The Embedded Revolution 🖇
🤝 What do you think of getting your next loan from someone other than a bank, of being automatically insured while buying a flight, or of getting a new fridge paying for it much later?
The answer to these rhetorical questions is a relatively recent phenomenon which is quickly gaining momentum: Embedded Finance.
🧘🏻♀️ As a customer, you never want to think about finance. In an ideal world, you want your payments, loans and insurances to be executed instantly, without any paperwork or hassle. Uber didn’t change payments as you still have to pay for your Uber ride. What it did was to deliver a fully frictionless transaction by removing the physical exchange of cash or credit card between the driver and customer.
🪢 Embedded Finance is when non-financial businesses and organisations include financial services — such as payments, credit, insurance, savings — as part of their offering, either at checkout page or directly into SaaS or tools to manage a business. It is being driven by consumers’ desire for more convenient and frictionless financial services. That being said, the next challenge is now to offer more financial capabilities, at the right time, in the most seamless but safest way — allowing businesses to engage more effectively with their customers.
📈 The Embedded Finance industry is growing rapidly. Currently estimated at $43 billion globally, it is expected to reach $230 billion by 2025. Embedded Finance companies have the potential to capture up to 26% of the global SME market by 2025, worth $124 billion. As mentioned by Angela Strange, GP at Andreessen Horowitz: “Every company will be a fintech company”. We are convinced that any application with a large enough user base is going to add-in financial services as an offering, considering Embedded Finance as a key monetization lever.
🖼️ As outlined in the mapping above, we’ve decided to deep-dive on the major segments of Embedded Finance — Embedded Payment, Embedded Lending and Embedded Insurance — and on financial institutions offering banking as a service (BaaS) to meet the rising demand for Embedded Finance. The boundaries between the different categories are porous, with some actors belonging to more than one category in an attempt to grab a larger share of the value chain.
The purpose here is not to do a comprehensive mapping, but rather to summarize our view of the European market and to assess future investment opportunities. We couldn’t fit all the great companies operating in this space, so if we failed to include you, please reach out to jessica@360cap.vc with an intro deck presenting your company!
EMBEDDED PAYMENT or HOW TO PAY LESS ATTENTION
Forget “Cash is king”. This is the era of digitization and seamless payment processing, both offline and online. But the digital evolution of payment processing doesn’t have to be painful for a brick-and-mortar retailer, an e-merchant or a business owner. On the contrary, it can make life simpler for all stakeholders: customers, merchants, and third-party participants in a transaction.
One-click checkout
COVID crisis accelerated customer adoption of digital wallets, mobile payments, contactless cards as touch-free, fast, and convenient payments became the new norm.
🤌 From the merchant POV, one-click checkout allows for speedy checkouts, which should help boost conversions and accelerate time-to-revenue. The other perk is that they do not have to care anymore of the storage of sensitive data as they are handled by the solution provider. The solution is available for first-time and returning customers.
🤝 For the end-users, taking out a credit card and entering its number is a friction point that can cause them to abandon a purchase should their card not be handy. One-click checkout allows repeat customers to complete a purchase in as little as a single click, maximizing convenience and minimizing friction, as they are also able to use this express flow across multiple sites and merchants.
Direct payment through Payment Initiation Service
Payment Initiation Service (PIS) is a new service, introduced by the PSD2, that use online banking to make payments over the Internet, where means of payment (such as a credit card or bank account) do not need to be used in the transaction. Thus, it gives the merchant the possibility to initiate a bank transfer on behalf of another person, provided that it obtains their prior consent. In France, Lydia is the top-of-mind peer-to-peer payment solution, relying on Budget Insight API. The initiative aims at fostering the introduction of new entrants in the payments field such as aggregators or payments originators, also known as Third Party Providers (TPP).
🤌 An e-merchant will be able to offer its customers an alternative payment experience based on the credit transfer, allowing them to exceed outstanding limits while the e-merchants saves on transaction fees (collecting payments directly from customers’ bank accounts, without any banking institution intermediation). They also have the assurance that the payment has been made, reducing the risk of fraud and allowing them to initiate the delivery of the good or provide the service without delay, as soon as the order is given.
