The Rise of Embedded Finance
An idea breaking through
Embedded finance’s rise to prominence rests on decades of prior innovation. The core idea behind embedded finance is to minimize friction between a customer’s commercial user experience and the financial linkages required to conclude the experience. Is the idea particularly new? Not entirely. Think buying and then financing a car at the dealership. The customer journey of buying a car now involves the availability of financial products. Or perhaps a more universal example, think of paying for products while shopping online. The process is fairly intuitive and exists within the product’s commercial ecosystem. The financial aspect of an experience is woven around the customer experience, embedded in it.
How far has embedded finance advanced? Not far enough, that’s for sure. There is substantial room for growth in this sector. According to a report on embedded finance published jointly by Deloitte and Plaid the industry could see net new revenues of $ 230 Billion by 2025. A substantial part of this growth will be earned by non-financial firms looking to add new channels for revenue whilst streamlining their customer journeys.
Firms are catching up to the idea of incorporating financial products within their non-financial products. As a case in point, Uber now gives its drivers the option to use credit cards issued by the firm to facilitate payments, quickly and cheaply. Shopify recently started Shopifypay that reduces friction in the customer journey by allowing customers to save their personal details which are then available at all stores powered by Shopify.
While essentially a digital version of 0% interest layaway financing, the recently emerged buy now, pay later (BNPL) industry provides a succinct use case of embedded finance reducing friction and improving outcomes for businesses. According to figures published by Klarna, retailers with a BNPL offering had a 58% increase in AOV (Average order value) and a 30% increase in checkout rates. By every measure, both figures point to substantial improvements in revenue for any retailer.
Data from the retailers’ side has been less compelling with mattress retailer Leesa experiencing an 8.7% increase in AOV and 8.3% increase in conversions, a far cry from figures reported by Affirm but still substantial.
In either case, the outcome is the same to varying degrees. Embedded finance in the form of BNPL financing increased revenue for the retailer by providing customers with financial services that allowed a more seamless transition from cart to checkout.
A cross-industry trend
The advent of APIs has positioned embedded finance at a tipping point of broader disruption. With integrations measured in weeks instead of months or years, embedded finance deployment can be brought to scale quicker than ever before. Given the pace at which ideas can now be deployed, which industries could experience disruption with embedded finance?
Insurance is already experiencing a turn towards embedded finance. Ridesharing drivers, in need of insurance that goes beyond the ambit of usual auto-insurance, now have the option to go for insurance that provides coverage only when the user has passengers aboard, reducing costs for drivers and tackling a key problem faced by P&C insurers, that of flexible, short term insurance coverage for ride-sharing. Trov is one such fintech that is working to bring real-time, embedded microinsurance products well suited to the ride-sharing economy.
B2B procurement is having its embedded finance moment. Small retailers, often neglected by mainstream banks, have historically been underserved by traditional financial institutions. The potential of embedded finance can be gauged from its value to underbanked SMEs. With significant data available, fintech firms with embedded finance solutions are well placed to serve sectors of the economy that have till now been neglected by traditional financial institutions. French start-up Ankorstore is doing just that in the wholesale B2B market in Europe. To facilitate their customers Ankorstore has embedded financing options for retailers, allowing a seamless customer journey through Ankorstore’s commercial ecosystem.
Similarly, Udaan a B2B service that brings together wholesalers and retailers on one single platform leverages real-time sales data available with it to provide financial services to smaller retailers that would have not been available through formal banking channels. Similarly, Tokopedia in Indonesia and Telio in Vietnam are providing a similar set of services to smaller retailers.
The investment industry is also seeing a move towards embedded finance. Complex sustainability-related investments backed by physical carbon permits equivalent to 1 ton of carbon are now available for investment without lengthy account set-ups that would usually be the case in stand-alone investments. Spark Change anchors its sustainability-linked securities within the carbon marketplace, allowing investors to access carbon permit-backed securities within the ecosystem and without the administrative friction that would accompany such investments.
What is driving the embedded finance boom?
The first driver of growth is obvious, a shift towards digital. We’d be hard pressed to find many people below 30 who regularly visit a bank branch. This move towards digital and the ability to integrate APIs quickly has resulted in synergies leading to a tipping point in the embedded finance industry.
The move towards digital has provided firms with large swathes of data that can be used to improve experiences and provide greater insights into consumer habits. Firms are incentivized to use this data to reduce friction during the customer journey by embedding financing options that would not be available in non-digital ecosystems.
What the Future Holds
As enabling technologies such as augmented reality, IoT, AI advance financial services will embed themselves deeper into our lives. Think robo-advisers but more personalized, providing tailored advice by considering a more holistic range of data points. Want to buy that expensive piece of tech you’ve been eyeing for a while? Ask your advisor how that fits in your overall financial situation and how it could affect your long-term goals. All this will be done in real-time, no lags, no paper, a seamless financial experience embedded in our lives.
Such a deep embed will depend greatly on individuals’ comfort in sharing their personal data. Amongst other catalysts, this provides an impetus for newer fintech firms to partner with trusted industry names to get their products across to customers whilst allaying customers’ concerns about their data being misused in any way.
Organizations that are slow to adopt embedded finance within their customer journeys will find themselves increasingly bested by firms that do. With the advent of enabling technologies, finance and financial advice will be increasingly enmeshed in our lives.