Back in 2005, Klarna was conceived to solve a simple problem. Three Swedish students found it awkward to type credit card details into websites, especially on clunky desktops in dimly lit dorm rooms. So, they came up with a workaround: let shoppers pay after delivery, while Klarna fronted the money to merchants. No credit card required.

From that small epiphany grew one of Europe’s most valuable fintechs. Klarna now processes $100 billion of purchases annually for 93 million customers, across 45 countries, including the US. It helped popularize “buy now, pay later” (BNPL) around the world.

As Klarna prepares for its pivotal IPO, we take a deep dive into the story behind its explosive growth, sudden market correction, and strategic pivot toward profitability. This is the first post in a three-part series unpacking Klarna’s journey, dissecting its evolving business model, and exploring what lies ahead, specifically in the all-important US market.

The Birth of Klarna: Solving an everyday problem

Buy now, pay later isn’t new. Catalog shopping relied on installments; store credit was a fixture of mid-century retail. But BNPL took off online when firms like Klarna, Affirm, and Afterpay digitized it - offering consumers a few months of interest-free installments, with minimal friction.

Merchants loved it. Shoppers spent more and checked out faster. BNPL became a way to boost conversion and lift average order value, especially for younger customers wary of revolving credit.

Klarna’s core offerings include:

• Pay in 3 or 4: Split the cost into interest-free installments.

• Pay in 30: Buy now, pay within 30 days, no interest or fees if paid on time.

• Long-term loans: Finance larger purchases with extended terms.

As a consumer, Klarna seems magical. How can I get interest-free loans at times of high interest rates? The answer: the merchant pays for the interest, not the consumer. Klarna charges them a fixed fee and percentage of the purchase - from 0.99% to 4.99%, depending on the country. Merchants accept it because, Klarna argues, BNPL users spend more, and when merchants don’t offer it, they risk losing the sale to competitors.

Merchants receive the full purchase value minus Klarna’s fee. Klarna assumes the credit risk and finances what is essentially a consumer loan. BNPL providers may do this on their balance sheet if they hold a banking license, or partner with a bank that originates and may resell the loans to the provider (Affirm model).

The BNPL Boom — and Bust

Between 2019 and 2021, usage soared. Klarna quadrupled its user base. Valuations followed: Klarna hit $45.6bn in mid-2021, just behind Revolut as Europe’s most valuable fintech. Sequoia, Silver Lake, and SoftBank piled in.

Then came the hangover. Interest rates rose. Capital became expensive. Credit losses mounted. Suddenly, fronting short-term loans to customers with little credit history didn’t look so clever.

Furthermore, the economics are fragile. As competition intensifies, merchant take rates come under pressure. Meanwhile, funding costs remain elevated, driven by high interest rates.

Klarna’s valuation was slashed by 85% in its last round, falling to $6.7 billion. The company cut headcount by 30% and pivoted from growth to profitability. It is now profitable, cash generating, and preparing to list at a $15-$20bn valuation.

The Pivot: Klarna’s Major Restructuring and Profitability Shift

Over the past five years, Klarna’s transaction margin deteriorated, largely due to two factors:

1. Rising funding costs, and

2. International expansion into lower-margin markets.

While interest rates are beyond Klarna’s control, the firm has mitigated their impact by increasing reliance on lower-cost funding - namely, consumer deposits. At the same time, transaction margins have improved significantly in the UK and US, suggesting positive operating leverage as Klarna scales in these markets.

In dollar terms, transaction margin rose sharply from $687 million in 2022 to $1.2 billion in 2024.

Operating Profit Moved Closer to the Black. Operating leverage is now kicking in. After years of heavy losses, Klarna is approaching break-even, thanks to tight cost control. Two key drivers account for the turnaround:

1. Incremental Transaction Margin: Roughly 58% of additional revenue dropped to margin.

2. Operating Expense Cuts: Adjusted opex was trimmed by $377 million.

Looking Ahead

Looking ahead, margin expansion remains viable, though opex reductions are unlikely to repeat at the same pace. The shape of US transaction margin will greatly impact profitability.

Klarna emerges leaner from the pivot, setting the stage for an influential IPO.

Stay tuned for our upcoming posts, where we'll dive deeper into Klarna’s business model and the competitive landscape shaping the future of buy-now-pay-later solutions.