🤝 Through a platform that acts as a bridge between the merchant and the customer, the customer enters all the necessary information to carry out the transfer, such as the amount of the transaction, the account number, etc., and informs the merchant that the transaction has been launched. They will not have to provide their bank details to the store every time they make a purchase. CX is key, so the value proposition for the consumer must be compelling when it comes to changing payment habits (either solving a consumer pain point or leveraging an existing consumer habit).
Platformization: the payment puzzle 🧩
Payment data can be a powerful tool for building customer loyalty.
🤌 Mastering and centralizing payment card data give retailers a better understanding of their customers, their profiles and habits, in real time, leveraging key information such as preferred purchase channels or average basket value to respond more quickly to their needs, while defining more effective product, marketing and operational strategies for the future. Platforms bring together end-to-end payments, data analytics and financial products in a single system to help companies achieve their ambitions quickly. As a one-stop-shop solution catering to all payment needs, they span the entire payment value chain.
🤝 Benefits for the B2B end-customers are multiple: cost-optimization (no ownership of the hardware and software nor specialized teams in-house), faster roll-out of new functionalities, improved reliability, scalability, and compliance management.
🔮 A report from IDC predicts that 74% of digital consumer payments globally will be conducted via platforms owned by non-financial institutions by 2030.
Intense disintermediation is hitting incumbent profits, the new era being prone to platformifization, unleashing full market potential by embracing open ecosystems.
Data prowess, API maturity and enhanced payment processing capabilities form the foundation of a robust reference architecture. Non-banks encroach faster into newer territories to threaten banks’ market share by empowering SMBs and merchants with innovative offers.
💡 Use cases:
1) 31.2M people use the Starbucks mobile payment app to purchase their coffee (over 1.2Bn deposits are loaded onto Starbucks cards). Thus, this app saves credit or debit card information for 1-click payments while customers earn points for using the app. With this user base, the Starbucks app accounts for more payments than Google Pay and Samsung Pay.
2) Stripe Checkout is a drop-in payments page designed to drive conversion. It dynamically surfaces mobile wallets when appropriate and supports 15 languages so customers can use a checkout form that’s personalized and relevant.
EMBEDDED LENDING: THE LEND AND EXPENSE STRATEGY
The BNPL (Buy Now Pay Later) Game of Thrones ⚔️
As mentioned by my fellow colleague Clara in her e-commerce stack mapping: “Merchants are now pressured to offer a greater catalog of options in order to retain users. Among them, the most popular one among customers is probably BNPL, allowing them to decrease their Working Capital Requirement by postponing or splitting the payment due date. Retailers are big fans as well as they aim at +20% conversion rate increase and +30–50% AOV increase.”
BNPL is clearly the hottest area of Embedded Finance represented by highly value companies such as Klarna, Afterpay and Affirm. In some countries like Sweden, BNPL is already the most popular e-commerce payment method. Even Apple announced on June it would offer BNPL financing through Apple Pay in the U.S. in the fall, and recently partnered with Alma in France to manage all the Apple brand’s fractional payment flows for the French territory, whether in the Apple Store or on the e-commerce site.
These schemes aren’t exactly new — car dealerships and furniture stores have commonly offered no-interest financing options for years. But BNPL loans are becoming more mainstream and better integrated with online shopping platforms, giving consumers the chance to finance nearly any kind of purchase with the click of a button.
B2B embedded solution through automation tools
Cash flow problems are crucial for SMEs. To remedy this, startups have modernized the most common cash flow solutions: customer recalls, factoring, but also alternative financing such as BNPL, RBF and Deferred payments.
BNPL
We see room for untapped opportunities in the B2B space, as companies are always trying to make sure that they can balance payments in and out, especially at the end of the month. BNPL can be a way around the time-consuming credit approval process that B2Bs face. It also enables outlay management, and getting margin contribution back into the business is an upside for any company.
Revenue Based financing (RBF)
RBF actors have identified a need for alternative financing to the VC dilution and bank loans. They address the need for fast, flexible, non-dilutive and short-term financing solutions for small to mid-sized businesses who otherwise can’t obtain other traditional forms of capital: SaaS, D2C subscription, E-commerce companies. Basically, it translates MRR revenues into upfront ARR, replacing costly equity or venture debt solutions, as well as debt loans which are not available to young companies that cannot offer collateral.
