A primer on embedded finance, 'fintech as a service'

Introduction

Financial technology is transitioning from a discrete vertical market into a horizontal opportunity. This, in essence, is the genesis of embedded finance. Companies across industries — from retail to technology to banking — are embracing fintech as part of their technology stack and business model to deliver a richer, "stickier" and more lucrative user value proposition. This report is a primer on the embedded finance market opportunity and the fintech-as-a-service vendor ecosystem that has emerged to power it.

Fintech is evolving from a group of stand-alone products and services targeted at end users to an infrastructure layer that existing companies can build on. This trend, widely referred to as embedded finance, is dramatically expanding the size of the fintech market opportunity and reshaping the distribution model for financial services. We firmly believe that many of the largest and most important fintech companies over the next decade will be those offering their capabilities via a service-based model.

The evolution of fintech

In the early days of fintech, startups primarily came to market offering distinct financial services that targeted end users, such as lending or peer-to-peer, or P2P, payments. New entrants like PayPal Holdings Inc.'s Venmo LLC and LendingClub Corp. built a business by unbundling specific banking products/features and acquiring users one by one. Today, fintech is increasingly considered an infrastructure layer that existing business-to-business and business-to-consumer, or B2C, organizations can build on to create new products and value propositions for their own customers. The examples of companies embedding fintech capabilities to better serve their customers are plentiful:

* Shopify Inc. offers payment processing, working capital, money accounts and payment cards to help its merchant customers better run and grow their business. Its vendor partner is Stripe Inc.

* DoorDash Inc. provides working capital to its merchant partners to invest in the growth of their business. Its vendor partner is Parafin Inc.

* Citizens Financial Group Inc. has launched a branded buy-now, pay-later, or BNPL, service to acquire new customers and better compete with third-party BNPL providers. Its vendor partner is Amount Inc.

* Google LLC offers virtual cards for Google Pay users to more easily spend their cash balance online in-app or in-store. Its vendor partner is Marqeta Inc.

* Uber Technologies Inc. provides drivers with a branded bank account and a debit card to receive instant payouts and spend earnings. Its vendor partner is Green Dot Corp.

Essentially, fintech is evolving into more of an ingredient baked into the services consumers and enterprises are already deploying. Instead of operating alongside the day-to-day activities of consumers, employees and enterprises, financial products are increasingly becoming enmeshed within them. We believe this trend provides a pathway for fintech to deliver greater value and utility to users.

Business drivers for embedded finance

Why are more companies offering their customers embedded fintech services? There are three tried-and-tested business goals that we see moving this trend forward:

* Drive revenue growth. Perhaps the most obvious reason for B2C and B2B companies to move into fintech is to increase average revenue per user. Generating per-transaction revenue can be a force multiplier for growth, as software-as-a-service firms such as Toast Inc. and Shopify have demonstrated. Similarly, offering a lending product enables platforms and marketplace businesses to catalyze growth for their customers, creating multiple opportunities down the line, e.g., increased transaction volume as the business grows. It is important to note that embedded finance revenue comes at essentially zero additional customer acquisition cost.

* Enhance the user experience. Traditionally, most financial products were not built with a strong focus on design and user experience. This can be particularly problematic when considering how deeply ingrained various financial services are within many technology vendors' user experience. Common outcomes include servicing issues, process delays and data reconciliation challenges, which can all lead to customer dissatisfaction and churn. When a company takes greater ownership over the financial processes that are core to how users engage with its product(s), that directly translates into enhancing control over — and refinement of — their user experience.

* Increase product stickiness. Financial services are inextricably intertwined with the daily activities of consumers and enterprises. Directly offering financial services, therefore, enables technology firms to increase product engagement. It also provides an avenue to deliver greater value and become a more indispensable partner. Ultimately, this can boost retention. As Blackbaud Inc. CFO Anthony Boor emphasized during the company's fourth-quarter 2020 earnings call, "Our payments business is very, very sticky," pointing out that customers using its payments service generally exhibit higher retention rates than those that do not.

Emergence of fintech "as a service"

An "as a service" market opportunity has emerged centered around enabling enterprises to outsource the capabilities and infrastructure required to deliver fintech products and services to their customers. The trend is not a foreign one in the technology industry. Just as many enterprises are choosing to work with a vendor like Salesforce Inc. instead of building their own customer relationship management system, or a cloud provider like Amazon.com Inc.'s Amazon Web Services Inc. instead of building their own data centers, many are electing to leverage the infrastructure of fintech-as-a-service providers to abstract the complexity and resource investment associated with launching fintech products. This trend has begun augmenting the go-to-market strategies and business models of many fintech vendors. Fintech firms increasingly view a one-to-many model as a more effective and efficient way to scale.

Thanks to fintech as a service, it has never been easier to launch a new fintech product or startup. Enterprises that partner with a fintech-as-a-service vendor can remain focused on their core business while expanding into fintech with enhanced speed to market and reduced up-front investments and operational requirements. Ultimately, this trend is reshaping the unit economics associated with offering financial services.

Across the full spectrum of embedded finance use cases, a variety of fintech-as-a-service categories are emerging, featuring a rapidly expanding list of vendors offering their infrastructure and services on a white-label basis. Below, we highlight four key categories of the vendor ecosystem, along with some representative vendors participating in each category.

Cards

Players in this category typically offer a comprehensive platform that encompasses all functions required to issue payment cards to customers or employees — for example, issuer processing, card provisioning services for digital wallets, program management, card printing and fulfillment. Similarly, they provide connections to required partners — such as bank sponsors and networks — eliminating the need to source multiple relationships. Examples of vendors in this category include Marqeta Inc., Lithic, Apto Payments Inc. and Highnote Platform Inc.

Banking

Firms in this category, including banks and technology providers, enable organizations to offer money management accounts such as a bank account or digital wallet. These accounts typically support a variety of traditional bank account functions, such as holding balances, sending/receiving funds, ATM access, interest and rewards. Vendors typically offer a suite of capabilities, including compliance and identity verification tools, fraud and risk management tools, card issuance capabilities and program management. Some even hold their own banking licenses. Examples of players in this category include Railsbank Technology Ltd, Bond, Green Dot Corp. and Q2 Holdings Inc.

Payment processing

Vendors in this segment enable companies, typically software platform specialists, to offer payment-processing services to their customers. Deployment models vary, but among the most common is the hybrid approach, where the embedded payment provider generally handles resource-intensive tasks such as identity verification checks, payment card industry compliance and validation, licenses and underwriting. Similarly, the embedded payments provider's infrastructure — which can include a gateway, token vault, payout mechanisms and reporting tools — is utilized to enable payment acceptance and processing. Firms in this category include Stripe, BlueSnap Inc., Finix Payments Inc. and Payrix Solutions LLC.

Lending

Companies in this sector enable organizations to offer various types of lending products, ranging from BNPL to working capital to micro-loans to credit cards. Vendors typically specialize in one or two lending products. They often offer a platform that includes underwriting and risk and compliance management tools, in addition to servicing capabilities and lender connections. Examples of players in this segment include Amount, Jifiti.com Inc., Deserve, Parafin and Stilt Inc.'s Onbo.

^{This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.}

^{451 Research is part of S&P Global Market Intelligence. For more about 451 Research, please contact 451ClientServices@spglobal.com.}