Member Brief: Klarna’s Challenges Ahead

Venture-backed consumer technologies thrived throughout the decade-plus long bull market. Profitability was secondary to growth. Market capture was the key performance indicator. The buy now, pay later (BNPL) industry is one of those industries facing the strongest headwinds.

From $5.5 billion market capitalization and up to a $46 billion before falling to $15 billion and dropping: Klarna’s rollercoaster valuation over the past two years is symbolic of the larger buy now, pay later cohort of fintech companies that promised to change the way we consume online. For online retailers, BNPL represented a promise of higher conversion rates for costly products. According to recent reports, the investment capital has dried up. Of all of the recent reports on the matter, WIRED’s was the most thorough:

Klarna’s dream—to replace credit cards, which Siemiatkowski describes as “the worst form of credit”—is facing a series of existential threats. The company’s workforce is still reeling from layoffs that affected 10 percent of its staff and new regulation which will impose stricter rules on BNPL providers in the UK, one of its key markets. At the same time, BNPL executives told WIRED that investors are losing faith in the sector in the face of a potential recession.

What is the main culprit causing Klarna’s valuation to tank after such soaring heights? Is it being in the sights of Apple’s next ground capture? Or PayPal developing its own competitive products? Is it the regulations emerging in the UK against Klarna and its peers over predatory practices appealing to young customers? Or is it the sobering up of venture capitalists as we loom on the brink of a recession? It’s likely a combination of the above.

What it all means is that Klarna and companies like it, including Affirm and Afterpay, will need to place greater ambitions for taking over online shopping on the backburner in order to focus on core product and profitability. It’s back to reality.

The most apparent form of that reality is the impending regulation that 2PM forecasted back in 2020. As BNPL normalizes, more attention will be paid to how these companies operate. From the recent report in WIRED:

The problem of the summer surge in competition is compounded by the UK government’s plan, announced on June 21, to require lenders to carry out affordability checks on people using BNPL, to make sure they can afford the loans they take out. (1)

This was predictable based upon our study of the consumer debt cycle in China, a country that adopted the democratization of this form of debt long before the United States.

Like millions of people around the world, Zhang Chunzi borrowed money she thought she’d be able to repay before the coronavirus changed everything.

Now laid off from her job at an apparel exporter in Hangzhou — one of China’s most prosperous cities — the 23-year-old is missing payments on 12,000 yuan ($1,700) of debt from her credit card and an online lending platform operated by Jack Ma’s Ant Financial. “I’m late on all the bills and there’s no way I can pay my debt in full,” Zhang said. (2)

China has since regulated their accessible consumer credit industry. In America, regulations could lead to a ripple effect, putting a leash on Klarna and other BNPL’s bounds by enacting borrowing protections typical of regular credit. According to the UK government’s statement, BNPLs are “rapidly increasing in popularity, resulting in potential risk of harm to users.” As more risks behind BNPL schemes – which can sometimes seem too good to be true – are made apparent, users could second guess whether or not to use them at all.

Klarna and its peers are not the only class of disruptors who are facing growing pains. The glory days are over for other companies like Uber and Airbnb, and the industries they operate in. Ride share companies in New York City often make less sense than hailing a taxi, while rates have ballooned in all markets to make up for driver shortages. Uber is in ongoing legal battles over whether or not its drivers count as employees, as regulations hit the rideshare industry. Airbnb is wading through customer backlash as people report poor experiences and stacked-high fees that make hotels the better option in comparison. How Airbnb began, versus where it is now, is drastically different: it’s playing into the housing crisis and struggling to maintain quality across its rental options as its inventory has become more and more expensive.

When disruptor companies grow out of their scrappy startup stages, they face realities of incumbents: regulation, widespread competition and fewer outside funds. For BNPL companies, the biggest threat is being replicated by institutions that have the customer base and protections to withstand regulations. Why outsource your payments to Klarna when you could use Apple Pay? And who says Apple and PayPal are the last to step into this territory. This scenario is reminiscent of a concern that we published in 2020 on The Credit Report. In it, we explain what happened to the debt bubble in China:

According to Atlantis Financial Research, defaults in China have risen from 1% to 4%. And with overdue credit up 50%, delinquency has increased from 13% to 20%. Once a conservative country with respect to debt-to-income ratios, China’s consumer habits mirror America’s. The aggregate debt load of China has doubled since 2015. Globally, it’s even more frightening. Some projections by the International Labour Organization cite 25 million global jobs lost with a potential debt load of $3.4 trillion. But here in the United States, economic matters are shaping up to be an historic outlier of devastation.