RBF players integrate via API with the various management softwares (Stripe, Bridge, Regate…) used by companies in order to establish a scoring. This makes it possible to define the acceptable risk and the amount that can be lent, mainly based on the cash flows and the churn rate. For example Karmen only finances up to 1/3 of its clients ARR, keeping 2/3 as buffer in case of churn. To finance the amount lent, RBF companies can either raise debt or sell this recurring income to investors in return for interests.
While this solution represents many advantages for companies looking to access capital on good conditions, it also has several challenges. First, this is a data driven business which requires to generate a large amount of data to predict future cash flows, create risk profiles and limit default risk. Second, it is a business that relies on the ability to raise debt on favorable terms. The current rise in interest rates is disrupting this balance and therefore could represent a major challenge for RBF actors.
Deferred payment
Some businesses have decided to tackle cash flow issues from their clients by embedding lending in their customer journey.
Deferred payments (commonly referred to as ‘net terms’) describe a payment delay of 30, 60, or 90 days that has come to be expected by business customers. The issue for the business seller is that they are required to act like a bank. They need to give short-term credit to their customers and ‘float’ these net terms invoice payments. Some new actors take care of every aspect of a business being able to offer net terms as a payment option; they solve for the credit checking process, provide invoice financing, automate accounts receivable processes, and speed up payments processing. They enable simpler B2B deferred payments through an end-to-end and embedded ‘credit billing’ solution. They automate and streamline all of the tasks associated with offering net terms. The result is easier net terms while improving their customer’s cash flow, reducing their financial risk, reducing accounts receivable resource requirements, and increasing their B2B sales.
Credit analysis turns out to be simpler because the buyer is not applying for credit, the seller is. Providers of these solutions leverage the sales history of their customers, which facilitates the credit analysis and therefore reduces the risk of non-payment.
Credit scoring
With the emergence of new instant scoring solutions, merchants can maximize their adoption rates while minimizing risk. They see their customer base grow as they confidently accept more loan applications. New models, based on Open Banking, lower the risk rate by combining transactional data provided directly by banks with machine learning technology. With API-based behavioral credit scoring, the borrowers’ solvency and creditworthiness are assessed using financial data that is reliable and universal. Barriers to entry for new entrants to the credit industry are disappearing, and that naturally opens the market to new players.
🔮 According to the Q4 2021 Embedded Finance Survey, Embedded Lending revenues will increase from US$52 billion in 2022 to reach US$200 billion by 2029.
Partnerships can easily be established with marketplaces for contractors, freelancers, logistics, freight and more. Opportunities of being distributed by other channels will also be seized: what if fintech solutions for SMEs accounting, accounts receivable and accounts payable such as Regate wanted to offer credit?
EMBEDDED INSURANCE: ON-DEMAND TAILORED PROTECTION
The insurance sector has benefited, and continues to benefit from a lot of innovation over the last few years, both on the BtoC side with successes like Luko or Wefox but also on the BtoB side with for example startups like Alan, Seyna, Shift Technology, +Simple or Tractable.
It’s exciting to see so many insurtechs offering new things in terms of digitalization and technological products: they are shaking up the industry! This technological shift was expectable, as it occurred a little earlier in the banking sector, and has been well summarized by A16Z: “Insurance should be a convenient opt-out experience, rather than an inconvenient opt-in”.
Even if Embedded Insurance at the in-store checkout has been around for some time, financial API technology now facilitates its spread to digital marketplaces and additional products. It is about presenting customers with affordable, relevant and personalized insurance at the most appropriate time, with no need for a separate engagement with an insurance company or agent — and sometimes with multiple competitive options. Data provided by purchase or browsing history can be used to build an accurate customer profile to streamline underwriting and tailor coverage. The product is able to meet customers at the point of transaction when complementary services upselling is most relevant.
💡 Use cases:
1) Opting for extended protections on a new cellular device
2) Travel insurance when you book a flight
3) Coverage for new appliances while checking out — either online or in-store
4) Airbnb offering Host Protection and Host Guarantee insurance
5) Car rental companies offering coverage while renting a vehicle
6) Tesla offering insurance using real-time driving behavior (30% of its activities)
7) Ornikar, the leading online French driving and road safety education service provider, has solidified its plans to move into the car insurance sector by raising $120m in 2021
Insurance as a Service (IaaS) and Brokers relationship
A broker who wants to launch a new line of business will have to wait between 6 and 18 months to build an offer with an insurer and deploy significant financial resources to build the tools to operate the distribution and management of the program. What IaaS companies offer is an accelerated “time to market” and operational efficiency. They offer all the tools to quickly acquire new customers (insurance product/subscription process with prospect management/follow-up of the effectiveness of the process) and to retain them with a unique digital experience (customer space allowing the end insured to manage his contracts and claims independently).
