Welcome back to Compound Interest from Semaphore Business. I'm Liz Hoffman, Semaphore's business and finance editor. Joined as always by my colleague Rohan Gowwami. Hey Rohan.
Hi Liz. How you doing? Question for you. What was the last big ticket purchase you made and how did you pay for it?
Big ticket purchase. Ah, I don't know if this is going to air, but probably my anniversary gift which was last week.
Well, I don't know if this is going to air in time. I don't want to spoil the surprise. She does shockingly listen to the show, but it was... okay. My last big one was a shocking number of dollars worth of wood flooring doing some renovations.
I remember this saga. And I paid for it with a buy now pay later loan. I asked because our guest this week is Sebastian Siemiatkowski who's the CEO of Klarna. Klarna launched 20 years ago, sort of an eternity in startup land as a buy now pay later company offering interest-free loans to online shoppers and going after the last great racket in finance which is credit cards.
Indeed. And it's been sort of broadening its business away from that trying to turn into more of a bank doing things like debit cards and loans that charge interest. And that is weird to me because I came up covering banks and the generation of fintech companies that Klarna belongs to which launched as just proudly anti-bank. Regulation was for suckers and being a bank was lame. And one by one they have all caved. PayPal, SoFi, Lending Club, Revolut. They just one by one either bought banks or became banks in part because it turns out that the stuff they wanted to do just you needed a banking license and really you needed a balance sheet the ability to extend money without having to rely on like very fickle investors in the background.
And of course though you know the downside to that model and the reason why they at least very loudly said they didn't want to be banks is because regulation is hard and compliance is even harder. And when you are a fintech, you can kind of skirt some of that and take the very Uberesque, right, move fast, break things, figure it out later approach. But you can't when you're a regulated entity like a bank.
I mean, regulators really don't like to see banks growing very fast. And in fact, you know, we talked to Vlad Tenev at Robinhood a year ago kind of about their banking ambitions. He said that's what had held them back before was that they were just posting this, you know, double-digit annual growth that would have had regulators crawling all over their office. And there's a sense...
The other reason is that tech stocks trade much higher than bank stocks. And as you've seen Klarna get more and more into banking. I mean their stock price is down I think about 50% over the last 6 months.
It has not been great but that's also hard for them right because they are and I think Sebastian has been really front-footed about this maybe to his chagrin maybe too much. They are sort of at the forefront and the center of this debate over what role does AI, what role do agents play in finance in our financial lives. How does that look? What does that feel like?
They also were early to stop being a Salesforce customer and in something that you know looking back was kind of the first shot fired in the enterprise software war that has turned into these SaaS apocalypse. I know he said he had some regrets about how that all was kind of communicated. And remains a fan of Salesforce and thinks they'll be just fine.
But, you know, Sebastian is obviously like the person best placed to answer these questions. He's waiting for us. Why don't we bring him in?
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Sebastian, welcome to the show.
Sebastian Siemiatkowski
4:00 ↗
Thanks for having me.
Let's start here. You know, a whole generation of fintech companies launched by saying we are not a bank. You know, one by one. SoFi, Lending Club, Block, Revolut, they've all kind of moved in that direction. Obviously, so have you. Like why?
Sebastian Siemiatkowski
4:14 ↗
Oh, good question. I mean, I can't answer obviously for the others, but I can answer for us. Many people told us that it's so difficult to become a bank. It's so hard being regulated and all these things. So, for a while, we were cautious about it as well. But we got our first banking-like license after about 5 years of existing back in 2010. And to us we only saw advantages. It created clarity on how to operate and run our product in a compliant ways. It gave us access to things like deposits that allows us to fund the business more and kind of removed some of the structural competitive barriers versus the banks themselves. So to me, it's just been advantageous rather than the opposite.
And is there something cultural that kind of got lost in the process? I mean, just the idea that there was a way to serve these customers without the kind of regulatory overhang or frankly just like the lameness of being a bank.
