Mastering Embedded Finance Dynamics

Mastering Embedded Finance Dynamics

Time Stamp: December 22, 2023 9:01 AM
Source Node: 3033295

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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