If more and more brokers are taking the digital turn, it’s mainly because they see opportunities for quick commercial benefits: as digital tools make them save time on administrative tasks or management, they are able to lower the price of the insurance. But digital also remains a way to extend its catchment area, easing the international scale, as long as a risk carrier allows it.
Often marketed as a complement to other products or services, white label insurance is a win-win situation. It is a source of additional revenue for the various stakeholders. Distributors receive between 30% and 50% of the premium and brokers between 10% and 20%, with the balance going to the insurer. Beyond that, increasing the average customer basket for the non-financial players became essential in order to restore margins that have sometimes been eroded by the growth of e-commerce. It is also a good way to take advantage of the flow of customers in stores and build loyalty.
🔮 Estimates show that “fully embedded” insurance distributed through partner channels will generate $140 billion in Gross Written Premium by 2030 in Property and Casualty alone (OECD, McKinsey, SwissRe Institute). But as Embedded Insurance is about high volumes and low pricing, it’s critical that conversion rate are high, claims processes are automated end-to-end claims and become increasingly parametric — all of this has yet to be proven. Margin monitoring is key, and the broker business model can appear less resilient than full-stack players’ one, as they remain squeezed between different players such as frontiers, reinsurers and distribution partners.
BANK AS A SERVICE (BaaS) & EMBEDDED FINANCE
BaaS is basically an end-to-end process ensuring the execution of any financial service providing it behind third-party interfaces and making it invisible to the user (white-label digital banking services).
Typical banking services — including cards, payments, loans, asset management services — become available on a multitude of digital channels and usable in real time by non-financial institutions. This is a real revolution not only for traditional institutions, which now have access to a new line of business capable of generating new sources of revenue, but also, and above all, for non-regulated entities which, not being banks, would have no way of developing this type of offer.
Thus, one way to look at the relationship between Embedded Finance and BaaS is to say that the former is enabled by the latter. Embedded Finance takes the end-to-end model of BaaS and presents it as an option of integrated finance to consumers of other products or services. Essentially, BaaS is required to support the integrated finance framework.
Embedded finance is defined more by front-end access to financial services, while BaaS is defined more by its back-end banking functionality. In other words, the former focuses on integrated access to solutions; the latter focuses on the technology foundation that digital banks and non-banks rely on to deliver financial services. So BaaS can be associated to the 🐓 that can lay Embedded Finance products🥚. Fintechs of the fintechs, BaaS companies could also be qualified as potential “unicorn farmers” 👨🏻🌾 🦄!
Services offered through BaaS providers are part of a regulated industry, resulting in a long list of compliance and regulatory requirements that must managed and maintained. For example, offering expense cards means managing user verification, ensuring PCI compliance, understanding KYC requirements, and maintaining measures to reduce fraud.
The biggest challenge for BaaS companies is to address use cases with a modular and agile approach: their customers will expect compatible and easy-to-implement bricks to meet their bespoke needs and unlock new business opportunities quickly. Complementing a BaaS offering with a specific infrastructure layer enabled newcomers such as Formance to pop up, modeling specific payment scenarios and simplifying the process of breaking down and tracking these money flows properly.
💡 Use cases:
1) Australia’s Westpac onboarded BNPL provider Afterpay as its first partner on its BaaS platform
2) BBVA developed its own BaaS offering and works with Google Pay in the US to offer digital bank accounts to interested customers
3) Shopify Balance offers Shopify merchants a fast, simple, and integrated way to manage their funds, pay bills, and track expenses — giving them easier access to financial products and greater control over their finances
ADAPTATION IS KEY
Incumbents must stay alert
Embedded finance is a very difficult territory for banks by nature, because banks are used to having end-to-end control over the user experience. It’s a really important part of their risk management: they control the environment in which they onboard customers and they control the environment where they see what customers are doing. In Embedded Finance, by definition, they’re relinquishing that control. Thus, the risk for them is they get relegated to a commodity position. They will need to make moves to compete, acquire or partner with fintechs that are disrupting this sector.
