies: rising interest rates. 

Aggressively marketed as the friendlier alternative to pesky interest-charging credit cards, BNPL gives consumers the option to split their payment for an item into instalments that are, crucially, interest-free.

This means BNPL providers thrive in a low-interest rate environment, where it doesn’t cost them too much to offer credit to consumers for no or very low interest. For the past couple of years this has meant merchant fees and late payment charges brought enough revenue — but their margins begin to narrow when central banks hike rates.

“More than ever, we [Klarna] need to be laser-focused on what really will make us successful going forward”

“If you can’t necessarily charge higher rates to merchants, and you can’t charge higher rates to consumer borrowers, this has a serious impact on their business model,” says Jeff Tijssen, global head of fintech at Bain & Co. “It’s driving up the cost of doing business in general for these organisations.” 

Unlike many other BNPL companies, Klarna offers retail bank accounts in Sweden and Germany, which offer another revenue stream that actually profits from higher interest rates. That said, it also faces interest rate risk. 

“The degree to which interest rates may vary is uncertain and presents a significant risk to Klarna’s financial position,” the company said in a prospectus last month.

When asked about the company’s exposure to interest rate hikes, a spokesperson for Klarna tells Sifted that the company “continually optimises” its funding mix through retail deposits, bonds and other debt instruments.

“Interest rate costs were equivalent to just under 6% of Klarna’s total net operating income and around 5% of operating expenses in 2021,” the spokesperson says. “So the risks of rising interest rates need to be viewed in the context of how small they are in relation to our revenues and costs.”

Tightened wallets 

The second blow to BNPL is a slowdown in consumer spending. According to Eurostat’s latest data, retail spending in Europe has been dropping at a sharper rate than economists expected. 

“Even if more people want to use BNPL, the actual number of people making BNPL-related transactions is likely to fall when inflation rises, and therefore, your default rates for these fintechs will probably also increase,” says Tijssen. 

But the strain on personal finances has a darker side, too, as consumers may be forced to lean into credit products more when they can’t immediately afford purchases.

In the US, credit card debt has already hit an all-time high, and according to the latest figures from the Bank of England, UK consumers hit their highest level of borrowing in five years in February. 

49% of millennials (25 to 34-year-olds) in the UK used BNPL in 2020

BNPL providers are currently unregulated in the UK, but following concerns from debt charities and a government-commissioned review into the sector, this is soon to change.

Where BNPL companies such as the UK’s Zilch have begun offering a payment option on groceries, this could lead to unwanted debt — and potentially more heat from regulators. 

“The key question will be how much of the BNPL solution is being used for discretionary spending,” says Craig Fox, managing director of fintech at Silicon Valley Bank. 

“How much will an increase in the percentage of people resorting to credit products counteract the decrease in the discretionary spending side?”  

In the April prospectus mentioned above, Klarna lists consumer trends as a result of the macroeconomic situation as its number one risk. The company acknowledges that it’s “dependent on general consumption”, a reduction of which “presents a significant risk to the financial position of Klarna”.

Survival of the fittest 

So what does the future look like for BNPL? Although most of Europe’s BNPL providers are still privately owned, the performance of the sector’s public stocks serve as an interesting indicator for the long-term health of the business model.

Even before the current tech stock sell-off, shares in Australia’s public BNPL companies lost over $1bn in value, driven by doubts over wafer-thin margins and soaring bad debt numbers. 

Openpay pulled out of Europe earlier this year, three years after entering. And on Monday, Australian-headquartered Zip, Diane Smith-Gander, admitted that the sector hadn’t kept up with economic changes, and was now “going to have to dig our way out of that”.

Unlike smaller players — who are vulnerable to competition squeezing their already-thin margins — Klarna has tried to diversify its products in some markets to include retail banking, a shopping app and even a B2B lending side of its business. 

👉 Read: Klarna’s valuation history: explained

To do so, it’s been rapidly splashing cash, acquiring seven smaller startups in 2021 like PriceRunner, Hero and Toplooks to launch its new product streams, and partnering with German B2B BNPL lender Billie. 

A spokesperson for Klarna tells Sifted that the income it derives from “retailer fees and marketing services” is “not capital intensive”. 

“The ability to raise retail deposits and the overall balance sheet flexibility we derive from our banking licence is a clear competitive advantage for Klarna versus other BNPL providers,” the spokesperson says. They point to the fixed-term savings account Klarna offers as giving it “significant confidence in the stability of future funding”. 

That said, the Swedish fintech is reportedly tapping investors for $1bn more cash and will likely see its valuation slashed, as it faces increased scrutiny over its path to profitability. Klarna had been one of the most hyped 2022 IPO prospects — and although the company says it won’t comment on this “speculation”, it’s looking likely that a float is now off the cards. Likewise, Klarna would not confirm the WSJ reports of its shaved valuation. 

But smaller companies that don’t have Klarna’s scale might find it harder to source runway — making the sector fertile ground for consolidation over the next few months.

“The broader changes that are currently happening in the macroeconomic environment have serious implications on the BNPL business model, and therefore, serious implications on investors’ confidence in their ability to work towards sustainable profitability in the short term,” says Bain’s Tijssen. 

Amy O’Brien is Sifted’s fintech reporter. She coauthors Sifted’s fintech newsletter and tweets from @Amy_EOBrien.

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bryan
bryan

I have a relevant but somewhat unrelated question to the article. Is there a place to submit feedback on an article, particularly when there’s a minor typo/grammatical error? Is there any value in that from the perspective of the author or site? Or does it just make me look like a pedantic jackass? I ask because, I have no desire or intention to embarrass anyone, but I know (being dyslexic as hell) that I appreciate when someone lets me know in my copy/paste/edit frenzy, especially when it will be widely read, I may have left a dangling word or sentence… Read more »

Alex Oscroft
Alex Oscroft

Hi Bryan – feel free to email the writer or [email protected]. Thanks!

James
James

As a former quant fund manager and part time VC, not sure I agree with this ‘received wisdom’ analysis: 1) BNPL companies make 2-3% per transaction, which typically lasts 4 weeks, ie they roll it 12x per annum. This gives APR of about 30-50% and a rise in interest rates of 2 or 3 % (annually) has little effect on this. As Klarna say, the additional cost of higher interest rates is very small. 2) if consumers are pinched, they might not do as much discretionary spending, as the article says, but they will still do some and likely that… Read more »