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Evolution and opportunity in the embedded finance ecosystem

In this article, we’re exploring the embedded finance environment today. How and why we’ve got to where we are, and what embedded finance means for consumers, merchants, and other key players.

Towards more agile payments functionality

Open banking has been the enabler of many aspects of disruption in financial services and payments. And as the disruption has played out, embedded finance has become increasingly relevant. This, along with the shift to online in the wake of the pandemic and greater customer expectations of the payment experience, has accelerated the speed with which we’ve arrived at where we are. And that, in a nutshell, is lots more embedded finance use cases. It’s also what’s fuelling forecasts of growth over the next few years – a $230 billion revenue market by 2025, according to Lightyear Capital, with embedded payments making up around 60% of that.

The rapid changes happening at the checkout – for example, the rise in both cryptocurrency payment methods (63% growth in the year ending October 2021, as we saw in our survey) and digital wallets (67%) – is a clear signal to all companies that they need an agile way to provide new payment capabilities. Because while the landscape looks different today compared to 12 months ago, it’s a given that we’ll be saying the same thing in another 12 months’ time. This is why building financial functionality into their offerings – and by that I mean functionality that can change as demands do – is going to be essential for the vast majority of brands.

The road to embedded finance: from opening gateways, to open banking and open ecosystems

We can look at payments innovation as an evolution in three stages. Back in the day – before we lived in a world of pandemics and lockdowns – we watched the payment gateway come to the fore: both dedicated gateway services provided by the payment provider and those which are directed by a gateway vendor to the processor. The aim was to remove friction from the payments process. Simply, ecommerce firms and merchants operating online could use a payment gateway of whatever flavour to make it easier for their customers to pay.

With open banking on the scene, payments evolved. A frictionless experience when paying by debit card online was one thing. Customers wanted more choice. Open banking provided this – the ability to offer alternative payment methods like digital wallets as well as allow consumers to pay for services from their bank accounts. So from more seamless experiences we started seeing optionality of payment and a proliferation of alternative payment providers to service this need.

As consumers and merchants – and all the providers (financial, tech or fintech) in between – have become more savvy, the platform economy has started to emerge. We have different ways to pay, but we also have a host of associated services within our reach in this same space. And we don’t have to leave the environment we’re in to access the products we require. This is where embedded finance is finding its feet, enabling the fulfilment of a variety of financial needs as part of a highly integrated services experience.

What’s driving the trend?

The embedded finance phenomenon has been both customer- and merchant-led. Customers get fast, seamless experiences. They get convenience. They get to pay how they want within an environment and through a brand they trust.

The merchant reaps numerous benefits too. Reduced transaction costs, increased revenue opportunities, better control over what services it can deliver, and a keener level of insight into its consumers’ spending and habits. And, as a result of being able to target appropriate products at the point of need, the value the brand delivers to the customer grows, with a corresponding hike in satisfaction and loyalty.

When done right, it’s a win-win situation.

Perception around financial services, and who dispenses these services, is also changing. Consumers are becoming more used to sharing their data, especially if they get something in return. So, with the right incentives, they’re more likely to be comfortable signing up to financial products through non-financial companies. Especially if that company is a brand they know and have had good experiences with in the past.

So, all-in, there are quite a few forces at work making embedded finance a perfect solution to both consumer and merchant needs.

The shift to a platform economy

There are many embedded finance use cases that have been about for a while. As online shoppers, we’ve all come across the option to pay in instalments for a product or service. This type of embedded lending at the checkout – buy now, pay later – is often faster and more seamless than getting your credit card out, punching in the details and waiting for authorisation. And the merchant gains advantage by keeping the customer on its site and opening up a new revenue stream.

Other classic embedded finance use cases include financial service add-ons to a primary product, such as integrating insurance when you buy a fridge freezer. Or the financing of larger purchases through loans enabled by the merchant. These payments methods are being embedded by companies in every sector. Car retailers offer not just leasing, but their own insurance products. Airlines provide you with a loan for your annual family holiday.

The transition now is towards greater integration. Platform companies like Uber, Grab and Toast, are successfully embedding entire portfolios of financial services into their businesses and creating significant new revenue streams as a result. In these examples, it’s almost not about the payment at all. It’s about the experience.

Getting a piece of the action

There’s opportunity at both ends of the spectrum. But to hit the mark with consumers, organisations need to ask some key questions about their business models, and consider not just the tech they’ll require, but, more critically, what issue they’re trying to solve. In our next article, we’ll explore what some of those questions are.