💡 Some examples:
1) Société Générale acquiring Treezor
2) BNP Paribas acquiring Floa Bank
3) Visa acquiring Tink and CurrencyCloud
4) PayPal acquiring Paidy and partnering with Shopify
5) BBVA partnering with Google Pay in the US
Leading banks and platforms are already thinking about how best to position themselves in this emerging sector, and which partners can help them deliver innovative propositions at scale. Those that are not yet moving into this market are at risk of missing a multi-billion dollar opportunity.
Regulate to protect and project
Embedded Finance does not derive from legislation, but it is one of the many innovations enabled by the adoption of open banking with PSD2, allowing the widespread use of APIs in the banking world. It is not a simple communion of IT systems, but a deep transformation combining different organizations and cultures. Through its exploitation, the PSD2 EU directive has “opened” competition in the banking field, introducing and unifying the concept of open banking at a European level.
PSD2 allows e-merchants to revitalize their offer and to propose innovative payment methods. Direct access to customer’s banking data is a definite upside in terms of user experience because it eliminates the need to provide (too many) documents. By giving access to his bank account, the customer also shows an absolute transparency, the data being unfalsifiable and obviously richer than one or two pages of salary slip. The scoring algorithms can thus be much more powerful.
However, Europe is way behind USA or Asia in terms of KYC: there is a clear lack of harmonization regarding the data that companies can collect and can transcribe into services. This will generate an unfair competition that needs to be regulated by the European Union.
Regarding BNPL, European regulations are evolving to provide a better framework for these new payment facilities and to strengthen scoring.
In France, discussions had already begun last year. The Chassaing report on overindebtedness (submitted in October 2021), calls for better supervision of microcredit and fractional payments, as BNPL is not covered by the regulations of the 2010 Lagarde law.
This is all the more true given that developments such as Request to Pay (RTP) and Instant Payment (IP) are imminent and will also turn the world of payments upside down to offer ever more instantaneous payments.
CONCLUSION
The distinctive feature of Embedded Finance models is the possibility to lower the barriers to access financial services, thus allowing to access and compete in a highly regulated and technology-intensive environment.
The companies’ embrace of Embedded Finance — banking/insurance-like services offered by non financial companies — aims to:
- Improve user experience, increase their satisfaction by offering them innovative bespoke products in the right place at the right moment, quickly implemented
- Retain customers/decrease churn and increase their lifetime value
- Seek additional income (upsell, cross-sell opportunities) without increasing CAC: depending on which financial services a company enables, it can also earn money by capturing interchange revenue, charging a payment processing fee, or for helping bank partners provide financial services to its customers
- Focus on their core business/product
But how far can Embedded Finance go?
Some say we have just seen the tip of the iceberg, as use cases can move wider than just those previously mentioned in this article, to sports clubs, healthcare companies or major brands (among others) that have never thought of it.
But before companies get started adding more financial services to their platform, they need to make sure they know which services make the most sense to offer to their customers. There is no one-size-fits-all approach — most businesses start with embedding payments, but they should also keep in mind that full stack solutions can be core in their GTM strategy, picking one company that does everything for them instead of selecting pieces of the puzzle that won’t easily fit together. This is why insurance players can still get ahead of the newcomers as they already developed a wide range of products and established strong partnerships with the value chain stakeholders.
As investors, we are eager to see who will include Embedded Finance products in their roadmap in order to increase their TAM, stacking different business models that used to belong to big financial institutions, without having to reacquire their client. We are also looking forward to assessing which of the players are going to establish the best partnerships, to put together the right package of financial services and to come up with an appealing and relevant offering, with sustainable margins, leading inevitably to more regulation but also more protection and inclusion.
🔴🟠🟡 Our investments in Regate, Banca Aidexa, Leetchi and Tiller Systems demonstrate our deep interest for disruptive trends within the financial industry and we are convinced that the next gem will come from the Embedded World!
If you are building something in this space, we’d be happy to know more about it → jessica@360cap.vc 🕵🏻
🙏🏻 Thank you Anne-Sybille Pradelles (Formance), Elias Ghanem & Olivier Jamault (Capgemini), Carla Venter (Aperture), Vanessa Pinter (Digital+ Partners) and my 360 A-team for your expertise and insights that have been very precious for this article!
