Why Embedded Finance is the Next Act for Software-Led Payments – and Why It Matters

Embedded Finance Series, Part 1

By Michael Bradley, Senior Vice President of Growth, Infinicept

Making big, bold statements on the future of fintech is both easier and harder these days. The capital underpinning a complete rewriting of the industry (KPMG says that venture capital investment in fintech hit $98 billion in the first half of this year) is giving rise to a mind-bending number of new payment, banking, blockchain, crypto and other related companies.

The potential within the space is enormous. That’s the easy part to predict.

The trickier part is that companies and markets are evolving so quickly, and secular shifts happening from such unremarkable origins, projecting three to five years into the future will likely get you proven wrong.

But I would say we can bet with conviction that there will be two dominant, interrelated market forces that will reshape payments and more broadly, financial services. First is the continued rise of software-led payments – with the payment facilitator model the north star of this shifting industry paradigm. For those of you following the Infinicept journey, you’ll know we have been at the vanguard of this change in how merchant services are marketed, sold and enabled to SMBs on a global basis.

The second market-changing shift is embedded finance, which (as we will see in a moment) is the logical extension of the foundation laid down by software-led payments companies. Forecasts predict a $7 trillion total addressable market for embedded finance, and analysts expect $825 billion of that to be carved out for software-led payments companies alone.

What does embedded finance really mean?

Embedded finance is the delivery of banking, payment and financial services within the context of a user experience – predominately a software or app-based user experience. The financial service offering is positioned at the most relevant point of a business process for the customer of the software platform. Angus Ross, Global Head of Banking as a Service for Finastra, eloquently articulated this “contextual finance” concept at the recent FTT Embedded Finance North America conference.

To put this in a real-world scenario: think of a business owner for a small chain of local bakeries placing an order for $10,000 of confectioner’s sugar. Within the order management system, the manager is presented with options to finance the order, based specifically on that bakery’s business data profile.

Meanwhile, that same bakery chain could have multiple options for paying its drivers or sales agents – perhaps disbursing funds into a virtual account or a prepaid card linked to a bank account – delivered through its accounting or payroll system.

And all that is happening amid a profound makeover in payment services, where the distribution of merchant services to small and medium-sized businesses (SMBs) is continuing its shift to software-led payments platforms. In this new world, SMBs get payment services from their restaurant POS software provider, their practice management software provider, their construction management software provider, etc.

This is true whether the payments business of the software is powered by a third party like Stripe, or the software companies themselves in the role of a payment facilitator. Today, $1 trillion in payment volume is processed by software-led payments companies, and we expect that share to increase 400% in the next five years.

And the sequel to that movie is now playing for embedded finance.

Why is this happening now?

In part, it’s because payments provide the foundation for a whole universe of financial services. As an embedded payments company, you have deep insight and data from a risk and underwriting perspective that can feed into a data profile that supports other extended services, such as risk modeling to help determine creditworthiness.

This is against the backdrop of industry trends that are supporting the rise of embedded finance with technological tools that make it easier than ever. The infrastructure – the API layer of the world – is now there.

As I stated recently, the monolithic value chain that was a “bank” is now being broken down into many discrete, a la carte services. Deloitte notes in a recent report that this “API-fication” of services is a result of several forces: the rise of cloud computing, a shift to more open banking services, and changing end user expectations (like mobile access, immediacy, and seamless cross-channel experiences).

These developments are the foundation for myriad new and inventive business models. Stripe hasn’t reinvented Wells Fargo or Visa. What it has done is taken these services and created a new way to access them (API layer, new permutations of the value chain), making them digestible, discrete, and available for integration.

What’s in it for the software-led payment companies?

From a business standpoint, embracing embedded finance delivers on three fronts.

First, embedded finance creates better user experiences and ultimately greater stickiness with customers. You started with a piece of software that serves as the control panel for the business. Then you brought in payments. Now, you offer even more products and services to help your customers expand. The value journey is natural and seamless, and it cements you as the long-term provider for your business customers.

Second, embedded finance is a competitive hedge. In highly competitive software markets, those with just a software offering are at a disadvantage compared to those competitors that bundle software and payments. Those that bundle software with payments and a financial offering create further differentiation.

Put simply, if you’re offering a software platform for restaurants and the competitor down the street is now offering a similar platform that includes payments and financial service offerings, all other things being equal, the business customer tends to gravitate toward the solution that can be a one-stop shop.

Finally, embedded finance offerings are attractive economic line items. Consider revenue share opportunities for issuing and cash disbursements to a virtual or an account-linked card program. A typical model would see 30-40% revenue share on interchange margins with little overhead. Short-term and working capital solutions also offer attractive origination and revenue share options.

All of these factors point to a trend that’s poised to move well beyond a “nice-to-have” into a strategic driver of business decisions over the next few years.