One of the most transformative trends in fintech taking shape today is embedded finance.
It used to be that financial services was an industry unto its own – there was healthcare, education, commerce, metals & mining, etc… and of course financial services.
Financial services is now an enabler that touches industries far and wide, which are incorporating financial products and services into their core offering. These features are often provided by a growing class of fintech and other enablers.
What is embedded finance? Embedded finance can take many forms. The simplest could mean enabling payments to create an entirely new type of category. In China, companies like Yizhibo or Kuaishou allow you to purchase merchandise you see in livestreams with a click of the button, with payment powered by fintechs like Ant Financial. In the U.S. Google
Maps recently announced users would be able to find and purchase parking directly through the interface. Coding bootcamps like the Lambda school include Income Sharing agreements into their offering to increase affordability and convince would-be students to enroll at no risk. Tesla
offers its own car insurance through its car sales program.
Embedding financial products and services is big business. The venture firm Andreessen Horowitz estimates it will increase the profitability of a customer by over 5x the original revenue stream. A nascent enabling ecosystem is growing rapidly.
Because the stakes are so high, the question is what will make these offerings most successful? I believe five drivers will enable this model.
1. Offer them at the right time and right place
Embedded finance works naturally when it is built into the product or service at the exact moment it is needed.
Take the startup Salty for instance. They sell car insurance, but embedded within the car sales transaction at a car dealer. When a customer representative starts the car transaction process, and begins entering customer details, the customer automatically gets an SMS with a quote and an easy sign-up (since most of the information is already pre-filled by the dealer).
Likewise, the aforementioned Google parking example is interesting because it enables customers to purchase parking exactly when they need it: when they are driving around to a destination. The same is true of the TV live shopping example, allowing customers to purchase the clothes they like, when they discover them.
To increase conversion and provide greater customer convenience, companies like Affirm in the US or FinAccel (a portfolio company at the fund I work at) in South East Asia, offer point of sale lending to customers on ecommerce sites. Many would-be customers were previously lost since they did not have the immediate means to purchase the product. Embedding lending at the point of sale allowed the transaction to happen.
2. Leverage data to make the experience even better
Embedded finance does not need to be a siloed stand-alone product. By living symbiotically with the host platform, it can improve its product offering.
In insurance for instance, ZhongAn in China has scaled rapidly through embedded insurance. For instance, in a partnership with Xiaomi, an embedded sensor is built into phones and can automatically detect if there is a cracked screen. Instead of customers having to file a tedious claim form, ZhongAn automatically detects the claim, authenticates and adjudicates it (all in real time) and offers to ship a new phone – all before the original one is picked off the ground.
Players like Shopify and Amazon
are becoming important formidable lenders in their own right, offering merchants on their platforms working capital loans. By relying on their visibility into a merchant’s business, including working capital cycles, unit economics and profitability, they can make fast and accurate credit decisions. Of course, these have the added benefit of then driving more sales on the host platform. Amazon’s is lending over $1 billion annually and Shopify’s annualized lending volume is $650 million (Q1).
3. Don’t be shy about your trusted brand
The average NPS in financial services is 34 (about half of the average for technology companies). Yet, at the end of the day, financial services are based on trust.
This is one reason that embedded finance may see greater uplift among popular brands. Notably, Apple
(NPS: 72) launched a credit card powered by Goldman Sachs
has now seen 3.1 million sign-ups. For context, that’s roughly 1/3 of USAA’s card membership – reached in one year!
There is a range of “Banking as a service partners” that allow anyone to offer customers bank accounts and other loans. Disney checking account anyone? Trusted brands will be a key driver to embedded finance uplift.
4. Keep it incredibly simple
One of the keys to embedded finance products, is simplicity. As a rule of thumb, the more distant the core offering is to financial services, the simpler the embedded finance product needs to be.
This is a radical approach in financial services. Many traditional financial products are complicated. My home insurance is pages long with many particular exclusions. My mortgage documents are even longer.
For embedded insurance or lending to work, a customer must be able to understand the key terms intuitively and on the fly. Remember, the end goal is to delight the customer with a better customer experience, and leverage an opportunity to deepen the relationship with them. That’s why the product must make the transaction easier not harder.
Therefore, instead of long disclosures, or complicated redemption clauses, the products should be in plain English, have standard easy to understand fees, and be on/off – just like best in class consumer products today.
Incidentally, while little research has covered the topic, I expect simple embedded finance will support greater financial literacy.
5. Get creative
At its best, embedded finance allows us to create entirely new product categories of business models.
For example, what nobler goal could there be than solving energy poverty? Over 1 billion people live without access to electricity. Instead, they burn kerosene lanterns for basic light in their homes. Yet, solar home electricity systems exist, which equipped with a few solar batteries and panels, could provide enough power for lights, a TV, a radio, fans and cellphone charging. The problem is that these systems are beyond the financial means of most of their customers. Yet, on a daily or monthly basis, their customers spend more for kerosene to light their homes.
Two parallel fintech products unlocked the market. The first, is that these energy innovators bundle credit into the product or service – essentially a digital microfinance loan collateralized by the energy system. The second is digital payments: through mobile banking, providers can efficiently collect small daily/weekly/monthly payments digitally. Without it, cash collection would render the models uneconomical. Already the offgrid solar market reaches 420 million users (from zero less than a decade ago) and represents a $1.75 billion dollar market, driven by these types of innovations.
Leveraging embedded finance lets us reimagine entire industries and create entirely new types of products.
Where its going from here
Fintech will be eating the world. It will also take time. JP Morgan estimates embedded finance penetration is still low, at about 10% today.
However, the prize is large enough that we will continue investing behind it. What’s more, the embedded finance ecosystem continues to get built, to offer a greater range of products or services.
The next few years will prove exciting. But will require thoughtful execution, including the five rules above.