The concept of embedded finance is, at the face of it, a simple one to grasp; be it a loan at the point of purchase or an insurance offer when you rent an apartment. While it simplifies the lives of consumers everywhere, the embedded finance proposition
is not a simple one to grasp from an investment perspective.
Is embedded finance a fad or a revolution? How should you approach it – whether you are an established financial institution (FI) or a fintech looking to make its mark?
Embedded finance is here to stay
The reason you can be confident that embedded finance is not a fad is that it arrives on the wave of a much more fundamental shift in the way we do business in the 21st century.
It used to be nearly enough to have a bold product, service, idea, or marketing approach. Just think Nike, McDonald’s, or American Express. Today, you still need the idea, but above all, you need a powerful alliance — an ecosystem.
In a world made of specialists, it is necessary for partners with different specialties to come together to play on each other’s strengths and neutralise each other’s weaknesses. Embedded finance is merely an embodiment of the much broader shift of value
towards ecosystems.
In a survey of the Top 100 banks by market capitalisation, BCG has found that virtually all are pursuing some type of ecosystem engagement, and this may not come as a surprise. However, the correlation between significant ecosystem engagement and key metrics
such as income growth and shareholder return indicates that the best-managed companies already understand the seismic shift taking place and are futureproofing their strategy.
Speaking of futureproofing, the areas of investment in embedded finance today are not necessarily the ones that have the strongest future potential. This is why it’s important to take a look at the current market landscape and compare it with points of view
from VCs and key industry players. If you are evaluating potential partners for your ecosystem, being able to agree on a long-term direction is crucial.
The market is changing directions, and we are at a proverbial fork in the road. If you want to win in the market — you better bring an ally who shares your long-term vision.
SMEs will fuel embedded finance growth
In addition to bringing the right allies and adopting early, an understanding of where the market is headed is crucial to success in the embedded finance market. The surprising part is that the future of embedded finance is B2B, not B2C.
Of course, you wouldn’t think that based on what we see in the market today. The current market for embedded finance is estimated by PwC to be $54.3B, and the associated transaction volume is $141.8B. More than 70% of the current players in this market are
focused on B2B2C.
Yet, both VC investment direction and key market players’ attitudes indicate that the future is B2B(2B). As it turns out, embedded finance may be key to unlocking a market segment that large FIs have tried (and failed) to crack for decades.
SMEs are currently underserved by the traditional FIs, and they have been for a long time. They have trouble obtaining loans as they are not as attractive to banks as their corporate customers, and yet have more complex needs than an individual. SMEs are
also underinsured and fly under the radar of traditional wealth managers and benefit providers. The list goes on.
A global Accenture survey of 1,000 SMEs indicates that new embedded finance market entrants could take away as much as 25% of the global SME market from the traditional FIs. This equates to about a $32B market share loss if banks do nothing. By the same
token, embedded finance is expected to add $92B to the SME market in the near future.
Yet, SMEs are not intuitive to understand. Mom-and-pop shops actually prefer traditional FIs, while it’s the larger SMEs that have the opposite preference. In other words, SMEs are not to be targeted as a single, homogenous market with identical preferences.
Getting this segment right is not easy, but the ROI, as you will see, could be beyond your wildest expectations.
Embedded finance trends to watch in 2024
While our whitepaper is focused on a multiyear horizon, you will need to look no further than 2024 as some of the key trends I highlighted above start to take shape.
1. B2B segment takes off: Payment acceleration
Having transformed the B2C market, we will see embedded finance start to take off on the B2B front, and firstly in those areas where transformation is most obviously needed, such as payments. B2B financial transactions are notoriously sluggish, with often
antiquated processes and platforms, and a negative impact on all stakeholders’ cash visibility and financial management.
I expect to see an increase in Request-to-Pay (R2P) transactions, allowing billing issuers to send electronic invoices, eliminating delays, and process bottlenecks across large volumes of payments. Purchase order financing will help businesses cover the
cost of materials required for product or service delivery without waiting for payments, with Buy Now Pay Later allowing vendors to assess buyers’ creditworthiness, informing their lending decisions.
2. Further growth in A2A payments
While A2A payments struggle to take hold in many mature consumer markets, such as North America, due to the benefits and convenience of credit cards, I expect to see further growth in A2A payments globally in 2024.
This will be fueled by emerging consumer markets such as China and India, where traditional payment methods have not taken hold, and the cost of traditional payment modes continues to be a barrier. There will also be growth in A2A payments in the B2B segment
globally, where the inherent clunkiness of the present payment modes I referenced above leaves the door open to innovation.
3. Banks enter the equation as emerging technologies converge
Banks have been increasingly embracing business and technological ecosystems as they see new embedded finance market entrants start to take away market share.
Partnering with fintechs will allow banks to capitalise on the embedded finance revolution while providing fintechs with access to capital to drive the convergence of cost-intensive emerging technologies such as artificial intelligence and machine learning.
Flawless execution is essential
Travelling and charting new territory has been fraught with danger since time immemorial. The unexplored landscape of embedded finance is no different.
Firstly, one’s embedded finance market strategy must be based on a detailed understanding of the associated value chain. Different types of opportunities and players require different core strengths, and can count on differing returns.
In addition to strategic considerations, there are specific tactical considerations unique to the embedded finance market. While there are many opportunities and roles to play in the embedded finance value chain, truly successful entrepreneurs will develop
an understanding of the associated risks.
Ecosystems imply complex partnerships. Risks to one partner are distributed to all partners. Add to that the regulatory complexity inherent to the financial services domain. Each partner in the ecosystem will have to execute near-flawlessly and maintain
both domain and technical expertise. Metaphorically speaking, they must speak the same language — even if it is not their first.
It is in consideration of the above risks that we make recommendations about internal processes, technologies, and overall approaches to managing risks within an ecosystem.
These considerations are different for traditional FIs than for fintechs, and our recommendations are meant to improve understanding between different types of players in the embedded finance value chain.
When it comes to flawless execution, there are technical considerations as well. Building a seamless experience for developers within an ecosystem is complex and yet crucially important. To achieve this, one must provide things such as self-service access
and APIs with solid documentation. There is additional complexity here in that banks and fintechs will have a very different view of technical requirements given their competing priorities and perspectives.
In conclusion, banks will need to have an understanding with their tech providers. Tech providers need to ensure not to run afoul of FS regulations. Each should choose their partners wisely.
Our whitepaper is a guide to strategic and technical considerations for all market entrants. I’ve surveyed data and perspectives from 12 of the world’s foremost thought leaders in the field of finance and applied my more than 25 years of global experience
in financial services digital strategy, consulting, and product development.
“Growth reimagined: Capitalising on the embedded finance revolution” looks at key aspects to success in the field of embedded finance. From high-level strategy to choosing the right partners, understanding your customers, and understanding key risks, you will find data and points of view to support your informed decisions. You can download the whitepaper here.