Fintech hasn’t solved financial exclusion, but embedded finance will
Fintech has achieved a lot — notably around making financial services simpler and more intuitive — but it has failed to solve society’s big financial challenges. Embedded finance, if implemented well, will change that.
TL;DR Fintech has been through two waves, and is just entering its third wave, embedded finance. The first two waves brought product and channel innovation, but they didn’t fundamentally change the business model of financial services. As a result, the chronic underprovision of financial services persisted or worsened. Embedded finance, by introducing business model change, promises to solve these structural challenges, catalysing massive benefits for people, households and businesses globally. However, even though the potential of embedded finance is becoming well-understood, the complexities around delivering embedded finance projects are underestimated. To be successful, embedder brands must develop the right strategy, translate this strategy into an actionable plan, and pick the right embedded finance partners.
New channels, same products
The first wave of fintech innovation was centred on using new digital channels. This rendered financial products self-service and available anytime. You didn’t need to go into a branch to make a payment, you could set it up yourself, whenever it suited. But while convenience was improved, these were broadly the same products offered by vertically-integrated service providers, just made available over new channels.
New channels, better products
The next wave of fintech has been much more disruptive. New entrants poured into the financial services market, taking advantage of new routes to customers opened up by internet channels, but leveraging these same technologies to make the products better, too. In insurance, these are companies like Lemonade, in payments companies like (Transfer)Wise, in wealth management companies like Wealthfront (recently acquired by UBS), and in lending, companies like Kabbage. They offer services that are distributed through the internet, but which are simpler and more intuitive, with better customer experience, with much faster onboarding, decisioning and fulfilment, and which are also more personalized — using the trail of data left by digital customers to tailor experiences to them.
This wave has also seen the advent of the challenger bank. As opposed to “internet banks” like ING Direct or Cahoot which preceded them, these challenger banks innovate with both distribution channels and products — for instance, using AI to give people insights into their spending and helping them to start saving.
But the commonality with almost all of these models is that they are vertically integrated. Even when not fully vertically integrated, where built on an underlying bank or reinsurer, they still have vertically integrated product manufacturing and distribution.
Better, but not great
The challenge with the vertically integrated fintech model is that, while the experience and pricing for consumers is better, it hasn’t been innovative enough to address the sticky problems of underprovision.
For the fintech and insurtechs, the economics of a direct-to-consumer model remain difficult.
- Customers are expensive to acquire: time-poor, they’re hard to reach; attention-poor, they difficult to convince. CAC has become the new rent.
- Barriers to entry have been lowered for all. The recent phenomena —lower and variable IT costs thanks to cloud computing, regulators encouraging new competition, smartphones obviating the need for physical distribution — that have given rise to an influx of new entrants will continue to do so, increasing the risk of customer defection.
- And then, in the main, these new fintech solution providers are “thin”, offering single products solving single customer use cases, like automated investments. This means they have low customer lifetime value, which in turn makes it difficult for providers to spread the high cost of acquisition.
As a recent study showed, of the 400 neobanks in the world, less than 5% are breaking even.
For the consumer, the services are better, but not transformative. Each app or service provides individually a much better user experience, but because the consumer has to use multiple providers, the overall experience is fragmented. Each individual service adds value, but because the product set is narrow, the overall value-add remains relatively low. And while these services have better fulfilment, they are typically not profoundly different in areas like cost, accessibility and discoverability.
Underprovision persists…
And, as a result, the chronic underprovision of financial services persists and has worsened in many areas. According to The World Bank, there are still 1.7 billion unbanked people in the world. There is a $140 trillion life insurance protection gap. There is a ballooning $100 trillion pension deficit. There is still a $5 trillion SME funding gap. There is a $100 billion of annual unhedged FX risk — to give just a few examples.
..But so, paradoxically, does overprovision
But, at the same time as there is massive underprovision, there are also considerable pockets of overprovision. Underprovision is acute for the least affluent individuals and households and the smallest companies; those without strong credit history, assets to collateralize, or whose needs are too insignificant to merit the costs of servicing them. But conversely, the most affluent and the largest companies are overserved, inundated with offers and able to borrow money at ultra-low rates. As a case in point, while there are 1.7bn unbanked people worldwide, according to Ron Shevlin at Cornerstone Advisors, it’s not uncommon for millennial couples in the US to have 30–40 different financial services providers. This is both a reflection of this demographic being overserved as well as the fragmentation of financial services that has taken place during this “unbundling” era of fintech.