Sebastian Siemiatkowski
5:09 ↗
I haven't seen that. I mean, I've seen obviously that there are potentially there's more compliance work, there's more second line work, there's some more process and some more legal requirements that needs to be met. All of these things that are required of one are actually good stuff if implemented well. What I hear when I talk to my incumbent CEO is that in many organizations seems that those are treated as side things that are bureaucracy and only there to tick the boxes and then they don't necessarily serve their purpose. But if you go and read the law carefully and you understand the prerequisites and the ideas that the regulators had with these, you generally see a lot of them are actually quite smart. Like take as an example, we have something called a new product approval process. So you need every new major product approval needs to be combined with risk assessments, financial implications of those changes, product and consumer implications and so forth. That's a pretty good thing to do and I would argue most good tech companies would apply that anyways. But what ends up happening many times is things gets implemented poorly and then instead it just becomes bureaucracy.
You have this license in Sweden, you have it in Europe, but not in the US and you've done what a lot of fintechs have done, which is to partner with smaller banks to make loans behind the scenes. Do you plan to apply for a de novo license here?
Sebastian Siemiatkowski
6:33 ↗
We have not publicly commented on that. We haven't given any answer to that. I think it's like what I try to say at least is directionally speaking it would make sense for us to do so over time in the US as well because we have seen in Europe a lot of advantages of it but there's no like official timeline or decision made that we would have shared publicly today.
The administration here is pretty friendly to that. They seem to want some new banks.
Sebastian Siemiatkowski
6:56 ↗
I'm very happy to hear that and see that because it was actually a big surprise to me coming from what is usually treated as less competitive and less capitalistic Europe versus the US where when it comes to getting a bank license what you had to do in Europe was just go and apply and historically in the US it was like it is not clear whether you will get one and nobody can really tell you what is required to get one because right now we don't want more or the regulators don't want more banks. That was kind of the message we used to get back in the days. So I think it's a great improvement.
The competition for fintechs moving into the banking space. It's pretty fierce. What's your edge in the banking space over the other neobanks that have already gotten started here?
Sebastian Siemiatkowski
7:40 ↗
I've given that a lot of thought over the years. I used to have Nigel Morris on my board, co-founder of Capital One. I remember back in the days we were talking about, you know, country expansion and how to establish in one. And at that point of time, one of the most coolest popular things were, oh, we're going to use Facebook data to do social underwriting and people were going to use that to improve, you know, that was like one of the big things in fintech back then. Not something Klarna pursued, but others were. And I remember speaking to Nigel about it and he said, well, look, you know, for Capital One, even if that would turn out to be the thing, it would be like improving their margins a few bits. You know, it's not going to disrupt banking. It's not what's necessary if you truly want to go after the incumbents. And what we arrived at Klarna is that the key is customer acquisition cost. The fact that in the US it may cost $100, $200 to acquire a customer in the more subprime Capital One category and $400, $500 if you're Amex. So to me, the key was that a great app is nice. There used to be Simple.com, some of may remember it back in the US. All of these things are nice, but you have to find a way to acquire customers at a lower cost. In Klarna's case, the fact that we have this huge merchant network of over a million merchants offering Klarna where consumers can come and say, 'Hey, I can either use my traditional bank card or I can just with a single almost click experience try this new thing called Klarna' has become a very efficient customer acquisition channel that has allowed us to achieve 130 million users at basically zero CAC. So that is our entry point but other neobanks seem have found others and we are happy to see even in the US we're close to 30 million right through that mechanics.
Is the goal to be a better PayPal or are you really trying to take on JP Morgan Chase?
Sebastian Siemiatkowski
9:28 ↗
What I find attractive is the position that Amex has and I think there is something unique about Amex and we are very deeply inspired by what they're doing. We call it spend-centric rather than lend-centric which is the similar terminology that Amex uses because different than your kind of lending there are a couple of players in lending there's Affirm there's Synchrony etc they turn around their books maybe two times a year so they are predominantly a balance sheet lender while Klarna is predominantly spend-centric. We turn around our balance sheet more than 10 times a year and that changes the characteristics of the business but most importantly it grows a different type of relationship with the consumer something that you use very frequently, you have a different relationship with than something you just took a loan with at some point of time when you did a big ticket purchase. So for us, we think that's the position to be in. Now, what people tend to forget is, you know, Amex is the 10th largest bank in the US. And but people still don't talk about them as a bank. And I think that's the route that Klarna is at. We're trying to create a differentiated service, a different brand, a different value for our customers and some of the services we provide are bank-like just like Amex does. But the key of our is the lifestyle, the brand, the customer service of what we do.
