Embedded Finance examples: The hotel
Embedded Finance provides an alternative infrastructure for capital to flow from those wishing to deploy it for a risk-adjusted return (the capital markets) to consumers and small businesses accessing it in the form of financial services products within the digital economy.
Here we explore the benefits of embedded finance across the value chain and consider the example of a boutique hotel accessing working capital finance from within their digital ecosystem.
Traditional forms of finance
In the UK alone, nearly 78% of businesses are paid late with 34% relying on an overdraft facility for cash flow. Why is it then, that only a small fraction of small businesses are using alternative forms of finance to improve their working capital position?
Traditional working capital finance, is characterised by low profitability, thin margins and scaling challenges:
- Inefficient, legacy technology means that operations do not scale
- Traditional distribution channels are labour intensive and expensive
- Archaic products and propositions are rigid and often not fit for purpose
The digital economy
Meanwhile, the digital economy is growing exponentially with huge numbers of small businesses digitising their operations and in the process, depositing vast quantities of data with every interaction. A typical digitally enlightened SME will divide their usage between fintech, horizontal and vertical SaaS platforms — collectively referred to in this article as digital applications — depending on the nature of their business.
For example, a London based boutique hotel might have a business bank account with Revolut Business (Fintech), manage their financial accounts using Sage (Horizontal SaaS) and manage their day to day hotel operations using Cloudbeds (Vertical SaaS).
While digital applications represent some of today’s most notable businesses, the digital business model presents common scale challenges for growth and ultimately profitability:
- Customer acquisition is expensive, competitive and capital intensive
- Propositions consolidate and converge at scale resulting in limited differentiation
- Growth in revenues and margins is not fast enough to sustain heady enterprise valuations
Embedded Finance
The advent of Embedded Finance has seen financial services products be made available seamlessly to embed within these digital applications, marketplaces and other channels. Unlike Fintech 1.0 — which saw the digitisation of incumbent financial services products — Embedded Finance is fundamentally changing the way that financial services products are designed, built, bought and sold. The consequential benefits are threefold across the value chain with increased utility for capital providers, digital distribution platforms and most importantly for the end customer.
Benefits across the value chain
Given these benefits, Embedded Finance in digital applications provides an opportunity to solve longstanding market failures in financial services.
This opportunity is already being exploited with embedded payments, the latest evolution in payments infrastructure, which has transformed the profitability of digital applications. For example, Shopify, a digital ecommerce platform with a subscription based business model, successfully diversified it’s revenue by embedding payments services which have become a significant value driver.
Examples for the boutique hotel
The same shift is happening now in credit. Consider the boutique hotel, they could (and should) be able to access working capital finance in all areas of their existing digital ecosystem:
Via their business bank account (Revolut):
- Revolut’s data asset, including KYC/AML/ID verification and transaction record should provide a detailed foundation for risk assessment.
- Given unused balance sheet, digital data asset and the nature of the banking product, there should exist a seamless opportunity to provide an overdraft and/or a business loan offering.
Via their accounting package (Sage):
- Sage’s data asset, including historical management accounts and invoice repayment behaviour, again should provide a solid foundation for risk assessment.
- Invoice management functionality provides a seamless entry point for the provision of an invoice finance product.
Via their hotel management platform (Cloudbeds):
- Cloudbeds data asset, including historical booking information, occupancy ratios and other industry wide benchmarks provide an alternative data asset for innovative risk assessment approaches to be explored.
- Payment terminal provision and online payment gateway services provide a seamless entry point for a merchant cash advance product.
Simultaneously, capital providers will benefit from open access to alternative digital distribution channels, increased profitability through improved risk assessment (given differentiated data assets and real time monitoring) and a low cost, scalable operational infrastructure.
Despite the above, the boutique hotel in today’s market is forced to leave this digital ecosystem — taking with them their data in a non-standardised, low security format — and apply for a traditional working capital finance product, either from a bank or an alternative capital provider.
Perhaps this explains why so few small businesses are taking advantage of the traditional products… and more importantly, why the market opportunity for embedded working capital finance is colossal.
Other examples of those leading the charge:
- Fintech: Tide Capital
- Horizontal SaaS: Shopify Capital
- Vertical SaaS: Mindbody Capital