To paraphrase Peter Thiel, we wanted fintech to solve financial exclusion, but instead millennials got 40 different banking apps.
Embedded finance promises to address these long-standing challenges
Embedded finance is much more transformative because it changes the business model of financial services. It breaks the value chain horizontally, not vertically, leveraging existing, typically non-financial, distribution channels to provide financial services at lower cost and with the contextual awareness to address challenges of accessibility, understandability and discoverability.
Embedded finance is about meeting customers’ diverse needs, in the right form, at the right time.
Arguably a full service, universal bancassurer could meet customers’ diverse needs, but being able to supply these products is not the same thing as consumers consuming them. In their current vertically integrated model, financial providers are figuratively asking consumers to buy directly from the factory. Consumers not only have to self-diagnose their needs, but they also have to know what products to ask for — which in many cases, is far from obvious. Which small business owner intuitively knows they need a forfeiting or factoring service?
Embedded finance starts from the demand side, the customer need. Financial services are embedded into a channel that a customer already uses, and normally into an existing user journey. The context is understood and, by extension, the need is understood.
For instance, if you’re buying an airline ticket, you might need travel insurance, you definitely need to make a payment, you might need credit, and you might need foreign currency. By understanding the context, the embedder brand is more likely to identify the consumers’ diverse needs, and to be able to offer solutions at the right time — at the time the need arises. Furthermore, because embedded finance starts with the need, the job to be done, it is also more likely to offer up the service in the right form. For instance, if you go to an insurance broker for travel insurance, you’re likely to be offered annual and individual policies, but when you take a week-long holiday with your family, you probably want a week-long policy covering a group.
Embedded finance rests on utility, engagement, and loyalty
The embedded finance channel does not have to be, in itself, a purchasing channel and the service does not need to be embedded into a buying journey.
The precondition for successful embedded finance is that the embedder channel possesses one — or ideally all — of high utility, high engagement, and high customer loyalty/brand power.
By utility, we mean usefulness. An accounting system like Xero is highly useful to the companies (and the individuals) who use it. It keeps a record of their financial performance and their financial position, it enables them to generate customer invoices, to match receipts against those invoices, and so on. Because it is so useful, the application becomes a key repository of information. That information can be used as the basis for embedding finance. For instance, that information allows the system to understand diverse needs, such as the need for credit or the need for treasury instruments, or the need for FX hedging. That information also allows the system to suggest services in the right form — for example, an FX forward or a short-term loan — and at the right time, when the need crystallises.
Engagement is different. Xero is useful and functional, but not highly engaging. TikTok is engaging. It is a service that captures the attention of the people who use it, that keeps them coming back for more. Because users spend a lot of time on high engagement channels, like YouTube and TikTok, these platforms capture a lot of data, which can help them understand customer needs, and they have a large surface area over which to suggest and fulfil relevant services — especially when they introduce wallets, like Novi from Facebook, that facilitate their customers’ transactions and act as the nexus for additional services like credit.
Loyalty and brand power are important because strong brands come to know a lot about their repeat customers, but also because there a higher likelihood of conversion because of the signalling effect. Having a credit card is not making a personal statement, having an Apple-branded credit card is. Large brands have been partnering with financial services for years, but it has historically not been embedded in the way, say, a Klarna buy now pay later loan is. The most obvious opportunities for embedded finance are in areas like credit, rewards, insurance and payments, but they extend beyond these areas— see, for example, UK retailer John Lewis’ tie-up with wealth management fintech Nutmeg.
Where a company like Amazon can operate across all of utility, engagement and brand power, the fintech providers creating financial super apps — like PayPal or Revolut or Block — all use utility as their ‘hook’ to bundle additional services. You can argue that eToro has strong engagement, but few others. And financial services companies with fanatical levels of brand power…it’s difficult to think of any.
Increasing the provision of financial services
If embedded finance is able to meet customers’ diverse needs, in the right form, at the right time, then it holds the promise to tackle financial exclusion.
Theoretically, mobile phones should have solved the problem of access since 92% of people globally own a mobile phone. But still a quarter of the world’s adult population doesn’t have a bank account.
Theoretically, digitization of manual processes and collectivization of hardware costs (cloud computing) should have solved the affordability challenges. But the world is underinsured to the tune of hundreds of trillions of dollars and yet, according to McKinsey, the majority of the world’s listed insurance companies make no economic profit.
