A primer on embedded finance, ‘fintech as a service

Introduction

Financial technology is moving from a discreet vertical market to a horizontal opportunity. This is mainly the origin of embedded finance. Businesses across industries – from retail to technology to banking – are embracing fintech as part of their technology table and business model to deliver a richer, “stickier” and more lucrative user value proposition. This report is a primer on the built-in financial market opportunity and fintech-as-a-service vendor ecosystem that has emerged to drive it.

Fintech is evolving from a group of stand-alone products and services aimed at end users to an infrastructure team on which existing companies can build. This trend, often referred to as embedded finance, dramatically expands the size of fintech market opportunities and transforms the distribution model for financial services. We are convinced that many of the largest and most important fintech companies over the next decade will be the ones offering their capabilities via a service-based model.

The development of fintech

In the early days of fintech, startups first and foremost entered the market and offered distinct financial services aimed at end users, such as lending or peer-to-peer, or P2P, payments. New participants like PayPal Holdings Inc.‘s Venmo LLC and LendingClub Corp. built a business by distinguishing specific banking products / features and acquiring users one by one. Today, fintech is increasingly seen as an infrastructure team that existing business-to-business and business-to-consumer, or B2C, organizations can build on to create new products and value propositions for their own customers. The examples of companies that build fintech capabilities to better serve their customers are many:

* Shopify Inc. offers payment processing, working capital, money accounts and payment cards to help its sales customers better run and expand their business. The supplier’s partner is Stripe Inc.

* DoorDash Inc. provides working capital to its trading partners to invest in the growth of their business. The supplier’s partner is Parafin Inc.

* Citizens Financial Group Inc. has launched a branded buy now, pay-later or BNPL service to acquire new customers and better compete with third-party BNPL suppliers. The supplier’s partner is Amount Inc.

* Google LLC offers virtual cards for Google Pay users to make it easier to use your cash balance online in the app or in-store. The supplier’s partner is Marqeta Inc.

* Uber Technologies Inc. provides drivers with a marked bank account and a debit card to receive immediate payments and consumption revenue. The supplier’s partner is Green Dot Corp.

Essentially, fintech is evolving into more of an ingredient baked into the services consumers and businesses are already implementing. Instead of operating together with the daily activities of consumers, employees and companies, financial products are increasingly wrapped up in them. We believe this trend gives fintech a way to deliver greater value and benefit to users.

Business drivers for embedded finance

Why do more companies offer their customers built-in fintech services? There are three proven business goals that we see that are driving this trend forward:

* Drive revenue growth. Perhaps the most obvious reason why B2C and B2B companies are switching to fintech is to increase average revenue per user. Generating revenue per transaction can be a power multiplier for growth, as software-as-a-service companies such as Toast Inc. and Shopify have demonstrated. Similarly, the offer of a lending product makes it possible for platforms and marketplace companies to catalyze growth for their customers, and creates more opportunities along the line, e.g. increased transaction volume as the business grows. It is important to note that income from embedded finance comes to essentially zero extra customer acquisition costs.

* Improve the user experience. Traditionally, most financial products were not built with a strong focus on design and user experience. This can be particularly problematic when considering how deeply ingrained various financial services are within many technology providers’ user experience. Common outcomes include service issues, process delays, and data reconciliation challenges, all of which can lead to dissatisfaction and customer failure. When a company takes greater ownership of the financial processes that are at the core of how users engage with their products, it will directly translate into increased control over – and refinement of – their user experience.

* Increase product tack. Financial services are inextricably linked to the daily activities of consumers and businesses. Offering financial services directly therefore enables technology companies to increase product engagement. It also provides an opportunity to deliver greater value and become a more indispensable partner. Ultimately, this can increase storage. As Blackbaud Inc. CFO Anthony Boor emphasized during the company’s earnings interview for the fourth quarter of 2020: “Our payment business is very, very sticky,” pointing out that customers who use the payment service generally show higher retention rates than those who do not.

The rise of fintech “as a service”

An “as a service” market opportunity has emerged centered around enabling companies to outsource the capacity and infrastructure required to deliver fintech products and services to their customers. The trend is not foreign in the technology industry. Just like many companies choose to work with a supplier like Salesforce Inc. instead of building their own customer relationship management system, or a cloud provider like Amazon.com Inc.‘s Amazon Web Services Inc. Instead of building their own data centers, many choose to leverage the infrastructure of fintech-as-a-service providers to abstract the complexity and resource investment associated with the launch of fintech products. This trend has begun to reinforce the go-to-market strategies and business models of many fintech suppliers. Fintech companies are increasingly seeing a one-to-many model as a more efficient and effective way to scale.

Thanks to fintech as a service, launching a new fintech product or startup has never been easier. Companies that partner with a fintech-as-a-service provider can stay focused on their core business as they expand into fintech with increased market speed and reduced upfront investment and operational requirements. Ultimately, this trend is in the process of reshaping the unit economy to provide financial services.

Across the full range of built-in economy applications, a number of fintech-as-a-service categories are emerging, with a rapidly growing list of providers offering their infrastructure and services on a white-label basis. Below, we highlight four key categories of the supplier’s ecosystem, along with some representative suppliers participating in each category.

Card

Players in this category typically offer a comprehensive platform that includes all the features required to issue payment cards to customers or employees – such as issuer processing, digital wallet card delivery services, application management, card printing and fulfillment. In the same way, they provide connections to necessary partners – such as bank sponsors and networks – and eliminate the need to acquire more relationships. Examples of suppliers in this category include Marqeta Inc., Lithic, Apto Payments Inc. and Highnote Platform Inc.

Banking

Businesses in this category, including banks and technology providers, enable organizations to offer money management accounts such as a bank account or digital wallet. These accounts usually support a number of traditional bank account features, such as keeping balance, sending / receiving funds, ATM access, interest and rewards. Vendors typically offer a variety of features, including compliance and identity verification tools, fraud and risk management tools, card issuance capabilities, and application management. Some even have their own banking licenses. Examples of players in this category include Railsbank Technology LtdBond, Green Dot Corp. and Q2 Holdings Inc.

Payment processing

Providers in this segment enable companies, usually specialists in software platforms, to offer payment processing services to their customers. The implementation models vary, but among the most common is the hybrid approach, where the embedded payment provider generally handles resource-intensive tasks such as identity verification checks, compliance and validation of the payment card industry, licenses and underwriting. Similarly, the embedded payment provider’s infrastructure – which may include a gateway, token vault, payout mechanisms and reporting tools – to enable payment acceptance and processing. Companies in this category include Stripe, BlueSnap Inc., Finix Payments Inc. and Payrix Solutions LLC.

Lending

Companies in this sector make it possible for organizations to offer different types of lending products, ranging from BNPL to working capital to microloans to credit cards. Lenders usually specialize in one or two lending products. They often offer a platform that includes guarantee and risk and compliance management tools, as well as service features and lender connections. Examples of players in this segment include Amounts, Jifiti.com Inc.Deserve, Paraffin and Stilt Inc.is Onbo.