Is the goal then for people to say, 'Oh, I'll just Klarna it' to become a verb?
It's fun obviously when people love the product to that extent where they use your name as a description for what they're doing. But I think the key for us is that we want to be relevant for every type of purchase that the customer do. Both the big ticket spend which is a category we just entered into the US more recently or have scaled more recently the mid-tier kind of charge card equivalent type which is the $100 type of purchase fashion etc. and the everyday spend the groceries and so forth. So we need one that is relevant for all of these, but obviously we're mostly associated with this 0% interest paying for product which has been extremely popular and well-received in the US.
You've moved into these sort of longer-term interest-bearing loans that do make money not just from the merchant but from me as a borrower paying interest over the life of the loan. I mean I think you've talked about that as a substitute for credit cards. How do you think about a consumer that takes out a 24-month Klarna loan that perhaps they can't afford versus a consumer that takes out a credit card that they can't afford?
First and foremost, we do not offer revolving. We think revolving is a bad concept. It's confusing. It's difficult for people to understand how long will it take and people tend to pay off for a much longer period of time. So, we only do fixed-term installments. The other one is we try to make sure that our interest is fair and that it's well priced compared to any other alternatives that consumers may have for financing that particular purchase. And many times we try to work with merchants to make sure that they are funding the interest. So it's a 0% offering which also is more attractive than using your credit card and borrowing at a higher rate. Then there's also a third thing. We're trying to be mindful of not pushing your limit into your face. We're trying to find a good balance there because we know that sometimes the limit can be misunderstood as I have more money than I believe I have. And then obviously that the primary product that we are promoting is the charge card equivalent of buy now pay later which is 0% and paying four installments. That is basically a charge card product an equivalent of a charge card product. And that one is also I would argue much healthier just like Amex has been pushing charge cards more than revolving for many many decades. So I think it's all of these things where we've tried to make a difference. But obviously as anyone issuing credit, you will still have some consumers that you know unfortunately overextend themselves or use the product in a way it's not intended to be used and so forth. It doesn't matter if it's DoorDash or you know groceries or everything is on your credit card and then you are more likely to revolve and this is why the average outstanding balance on a credit card is like $5,000, $6,000 while the average outstanding balance with Klarna is a hundred.
Let's get into the DoorDash discourse because, you know, it's been something that has like just been in the news a lot lately. This sense that particularly younger people who have limited incomes are just spending way too much of it on delivery. You guys had a product last summer partnered with DoorDash to be able to pay for food delivery in installments. There's just it feels like there are more ways for people to spend money that they may not in fact have. And I'm curious how you think about that, like what you made of the burrito bond discourse last summer.
Ironically, I saw the same when we launched with Deliveroo in the UK a few years earlier because Klarna is so strongly associated with buy now pay later. That always becomes like a gimmick or an interesting point as you highlighted but you have to remember we're competing with PayPal and we offer debit pay in installments like small or medium-sized tickets and big tickets. What we're trying to do is make sure that we're relevant in every checkout for every purchase. So going into things like Uber, DoorDash, and so forth is part of that PayPal strategy. Nobody is talking about the fact that PayPal is available in these apps such as DoorDash. Nobody talks about the fact that you can use your credit card and revolve on your DoorDash purchase. So one has to separate with Klarna as a merchant network wants to be relevant for everyday spend groceries, gas stations with our debit product predominantly and in the mid-tier segment with our buy now pay later and in the big ticket segment with financing. Now, occasionally, may that mean that a customer goes to DoorDash and puts a purchase, a fairly small purchase on for interest-free installment? Yes, it can happen. Just like people will go there with a credit card and revolve on a purchase they did at DoorDash or a balance that was partially DoorDash, right? So, the same thing may happen, but that's not the intent. The intent is to give Klarna or the availability to use Klarna at any merchant for all the three different payment products that we offer. And it's interesting that in a lot of countries in Europe where Klarna is widely known to be used for different type of payment methods, this is not really a debate. You won't see this in these countries because to them it's just like yeah, of course they're there just like Visa and Mastercard are there. But in some markets where we strongly still only associated with buy now pay later, then this becomes a bigger thing.
But this was a bunch of US reporters losing their minds.
