Embedded Finance - Case Studies
We recently welcomed Marton Erdei, Head of Capital Markets at Mission Lane on our regular Budapest FinTech Meetup event at OTP’s HQ. The discussion did not represent Mission Lane’s but Marton Erdei’s personal views, and throughout his presentation, Marton leveraged some great hands-on examples from prior work experiences.
What is embedded finance and why does it matter?
The construct is not new and could be defined as "non-financial companies offering financial products and services". According to McKinsey,what has changed is the distribution channels have become increasingly more "digital interfaces that users interact with daily.” It sounds simple enough, but there is a whole new set of services built to make this possible, and it is a thriving market likely to double its size in the next 3 to 5 years.
Marton's journey and interest in embedded finance services started early. His family was running a small book store, and it was a daily challenge to track how much money they made on a given day. While payments were made in cash mostly back in those days, their inventory management was also paper-based - so it took a lot of effort to calculate the store's P&L.
This challenge gave Marton the goal to help SME businesses with financial data, analytics, and other crucial financial services offerings. Given the sudden emergence of digitization across all industries and services, there is plenty of transactional and user data to build products on. A a more recent example is the buy now, pay later product embedded in the checkout process offered by several e-commerce marketplaces, but Marton unfolded some other key trends and models during the Meetup.
Credit services framework
It is becoming an ever-growing digital trend for businesses to offer their customers different credit products, like loans or credit cards. Marton sees there are three fundamental pillars to doing credit services right for businesses:
- Differentiated way to acquire customers
- Access alternative sources of timely and accurate data (underwriting)
- Ability to serve your customer through the customer journey (servicing)
Having all three of the above fundamentals is quite rare, according to Marton. Suppose you are a SaaS product company operating on high volume and low margins. Your core focus needs to be around avoiding churn of your customers, diversifying your revenue mix, and reaching economies of scale. In contrast, if you are in the business of credit services operating on low-volume and high margins, your core focus should be on acquiring new customers, data gathering for underwriting, and performing continuous risk monitoring activities. By offering embedded credit or financial services, your business should be able to retain more customers, as they are less likely to churn with a sticky financial relationship in place. Through frequent platform interactions, gathering data for underwriting and servicing, credit can become a whole lot more effective as well; synergy on both fronts.
Product and market overview
Whether you are B2B, B2C, or B2B2C digital business, your users interact with their favorite features and services daily. Throughout their journey, they integrate with various financial services, often beyond the original scope of the digital business. Such financial products can range from deposits, payments, cards, loans, lines, receivables, trading, and insurance to even crypto offerings. Generally, small businesses are the target beneficiaries of this emerging technology, primarily via payments processing services.
One of the most well-known providers in this field is Shopify, which provides easy webshop services integration, online selling, and useful analytics for small businesses.Clearco specializes in providing funding to SMEs in the ecommerce space through platforms, like Shopify. Customers can use the non-dilutive funding on targeted campaigns and accelerate their growth. Square, co-founded by Jack Dorsey, Twitter's former CEO and Co-Founder, is another notable embedded finance provider for SMEs, focusing on credit card payments and usage of tablet devices as payment registers for a point-of-sale (PoS) system. Stripe was also able to figure out a way to be in a unique position between banks and other financing solutions and platforms through leveraging data and payment processing.
A popular choice in the hospitality industry is Toast, which initially focused on restaurants' payment processing services and revolutionizing how restaurants use customer data to run processes more efficiently. They had an intense journey in diversifying offerings to payroll, capital, and rewards programs. Another example was Levelset (acquired by Procore) which offers lien filing solutions for subcontractors to accelerate the payment cycle. We have applied the credit framework above to these different business models and identified bright spots as well as challenges in each case study.
Back to Marton’s use case with their family-run store - he would have loved to see a similar locally run platform like SumUp and OTP’s eBIZ app as they provide a great end-to-end solution for Hungarian SMEs' financial needs.
Another viable use case is payroll lending services. In the Hungarian market, a local example in this field is Salarify which provides employees early wage access from their employers. It involves a fairly long sales cycle to onboard a new employer but once the partnership is established, the access to employees makes customer acquisition seamless. UK's SalaryFinance established a strong local presence, mostly in their domestic market, yet they struggled with entering the US Market. The previous taxation scheme of KATA in Hungary could have provided a big opportunity for embedded finance product companies to build services for the underserved KATA population, but given the recent changes in local taxation rules, this opportunity slipped away. Marton still sees immense potential for new entrants in this market as well as localizing the examples discussed in the case studies.
Marton offered a balanced view of the future of the embedded finance services industry in continental Europe. On one hand, cross-border credit products seem to have some headwinds despite the integration efforts across the EU. Expectedly,on the other hand, consolidation in the fintech space and the ever more digital consumer behavior should provide excellent opportunities to target.
Stay tuned with OTP LAB and Sprintform on Budapest's latest fintech events, programs, and news.
Sources:
https://plaid.com/resources/fintech/what-is-embedded-finance/
