Embedded finance is a new trend in the financial services industry that involves integrating financial services into non-financial products and services. This integration is possible thanks to APIs, which allow users to access financial services without leaving the application or platform they are using.
Embedded finance is still a relatively new industry, but it is growing rapidly. The global embedded finance market is expected to reach $248.4 billion by 2032 (Source: Pwc.com).
There are a number of benefits to embedded finance for both platforms and consumers. For platforms, embedded finance can help them to increase their customer base, improve customer loyalty and generate new revenue streams. For consumers, embedded finance can make it easier and more convenient to access financial services.
Some of the most common examples of embedded finance include:
Payment processing: Payment processing companies are offering their services through non-financial businesses, such as e-commerce platforms and mobile apps. This allows businesses to accept payments from their customers without having to set up their own payment processing infrastructure.
Buy now, pay later (BNPL): BNPL services allow consumers to purchase goods or services now and pay for them later, often in installments. BNPL services are offered by a number of non-financial businesses, such as retailers, travel companies, and furniture stores.
Cash advance: A cash advance, within the context of embedded finance, refers to the inclusion of instant or short-term cash advance services within a non-financial platform. For example, a retail platform may embed a feature that allows users to access cash advances directly through the platform, eliminating the need to use a separate financial institution. This integration streamlines the process, offering users quick and convenient access to funds without navigating external financial channels
Card issuing: S retail platform or a technology company can embed card issuing capabilities into their services, allowing users to obtain and use payment cards seamlessly within the platform. This integration facilitates transactions, payments, and financial activities without the need for users to go through a separate banking institution.
The embedded finance industry is still in its early stages, but it is growing rapidly. As the industry matures, we can expect to see even more innovative and creative ways to integrate financial services into non-financial products and services.
Here are some of the challenges facing the embedded finance industry:
Regulation: The embedded finance industry is still new, and there is a lack of clear regulations in many jurisdictions. This can make it difficult for platforms to offer embedded finance products and services.
Security: Embedded finance relies on APIs, which can be vulnerable to cyberattacks. Businesses need to take steps to protect their APIs and the data that they transmit.
Compliance: Platforms that offer embedded finance products and services need to comply with a variety of regulations, such as anti-money laundering (AML) and know-your-customer (KYC) regulations.
What is the appetite of SMBs for embedded finance
The image below shows the interest of small and medium-sized businesses (SMBs) in business accounts, cash advances, and issued cards on platforms, by country and vertical. It is clear that SMBs are increasingly interested in these products and services, with a majority of respondents in most countries and verticals expressing interest.
Implications for platforms
The findings of this study have a number of implications for businesses.
First, platforms should consider offering business accounts, cash advances, and issued cards on their platforms. This could help them to attract and retain SMB customers.
Second, platforms should focus on making their products and services as convenient and efficient as possible. SMBs are busy businesses, and they want to be able to access the products and services they need quickly and easily.
Third, businesses should be aware of the cash flow challenges that some SMBs are facing. They may want to consider offering cash advance products to help these businesses bridge the gap.
The image above shows the demand for cash advances by industry, with the transport and logistics industry having the highest demand (72%), followed by the hospitality industry (66%), the professional services industry (62%), the retail industry (61%), and the "Others" category (47%).
Cash advances can be a helpful tool for businesses in these industries, as they can provide quick access to cash without having to go through a traditional bank loan process.
There are a number of reasons why businesses in these industries may be facing cash flow challenges. For example, businesses in the transport and logistics industry may have to pay for fuel, maintenance, and other expenses upfront, before they receive payment from their customers. Businesses in the hospitality industry may have seasonal fluctuations in revenue, and they may need cash advances to cover expenses during the off-season. Businesses in the professional services industry may have to bill their customers on a net 30 or net 60 basis, which means that they may not receive payment for their services for several weeks or even months after they have been provided. Businesses in the retail industry may have to invest in inventory upfront, before they can sell it to their customers.
How are embedded payments distributed through channels today
According to a Flagship Advisory partners’ report “ Saas and ISVs are the largest channel for distribution of SMB payment acceptance in the US, UK and EU.
The above shows that yet there is a lot of margin in Europe for Saas companies adopting embedded payments, with banks still playing a key role in the offline markets.
The rise of integrated and embedded payments
The industry is moving towards deeply embedded payments, where software and payment functionalities are intricately combined and controlled either by a singular entity or through closely woven partnerships between software and payment providers.
The amalgamation of integrated or embedded payments also presents an outstanding value proposition for merchants. A unified software + payments platform evolves into a comprehensive solution for merchants, offering a singular point of service, data management and valuable business insights.
As depicted in Figure 2, the United States stands at the forefront globally in terms of product adoption rates for embedded and integrated payments (approximately 75-90% of Small and Medium-sized Business (SMB) merchants are utilizing embedded or fully integrated payment solutions). Conversely, the United Kingdom and Europe lag behind in the fusion of software and payments at Point of Sale (POS), although e-commerce platforms in Europe are generally incorporating payments deeply. Payment Service Providers (PSPs) in Europe are swiftly formulating strategies to enter the market with Independent Software Vendors.
Models of integrations for Saas and Payments companies
As ISVs grow in size, they typically transition from basic referral partnerships to more sophisticated integrated operating models. In the U.S., larger SaaS companies have already adopted Payfac Lite or Full Payfac models, while smaller ISVs often stick to referral models due to the complexities involved in managing more payment-related operations.
Most ISVs in Europe and the UK still primarily utilize straightforward referral models to monetize payments. However, there's a growing trend towards implementing Payfac Lite operating models, where the SaaS providers are not directly involved in the money flow or regulated as payment institutions. The functional differences between these various operating models are detailed in Figure 3.
Conclusions
Embedded finance in the United States
The U.S. showcases a mature market where larger Software as a Service (SaaS) entities predominantly adopt advanced payment operating models such as Payfac Lite or Full Payfac. Smaller Independent Software Vendors (ISVs), while scaling, often rely on simpler referral models due to the challenges associated with assuming greater ownership of payment processes. The market is characterized by a comprehensive integration of software and payments, with a significant percentage of Small and Medium-sized Business (SMB) merchants utilizing embedded or fully integrated payment solutions.
Embedded finance in the United Kingdom
In the U.K., Independent Software Vendors predominantly adhere to a basic referral model for monetizing payments. However, there is a noticeable trend towards the deployment of Payfac Lite operating models. This shift suggests an increasing inclination towards more integrated payment structures, aligning with global industry trends. While e-commerce platforms in the region deeply integrate payments, there is still a lag in the adoption of integrated software and payment solutions at the Point of Sale (POS).
Embedded finance in the European Union
Within the European Union, ISVs commonly rely on a straightforward referral approach for payment monetization. However, there is a swift rise in the adoption of Payfac Lite operating models, especially in cases where SaaS entities are not intricately involved in financial transactions or licensed as payment institutions. Payment Service Providers (PSPs) in Europe are strategically developing Independent Software Vendor (ISV) go-to-market strategies to catch up with global competitors.
Book a free consulting call today to evaluate how strategic partnerships can drive top and bottom line growth for your company.
Comments