This makes debt alternatives more risky than the traditional credit institutions, a realization that only seems to arrive as bull markets become bear markets. Here is that TL;DR from that now two year old report on the matter:

In the short-term, there is a train headed towards the consumer economy that can only be slowed. If China’s response to a weakening economy is any indication, the corporate and consumer debt bubbles are in danger.

For now, BNPL firms are going to try to distance themselves from the BNPL tagline. According to WIRED, Klarna, Affirm and others will focus on profits as well as other financial services like debit and wallets. Klarna’s modest valuation could set the space on a more responsible track. It’s the market leader of the new era of fintech creditors like Afterpay, Zip, Sezzle, and Affirm. In pursuing profitability and product diversification, its next steps will serve as a bellwether for the rest of the industry.

By the 2PM Team 

Memo: The Daily Harvest Ordeal

You’re damned if you do; you’re damned if you don’t. Keep this old adage in mind as you read on.

In the four weeks leading up to the recall, Daily Harvest was riding the high of positive press; it was the flavor of media attention that direct to consumer brands clamor for. The Forbes treatment highlighted the equity partnership between Daily Harvest and Blake Griffin, Carmelo Anthony and other notable athletes through the Patricof Co investment vehicle and advisory platform. Each of those involved were a part of the Series D financing which was announced in Q4 2021 and closed in Q1 2022. The Fortune treatment focused on the spectacular achievements of CEO Rachel Drori, the former marketing executive turned consumer goods founder. You know the narrative by now:

Daily Harvest saw exponential growth through the pandemic, when people all over the world turned to their freezers with newfound appreciation. When the crisis started in the U.S., Drori began doubling up on inventory and appealed to her network of farming suppliers to keep fruits and vegetables flowing to Daily Harvest kitchens. (3)

She is now worth $350 million after just seven years of building a retail operation whose revenues lived up to the marketing and branding hype. The DTC Power List estimates annual revenues at $158 million and that is likely on the conservative end. When a brand is on that type of press track, they will do anything to preserve it. Here is a short timeline of events:

  • April 28: Daily Harvest announced the launch of Crumbles (positive)
  • May 28: Daily Harvest announced partnership with Blake Griffin (positive)
  • June 15: Daily Harvest founder is featured in Forbes (positive)
  • June 21: Daily Harvest is featured in Eater, NBC News, and others (critical)

It’s the worst-case scenario for a CPG brand in the fastest growing sectors in direct to consumer retail. Earned media (in Forbes and Fortune, for that matter) are rare. Few brand CEOs would be willing to put that to a premature end to face more complicated matters. But one could argue that it may have been the only option. There is also a counter-argument, however.

As early as April, Daily Harvest customers were reporting severe stomach discomfort, liver pain, and gastrointestinal problems that landed some in emergency rooms. The issue was traced back to the product announced in April. Almost immediately, the conversation shifted from recipes to criticism on Daily Harvest’s subreddit.

Two weeks ago I tried the crumbles for the first time. That night, I had debilitating stomach pain, like nothing I had ever felt before. It was so bad I had to go to the ER as a last ditch effort to alleviate and manage the pain. After a CT scan, IV, meds, and a week on a bland diet I thought perhaps it was some sort of bug.

Several days later I tried a flatbread from them and had a fever the next day. I thought it was related to the previous bout of illness.

Fast forward to yesterday, I decided to try the crumbles again. Lo and behold I am awake with the exact same horrible stomach pain. Luckily I have prescription meds from the last time this happened and do not need to go back to the ER.

Before issuing an official recall on Sunday, the team seemed to have a faulty approach to customer service outreach, with NBC reporting that it had reached out to at least one customer to advise they throw out the lentils and offering a discount code days before there would be a statement released. What became clear is that the problem was more widespread than Daily Harvest’s team likely communicated through its social media presences. In the days before issuing a recall, Daily Harvest was in an unenviable position. There was the positive press that they hoped to amplify to help them reignite the growth that they’d gained over the pandemic. There was also the negative sentiment that they knew to address.

