Embedding finance into consumer channels: a $7trillion opportunity
w/ Simon Torrance
For this Talking Hedge session, we were joined by Simon Torrance, Founder at Embedded Finance & Super App Strategies. Simon is an advisor to Boards and Leadership Teams on Embedded Finance, business model transformation, platform and ecosystem strategy, corporate innovation and venture building. He wrote an indepth analysis of the $7 Trillion Embedded Finance market opportunity and on the $3 Trillion Embedded Insurance opportunity. Simon is a member of the World Economic Forum’s ‘Accelerating Digital Transformation’ working group, and a guest lecturer at Singularity University.
YOU WILL HEAR MORE ON
[00:04:23] Embedded Finance 101
[00:16:05] What are the prerequisites for a brand to launch a successful embedded finance business
[00:24:19] How many incumbent institutions are providing banking-as-a-service
[00:24:19] Is embedded finance coming to capital markets?
[00:00:14] Ben: My name is Ben Robinson. I’m your host for this very special episode, where we have as our guest Simon Torrance. Let me quickly introduce Simon. Simon is a founder of his own consulting company, which is called Embedded Finance & Super App Strategies. Simon is an advisor to Boards and Leadership Teams on Embedded Finance, business model transformation, platform and ecosystem strategy, corporate innovation and venture building.
Simon is also a member of the world Economic Forum’s ‘Accelerating Digital Transformation’ working group, and he’s a guest lecturer at Singularity University. Simon, welcome. What a CV! I think it’s fair to say that you’ve become the authority on all things embedded finance. My first question to you, Simon, is what is your background and how did you get to this point of being the embedded finance guru?
[00:01:24] Simon: Well, I’ve spent the last 20 years now trying to help traditional companies think about their business models, the fundamental way they create and capture value, particularly looking at how they can adopt and adapt the digital business models that have been so successful coming out of initially Silicon Valley and then increasingly now China and the far east.
I specialize particularly in platform and ecosystem based business models, which are the most dominant business models today because they really leverage digital technology. About two years ago, I was invited by a large financial institution, very large financial institution, that said that, “We’re looking for new ways to grow. Our business model is under increasing pressure. How can you help us?”
I got really fascinated by financial services. I hadn’t worked in financial services much in the past. But once you get under the skin of the industry, you see this enormous problem in financial services. There’s this enormous gap between what people need and what they’re currently being offered. You hear a lot about protection gaps in terms of insurance; people just having no protection at all, or small businesses having very limited protection. Then gaps in terms of lending; small businesses unable to get loans to help them grow their business, indeed so many people around the world being unbanked or underbanked. When you look at it more deeply, you see there’s this problem, people are not getting what they need.
Then you look at the supply side, the majority of public financial institutions around the world make negative economic profit. That means profit after cost of capital. They’re not making money from trying to serve the market.
I saw this multiple opportunity to help, if you like, those who are in the space to reinvent or rejuvenate their business models so they could make good profit. The only way of doing that is to create solutions that solve problems for end users. I got fascinated by the whole finance sector. But really about how it can add value to end-users. Then looking at some of the cutting edge thinking coming out of Silicon Valley and China, in terms of rethinking the way that financial services are created and then distributed, you come to the point of embedded finance, which is about how other organizations that are closer to end customers can help to close these gaps.
[00:04:23] Ben: I don’t suppose that everybody listens to this is familiar with embedded finance. Do you mind just double clicking on that and telling us how embedded finance starts to solve that challenge of under provision of financial services?
[00:04:38] Simon: I’ll give you a really good example from China. Well, I’ll give you a theoretical idea and then I’ll give you some examples to bring it to life. We need financial services when we need them. There are organizations who have much closer interactions with us in our daily lives, and do banks and insurance companies and others. The principle is that they are in a better position to make available financial solutions at the point of need, better and more convenient and potentially much more personalized and relevant, than me as a consumer having to scratch my head, “Now I need a loan, who can offer me a loan?” Because I bought this car. Or, “My business is growing, I need some liability insurance, my employees.”
There are other organizations that are helping me in those interactions, those things I go through my daily lives with, and they probably understand me better than the financial institutions, and they’re in a good position to help me access those products and services because they are very complimentary to their own proposition.
I’ll give you a few examples to bring it to life. One of my favorite examples is from China, which is Alipay, the super app. It has about 900 million users, because it’s created an app that the people use daily for payments and for all kinds of other services. Because they’re in this daily interaction engagement situation with all their consumers, they’re seeing what those consumers are doing. They have a huge amount of data on them, and they’re in a golden position to say, “Well, it looks like you have no insurance or limited insurance, so let’s help you get that.” Or, “We have some special credits we can offer you as a small business to help grow your business. Because we know a lot about your transactions and so on, we can create much more attractive solutions for you.”
