It can be a difficult time right now for anyone in the startup ecosystem. Layoffs, falling valuations, and no clear picture of how the next few weeks and months will unfold While this may sound frightening, it is also clear that startups cannot stop building and shipping, which is why I want to use this blog post to highlight why it is extremely smart to begin your Embedded Finance journey today.
This is the fourth post of The Embedded Finance Guide. If this is your first visit, you can find previous posts here. To refresh your memory, when I refer to Embedded Finance, I am referring to non-financial providers that are offering financial services that are seamlessly integrated into their core product. If you enjoyed this post, please consider subscribing to my newsletter and sharing this post with a friend or coworker.
Why should you pursue Embedded Finance?
There are already hundreds of Embedded Finance solutions available around the world (see here, here, and here), and as an outsider, you might wonder what motivates these companies to provide financial services. You might also wonder if these same advantages apply to you.
As shown in the graphic below, there are three major advantages to incorporating financial services into a non-financial offering:
Let's go over them one by one.
1. Attract new customers
Founders are always looking for new ways to expand their customer base. Embedding Financial Services could be one way to accomplish this. Let's look at a theoretical example to help explain this: I envision a vertical B2B SaaS solution that has built an accounting and invoicing solution specifically for cleaning companies. Let's call the company McCleanly. Customers of McCleanly can use their solution for a variety of accounting and bookkeeping tasks; however, if they want to use financial services, they must find another provider. McCleanly may be very successful in the market because they are able to address the unique needs of cleaning companies; however, some cleaning companies have already signed up for an expense management solution that includes virtual and plastic cards as a core offering. This cleaning company might not want to sign up for McCleanly because it would require paying for two services, and money might be tight - especially these days. When McCleanly integrates cards (or other financial products), the total product offering could be far more compelling than the solution with financial products. Furthermore, McCleanly is able to enter the market from a new angle, and thus is likely to reduce their Customer Acquisition Costs (CAC).
2. Reduce churn
Financial products, as we all know, cause stickiness. Switching financial products is not impossible, but it is usually not the most pleasurable activity either. This is obviously a challenge that a service provider must overcome in order to persuade their own customers to switch to their own financial products. However, once the customer begins to use your financial product, the stickiness works in your favour because switching to someone else will be more difficult. You will most likely agree with this and consider the hassle of switching your personal bank account. And, yes, the time and effort required to change card details or account numbers with your customers and suppliers is a major reason for the stickiness. However, there is one more factor to consider in the Embedded Finance ecosystem: Your direct competitors may not yet offer Embedded Finance. Thus, when your customer is targeted by your competition to switch, they will realise that they will need to switch from you to your competitor for non-financial services, but they will also need to find another service provider (perhaps a bank) for their financial product needs. As a result, switching may require the procurement of two distinct types of solutions. This obviously reduces the chances of such a customer switching to a competitor, even if the incentives are attractive. This decreased churn will result in an increase in Customer Lifetime Value (CLV), which may increase revenue or allow the service provider to spend more on Customer Acquisition Cost (CAC).
3. Increase revenue per customer
This third and final benefit of embedding financial products is, in my opinion, the most important one. It's all about making more money with each customer. While it is always nice to make more money without having to find new customers, I believe this is extremely valuable in today's world. Yes, embedded financial products will cost you money, but it will be much less than it used to be. Even more importantly, you can accomplish this with your current staff rather than hiring a team of experts. But let's not get too caught up on the cost side of things (more about this in another post), and instead let me show you how you can increase your revenue with Embedded Finance. To give you a ballpark, the investor a16z puts this number to up to 5x of the previous revenue for B2B SaaS companies (source). This may sound high but it’s actually achievable. Consider the following areas where a non-financial company can increase revenue by adding Embedded Finance to their offering:
a. Increase usage of core product
In a previous paragraph, I mentioned stickiness as a benefit of financial products; additionally, financial products create new touch points. These new touch points can be used to re-engage the customer and lead to increased usage of the main product, and thus revenue for the service provider. You could say that Embedded Finance works like a loyalty system - and often it's designed in this way.
