Whether you use Klarna all the time or have barely heard of it, it’s time to start paying attention: the buy now, pay later app has just become the largest private fintech company in Europe. Klarna has completed another round of fundraising, valuing it at $ 46 billion. That’s four times what it was worth last September, and on par with Swedish tech giant Spotify.
Klarna offers interest-free credit on purchases at participating retailers including Decathlon, Desigual, JD Sports and Oasis. It allows buyers to delay payment or split larger purchases into manageable sums, and does not perform traditional credit checks, opting for a more permissive “soft search”. Retailers cover the cost of interest as if it were a rebate on sales.
Klarna operates in Western Europe, Australia and the United States, and has exploded in popularity during the pandemic. It claims to have 90 million customers and has many rivals such as Clearpay / Afterpay, Affirm and Sezzle.
However, such offers are controversial. Critics allege that such programs encourage overspending and can potentially ruin customers’ credit histories if they fail to keep up with payments. Many see parallels between these plans and the notorious “payday lenders” of years past, such as Wonga.
In the UK, four in ten customers who have used these apps in the past 12 months would have difficulty repaying. A quarter of consumers said they regretted using these platforms, with many saying they couldn’t afford the refunds or were spending more than expected. Likewise, Compare the Market reported earlier this year that a fifth of users couldn’t pay off Christmas expenses without taking on more debt.
These concerns prompted a study published in February by Christopher Woolard, formerly of the UK’s Financial Conduct Authority (FCA). As a result, the FCA now subjects these operators to the same regulations as more traditional creditors, demanding things like affordability checks and ensuring that customers are treated fairly.
Some might argue that this fixes the problem, but I disagree. Knowledge of behavioral psychology can shed light on this point, and the seemingly dusty debates of ancient Greek philosophy reveal why this is wrong.
Klarna claims to offer a “healthier, simpler and smarter alternative to credit cards”. It primarily targets millennials, with an average customer age of 33. Marketing materials present the app as the choice of the discerning shopper, with a clean and healthy aesthetic, reminiscent of a Scandinavian-style ad agency or a trendy cafe menu.
Under FCA regulations, these lenders will be treated like other financial services targeting millennials such as Starling Bank or Monzo. So why isn’t this a case of a problem solved?
By offering goods immediately and delaying the pain of parting with all money, lenders who buy now and pay later exploit the human tendency to understate future losses and overstate current satisfaction, so-called the current bias. Research shows that this bias increases in response to instability and stress, raising concerns that these services disproportionately target already vulnerable consumers.
You could argue that credit cards do this too, but lenders who buy now and pay later operate without a rigorous credit check and are doing it in ways of particular concern. The service is offered at online checkout and often set by the business partner as the default payment option. As Nobel Prize winning economists Richard H. Thaler and Cass R. Sunstein argue in their influential book Nudge, changing the default values is particularly effective in changing behavior.
Lenders mainly focus on consumer goods such as clothing and cosmetics, which are generally the subject of impulse purchases. Focusing on products related to physical appearance and targeting a particular age group could change social norms regarding consumption among the population, making higher value clothing the norm. Once established, these standards are difficult to avoid.
These lenders also profit from loss aversion – the universal human tendency to prefer avoiding losses to acquiring equivalent gains. They do this by promoting their services as a way for online shoppers to order multiple items and then return the ones they don’t like. Due to this bias, buyers may not return products once they have them in their homes, even if that was their original intention.
Thank you Aristotle
You could say that these strategies manipulate customers. Yet the manipulation of one person is the persuasion of another, and all business enterprises employ persuasion strategies to encourage customers to spend.
The Greek philosopher Aristotle and his followers can help us make a meaningful distinction between persuasion and manipulation. In a debate with the Sophists (specialists in the art of persuasion), the Aristotelians argued that the difference between manipulation and other persuasion strategies is that it circumvents or subverts the rational abilities of the target.
On this basis, buy now apps are arguably manipulative because they are based on our irrational psychological biases. The concern is therefore less that they make us spend, but how they do it. Some might argue that manipulation is everywhere, especially in advertising, but that doesn’t make it right. This is an ethical issue that simply classifying Klarna as a bank will not resolve.
What to do then? An outright ban would have an unfair impact on the users responsible for the service. What is needed is regulation sensitive to the unique nature of these lenders, their services and the risks. It should include a duty to inform clients of the psychological biases that these services take advantage of (unwittingly or not), to help consumers make rational financial decisions. Apps should therefore flag, for example, the risks that consumers will be tempted to keep more items once they have been purchased, and the risks of default payment options.
At the same time, we need a new professional body dedicated to overseeing this form of loan. It would need regulatory powers and a commitment to act in the public interest enshrined in a code of conduct reflecting the unique ethical risks involved.
Joshua Hobbs, Lecturer and Consultant in Applied Ethics, University of Leeds. This article is republished from The conversation under a Creative Commons license. Read the original article.