Embedded Fintech: Who should consider an embedded finance offering and how to get from decision to launch (Part III)

By: Medha Agarwal, Emily Man, and Urvashi Barooah

Launching a financial product is a serious undertaking. This is even more true for companies that don’t have prior fintech experience–not only does it require developing and launching a new product (or products) that has limited overlap with the core business, it also requires navigating a complex regulatory landscape and learning a whole new language.

Today, launching a financial product is easier than ever thanks to the landscape of emerging enablers that we covered in Post II. However, it’s still far from turnkey. While white-labled third-parties are taking on significant technical and regulatory lifts, they can only do so much. Elements such as product vision and design, distribution and marketing, communication and customer support, and sometimes risk and fraud tolerance are ultimately the responsibility of the core platform. Developing an embedded finance offering still requires a significant investment of time and resources across product and engineering, operations, and customer support and can require building new muscles in legal, compliance, and fraud. Given the nascency of the market, this involves stitching together several providers in addition to handling other aspects internally.

We’ve covered some of the benefits of embedded finance in Post I but ultimately, these efforts can distract from the core business and dilute the brand if not done well. At Redpoint, we often get questions from portfolio companies about the practicality of embedding fintech. In particular, we’re asked if it makes sense for them, and if so, how to best go about it. Given how new the space is, there’s no playbook–so we wanted to provide our framework for what we’ve seen work.

Who should embed financial products and services?

Looking across the landscape of companies that have succeeded in offering financial products and services, we’ve seen some shared characteristics that are key indicators of success:

  • A trusted brand and a highly engaged captive audience
  • A unique value proposition that solves an acute customer need
  • An existing position within the flow of funds
  • Proprietary access to data about customers

These attributes are not necessarily pre-requisites for success, nor are they mutually exclusive. But they can provide tenants for evaluating whether or not an embedded fintech offering will provide a valuable enough proposition to end users to be successful.

A trusted brand and a highly engaged captive audience

Financial products and services require a level of trust beyond that of a typical vendor or software provider. In recent years, tech companies have gained a lot of ground in consumer willingness to transact on their platforms (e.g. pay for goods or services, P2P transfers). Some financial products like banking require an additional leap of faith. For all their flaws, traditional banking institutions are still perceived as being safe. Thus, companies that are looking to embed financial services need to have a trusted relationship with their end-users to see appropriate adoption of financial offerings.

Source: https://thefinancialbrand.com/127722/new-data-people-dont-trust-open-banking-or-fintechs-but-use-both/

A trusted brand alone is not enough; for a leap to financial services to make sense, strong user engagement is key. One of the main benefits of an embedded solution and drivers of adoption is convenience. By enabling users to transact in a way that would otherwise require a detour, these solutions ease frictions in day-to-day life.

Brands or organizations who fall short on trust can make up for it with hyper-relevance. The best example of this is auto loans. Car dealerships are responsible for 61 percent of new car financing by providing a solution to a captive audience with a strong buying signal. Even though 72% of consumers would get a better rate elsewhere, by being present at the point of need as the most convenient option, the dealership can capture the lion’s share of these leads. It’s important to note that these cases most commonly occur with lending related financial products. The trust threshold for receiving money is much lower than that of giving money.

A unique value proposition that solves an acute customer need

Another hallmark of future success is a unique ability to solve a customer need. In particular, platforms and services that offer a value proposition that is differentiated from the generic solutions in the broader financial services market. Customer acquisition for financial services is increasingly competitive; over the last year, finance apps’ average ad spending rose by 51 percent while conversion rates fell from 6.8 to 5.8 percent (on iOS). Financial products tend to be highly sticky, so it can be difficult (and expensive) to convince a potential user of the benefits of switching.

Successful examples of embedded finance leverage their position to solve core customer problems in a way that traditional financial services providers can’t. Good examples of this are seen across the gig and creator economies. It is estimated that 55 million people (or 34 percent of the workforce) in the US are gig workers. Many of these workers heavily rely on their gig earnings to make ends meet but are also “credit invisible.” Traditional financial services providers are unable or unwilling to underwrite gig earnings, which they view as volatile. The platforms gig workers use, however, are well positioned to fill the gap. Many gig platforms today including Uber, Lyft, and Instacart offer their workers the ability to get paid out immediately for completed jobs. In Uber’s case, drivers cashed out $1.3B in earnings in the first 12 months of launching of Instant Pay. Offering these types of embedded financial services has a compounding impact on the core business by strengthening the ecosystem by improving the viability of gig work.

An existing position within the flow of funds

Another strong indicator that a company can develop a successful offering is a natural position in the flow of funds. This is true of many marketplaces and vertical SaaS companies already handling money movement on behalf of their customers as part of their core product offering. Leveraging this positioning and extending into adjacent financial products can help create unique and compelling value propositions.

