Embedded Finance: we need to stay the course

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Banks like Starling, Westpac and BBVA have slowed down or stopped their BaaS sales. BaaS providers like Solaris, Varengold and Cross River have got into hot water with regulators. Railsr went into administration. And valuations of former embedded finance darlings like Stripe and Klarna have been hit massively.

What happened? We were told that embedded finance was a panacea, capable of turbocharging bank margins at the same time as boosting revenues and customer loyalty for their brand partners.

The truth is that sentiment overshot. The near universal view of the last couple of years that embedded finance would imminently transform banking has given way to a lot of doubt and scepticism. Part of this is broader market sentiment — fintech has been the eye of the storm of the recent market crash — but part is a realisation that embedded finance is harder and more complicated than people thought.

But, embedded finance will transform banking. It will just take a while as the missing infrastructure and expertise is built out. We need to stay the course.

A recap on why embedded finance is changing the business model of finance

Embedded finance refers to the integration of financial services into (typically) non-financial platforms, applications, or processes. It aims to create a seamless experience for the end-user by eliminating the need to use separate platforms for financial services, and to address financial inclusion, using contextual data to better understand customer needs and provide them with the right financial services.


Embedded finance value chain (taken from additiv.com)

For the brands which act as distributors of financial products, it enables them to leverage their captive customer base to generate new revenue streams. In addition, by either solving unmet needs or just improving customer convenience, it also increases customer loyalty and gives the brand more comprehensive data about customers to facilitate further product innovation.

For the financial services company offering their products over new distribution channels, there are also strong benefits. The cost of acquiring customers is reduced, while spreading infrastructure costs over higher volumes leads to lower average costs and better margins.

Easy to understand, harder to execute well in practice

The concepts explained above are intuitive and easy to understand. Furthermore, the perquisites to be an effective “embedder” brand are also reasonably easy to fathom. A brand needs a large customer base. They need online distribution. And strong customer engagement is a big plus, since it means customers spend longer using the service, creating a larger surface area (as well as more data) to cross-sell relevant financial products.

The challenge comes from the fact that brands are not financial institutions. They know their customers and they’re experts in service delivery. But financial services are something new. There is a knowledge gap around how to define propositions, how to price, bundle and take them to market. And their Banking-as-a-Service (BaaS) and embedded finance partners often can’t fill this gap because they either provide technology or they provide banking services — critically, they do not guide the brand step by step through what is required to launch financial services.

As a result, many embedded finance projects don’t go live. Many fail to deliver value. And many run into challenges, around regulatory compliance or division of responsibilities.

Consumer payments show us the potential for embedded finance

Embedding consumer payments has worked well. It’s easy to understand how embedding payments into a check-out process can improve customer convenience, increase conversions and grow net take. In the case of marketplaces, it’s easy to see how introducing a seamless payments experience can grow revenues. Examples of platforms that have benefited strongly from embedding payments are Lightspeed, Toast and Shopify, the last of which generates more than 50% of its revenues today from payments.

Furthermore, the provider landscape around embedded payments is also relatively mature. Put (very) simply, for brands there are three principal payment service providers to choose from in an ecosystem.

  1. Modular payments-as-a-service providers, who orchestrate between the companies and platforms embedding payments and the underlying payment infrastructure and, increasingly, the (international) payment methods. An example here would be Stripe Connect, which is the full-service product of Stripe. This space is also populated by smaller operations-focused orchestrators like TrustAp. They are all connected by the same value proposition: merchants and platforms can connect to get an end-to-end payment service including the necessary operations like customer service and KYC;
  2. There are the digital payment service providers (PSPs), which might move to adjacent verticals like Adyen (accounts) or Stripe (treasury); and,
  3. Payment technology providers, such as Finix and IXOPAY, which are providing technology, enabling brands to become payment facilitators.

These software providers play in an ecosystem with payment methods (bank networks, credit card networks, wallets) and leverage different gateways either online, hosted or POS. Additionally, the ecosystem is complemented through services like credit checks, invoicing or KYC, to finalize the entire journey with external providers.


But moving beyond consumer payments is harder

The first issue is that outside of consumer payments, the embedded finance ecosystem is less mature.

Take business-to-business payments. The maturity of infrastructure is substantially lower than in B2C payments. Many of the necessary technical infrastructure components to launch B2B payments as a corporate are offered on a customized basis, which slows development and adoption. Even basic processes like invoice reconciliation (a standard process for businesses of all sizes) are still being individually connected to the payment gateway providers systems and not always offered as part of the platforms.

The same is also true to an extent in embedded lending. Buy Now Pay Later (BNPL) is a relatively straightforward use case to execute, which is part of the reason why it was rolled out too quickly, without adequate focus on consumer protection or unit economics. But the infrastructure and use cases in B2B embedded lending, conversely, are barely existent. This is counterintuitive as corporate banking is estimated 3x the size of consumer finance.

Business customers tend to have more complex requirements. As a result, it may not always be possible to meet client needs through a single financial services partner, especially when corporate clients are also operating internationally. Further, it is harder to offer a standardized service since business requirements are likely to be more heterogeneous, translating into a need to vary conditions and, by extension, a greater risk and compliance overhead.

But there is not just the dichotomy between consumer and business use cases. Consumer use cases also vary in complexity. Payments and product insurance are much more straightforward than, say, life insurance or private wealth management to embed into non-financial distribution channels.


And, moreover, it is not just infrastructure that is missing for these use cases but other factors too.

There has been a limited pressure to act…

As already noted, the power and competitive right-to-win in financial services distribution is shifting significantly from global banks to global brands. But, the fact that brands can realise massive benefits from distributing financial services does not necessarily mean that they will become “embedder brands”.

In any successful organization, there is always inertia and a bias to the status quo which, as Clayton Christensen explains in the “Innovator’s Dilemma”, is often paradoxically higher the more successful the company. In general, psychological frameworks show that the urgency to act in case of pain is 3x higher than in case of potential gain. As a result, when times are good, it’s rare that a decision maker ever wakes up one morning ready to start an embedded finance project.

…along with a general risk aversion…

Embedded finance projects are estimated to have high ROIs, are close enough to the core business to be in familiar territory (same customer, same channels, same user journeys), and are innovative enough to bring our Digitization and Innovation budgets. This should make adoption a breeze in corporate processes, but it’s not.

One factor is a lack of success stories. Outside of consumer payments, insurance and lending, there are not so many case studies that provide the robust evidence to prove the technology, to build the business case, and to establish operational frameworks using compliance-approved norms. On the contrary, the many stalled embedded finance projects likely give ammunition to management to turn down internal requests to launch proofs-of-concept and other small-scale experimentation projects in this area.

…and a lack of expertise

But, the bigger factor is a lack of internal expertise at wannabe embedder brands.

Embedded finance is not a line of business, it brings together multiple lines of business. Project managers need to be comfortable to move through three territories, which makes these projects highly difficult to execute well:

  • the core business and its customers;
  • the process of launching new solutions and innovation in corporates;
  • and, Fintech-specific knowledge about solutions, partners and regulation.

But, the situation is changing.

Successful cases are emerging

While, for now, embedded finance has not lived up the hype, successful case studies are emerging. In our Embedded Insurance 2.0 report, for example, we included 12 case studies, across both B2C and B2B use cases, and many more have emerged since.

These case studies will help overcome risk-averse decision-making, by providing concrete proof points to justify proof-of-concept projects, which will in generate more evidence and success, creating a flywheel effect.

In addition, the need to act will grow. Embedded finance doesn’t just create new revenue streams, it creates a better business. That is to say, embedded finance strengthens the value proposition of the core business. A brand with trade financing will sell more than one without, a brand with alternative payment methods will have higher conversion than one without, and a brand with supplementary insurance revenue will be able to outspend competition on marketing. As such, corporates will soon face competitors who have successfully implemented Fintech products in their core business and gained a competitive advantage as a result. This will create the pain that will see them scramble to catch up.

Technology providers are stepping up

In addition, the technology landscape is evolving. Effectively, we are seeing the same kind of ecosystem emerge in other verticals of financial services that has been established in payments. That is, we’re seeing the emergence of scaled regulated infrastructure providers (or carriers in the case of insurance); scaled vertically integrated providers; and modular technology providers that sit in between regulated financial institutions and brands.

This may not sound new, but there are two important trends to highlight.

The first is the growing importance of incumbent banks and (re)insurers in providing regulated infrastructure and capital. This is important not just because it brings balance sheet scale. It also helps to make embedded finance more global since these providers have international footprints. For example, Goldman Sachs, whose BaaS business we wrote about here, provides treasury services in 36 countries. Lastly, it brings regulatory muscle. In an embedded finance set up, the customer’s legal contractis with the regulated financial institution, irrespective of whether there is an embedded finance (technology) layer that controls the customer experience. In the first wave of embedded finance, some of these lines got blurred and, as a result, some of the decisions about which clients to onboard, how much scrutiny to place on KYC and so on were not well enforced by the underlying “sponsor” bank. This is changing and will change faster with larger incumbents propping up the ecosystem.

The second change is in the nature of the embedded finance providers. Their job was always to abstract away complexity: to make it easy for the embedder brand to introduce financial services seamlessly into their existing user journeys, and to make it easy for an underlying bank to distribute through multiple additional channels. Now, they have to do more. First, they have to up their game in terms of compliance, fraud and risk — abstracting away complexity for the brand without ignoring or arbitrating away the risk for the sponsor bank or carrier. Second, they have to orchestrate across more underlying providers, to extend the range of services a brand can offer without them handling complexity across multiple embedded finance providers, as well as bring the best combinations of providers for a given use case. Thirdly, they are beginning to operate more internationally, allowing embedder brands to offer the same use cases across international borders. Lastly, they are moving to contextualize services, at scale, to the needs of customers or groups of customers, allowing for more personalized services and more complex use cases. Examples of the new breed of embedded finance providers include additiv and Toqio for banking, and Alicia, for insurance.


From embedded to orchestrated finance

And there is a proven methodology to follow to deliver successful projects

To overcome the lack of internal know-how or expertise, consultants like aperture have developed proven methodologies for implementing (complex) embedded finance projects.

In our case, our methodology, which we have tested in 12+ embedded finance projects, covers:

  • Analysing user needs and designing a proposition
  • Evaluating feasibility of embedded finance solutions and necessary partners
  • Screening and cooperating with partners from longlist to contract signing
  • Building the proposition and testing it
  • Taking it to market and continually growing adoption

On top of a systematic approach, close collaboration with innovative enablers is required. Through our work with FinTechs, we are in touch with the market and bring in an accelerated connection to preferred partners on top of our project and process know-how.


A repeatable process for launching embeded finance solutions

Renovate in winter

Embedded finance has fallen out of favour. But it won’t last long. The opportunity and advantages of providing financial services to consumers through channels they use already and in which their buying intentions and context can be easily understood, is too irresistible to ignore. Brands will improve their core product and grow their revenues. Consumers will enjoy a better experience and get solutions to unmet needs. And underlying financial institutions will be able to spread their costs over higher volumes of business, lowering average costs.

The factors that have held back wider implementation of embedded finance projects are being addressed. More successful case studies are emerging, which will provide confidence to decision makers at the same time as increasing urgency to act. The provider landscape is maturing, growing its value add beyond just providing technology and financial services to proving compliant, contextualized, composite services at global scale. And the pool of project expertise is also expanding, creating a bedrock of proven processes, vendor knowledge and implementation best-practices that brands can rely on to accelerate and de-risk their projects.

We just need to sit tight and stay the course.

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