Mastering Embedded Finance Dynamics

by Pedro Ferreira
  • Turning challenges into triumphs in Embedded Finance.
banking 2024
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In the dynamic realm of financial services, embedded finance stands as a transformative force, reshaping revenue dynamics and ushering in both challenges and opportunities for industry stakeholders. A nuanced understanding of this rising trend is imperative for financial professionals navigating these uncharted waters. While the benefits are not uniform across the board, strategic differentiation emerges as the linchpin for success, with careful consideration of evolving market trends.

Deciphering Revenue Dynamics in Embedded Finance

Embedded finance, akin to traditional banking, exhibits a distribution of revenue favoring those willing to bear risks and distributors fostering direct customer relationships. A recent McKinsey study delineates the prominence of balance sheet providers in the lending domain, where 55 percent of the $14 billion generated in the United States in 2021 primarily accrued to those assuming the risk of credit default. Conversely, distributors owning customer relationships thrive in payments and deposit products, claiming the lion's share of the revenue pool.

Market Trends and Strategic Differentiation

Two discernible trends have emerged from the complex interplay of revenue dynamics in embedded finance. Firstly, many embedded-finance distributors strategically initiate their foray by offering deposit and payment products. This sequential approach, often termed "land and expand," enables them to cultivate customer relationships and acquire invaluable data for future, higher-margin lending products. Such a calculated strategy establishes credibility and trust before venturing into more complex financial offerings.

Secondly, technology providers are actively pursuing a broader share of embedded-finance revenues by expanding across the value chain. In the lending sphere, for instance, they explore mechanisms like repurchase agreements to share in the risk, signaling a strategic move to increase their stake in revenue distribution.

Strategies for Triumph in Embedded Finance

Success in the embedded-finance landscape hinges on clear differentiation and a keen understanding of strategic avenues for stakeholders – distributors, balance sheet providers, and technology providers.

  1. Product breadth: Many embedded-finance distributors opt for a "land and expand" strategy, commencing with payment acceptance or deposits and gradually extending their product portfolio. The choice between a one-stop-shop approach with a single technology partner offering a wide array of products or collaboration with multiple providers underscores the importance of product breadth.
  2. Product depth: A select few technology and balance sheet providers focus on building deep expertise in specific embedded-finance categories, creating innovative use cases and claiming significant market share in niche areas. However, the trend suggests a future pivot towards integrated financial solutions, necessitating product breadth to capture synergies across categories.
  3. Program management support: Recognizing the apprehension of new entrants in managing financial products, especially lending, many embedded-finance technology providers offer program management support. This includes expertise in sales, servicing, and risk management, acting as a crucial differentiator for distributors navigating the complexities of the financial landscape.

Strategic Decisions for Market Entrants

As the embedded-finance market continues its expansion, new entrants can position themselves for success by implementing four crucial initiatives:

  1. Choosing a strategy: Market entrants must carefully choose their strategy based on existing strengths and market positioning. Banks with limited footprints may find embedded finance as an avenue for revenue expansion, while technology providers with payment-focused capabilities often lead the charge.
  2. Establishing a developer experience: To scale quickly, distributors must build a modern developer experience, providing third-party developers with self-service access and well-documented APIs. This enables seamless integration of embedded-finance products into various platforms.
  3. Adapting sales motions: Financial institutions accustomed to direct customer interactions must adapt to new sales motions, including B2B2C and B2B2B models. Building capabilities to support distributors in selling embedded-finance products becomes pivotal.
  4. Developing support and risk services: Retailers, manufacturers, telecoms, and other distributors of embedded finance may not have the capabilities to build, sell, and service financial products in a risk-controlled, regulatory-compliant, effective manner. Balance sheet and technology providers must provide advice and build a risk management framework, ensuring compliance within risk appetite.

Conclusion

While leaders are already emerging in the embedded-finance landscape, ample white space remains for new entrants. The key to long-term success lies in building the necessary technological infrastructure, expertise, and relationships today to secure a leadership position tomorrow. For financial services firms and fintechs eyeing a stake in embedded finance, commitment to strategic initiatives is the gateway to unlocking the full potential of this transformative trend.

