How Klarna’s Sebastian Siemiatkowski is making retail payments smoother (Cornell Tech @ Bloomberg)

As a teenage Polish immigrant in Sweden who was flipping patties at Burger King by day and reading Richard Branson’s memoir by night, Sebastian Siemiatkowski dreamed of something bigger. Perhaps not as big as his eventual achievement: He co-founded a Swedish digital payments startup that now boasts more than 90 million customers worldwide and is valued at $45.6 billion. That makes it the most highly-valued fintech startup in all of Europe and second-highest worldwide.

Founded in 2005 and now operating in 19 countries, Klarna is one of Europe’s most successful unicorns that is now expanding furiously across the globe. The company’s business is summarized as a leading global retail bank, payments and shopping service, offering flexible payment options that enable consumers to either pay now or over time, without interest, for online and in-store purchases. Klarna’s offering may be attractive to shoppers who’ve been burned by the myriad ways that credit cards ensnare consumers, with high interest rates and unexpected fees.

“They [display] the credit limit and they push it into your face,” says Siemiatkowski. “Look, it feels like I have all this money to spend! But it’s not really the same thing as a positive balance on your debit account. I think people have really woken up to the bad practices and they are looking for alternatives that are more favorable.”

Klarna’s services also extend beyond payments, including delivery tracking, price drop notifications, inspirational content, and more that users can enjoy through the app.

So how does Klarna make money? Its primary business model is charging retailers a transaction fee. In return, retailers can offer their customers the option to spread payments for their purchases out over several weeks. An ideal use case is fast approaching — think of the many parents out there who are about to drop around $500 on the latest PlayStation or Xbox console. They need the gift now so there’s something for the kids to unwrap during the holiday season, but they might need to wait until the next paycheck to afford such a big-ticket item.

Siemiatkowski joined Scarlet Fu, Bloomberg Television and Bloomberg QuickTake host, for an online conversation on Friday, December 17, as part of the Cornell Tech @ Bloomberg Speaker Series. He shared the story of how Klarna is challenging big banks and credit card companies with a simple, but clever, spending solution.

Instant gratification

While he was acquiring his master’s degree at the Stockholm School of Economics, Siemiatkowski and his co-founders, Niklas Adalberth and Victor Jacobsson, pitched their idea for Klarna in 2005. From that day forward, he got used to hearing the phrase “It’s never going to work.”

Siemiatkowski has worked hard to prove the naysayers wrong. Unlike most fintech startups, Klarna was profitable almost immediately. Only in the last few years has the company incurred losses, resulting from expansions into new markets, including the PayPal-dominated U.S. Klarna now processes over two million transactions every day, and has made strong in-roads stateside, with over 21 million users.

Klarna’s most popular service in the U.S., called “Pay in 4,” is emblazoned across many e-commerce platforms; shoppers pay back the cost of their purchase across four regular installments, paid out every two weeks. No interest rate, just a late fee of up to $7.00 in the U.S. if a customer misses payments, with Klarna restricting further usage so they can’t accumulate debt. The service is ideal for shoppers who may want to purchase a big-ticket item and expect to be able to cover the cost over the next few weeks. It’s also ideal for shoppers who, for whatever reason, have had difficulty qualifying for a credit card, don’t want to risk maxing out their credit card, or who may not want to do business with a big bank. It’s a kind of happy medium between paying up front with cash and using a credit card. Consumers undergo a soft credit check for every purchase they make, so Klarna only lends to those who can afford to repay. This is a stark contrast to credit cards, which set a credit limit and review it infrequently, allowing people to build up interest-bearing debt quickly.

“The dominant form is really people with debit cards who want to shop online, but find that a debit card does not work well for them,” says Siemiatkowski. “I think, in general, ‘installments’ is a healthier concept. It’s very clear. You’re paying down the debt with regularity. You’re not just pushing it ahead of yourself for a long period of time.”

Klarna appears directly on merchants’ checkout pages, and it has its own app on which users can browse product listings from a variety of Klarna’s merchant partners. According to Siemiatkowski, merchants partner with Klarna because they are seeing consumers reward them with higher average order values and bigger conversion rates.

The wide world of spending

Klarna has adapted its product offering over the years to shifting consumer trends, and the surprisingly disparate ways that people around the world spend their money. Siemiatkowski, for example, decided to enter the U.S. and UK markets when he perceived that young adults were abandoning the credit card model after their parents experienced their sting during the 2007-2008 financial crisis.

Some regions of the world that have less developed economies are actually more advanced in terms of the technology that’s available to consumers because they’ve leapfrogged more developed countries. In Latin America, says Siemiatkowski, installments have been a natural form of payment for a long time, so Klarna courted that market with other services. Russia is similarly advanced.

“If I go to an ATM machine in Russia, I can do fifty times more things than I can do at an ATM machine in Sweden or the U.S., and the same applies to a lot of Southeast Asian countries, China, and so forth. Take Africa — we talk about M-Pesa, which allows you to transfer money over mobile phones. It’s really recent here, but it’s been there for ten years. So we focus more on markets like Japan or South Korea because competition there is actually less than people think. You have entrenched players who maybe have gotten a little complacent.”

Nudging toward financial wellness

Because Klarna partners directly with merchants, they can gather much more data than banks can with a credit or debit card purchase. Your bank knows you made a purchase for $29 at Walmart. Klarna knows that you bought a size small Disney-branded sweater and a Gatorade at Walmart, and can use this information to build a richer profile of your purchasing behavior as an individual and as part of a demographic group. It’s nice for users to be able to track exactly what they’ve spent money on, and it enables Klarna to develop deeper insights into how consumers are spending with an underlying principle that adds value back to the customer and uses the data on their behalf.

“We already have tons of data to suggest that real-time information is much more powerful to predict people’s spending habits and their propensity for potentially getting into debt,” says Siemiatkowski. Richer real-time data could help Klarna develop a credit scoring system that’s far more accurate, useful, and even more equitable than traditional scoring systems.

Siemiatkowski imagines a day when Klarna is able to not only provide short-term loans, but also financial advice based on all this data. Klarna has the potential to transcend its role as a retail lender, perhaps one day becoming an everyday financial partner for consumers.

“We do budgeting tools, and I genuinely believe, as we advance our investments in that area, that we are going to come to a place where we’re telling customers ‘You know what? Don’t buy that,’” says Siemiatkowski. He argues that, in the end, every customer has to make their own decisions, but Klarna will be able to provide advice or prompts to help its customers form healthier spending habits. After all, customers with healthy budgets are more likely to be able to continue spending in the long term.

“In a perfect market, the only thing you have to care about is, ‘What’s the value I’m creating for my customers?’” says Siemiatkowski. “I think in the long-term, that’s what’s going to drive competitiveness. You may have to be willing to do things that may feel like bad business, like saying “Don’t spend on [that product] right now.”

This is a new approach to financial services, but one that today’s consumers seem to be demanding. Siemiatkowski projects that the broad disruption in the finance industry, of which Klarna is just a small piece, is just getting started.

“By the end of this decade, we are going to see a massive change of the overall landscape of retail banking,” he says, comparing our current moment to the dawn of e-commerce, when experts made confident proclamations that online shopping would never catch on. Then prognosticators shifted to “Maybe books, but certainly not clothing.” Today, it’s hard for us to imagine anyone ever holding such views, but it takes companies like Klarna to bring new paradigms to life.

You can watch the entire discussion below: