The embedded banking opportunity is clear, but choosing the right partner might be less so.
You probably won’t be very surprised to hear that the Banking-as-a-Service market is pretty hot right now. Just last week, Swan announced a series A fundraising, Starling announced it is taking its BaaS offering into Europe, Modularbank rebranded as Tuum to position itself as a core banking platform for BaaS – and there were probably dozens of other announcements we missed.
Making banking products available as a service to be embedded into non-banking channels is a logical next step to improve customer experience and grow the financial services market – which explains the market momentum we are seeing. However, even though the BaaS opportunity is compelling and well-understood, it doesn’t mean there aren’t significant nuances and complexities to navigate.
This is why we created this 10-point checklist for BaaS buyers: to distil some of our experience from helping companies to select the right BaaS platform.
Banking distribution is the hard bit
Banking services distribution is splitting from banking services manufacturing. As in other industries, this is happening because of digitization, which in the case of banking specifically has been given a helping hand by the open banking legislation that has increased the rate of data-sharing between institutions.
When services digitize, the pinch point in the value chain inverts from manufacturing to distribution. Back when it was difficult and costly to produce stuff, the manufacturers with scale economies enjoyed the highest return on assets and the highest profits. Now the costs of producing digital services have fallen, the difficulty has become distribution not production. (See below our Challenger Bank Map to get an idea of how many bank new entrants we’ve seen in recent years).
The distribution challenge manifests itself in high CAC and low LTV. B2C financial services companies, both incumbents as well as fintechs, need to reach time-poor and attention-poor consumers. This costs a lot of money. According to ARK Invest, the average Cost of Customer Acquisition (CAC) for a bank in the US in $1,500.
This might be lower for a fintech with an innovative product (Nutmeg, now acquired by JP Morgan, had a CAC of c.$680 for example), but fintechs tend to have narrower product sets with which to cross-sell customers, contributing to low revenue per customer (Nutmeg generated c.$200 per customer in 2019).
The bigger problem both banks and fintechs have, however, is low engagement. Banking is transactional. We open up an app to make a payment or check our balance and then we close it. There isn’t anything to hold our attention and keep up using the app. This makes up-selling and cross-selling difficult for both fintechs and banks, because it reduces the surface area, the touchpoints, for providing the right offers. As a result, customer LifeTime Value (LTV) suffers.
Embedded banking lowers CAC, but it does MUCH more too
Embedded banking, the act of inserting banking services into typically non-banking channels, can solve these issues of high CAC and low LTV. When, for example, H&M offers a customer credit for a purchase they make, there is no additional CAC; it’s an existing customer. The credit service is a cross-sell, boosting LTV, from an already engaged consumer.
But embedded banking goes much further than just improving the economics of banking – it also grows the market for banking services. Why? Because it presents what the customer needs, where the customer is and when the customer needs it – removing the friction and cost of discovery that result in massive under-provisioning of financial services.
It transforms banking because it adds it as part of an existing user or buying journey. If we continue with the H&M example, the buyer does not have to change channels. If the buyer needs credit for a purchase, they don’t have to open up a separate app and apply for credit. Instead, because the context is understood, the credit is presented at the right time and in the right place.
In addition, and this is often overlooked with embedded banking, the form of the banking products is changing – moving from off-the-shelf services closer towards what makes sense for that buyer journey (or what Clayton Christensen termed the customer’s “job-to-be-done”). In this H&M example, the customer is not presented with a credit card, but is offered the chance to pay for the purchase in installments.
BaaS has made embedded banking an option for every brand
Baas providers – and, by extension, the BaaS market – have emerged to build the bridge between banking and brands.
Linking banking with consumer brands is not new, but the speed and cost of doing so is what has changed with BaaS. Consumer brands have long seen the potential of distributing banking services. Some built banks. Others created deep partnerships with banks to white-label their products. But these were expensive, long-term projects with high switching costs.
As banking began to digitize, internet started to introduce banking services natively into their experience, such as the Amazon one-click checkout, which many credit as Amazon’s breakout moment – but without either becoming banks or having to white label banks. But, while Amazon and Uber demonstrated the massive potential of embedded banking, not many others were able to follow because they didn’t have the technology, compliance and other resources to do so.
This is where BaaS comes in. In an example of what Union Street Ventures termed the “apps-infrastructure cycle”, once the potential had been demonstrated, along came the infrastructure. In this case, the infrastructure sits between regulated banks, on one side, and brands on the other, abstracting away the complexity to make it possible for any company to distribute banking services.
Navigating the BaaS maze
Not all BaaS providers offer the same value proposition, however. As we set out in an earlier article, once you start to look into the market you realize there is a lot of complexity.
Some BaaS providers are vertically integrated, while others – what we call modular BaaS providers – sit between the bank and the brand. But modular BaaS providers are not all created equal either. Some, for example, are regulated and other are not. Furthermore, we see a growing trend towards further modularization – or fragmentation – with modular BaaS providers beginning to specialize on certain aspects such as user experience and aggregation. In addition, BaaS provider tend to cover specific use cases and specific geographies, which must also be considered.
All in all, it’s a bit of a maze.
A 10-point checklist
To help navigate this maze, we have put together a 10-point checklist as well as a Market Map for BaaS Providers.
Since not all BaaS providers are the same, here are some of the questions that an embedder brand should use when evaluating the options:
- Can the BaaS provider meet my use case? If your goal is to offer employees a debit card, you’ll need a BaaS provider that can issue cards.
- Could the BaaS provider meet my future use cases? This is important to consider upfront because once you’ve started to improve customer experience and retention with a single banking use case, you’ll want to add more. If your BaaS provider can’t meet these use cases, you might get stuck.
- Does the BaaS provider operate in my existing geographies? If your business is in France, you’ll need a BaaS provider that is regulated (through their own licenses or partnerships) to operate in France.
- Could the BaaS provider support international expansion? If yours is a global business or you’re considering expanding internationally, it is worth noting that many BaaS providers have a limited geographical footprint, which could evolve into you having to manage multiple BaaS relationships across the group.
- Does the BaaS provider offer competitive fees (and revenue share)? In our experience, there are massive variations in the way BaaS providers price – everything from the split of fixed vs variable costs, the per unit pricing for services (e.g an FX payment) as well as interchange revenue split. It is worth building a detailed model to compare BaaS providers side-by-side using business projections.
- What is the BaaS provider’s compliance status? Might we need to take on some compliance obligations? Significant differences appear here as well. Some BaaS providers manage all of the compliance obligations, while others do not. If your business is not banking, you might want to think carefully about whether you want to be hiring a Money Laundering Officer, for instance.
- How much development do we need to do to launch this service and do we have the resources/appetite for it? While some BaaS providers offer completely out-of-the-box service, including pre-built UIs, others require the embedder brand to do a lot of development. There are advantages and disadvantages for each approach, just make sure you go into the relationship with your eyes open, understanding you may have to take on a lot of development which impacts costs and timelines.
- How quickly can we launch this service? This question is partly a function of question of how much development is needed, but also reflects other factors, such as whether the BaaS provider already has all other ancillary services in place.
- Are we going to receive the insights to be make our end customers’ experiences truly contextual and relevant? This is crucial. Even if a BaaS provider can help you launch quickly across the globe, they may not have the capabilities that allow you to develop the insights to offer more relevant content and recommendations over time.
- Is the BaaS provider going to provide a service that gets better as its customer base grows? We think one of the main points of differentiation between BaaS providers is the extent to which they have built common models (e.g. for detecting fraud) that will confer network benefits to clients and make being part of ecosystem more valuable over time.
The Market Map for BaaS Providers
As an aid to navigating this complex space, and to begin to answer these 10 questions and others, we have put together The Market Map for BaaS providers.
The Market Map is a new approach to evaluating technology platforms. First used to look at WealthTech solutions, the Market Map ranks providers according to their ability to enable business model innovation and technology innovation.
Unlike other industry rankings, the methodology isn’t meant to separate the good from the bad, but rather to help decision makers determine which platforms can meet their strategic goals.
For example, if you’re a tech savvy challenger bank looking to get to market quicker with a new service using a BaaS provider, you are going completely different set of business and technology requirements from a small retailer with no tech department looking to offer its clients point-of-sale credit.
The opportunity is clear, the right BaaS partner might be less so.