In the dynamic realm of financial services, embedded finance stands as a transformative force, reshaping revenue dynamics and ushering in both challenges and opportunities for industry stakeholders. A nuanced understanding of this rising trend is imperative for financial professionals navigating these uncharted waters. While the benefits are not uniform across the board, strategic differentiation emerges as the linchpin for success, with careful consideration of evolving market trends.

Deciphering Revenue Dynamics in Embedded Finance

Embedded finance, akin to traditional banking, exhibits a distribution of revenue favoring those willing to bear risks and distributors fostering direct customer relationships. A recent McKinsey study delineates the prominence of balance sheet providers in the lending domain, where 55 percent of the $14 billion generated in the United States in 2021 primarily accrued to those assuming the risk of credit default. Conversely, distributors owning customer relationships thrive in payments and deposit products, claiming the lion's share of the revenue pool.

Market Trends and Strategic Differentiation

Two discernible trends have emerged from the complex interplay of revenue dynamics in embedded finance. Firstly, many embedded-finance distributors strategically initiate their foray by offering deposit and payment products. This sequential approach, often termed "land and expand," enables them to cultivate customer relationships and acquire invaluable data for future, higher-margin lending products. Such a calculated strategy establishes credibility and trust before venturing into more complex financial offerings.

Secondly, technology providers are actively pursuing a broader share of embedded-finance revenues by expanding across the value chain. In the lending sphere, for instance, they explore mechanisms like repurchase agreements to share in the risk, signaling a strategic move to increase their stake in revenue distribution.

Strategies for Triumph in Embedded Finance

Success in the embedded-finance landscape hinges on clear differentiation and a keen understanding of strategic avenues for stakeholders – distributors, balance sheet providers, and technology providers.

  1. Product breadth: Many embedded-finance distributors opt for a "land and expand" strategy, commencing with payment acceptance or deposits and gradually extending their product portfolio. The choice between a one-stop-shop approach with a single technology partner offering a wide array of products or collaboration with multiple providers underscores the importance of product breadth.
  2. Product depth: A select few technology and balance sheet providers focus on building deep expertise in specific embedded-finance categories, creating innovative use cases and claiming significant market share in niche areas. However, the trend suggests a future pivot towards integrated financial solutions, necessitating product breadth to capture synergies across categories.
  3. Program management support: Recognizing the apprehension of new entrants in managing financial products, especially lending, many embedded-finance technology providers offer program management support. This includes expertise in sales, servicing, and risk management, acting as a crucial differentiator for distributors navigating the complexities of the financial landscape.

Strategic Decisions for Market Entrants

As the embedded-finance market continues its expansion, new entrants can position themselves for success by implementing four crucial initiatives:

  1. Choosing a strategy: Market entrants must carefully choose their strategy based on existing strengths and market positioning. Banks with limited footprints may find embedded finance as an avenue for revenue expansion, while technology providers with payment-focused capabilities often lead the charge.
  2. Establishing a developer experience: To scale quickly, distributors must build a modern developer experience, providing third-party developers with self-service access and well-documented APIs. This enables seamless integration of embedded-finance products into various platforms.
  3. Adapting sales motions: Financial institutions accustomed to direct customer interactions must adapt to new sales motions, including B2B2C and B2B2B models. Building capabilities to support distributors in selling embedded-finance products becomes pivotal.
  4. Developing support and risk services: Retailers, manufacturers, telecoms, and other distributors of embedded finance may not have the capabilities to build, sell, and service financial products in a risk-controlled, regulatory-compliant, effective manner. Balance sheet and technology providers must provide advice and build a risk management framework, ensuring compliance within risk appetite.

Conclusion

While leaders are already emerging in the embedded-finance landscape, ample white space remains for new entrants. The key to long-term success lies in building the necessary technological infrastructure, expertise, and relationships today to secure a leadership position tomorrow. For financial services firms and fintechs eyeing a stake in embedded finance, commitment to strategic initiatives is the gateway to unlocking the full potential of this transformative trend.

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