Embedded Finance: How Software Companies Are Rising Above the Competition | Episode 20

It’s no secret that software led payments are taking our digital ecosystem by storm. It’s a buzzword that’s in just about every conversation regarding payments, payfacs and how to optimize the fintech space. But what about embedded finance as a SaaS offering? WorldPay Vice President of Merchant Strategy, Samuel Callen is back on PayFAQ: The Embedded Payments Podcast to follow up on our last episode — and joining him and Host, Bob Butler, is Worldpay Senior Director of Merchant Strategy and Platform GTM, Eric Lerch. 

According to Eric, embedded finance is a very mason offering within the fintech and SaaS ecosystem at large. The concept revolves around software companies extending financial services and products that are not core competencies of theirs to their software users natively, within their own software solutions. It takes the friction out of payment services for software customers in that they no longer must be redirected to another platform to apply for financial services. Eric also explains that embedded finance can include such services as bank accounts, payroll, account reconciliation, insurance and even card issuance. 

Sam drills it down a little more for us by referencing the small-to-midsize business customer journey when it comes to embedded finance. According to him, embedded finance solves one of the main customer pain points for SMBs: the inability to obtain capital. And he drills down even more by specifying the three core products most desired from SMBs.  

Finally, as for the revenue stream this can offer for SaaS companies, Sam goes on to say that the addressable market for SMBs is a 45% market share for embedded finance, with up to a 70% revenue uptick for participating SaaS companies. Tune in to hear more.

Full Transcript

Bob Butler

Hi, everyone. Welcome to the payback embedded payments podcast brought to you by Payrix. I’m your host, Bob Butler. And today we’re welcoming back Sam Callen, who’s the VP of Merchant Strategy and Platform Go-to-Market at FIS to talk a little bit about embedded finance. And joining him is Eric Lerch, the Senior Director of Merchant Strategy and Platform Go-to-Market at FIS. So welcome back to the show. And thanks for joining us, Eric.

Eric Lerch

Yeah, thanks for having me on here. Really looking forward to the discussion today. For a brief bit of background for everyone, I’ve been in payments for a little over 10 years, most of my time was actually focused on card issuers and issuer processors, and consulting, and have also been at Atlassian and helped define their go to market strategy for their issuing and embedded finance product rollout. Since joining Payrix, and FIS, I’ve been focused on working with our large platform partners, really kind of understanding what their product needs are, with a particular focus on bringing embedded finance products to those platform partners of ours.

Bob Butler

Well, Eric, that’s a great segue to I would really love to hear your definition of embedded finance.

Eric Lerch

Yeah, of course. So, to start, let me just mention that embedded finances is still a very incredibly nascent offering within the FinTech and software ecosystem at large, but, you know, has a lot of people talking about it, because it possesses tremendous promise, given the pain points it’s able to solve for for SMBs, and users of the software.

So to me, talking about embedded finance, what it is, and it’s core definition is really about software companies extending financial services and products that are not core competencies of theirs, to their software user base natively within their own software solution. Historically, when a when a software company user requests to financial product, for example, access to working capital, integrated with an E-commerce marketplace, the marketplace would redirect or refer the user to a financial service provider site where the user could then apply for working capital. While this flow works to offer a working capital product to the end user, it provides a clunky user experience as the user is redirected to another environment to consume or apply for the financial product.

Embedded finance is really about the modern API’s of financial infrastructure providers, enabling those API’s to be consumed by software companies that are now able to extend that financial product natively within their own software, which improves the overall end user experience. So this has obviously led to a large convenience factor for the end users consuming those products. And those end users have become increasingly comfortable consuming financial products from their software provider, rather than just from a traditional bank or financial institution.

Touching a little bit more on like, what kind of products are most common within embedded finance, I think a lot of people understand that payment acceptance API’s to accept the credit card is pretty common. However, in recent years, we’ve seen embedded finance, expand the product suites to include bank accounts, capital solutions, commercial credit cards, and even adjacent financial service products like payroll, automated accounting, and insurance products. So, to me, we’re really just at the precipice of embedded finance and expects the industry to expand rapidly over the next three to five years as software companies are able to fulfill unmet customer needs by bringing these products into their own software solution.

