The financial sector, formerly governed by a number of large banks, has historically been slow to adopt innovative practices. However, in 2009, the European Commission introduced the Payment Services Directive (PSD) 1 and then PSD 2 in 2018. These two directives paved the way for fintechs, with the emergence of the first payment service provider status and the requirement for banks to share customer data with other companies and applications. This led to the emergence of Open Banking, which currently represents a global market of $19.6 billion. The Open Banking market largely contributed to us seeing startups develop embedded finance solutions. These companies act as a link between banks/credit institutions and non-financial companies. They allow the latter to integrate banking services directly into their web interfaces. The size of the embedded finance market is currently estimated at $54.3 billion worldwide.

Embedded finance startups do not compete with banks but instead work in true collaboration, as they are so dependent on each other. Banks are not software companies, do not always have the funds to develop this type of solution and have much higher customer acquisition costs than e-commerce (x4 according to a study by Solarisbank). As for startups, they do not have the necessary cash flow, nor the accreditation to offer these products on their own. For these reasons and more, startups in the embedded finance sector have been very successful lately.

In this article we will try to explain this success, present the different offers that these embedded finance companies can provide and go over their benefits.

Improving the customer experience

One of the primary purposes behind embedded finance is to improve the customer experience. Indeed, this is one of the most sensitive issues in online retail, with almost 64% of online shoppers considering customer experience more important than price.

Embedded finance helps merchants with this through features like the integration of online payment methods. The buyer is therefore not redirected to third-party sites and does not have to fill in additional information to obtain an invoice. This is what the company Bridge API offers with its plug-and-play secure payment solution Bridge Pay, which is used by major groups such as Cdiscount. A digital wallet can also be created on the e-commerce site. It allows the data from a customer’s various cards to be stored digitally. Digital wallets are available for use on many sites such as Amazon or Uber. In order to support merchants, other companies such as Square have developed contactless payment methods to help entrepreneurs collect payments directly via their mobile phones and thus make less use of payment terminals.

However, startups are not the only players developing embedded finance modules to improve the customer experience. This is also the case with Meta. Indeed, Meta has developed its own technology in order to offer its users the possibility to transfer money from its messengers apps: Facebook or WhatsApp. The aim is to offer more possibilities to these users and thus retain them longer on said applications. This is a key issue as the average time spent on Facebook per user has dropped by 7% compared to last year, and on WhatsApp by 8%, directly impacting Meta’s revenue.

Offering new financing options

Improving the customer experience is not the only advantage of embedded finance for e-commerce. Indeed, startups such as Hokodo, Affirm and Klarna are providing e-commerce sites with a new payment method for their customers: Buy Now Pay Later (BNPL). This consists in allowing them to make a purchase now but pay for it later, without impacting the e-commerce site’s cash flow.

This new payment method has already convinced major retail players such as Nike, Ikea and Sephora. Thus, customers who could not finance their new purchase immediately can subscribe to this “interest-free credit”, and proceed with their various purchases. The merchant site in turn pays the company providing this service. This new means of payment is now widely adopted in several countries. In Sweden, for example, nearly one euro out of four spent online is spent via BNPL.

Embedded finance can therefore enable companies to increase their sales by offering financing solutions directly to their customers. However, we’re also seeing it enable companies to finance themselves directly. This is the case, for example, of Toast, a company specialising in POS for restaurants. Indeed, via its Toast Capital offer, in partnership with WeBank, the restaurant owner can take out a loan and gradually repay an automated system that takes a percentage from card payments received for their business. They no longer need to call on a banking institution and their repayments are adapted to their cash flow.

Facilitating cash flow and savings

Other embedded finance startups have developed solutions to improve corporate cash flow. For example, FundThrough offers a solution that is similar to BNPL, but is aimed solely at the B2B sector. Indeed, its API integrates directly with accounting and billing software such as Quickbooks. Businesses determine the invoices they want to fund and receive the invoice amount directly, minus a fee from FundThrough. As a result, the company goes from an average customer payment term of 43 days to a next-day payment. This improves the company’s working capital requirements, which can be a complicated issue for SMEs.

Still with this desire to support cash flow and savings, Save Now Pay Later solutions have emerged. This consists of creating savings plans directly on e-commerce sites. For example, the startup Accrue Savings is making its solution available on Eterneva, a jewelry brand. Customers can choose their ring, personalise it and then subscribe to the savings plan. The price of their product is then set and they receive a discount. The customer contributes a certain amount of money monthly towards the ring until they have saved enough funds to buy it. However, if they change their mind before the end, they can always liquidate the investment. This way, customers avoid getting into debt with BNPL and receive discounts (≈10%). The marketplace, on the other hand, reduces its shopping cart abandonment rate and creates a real relationship with its customer.

The future of the embedded finance market

On a B2C scale, embedded finance has therefore become a key element to improve the customer experience, but also to support financing and savings. For businesses, these solutions make it possible to relieve their cash flow without calling on financial players directly, but from the software/services they already use on a daily basis: invoicing systems, cash register software, etc. These companies thus have access to solutions that are truly adapted to their situation and its evolution.

Because of their strengths, embedded finance startups have been able to attract investment. In 2021 they raised nearly $3.1bn, 3.1x more than in 2020 according to Dealroom. This funding is provided from different types of investors. Tencent, for example, participated in Scalapay’s €497m fundraising in 2022, while Société Générale acquired Treezor in 2019. We can therefore note that the tech and financial ecosystems are participating in the development of embedded finance. This participation and the popularity of these solutions among consumers are driving significant growth in this sector. Indeed, it is estimated that embedded finance will grow at a CAGR of 16.4% until 2032.

It is also worth noting that other major sectors are developing along the same lines as embedded finance. This is the case, for example, of the insurance sector which has been embracing embedded insurance. This sector promises even stronger growth, with a CAGR in Europe of 30.8%.

Article written by Sacha Chérif, VC Analyst at Early Metrics.