Dear Luc: What’s the deal with embedded finance?

In Dear Luc, we answer the questions the industry’s fintech founders are too afraid to ask, and solve the problems they don’t want their VCs to know about.

From regulation readiness to technology teething troubles, our start-up agony uncle, Luc Gueriane, is here to help.

Luc has over seven years’ experience working with flagship fintechs like Revolut, Wise (formerly TransferWise), Monzo and Curve.

His expertise and extensive work in the fintech ecosystem mean that Luc is able to offer unique insight into the building of a successful fintech company.

Confession #11: Waking up on the wrong side of embedded

Dear Luc,

Everyone is talking about embedded finance and payments. What should I do?

Embedded finance has become one of the most discussed terms in the fintech and payments space in the year. However, despite all the recent attention, the concept has in fact been around for quite a long time.

It can be explained in a number of different ways, but Simon Taylor at 11:FS describes it best: “When you create a user journey that addresses common pain points – whatever that may be – and you happen to incorporate a financial element, that’s embedded finance. The end user shouldn’t really notice the finance if it’s properly embedded.”

And when we talk about embedded finance there are usually three actors involved: The fintech providing embedded financial services, the customer facing organisation – which can be a financial services provider or a non-financial services provider – that embeds the service in its customer journey, and the end customer who uses that financial service as part of the existing user journey.

After reading this, you may think, surely this is nothing new? You’re right – the only thing that has changed is the widespread awareness of the term and the variety of ways we may use it.

A recent report by Lightyear Capital estimates that embedded finance will grow to £164 billion in revenue by 2025, which is an incredible 10x rise from £16 billion in 2020.

The pandemic has undoubtedly caused this growth and “turbocharged a change in people’s financial needs and expectations.” As Keith Grose, head of international at Plaid says, integrated experiences are now seen as a standard for customers.

So, does this mean you need to get in on the game? Well, as a fintech founder of either a B2B or B2C product, it’s important to understand whether embedded finance is relevant for you. The rise in any new payment capability is always going to be intriguing but it must not be a distraction from your original business plan or ambitions.

Embedded finance is a marathon, not a sprint

The first thing I’d ask yourself is, who would be your competitors for this solution? Are they different from the competitors you already have with your existing B2B or B2C product, or is this an entirely different group?

Although I am a big believer in the fact that the fintech industry has room for every new idea, you want to make sure you’re not becoming a jack of all trades or re-inventing the wheel just for the sake of it.

Spend time researching the existing space and try to understand if there is a gap in the market that needs to be filled.

What is included within ‘embedded finance’ is no doubt going to expand far beyond what it currently does so don’t rush into it straight away.

Secondly, do you have potential clients who could benefit from embedded finance solution to offer to their customers?

With so many options already in the market, and embedded finance providers like Klarna dominating the headlines, you might want to focus your attention on existing clients or contacts who would see value in reducing the friction in their customer payments journey.

After all, it’s often quicker to scale a service by working with a brand that has an established customer base, than spend time and money growing your own.

For example, a customer making a purchase from a carpet company may buy it through Tapi, but they aren’t immediately aware that their financing option is provided by Hitachi Personal Finance. If Hitachi tried to tap into this market alone it would require a lot of marketing effort to acquire the same number of customers than simply partnering up with Tapi directly.

Similarly, if you have companies in mind who would be a natural fit to partner with, then this will make your journey into embedded finance much easier.

But this distribution method does have drawbacks. In particular, the partner who is embedding your service will want a share of the revenues for providing access to its customer base.

Thirdly, if you do collaborate, are you prepared and appropriately resourced for the potential headaches that could come with operating in the B2B2B or B2B2C space? As the fintech provider (if you’re the regulated part of the equation) you are shouldering any regulation risks, despite being a layer removed from the end user.

The Financial Conduct Authority (FCA) regularly publishes updated guidance to drive improvements in the way firms treat their customers, which aims to help minimise the risk of mis-selling.

If you are contracting with a number of customer facing firms (retailers, social media firms, travel providers etc), you need to ensure that you don’t use unclear or misleading language to speak to their customers (e.g best in market, cheapest, quickest) as this responsibility sits with you.

Despite these challenges, being able to embed fintech services in third party offerings can rapidly deliver the scale many fintechs have been striving for. Incumbent banks and insurance companies continue to dominate in terms of customers and transactions after all.

But customers are often more loyal to retailers or social media companies, and will be willing to use a financial service provided by them, especially if its embedded into their existing user journey and provides a great experience.

Embedded finance may be the industry watch word but before jumping in the ring, you need to question whether such a dramatic shift in your business will work long term. You may want to reconsider this move if it means taking a detour from your original business plan and jeopardising what you’ve already been working towards.

If in any case, you do have a game plan in motion, you’ll also need to consider whether it’s better to embed into a third party or invest in establishing your own client base. And last but certainly not least, are you prepared to take on the regulatory risks that comes with interacting with customers indirectly?

Embedded finance is here to stay and the fintech industry will surely benefit from any new ideas. So take it slow, do your research, and explore your options.

This is a marathon, not a sprint.

Do you have an embarrassing question you want answered, or a seemingly unsolvable problem you’d want help with? Post an anonymous comment below, or email FinTech Futures’ Alex Hamilton in confidence.

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