The response evolved from:

A small number of customers have reported gastrointestinal discomfort after consuming our French Lentil + Leek Crumbles, the email said. As included in our cooking instructions, lentils must be thoroughly cooked to an internal temperature of 165°F.

…to a response that included:

We launched an investigation to identify the root cause of the health issues being reported. We’re working closely with the FDA and with multiple independent labs to investigate this. We are working with a group of experts to help us get to the bottom of this—that includes microbiologists, toxin and pathogen experts as well as allergists.

Daily Harvest worked to balance corporate growth and stability with consumer accountability. I’d argue that their scenario is more complicated than the general public understands. Once the Food and Drug Administration (FDA) is involved, it is never an amicable scenario for the product manufacturer. Today, I interviewed an anonymous source with first-hand experience on dealing with the Administration:

When [the FDA] is involved, your brand instantly loses its voice. Nothing you say or do is right and everything bit of messaging goes through them. They prefer that your brand suffers and they will assure that it does. This is how they deflect blame with product defects.

There’s an ideal playbook for responding to a potential recall without losing consumer trust. You’d think that it looked like this: act quickly, be overly-cautious and be transparent. In 2015, Jeni’s Ice Cream – another 9-figure revenue CPG brand – had a listeria scare that could have been deadly. The way the company responded felt right but it had severe penalties.

In 2015, Jeni Britton of Jeni’s fame experienced a public backlash of her own. With the help of CEO John Lowe, the first of 16 appearances of Polymathic Audio, Jeni’s executives navigated a national listeria crisis by acting quickly, being overly-cautious, and being transparent. In many ways, while noble and morally-praised, it backfired. Nearly seven years to the day that a similar article ran on Eater about Daily Harvest, they published this on Jeni’s $2.5 million loss (the company was bootstrapped at the time).

Ohio-based ice cream company Jeni’s Splendid Ice Creams has traced the source of its listeria outbreak. Last month, Jeni’s —  which operates multiple scoops shops in addition to a national wholesale business — initiated a voluntary recall of all of its products after a random sample from a pint of ice cream showed that Listeria bacteria was present. A week later, the company announced that it destroyed over half of a million pounds of ice cream, which is estimated to have cost the company $2.5 million

Lowe, Britton and team destroyed their inventory and publicly sacrificed themselves at the altar of public opinion and made matters worse for the company. The news proceeded to package their company with Blue Bell Ice Creams, a separate company that allowed deaths caused by their own listeria outbreak. Blue Bell employed an opposing strategy: deny, stall, and keep quiet. While Jeni and her team did what was morally right, preventing sickness by recalling their own products, they dumped gasoline on an otherwise regional story and likely angered the FDA in the process (by going around them to publish a blog). Just three years later, an NBC News report recounted the ordeal:

Lowe and Britton Bauer decided the only way forward was to fully tackle the problem — and to do it with complete transparency. “We decided to pull all of our ice cream — not just that lot, not just that flavor, but everything, and shut down our scoop shops,” says Lowe. “We couldn’t — fathom the idea that somebody could walk into our scoop shop the next day and be injured.” The Jeni’s team also released a blog post about the recall on their website.

The sentiment of the NBC Report was simple: “Jeni’s commitment to complete transparency and damage control was costly.” In that report, you won’t find a single mention of the FDA who was reportedly angered by the approach of the Jeni’s team. I came to find a common thread by researching brand responses with FDA oversight. The government agency often prevents you from communicating effectively to consumers. In return, the brand is often dealing with an angry customer base, a media sentiment that reflects customer concern, and few allies willing to stand by the brand (until it is beyond its troubles).

There are lessons to be learned from any story involving CPG brands, harmed consumers, and the government agency enacted to be the buffer between consumer and the consumed. The first lesson is that there is no completely right way forward. Daily Harvest was lambasted by social media for being unnecessarily coy in their responses. Jeni’s was nearly bankrupted for being too transparent. You’re damned if you do; you’re damned if you don’t.

Rachel Drori and Daily Harvest will find a way through this. If Jeni’s story was any indication, it’s possible to rebuild trust with customers. Few remember 2015 at their countless scoop shops around the country. One takeaway from Jeni Britton’s work to rebuild her namesake brand is to over deliver until trust is rebuilt. The brand in question may build new brand advocates in the process.