A practical example would be a Debit/Credit Card offering from your favourite coffee shop. This card may entice you to spend more money or visit the coffee shop more frequently. This can be accomplished through a loyalty programme with discounts or push notifications from the app when you are in the area of one of their stores. In fact, Starbucks already provides a wallet (but not a full-fledged card or account) for similar benefits (more details). Other good examples can be found in the recent Embedded Finance study, which I linked in my previous blog post. One of the findings was that Playstation customers would be eager to use a Playstation Card if they received discounts and other benefits. This would almost certainly result in an increase in purchases.
b. Charging for financial products
While providing financial services, the non-financial service provider may charge for the use of their financial products. Due to the competitive landscape in most countries, charging for consumer banking functionality may be difficult, but it is not impossible - especially if it is in line with existing banking offerings. Furthermore, in the corporate banking world, charging companies for banking products is very common, and it may even be considered unusual not to charge for it.
Banking product fees could include:
- Subscription fee (likely as part of the overall subscription fee)
- Bank account transfers
- International account transfers
- Card transactions in foreign currencies
Keep in mind that the non-financial company offering these products is most likely collaborating with an infrastructure provider (such as Weavr) in the background. The non-financial company is most likely paying the infrastructure provider for such activities of their customers; thus, the non-financial company can pass this cost on to their users or also add a markup.
Aside from direct charges for financial services, the service provider may also receive kickbacks when their customers use specific products. The most common one is interchange. When a customer uses their card, the card issuing bank receives a kickback called interchange (perhaps a good idea to dive into these details in another blog post). Because consumer card interchange is regulated (0.2% for debit and 0.3% for credit cards), this is less relevant in the consumer space; however, corporate cards are not regulated, and interchange is often around 1.5%-2% percent (depending on different details).
As a result, a company that incorporates corporate cards into their offering could generate a substantial new revenue stream if their customers begin to use the cards on a regular basis.
There might also be other kickbacks available depending on the financial product being used. Perhaps in the future, we will see opportunities to generate revenue through interests when customers deposit funds with an embedded finance solution (in Europe; in other geographies this is already possible today). However, there will be limitations, and not every infrastructure provider will be able to provide this.
d. Leveraging financial data
Finally, embedding finance products will give the service provider access to completely new insights about their users. This could refer to incoming payments into a specified payment account, card-based expenses or the purpose of a loan. These new insights can be used by the embedded finance solution provider to adjust their product offering or create new products that their users are interested in. For example, a service provider may discover that a subset of their customers are paying for the services of another SaaS provider, which could lead to a deeper integration of their services or even the exploration of offering such services themselves.
Be like Shopify
As you can see, companies that embed financial products can benefit in a variety of ways, with additional revenue being a compelling reason to embark on this journey. Although I linked to a few Embedded Finance use cases in the introduction, you could argue that none of the providers profit from their Embedded Finance solution. So, consider Shopify, a prime example of an Embedded Finance company. Shopify is a software-as-a-service solution that allows anyone to sell their own products on the internet through their own webshop. Yes, the company went through some trying times with layoffs, but my point remains the same.
According to the most recent financial reporting (source), Shopify made $344.8 million with subscription services (their initial core product), which is growing at an 8 percent annual rate:
Merchant solutions (which consists mostly of Fintech products) generated $858.9 million with a 29 percent growth rate.
As you can see, Shopify's initial core product (subscriptions) accounts for approximately 28.6 percent of the total revenue, while Merchant Solutions accounts for the majority of their revenue. If you want to div a little deeper into this story, I highly recommend this article from last year, which includes an interesting interview with Kaz Nejatian of Shopify.
I'll end this blog post with a personal comment on your potential Embedded Finance journey. You may decide that now is the right time to Embed Finance or not. But keep in mind that this is a journey, and companies like Shopify have been on it for quite some time. In fact, Shopify Capital was launched in 2016! You might decide to wait and see how this trend develops. However, this may imply that your competitors will begin right away. You could hope they fail, but if they don't, they'll likely always be ahead of you.