The Perfect Storm
Article 2 in 'The Transformative Potential of Embedded Finance'
In the first of our series of articles exploring the transformative potential of embedded finance, we assessed the concept of what embedded finance is and why corporates are increasingly focusing on it. We also touched upon the four primary catalysts behind the recent rise in importance of embedded finance:
Changing Consumer Behaviour;
The Emergence of Data-Based Business Models;
The Disruption of the Banking Industry;
Strategic and Financial Benefits that corporates can obtain.
In this article, we will delve deeper into each of these factors and analyse why they are creating a perfect storm for the emergence of embedded finance.
Changing Consumer Behaviour
More and more consumers are moving to digital channels to shop, to watch films and sport, to manage their finances, to socialise, and to engage in meme-fuelled bouts of short squeezing (or alleged market manipulation, if you want to look at it that way). Consequently, over time, the point of friction in the customer experience has shifted.
Back in the day (i.e., 2007), if a customer wanted to buy a laptop, they would have to withdraw cash or use their credit card, go to the shop and buy the laptop. The decision of how to finance the purchase was generally made well in advance of the act of purchasing, and hence a source of friction was in knowing how they would finance their purchase. Today, consumer behaviours have changed. The focus is on immediacy – I want what I want, and I want it now! The decision of how to finance the purchase comes later on in the process now, i.e., at the point of sale.
This shift has led to around $200 billion in sales lost each year due to friction in the checkout process, equating to a 50% abandonment rate, with 60% of those who abandon their carts citing high costs as a primary deterrent. Corporates have zoned in on this problem and have identified point of sale financing as a solution to reduce friction. Apple is a good example of this – as the below image shows, they offer, side by side with a ‘Pay in Full’ option, a ‘Monthly Payment’ option that is cheaper. This option (currently only available in the US) further embeds customers into the Apple ecosystem (!) by virtue of them simultaneously buying the iPhone and subscribing to the Apple Card.
The Emergence of Data-Based Business Models
The move to digital channels and the associated shift in consumer behaviour has provided corporates like Netflix, Amazon, Nike, Airbnb, Walmart, etc., the opportunity to better understand their customers and maximise the vast amount of data collected on their platforms. The types of data used are increasingly diverse, with the use of alternative datasets (purchase information, website traffic, order volumes, etc.) becoming prominent over the last few years. Corporates have started to apply advanced analytics methods (Data Visualisation, AI-based Recommender Systems, Natural Language Processing) to this data to derive pinpointed, tailored customer behavioural insights. These insights are why the ads on Instagram don’t really feel invasive and probably make you buy more clothes than you need.
Stitch Fix, an online styling service, best illustrates how changing consumer behaviour and emerging data-based business models are enabling embedded finance. Stitch Fix uses customer data on budget, preferences, size and lifestyle combined with feedback data to curate a box of 5 items to deliver their personalised ‘fix’. The way data is being utilised is a self-fulfilling cycle: increased data collection allows corporates to offer more targeted and relevant products to their customers; analysing customer responses in turn lets them fine-tune their customer profiles and approach, and provide an even more bespoke service. This better understanding of customers and their preferences puts corporates in the perfect position to diversify their product lines and gain even more control of the customer experience by providing them tailored financial services.
Disruption of the Banking Industry
The challenges experienced by the banking sector over the last few years have aided corporates and FinTechs in slowly evolving the industry. Fifteen years ago, with trust in banks not yet decimated by the Global Financial Crisis, opening a bank account with a start-up was inconceivable and Financial Services was its own industry.
The chaos from the crisis eroded trust in banks, especially among millennials – in 2017, 45.3% of more than 30,000 millennials surveyed as part of WEF's Global Shapers Survey said they ‘disagreed’ with the statement that they trust banks to be fair and honest. Moreover, bank technology estates were slow to compete with the experiences offered by their new challengers; sprawling legacy systems, siloed databases, and a poorly developed digital presence have diminished the dominance of banks.
The lack of data utilisation to provide customer insights has hindered banks in their ability to suggest timely financing to their SME customers; combined with a one size fits all approach, narrow documentation criteria and a restrictive credit appetite due to underuse of alternative datasets, banks are being left behind in a world where 76% of businesses use industry specific software platforms to manage their businesses. This has led to 46% of businesses saying that their banking experience has hindered their growth.
The rise of challenger or neo-banks like Monzo, Revolut, Starling and Chime have highlighted both, the lack of trust and the trend towards digital-only services. The ease of having a seamless digital-only experience has made customers more likely to open bank accounts with and buy financial products from corporates of all shapes and sizes.
Customers, whether business or individual, are less concerned now about the location on the high street and increasingly value ease and convenience – and this is an area in which digitally mature companies are light years ahead of their financially literate brethren.
Strategic and Financial Benefits for Corporates from Embedded Finance
The growth of corporate balance sheets over the last decade has left them finding ways to most effectively deploy their cash. Apple, for example, has so much cash on its balance sheet ($191.83 billion as of October 2020) that since announcing its intention to reduce its cash reserves in 2018, it had returned 135% of free cash flow via dividends and stock repurchases by December 2019. Google ($121.08 billion), Amazon ($71.77 billion) and Microsoft ($137.98 billion) are also holding on to immense amounts of cash.
Utilising their stable balance sheets to expand their customer bases, serve their customers’ customers via embedded financing and create a stickier product is a strategic play with significant revenue potential. Further, deploying their cash more effectively through the provision of financial products will potentially give corporates the ability to achieve higher return on capital employed (ROCE, or the amount of profit a company is generating per $1 of capital employed). They are also able to potentially hold or lower the cost of customer acquisition (CAC) while increasing the lifetime value (LTV, i.e., the present value of the net profit from the customer over the duration of the relationship).
Companies with strong ecosystems (such as marketplaces or those within supply chain intensive industries) or strong user trust can leverage embedded finance not just to improve the user experience via their product, but also strengthen the companies’ cash flow fundamentals.
The Perfect Storm
This trend of corporates entering the financial sphere is not a newly discovered golden chalice, but is instead a path that has been trodden before:
General Electric has leveraged GE Capital, its financial subsidiary, to finance projects; this maintained the company’s sustained growth in the early 2000s;
Sony Bank established an online bank in 2001 to help their customers and promote brand loyalty.
The confluence of the drivers mentioned above, however, has created a perfect storm and opened up a significant market opportunity for corporates all over the globe to create longer, stickier and more profitable relationships with their customers.
What we will look to explore over the coming weeks and articles is how exactly this evolution of embedded finance will be different from the past and how it will be the catalyst in changing how we interact with money in the near future.
Related Reading
Lights Out: Pride, Delusion and the Fall of General Electric by Thomas Gryta and Ted Mann
Bank 4.0: Banking Everywhere, Never at a Bank by Brett King
Before Babylon, Beyond Bitcoin: From Money That We Understand to Money That Understands Us by David Birch
Articles in this Series
Article 1: The Rise of Embedded Finance
Article 3: Exploring Models of Embedding Finance
Article 4: Embedded Everything
Article 5: The Evolution of Embedded Finance
To join our journey into the worlds of tech and business, subscribe below!
Disclaimer
This is a personal blog. Any views or opinions represented in this blog are personal and belong solely to the article authors and do not represent those of people, institutions or organizations that those authors may or may not be associated with in professional or personal capacity, unless explicitly stated. All content provided on this blog is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. Any views or opinions are not intended to malign any religion, ethnic group, club, organization, company, or individual.