No, I wouldn't say that. You said that. But I would just say that like again I understand why because we're so strongly associated with this super successful paying for product and so everyone just inherently assumes that's what we're doing, right? We have a lot of other interesting products. One that really excites me is that another which is like you can take for example for somebody like Uber or these kinds you can aggregate all of their purchases and give you a kind of a charge card equivalent product where all of that gets paid at the end of the month which for a lot of merchants that see a lot of low value transactions where Visa and Mastercard charges a fixed fee in addition to the percentage fee per every transaction that's an amazing opportunity to drive down payments cost and it's not different I mean you go back you'll find a lot funny clips from the 80s where people are like arguing like why are credit cards used at Burger King? Like people think it's insane in the 80s and today's it's standard, right? Like we don't think about it as a problem that you can use your credit card at Burger King. So I just think it's the novelty of this and the difference of it.
One thing we talk a lot on the show about is sort of how everything is cash flow now. Where do you see the sort of natural endpoint of everyday transactions being financialized and ending up inside some portfolio somewhere, which I assume is the end point of a lot of some of yours, but certainly a lot of Affirm's loans end up getting sold to Wall Street.
Well, it's interesting because I've been in this for 20 years, I remember that after '07, everyone told me that like the idea of packaging and selling off loan portfolios is dead and is never going to come back. And here we are almost 20 years later and it's becoming a de facto standard. I was one of the ones who always believed that that model was superior like in the long-term perspective. If you think about it like x amount of years in the future, I find it very likely that providers like ourselves will basically to some degree be market makers. Meaning we recognize the consumer. We can underwrite them. We understand the risk profile of that consumer based on our internal data as well as combine it with some external data. And we are then going to allow people in the market to bet on providing financing at the most affordable rates to that particular cohort of consumers. I think that model makes a lot of sense that you have a separation between the kind of underwriting decision and the origination from who provides the balance sheet and who's willing to invest in that. Now what we also do know however is that over economical cycles we have seen sometimes the problem that such markets may dry up on very short notice and that's why from our perspective we decided to become a bank and fund by our own sourced deposit base which is still like 90% of what we're doing today because it just gives us a higher level of stability and predictability in the funding and companies that don't do that may you know we've seen that I've been here in fintech for 20 years I've seen some of that happen.
Yeah, some I think Lending Club got itself in a lot of trouble.
Yeah. There was a number of companies that ended up in that situation where suddenly these things dry up right and that just becomes a problem. So for us it's been important to establish that as only one form of financing but longer term does it make sense that that is a very popular and dominant form of financing? I would say yes. Makes sense.
Okay. But actually then to make that comparison, you're talking about, you know, the mortgage bond market obviously blew up in the 2000s, but that market was at least underwritten on the assumption that people would keep paying their mortgages, that that is the last bill they would possibly skip and that bet in fact turned out actually to be wrong. Are people going to feel the same way about their buy now pay later loan and how are they going to feel about continuing to pay that down the road?
You have to think about two aspects, right? Like in the mortgage world almost the whole thing is like can this person afford to service this loan over a longer period of time and what's the risks that unemployment hits them or something else happens under that time right and that is an important factor for us as well but in our case also an important factor is just behavioral because you know our outstanding loans are about $100 they usually the durations are very short as I said we turn around our balance sheet more than 10 times a year so what ends up happening many times is like if we see a macroeconomical shift or something happens in the economy, we just change our underwriting in real time and it takes only about 60 days for more than 50% of our balance sheet to be underwritten by the new standards. That's a level of agility and flexibility that the big banks don't have. That's also a downside. If you're pushing people into revolving and building large balances like the big credit card companies are when economical changes happen, you just can't shift out of it as fast because you have all these customers with all this depth. But with that said, also to your point, there's also like a preference. Why would consumers pay you versus somebody else? These things play in. And I think like that's why being a beloved brand, having preference, being a service that consumers appreciate and pay actually does matter for repayment rates as well. Especially in US actually a little bit less in Europe where the market works differently.
You're saying if the economy turns, the big banks in the US are still going to be writing garbage loans long after you have stopped.
I know their origination will change and their underwriting will change. They can change that pretty quickly. But the problem is they're stuck with whatever they originated for the last years, right? I mean a general bank in general has about I think 80% of their balance sheet has been originated two, three years previously so they just don't have that agility to changes even if they change their policies today it takes a lot of time before the majority of their balance sheet is underwritten by the new policies.