Shopify is one great example. By providing small ecommerce merchants with the infrastructure to power their online stores, Shopify sits between the transfer of funds from consumer to merchant. Many merchants come to Shopify to get their business off the ground and, as a result, need a new, separate business account from which to pay for suppliers, advertising, and other operating expenses in the onboarding flow. By embedding banking capabilities via Shopify Balance, Shopify can capture leads at the point of need and provide a better solution than a bank. Because the financial product can be tightly integrated with the business’ operations, these accounts can directly receive funds and make them available to spend more quickly than a non-embedded banking provider could.

For lending products, being in the flow of funds reduces friction associated with servicing a loan. Many vertical SaaS and POS providers with an embedded lending offering can collect repayment automatically from payment processing streams-simultaneously providing a better customer experience while also reducing losses. Ultimately, this additional data and premium positioning should reduce losses and therefore enable the platform to offer a lower cost product to its users. More on this below.

Proprietary access to data about customers

Platforms that have rich data on users can develop powerful embedded fintech offerings. This has several benefits including:

  • More accurate identification of pain points at the time of need
  • Better ability to underwrite traditionally underserved populations
  • Lower cost to serve or a stronger margin profile

Doordash illustrates this well. Restaurants are notoriously high-risk, and it can be difficult for traditional financial services providers to offer them capital needed for either investment in the business (e.g. renovation, expansion, etc) or easing short-term cash flow constraints. Doordash Capital is able to leverage the proprietary data Doordash has on restaurants (order throughput, reviews, basket size, promotion frequency) alongside a position in the flow of funds. This allows Doordash to offer a cash advance to a population that is oftentimes turned away by lenders. Lower costs come from no incremental CAC and lower default rates over time.

How should I embed financial products and services?

Even after you’ve determined embedded fintech is a potential fit for you, how do you go about building and launching a product? While there is no universal template for doing this well, we’ve found that there are several considerations every company needs to make. We’ve identified some essential considerations for businesses looking to make this shift:

Have a well-defined strategy in place: Before you build anything, be clear on what problem you’re solving. Embedded finance makes the most sense when you’re solving a clear need for your customers. Take embedded payroll for instance. Squire, a vertical SaaS provider for barbers, is using Gusto’s API to embed payroll within its software, which allows the company to offer a one-stop-shop solution that combines their operating system with payroll. Barbershops can simplify their payroll process by leveraging data that is already in Squire around commissions and hours worked, rather than having to translate this data to a separate payroll system. Most importantly, the combination allows barbershops to grant barbers immediate access to earned wages, which in turn drives up retention. In this case, there is a clear benefit to all three parties–Squire, barbershops, and barbers–from embedded payroll. It’s also important to be clear on the scope of your solution. Are you building a point solution or a suite of products? Will you be servicing 10K customers or 100K? What is your revenue model? Having a hypothesis for these questions upfront will give you a better framework for decision making.

Build or buy? The reality is that you will likely do both. In order to deliver a seamless end-to-end experience for your users, you will likely partner with one or more providers and also build key pieces internally. This has important implications for cost, time, and team investment, so companies should go in with eyes wide open. Too often we see companies embark on embedding an offering by assuming there is a single, turnkey solution that will enable them to go live with minimal effort — and that is not the case. We are hopeful that this will happen in the future, but that day is not here quite yet.

Resourcing: Setting your initiatives up for success requires at least one person–if not a team of people–dedicated to developing, managing, and driving the offering. Often, we have seen success when the dedicated person or team has fintech experience in that specific product, and can leverage their previous experience to avoid expensive and time-consuming pitfalls.

Success metrics: Be very clear upfront on what the goal of launching these products is for your company. It may be to drive topline revenue but could also be to drive retention, conversion, margin, or other company KPIs. Given the heavy time and cost commitments it takes to launch a fintech product, it is important to be ruthlessly focused on constantly assessing whether the product will drive improvement in that north star metric. It’s important to always assess and reassess the pros and cons of your product. Is the latest iteration worth doing? Or are there other initiatives that could also drive your core KPI? As with almost any other initiative, it is equally important to set a target goal (i.e. X percent lift in conversion in Y months) that you can directly attribute to this new product to determine whether the investment is worth it over time.

If you’re currently building an embedded fintech product, we hope these simple heuristics will resonate with you. If you have specific questions on how to go about it, or best practices you’ve identified from having done it before, please reach out — we’d love to hear from you.

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Medha Agarwal

Currently @RedpointVC. Former founder, ops, and consultant. Proud @HarvardHBS @Harvard @Radlwtcrew @Bainalerts alum. Recovering New Yorker, currently loving SF