By The 2PM Team: Art, Editing, Data, and Research

Member Brief: The First Omniversal Brand

We all have our opinions. To many, Michael Jordan is Nike’s greatest athlete. To others, it’s Kobe Bean Bryant, Cristiano Ronaldo, Tiger Woods, or Serena Williams. For me, it’s Steve Prefontaine. Nike’s first athlete set the stage for decades of the brand’s rebellious and counterintuitive thinking. The spirit of Pre lives on.

Nike is one part retailer, one part media company, and two parts religion. The company has been covered extensively throughout the 2PM library and for good reason. One of our earliest reports on Nike began:

History has a way of changing things. The way that consumers view things today will be different in a decade or two. By every indication, Nike is working to achieve a few things. The Beaverton, Oregon brand has gone all in on iconography, images of people who become bigger than life. Perhaps, their marketing decisions aren’t for our lifetimes. Perhaps they are for the lifetimes of our children.

Its cultural impact, global reach, and inventiveness have contributed to an evolution from independent running shoe company to an omniversal brand.

Defining an omniversal brand: Nike navigates traditional retail, DTC, and metaverse seamlessly through its physical and digital presences. It promotes commerce and relationship development in an integrated manner, elevating the brand in each format. To achieve this, Nike had to accomplish four separate objectives:

  • impact cultural moments
  • fortify its DTC channels
  • defend its intellectual property through resale
  • establish its IP rights through metaverse-adjacent projects

Impacting Cultural Moments

As an apparel retailer: Nike is in a class of its own. The New York Times’ Vanessa Friedman wrote the reflection on Nike’s cultural impact. Her deep dive spanned the early days with Spike Lee, the 1985 tie-up with Michael Jordan (remember, his rookie year shoes were initially banned), its new era of high fashion clout and its growing secondary market resale value. Its competitors can barely reach its stratosphere, though Adidas and Lululemon are trying. It sits on a Mount Rushmore of iconic American brands; its future is brighter because it’s the first of its kind.

It has its founding fathers: Phil Knight, a former University of Oregon runner, and Bill Bowerman, his college coach, who famously poured rubber into his wife’s waffle iron to make a new running sole. It has an anthem: “Just Do It,” introduced in 1988. Most of all, maybe, it has an emblem.

That puts it closer in history to such brands as Coke, IBM, Disney and McDonald’s than any athletic or even fashion name. The only other brand to make the leap so effectively and completely from commodity to identity in the last half-century is Apple.(1)

When a company like Nike, or Disney, or Apple makes a strategic move, it reverberates throughout numerous industries. They each have the ability to exist in every industry at once. Nike wants the resale market, too: a Nike-owned resale site has the potential to capture new ground that Nike has ceded to platforms like StockX.

Fortify its own DTC channels

Nike has proven that it decides its own fate when it comes to distribution. The one piece of the puzzle Nike doesn’t currently oversee? Resale. The sneaker resale market has become a robust secondary trade that marks the most coveted shoes on the internet. Nike accounts for the vast majority of sneakers sold at auction at Sotheby’s, according to the NYT. Companies like Stockx, Stadium Goods and more have built entire businesses around selling after market Nike sneakers. If Nike were to bring sneaker resale under its own hood, that would disrupt the entire sneaker ecosystem. From TechCrunch:

In May 2019, Nike called itself a tech company with the development of Nike Fit, a scanning solution to find Nike app users’ best shoe fit. The product was developed by Intervex, a Tel Aviv-based startup.

A Nike-owned resale marketplace could be an extension of the Nike app as a place to buy and sell used or deadstock, resold Nike sneakers and apparel. Functionally, it would be more similar to GOAT or eBay than Stadium Goods or StockX, which only allow unworn sneakers. (3)

Authentication would be guaranteed under a Nike-owned resale app. Fake sneakers often end up in the after market and those buying from Nike could rest assured they’re buying the real thing. Nike would also benefit from the influx of customer data. They’d know more about the customers most persistently active in both the primary and secondary markets and how to market to the consumers who prefer first market over second market (or vice versa). They could also better control and orchestrate demand without alienating too many customers. From Not Authenticated:

Nike then made bigger moves late last year when it built Nikeland and acquired RTFKT, a digital collectibles platform. And so, retaliation against StockX for selling Nike sneaker NFTs was inevitable.