The reason is that affordability and accessibility go beyond just changing technology, they require business model change. People don’t have as much insurance coverage as they should because they don’t know how insurance can help them and they can’t afford insurance in its current forms. But as already noted above, embedded insurance changes the form of financial services and introduces the right services at the right time, overcoming these challenges. Furthermore, accessing additional real-time and contextual data that brands hold reduces information asymmetry between provider and consumer, improving risk models and lowering costs.
The impact of embedded finance will be dramatic. Simon Torrance, who co-authored with Aperture a recent report on Embedded Insurance, expects by 2035 for $7.2 trillion of value to be created by the companies best able to exploit this opportunity; best able to increase the provision of financial by embedding it into everyday consumer channels.
But embedded finance is more nuanced than people think
Just because a company enjoys utility and/or engagement and/or strong customer loyalty doesn’t mean it will be successful with embedded finance.
Unfortunately, even though the technology infrastructure for embedded finance is increasingly plug-and-plug, embedded finance project are taking a long time to deliver value, and many fail. Based on interviews with over 100 embedded finance providers, we estimate that embedded finance projects are taking 18 months from initial conception to putting a product in market, and around 7 months from engaging an embedded finance provider to putting a product into market.
Where it used to be technology issues that delayed projects, now it is business issues. It is easy to make the high-level case that embedded finance turbocharges a company’s unit economics. However, it is much harder to turn this macro-level insight into a specific and actionable plan for introducing banking services.
Brands have to fulfil a number of key steps to deliver a successful embedded finance project, namely, they have to:
- determine their customers’ unmet financial needs
- develop a strategy and roadmap for introducing the services
- select the right embedded finance providers
- assemble the right propositions
- take these propositions to market effectively
A Map to help brands to navigate embedded finance
Take the issue of selecting the right embedded finance providers. The number of providers is mushrooming and the differences between them are not always easily discernible. Nonetheless, we have seen how picking the wrong providers can have ruinous effects on projects.
A lot of companies when looking at embedded finance partners tend to focus on lower-level, supply-side concerns. For sure, if you’re a ride-hailing platform, for example, and you want to offer your drivers coverage for vehicle theft or damage, then you’ll need to work with an embedded finance provider who can meet this need, operating in the locations where you operate. But, even though we encourage companies to start small, testing and iterating a single use case, once they realise the art of the possible with embedded finance, they will want to solve more and more of their customers’ needs — and this is where the issues arise.
When strategizing around embedded finance, it is important to anticipate future use cases and requirements. Continuing with the same example of the ride-hailing platform, if, after introducing vehicle insurance, it now decides to offer, or bundle for free, income protection in case of accidents, this could mean working with a second embedded finance provider. If it then decides to offer life insurance, this could mean working with a third, and so on.
If not careful, companies will find themselves in the same mess of siloed systems and user experiences as the banks and insurers whose role as financial services distributors they seek to displace.
So, it is important to work with an embedded finance provider, like Marcus from Goldman Sachs or Nexus from Standard Chartered, who can offer multiple products across multiple geographies — or, probably even better, to work with providers like additiv or bolttech who can aggregate multiple financial services from multiple underlying providers.
But even more important considerations are around the capabilities that will make the services truly contextualized and personalized. An embedded finance provider able to offer API integration to a single service, say travel insurance, is not going to do this by themselves. To meet diverse needs requires a provider to aggregate multiple financial and non-financial services. To provide financial services in the right form, requires aggregation of multiple services, but also orchestration, composing these underlying services into the right blended formats. People and companies have jobs to be done, like having enough money for a comfortable retirement, which aren’t likely to be neatly encapsulated into a single service. And, lastly, these aggregated and orchestrated services need to be contextualized to the individual consumer, with say extra reward points to recognise their loyalty or with a discount for their other family members, as well as offered at the right time and place.
To help companies to help navigate this nuanced space of embedded finance, we have put together our embedded finance provider selection checklist, as well as Market Maps for Embedded Insurance providers and Embedded Banking providers, with more Maps on their way…
Here is the link if you’d like to purchase a copy of our new paper, “Embedded Insurance 2.0: A trillion dollar opportunity for brands and insurers” and please reach out if you’d to discuss this article or how we could help you embark on your embedded finance journey.