Bob Butler

Yeah, I’m a strong believer in this distribution model of, especially in the SMB space and, and how that’s going to look going forward. And I guess, Sam, this is really directed towards you,

How would you see embedded finance? What does that really mean for small to midsize businesses?

Sam Callen

Yeah, it’s a good question, Bob. And as usual, thanks for having me back on the show. I think that it helps to just start with looking at the problem that you’re actually trying to solve. So I think that in the case of embedded finance, it’s really about solving the pain points of what are a fundamentally broken SMB banking system.

SMB banking is difficult for a large financial institution to do, the process is incredibly clunky. The revenue that they send to make on a given loan doesn’t necessarily always justify them going through their full process. So there’s a lot of pain points there. You take a look at that and what that winds up manifesting itself as -I think it was BCG, that did a study recently that showed that the small business loan approval rate at large traditional banks is less than 20% in the US.

So what’s the pain point that you’re trying to solve for an SMB? It’s the fact that you can’t get capital, I mean, fewer than one in five of these loans are getting filled, you couple that with another SMB need, which is just the ongoing capital that they need on a day to day basis to sustain their business. Average SMB in the US has about 27 days of cash reserves. So getting access to cash quickly, getting access to timely working capital loans, and stuff like that, incredibly important for SMBs. So that system is broken SMBs have expressed a desire to see that change. I think it’s right around two thirds of SMBs, now say that they actually want to consume these embedded finance solutions, because they’re better, they’re easier, they’re faster, they’re more timely.

The second key piece, in addition to kind of solving the breakdowns of the banking system is a timeliness and a relevancy of the solution. You go into a bank, it’s going to be a very cookie cutter loan type of an opportunity. With embedded finance and having those loan offers built right into the workflows of your business management solution, you’re going to be able to get loan offers that are pre approved, they’re custom tailored to your business, you get them at the exact time that you need them, they’re as simple as one click within your interface. And in some cases, you don’t even have to worry about the repayments on them because the repayments can come right out of your actual funds flow that you’re getting through your payments provider.

So if we take a real world example that say, Bob, you manage a local salon or a spa, you have a need for a bank account, and perhaps Short Term Lending, getting access to your funds quicker. With embedded finance, you log into your salon management software, right in there, you see your dashboard with your daily store operations, your financial reporting, all of that good stuff. Built right in there, you’ve got your bank account that’s linked to your business management software. And within that dashboard, you will be presented with pre-approved and timely loan offers or working capital offers. And it’s just as simple as potentially one click within your dashboard. So as I mentioned, you can fully automate some of those repayments as well. So really, in short, it just makes it simpler and easier to do business. So at the end of the day, it’s about being able to get access to real banking solutions that aren’t adequately served today, and just getting served a better product at the end of the day.

Bob Butler

Well, I’d like to follow up on that. Because, you know, when I think about it, you just talked about it from the from the small and mid-sized business point of view. And I think that makes the most sense, because I think that is solving a real world problem. But what does the rise of embedded finance mean, for the platforms that are actually providing services to those SMBs?

Sam Callen

Yeah, it’s, it’s a good point or a good question, I think that the first thing that comes to mind, is that if your clients are demanding this, it’s increasingly going to be table stakes, if you’re not able to offer it and your competitor is, it’s pretty clear which one of those providers the SMB is gonna go to, they’re gonna go to the one that makes their life easier. So at a base level, the clients are demanding it, and you’re gonna have to be able to offer that to stay relevant.

I think the second piece, though, is that, really, today, embedded finance adoption, it’s still quite low. And so I think that’s a key positive for a lot of these software platforms. Only about 10% of software platforms are able to offer embedded finance products today. And really only about 5% of SMBs are actively consuming embedded finance products in the market. So we’re still fairly early. There’s a lot of opportunity for platforms to get out in front of the trend here. But I think for them, you know, in addition to clients demanding, it’s just going to create a deeper, stickier relationship with that SMB, as you’re able to get more ingrained into what they need, you’re providing more value for those clients, the switching costs become higher, and you’re just gonna have a much better opportunity to retain some of those clients beyond just your core software.