Resale could seamlessly become part of Nike’s popular SNKRS app. It’s also possible to connect the dots between Nike’s metaverse efforts (which we’ll get to later) and resale. You can imagine Nike rewarding NFT holders with access to a resale auction, for instance. If Nike pulls it off, it would be the first major brand to fully close the loop on its resale business – something other companies would then be interested in copying. Nike is the first omniversal brand.

Defend intellectual property

Competition is fierce. Nike is known to throw its weight around in areas it wishes to own. Nike is no stranger to lawsuits: It’s currently embroiled in a battle with Stockx over Stockx selling NFTs of Nike sneakers as well as counterfeit Air Jordans. It’s taken MSCHF to task over its Satan sneakers. It’s on the receiving end, too. Adidas this week filed lawsuits against Nike over its adaptive sneaker patents and its app suite, which have become a defining strategy for Nike. It’s a typical back and forth spar for Adidas and Nike, but in the grand scheme, Adidas is ultimately nipping at Nike’s heels. From Business of Fashion:

Apps have become important tools for brands to reach customers that are increasingly living on their phones, and Adidas’ apps haven’t generally been as popular as Nike’s. Nike’s main retail app is currently the number eight shopping app on Apple’s iOS in the US, according to intelligence platform Apptopia. SNKRS ranks at 27 and Adidas’ equivalent, Confirmed, at 34.

As of February, SNKRS also had more than 2.5x the market share (vs. Adidas) based on monthly active users as confirmed among the leading, direct-to-consumer sneaker apps.

Establish IP rights in the metaverse

The complaint filed by Nike describes NFTs as “part of the future of commerce.” It also warns that the burgeoning technology is susceptible to trademark infringers seeking to reap profits off of rights that does not belong to them.

As the first omniversal brand titan, Nike’s push into the metaverse is one to take seriously. With RTFKT, the digital studio it acquired last year, it released its first digital sneaker, which sold out instantly and has become a collectors’ item in the virtual world. Nike has been working to carry over its cultural clout to the metaverse, by trademarking its name and logo and partnering with Roblox to built out a branded world, Nikeland. It’s claiming its turf now – other brands will find themselves playing catch up.

Nike’s move into the metaverse is so powerful because it has the means to build, test, and acquire new technologies. It has a metaverse team already in play to help it define its presence in the virtual world. The possibilities are near endless and that represents a huge business opportunity for retailers who will follow Nike’s playbook. Recently, it introduced direct-to-avatar purchases with RTFKT. It’s not just a metaverse strategy. From PSFK:

A key component of Nike’s metaverse-fueled direct-to-avatar virtual product sales approach is the launch of its own metaverse, Nikeland. Hosted within the immensely popular Roblox platform and metaverse, Nikeland has already received almost 7 million direct visits from 224 countries since its launch. Nikeland is free to access, and stocked with minigames. Users are encouraged to outfit their avatars with digital versions of the newest Nike product drops, and shoppers are able to purchase Nike CryptoKick and skins directly for their avatars. (2)

The adoption of Web3 principles by traditional retailers will be gradual but Nike has begun to lay an omniversal foundation by building up its direct-to-consumer business and investing in its own apps, trademarks, and intellectual properties, while reducing its dependence on traditional retail channels. Web3 and DTC are natural partners and Nike will be of the first major retailers to iterate around Web3 principles. It’s not just a new revenue stream: it’s community and status. It’s belonging.

As eCommerce becomes ever-present in our lives, that line of demarcation between eCommerce and our physical lives continues to blur. As brands adopt metaverse strategies, physical goods are getting digital versions. In December, we wrote on the CryptoKicks movement:

Nike prides itself on being first in line to new innovations or opportunities. The few times that it hasn’t been, it’s marketed so well that the consumer eventually forgot that another brand beat them to the punch (Nike has owned the mindshare in everything from NBA basketball to pro skateboarding). The retailer will not have to worry about coming in second on its way to the metaverse.

The retailer seems to understand the value of digital real estate, the future of virtual communities, and the importance of investing in the products that bring the two together today. When the late Steve Prefontaine used to run, it was wild and relentless. He ran for legacy and for principle. He made his own rules and established that he was the best at his craft. He would say, “I have to go out hard and lead from the start.”

Nike’s best athlete laid the strategy for much more than the sports icons it sponsored. The first omniversal brand is available anywhere and everywhere shoes are worn.

By the 2PM Team