Now, the third and very practical element of this to platforms is it’s a revenue stream. And so you can think about you know, you’ve got payments revenue opportunities, you’ve got your SaaS revenue opportunity, embedded finance is just another layer to that. And really, there’s three core products at the at the foundation of embedded finance, there’s a bank account, there’s a card, so a card issuing product, and short term loans or working capital. And by just offering those three products alone, you access about 45% of the total SMB banking addressable market. And it can actually represent as high as a 70% uplift for the revenue of your platform. And so we’re really talking about pretty big dollars there when it comes to embedded finance. And so, there’s the practical element of you have to be able to offer this because your clients are demanding it, it’s got the sticky relationship. But really, there’s just a lot of financial opportunity there as well for a lot of these platform clients.

Bob Butler

Now, that makes a ton of sense. So, Eric, back to you, you know, as you think about these vertical technology platforms, SaaS platform software platforms, you know, what should they be looking for, in a partner as they look to roll out embedded finance solutions to their customer base?

Eric Lerch

Yeah, for me, there’s really three key attributes software companies should consider when looking for a financial infrastructure provider that can enable the embedding of these products into their software. The first is really around integration flexibility. There’s a number a different ways to embed financial products, whether that be a direct API, a co-brand or white label of a complete portal, or embedding an iframe or a widget, which is just a component of a web page. And so based on the platform’s desire to control the end user experience and their time to market needs, the infrastructure provider that supports the embedding of these products into the platform, allows the platform to kind of select whichever integration method is most suitable for their needs. So integration, flexibility, I think is really important. And having a breadth of different options should be a major consideration set for the platform.

The other one is really kind of product breadth. You know, Sam just touched on bank accounts, commercial credit cards, working capital loans. And so I think, as you’re looking for avprovider that touches on all of these different products, making sure that provider checks the box across all of those so that you can consume all of those from one provider and think about different commercialization strategies by bundling different products will just give the platform more power in terms of how they actually commercialize these products.

And then the final vector, I’d say that’s important for software companies is really, that financial infrastructure providers expertise in financial services and payments. Many of these software companies are new to payments and financial services and just don’t have the breadth or expert expertise within financial services. So really finding a partner that they can rely on, to provide that advice, to augment certain functions, where needed, to take on program management and regulatory compliance is something that I think a lot of these software companies would find value in, a partner that can help them embed these products.

Bob Butler

Makes a ton of sense, Eric, really appreciate that. Sam, you know, both you and I know that FIS is well positioned to support software partners in realizing these embedded finance ambitions. But can you tell us a little bit more about that?

Sam Callen

Yeah, I mean, I think when you look at the history of FIS and Worldpay, there’s a lot that really plays into this, right, so FIS/Worldpay, have a long history of powering ISVs and SaaS providers, as well as PayFac®. To extend those products to SMBs, Worldpay pioneered the ISV referral model with Mercury Payments, literally trademarked the term PayFac® and then when you start to look at the broader assets of FIS, FIS is world renowned for powering some of the most complex financial institutions in the entire world. When you think of some of the largest most complex banks in the entire world, they rely on FIS banking tech to power them going forward. So I think it’s a really dynamic combination of payments and banking technology. And I think the FIS banking tech, with the program management capabilities that FIS provides, really makes us a strong partner within embedded finance. And this ultimately lets you, the software platform, focus on what you do best, which is building software that SMBs need to run their business. Leave the banking stuff, leave the payment stuff to us, and we’ll get that covered for you.

Bob Butler

Well, both Sam and Eric, I really appreciate you for joining me on the show today. And just really want to thank you for your time.

Sam Callen

Yeah, thank you, Bob. It’s been great chatting with you all.

Eric Lerch

Yeah, and thanks, Bob. And, you know, I really just hope that you know, all of your listeners were able to just absorb some of the opportunity in embedded finance and what that’s going to mean for their platform business. So as always, really appreciate you, you know, extending the forum to us and letting us share some of our knowledge with your listener base.

Bob Butler

Thank you so much. You know, having spent a lot of time with you both. I know, we’re all big believers in sharing knowledge and experience. So we really appreciate you joining us here today.

At Payrix, and FIS. and Worldpay for Platforms, we want to be a trusted resource for software providers who are out there trying to make sense of embedded payments, finance, and commerce, and to help them get the education that they need to make the business decisions their customers and investors will thank them for.