What they do, they educate and engage their end users and they feed that information back to a network of suppliers, either banks or insurance companies or credit lenders and so on, and say: we’ve got this huge captive market of in their case, 800 million people, these are the problems they’re having. They’re not able to get the types of solutions they need. You guys, lots of banks and insurance companies and wealth managers, please could you provide specific solutions or components of solutions that we can package up for our end users. That is the essence of embedded finance – other people helping to sell, or embedding in their own propositions financial service solutions or components to make their relationships stickier with our end users, and in so doing help to close what we called the protection gap or the gap between what people need and what they’re able to access or even know about, or even understand on the traditional financial service market.
[00:08:03] Ben: There’s an idea out there that embedded finance is all about just changing distribution channels; distributing where the customer is rather than forcing the customer to go away and independently do their research and go to a financial services provider. But listening to you, it’s more than that, right? Because it’s not just about distribution, it’s also about context. These companies, the embedder brands, are in a position to offer the right service at the right time because they understand the context, they understand the customer. Is that the key part to understanding embedded finance? That it’s more than just changing distribution channels?
[00:08:41] Simon: Yes, absolutely. It’s also about changing the problem, the nature of the product as well. Because if you’re a long way from the end customer, like most banks and insurance companies and wealth managers often, they’re a long way from the end customer, and they have to create standardized products that can scale and can be profitable.
If you’re a lot closer to the customer and you have much more data on them, real-time data in many ways, it changes the nature of what you could offer. You’re thinking, if I offer this type of thing in this way, I’ve got millions of customers? That that could be really attractive to them. That’s one of the key principles.
The other is that technology is enabling things that just weren’t possible before. Third parties, many of them, have always sold financial services. You think about the car company selling you the car loan, or the retailers selling insurance, and so on. But now technology is enabling that to happen in a completely different way. Even a tiny shop, I like to use the example of the bicycle retailer, but the e-bike retailer just around the corner from you. Even they are now able to embed financial services, loans, or insurance or other protection services at point of sale. You buy your bike. Would you like to buy it with a loan? Would you like to buy now pay later? Would you like some insurance, so if it’s stolen or if you are injured on it, you can buy that all from us? Now, it’s with a click of a button. That’s really attractive for the end-user. That’s very convenient, I don’t have to go somewhere else to sort this out. Secondly, it’s very attractive for the retailer here because this is a very high margin business. In the past, that was just impossible. Technically operationally impossible, too expensive, too complicated. But what’s happened is that FinTech has become so sophisticated now, that most of the capabilities of financial services have been modularized, turned into if you like almost like Lego bricks, that other people can configure to suit themselves.
The person running the store, the bike store, or even a developer at a bigger brand or retailer or any type of company, now has components that they can put together either to bundle into their own propositions, except it’s just a component of it, they don’t have to make direct revenues from it, or it could be to create a new solution. There are many platforms now that have emerged to enable that. That’s why this market is so exciting.
[00:11:30] Ben: I just want to talk about the size of the opportunity. You’ve published a couple of analyses on the size, which by the way, everybody quotes as I’m sure you’re aware. The numbers are, I think, 7 trillion for embedded finance and 3 trillion for embedded issuance. Correct me if I got those wrong, but so collectively $10 trillion.
[00:11:49] Simon: There’s subsets. 7 trillion in 10 years’ time, which 3 is already there.
[00:11:58] Ben: Okay, so collectively 7 trillion. Can we break that? What is the 7 trillion? Is that new revenues? Then, how does exactly that come about? Is that just through bridging that gap, so as people get the right level of financial services cover then the market just grows as a result?
[00:12:15] Simon: Well, I came to this figure in the following way. There’s some great analysis done by Matt Harris at Bain Capital Ventures. As a very leading FinTech VC company, they’ve been pumping a lot of money into this sector – they called it FinTech infrastructure – for some time. They looked at the impact of embedded payments to start with. They were seeing companies like Stripe and Clamor and many others, that were enabling companies to make money out of payments or to reduce their cost from payments. That market, they sized in the US and they thought that about 20% of payments would be distributed in this way in 10 years’ time, at 20% in 10 years’ time. Then the types of companies that are enabling that are software companies, so tech companies enabling payments to be distributed in a different way. Tech companies and SAS based companies have a valuation multiple of at least five times revenues.
They came up with a figure for the US for payments of, they said, well, 20% of the payment distribution is so-and-so, and you multiply that by five for the valuation of the companies that are enabling it. I thought that was really interesting analysis, so I adapted it for a global market, making some various assumptions about adoption rates and so on. Then I added on lending and insurance and wealth management, and then we put a little bit in for “other”. Bear in mind lending is much more regulated and insurance is even more regulated. You have to think about those points. You add all that up and you get to a figure that then you can multiply by five to get to the 7 trillion. I said that’s in 10 years’ time, it might be 15 years’ time, or it might be 8 years’ time. It might be more, it might be less, but it’s such an order of magnitude.
I’ll give you the comparison. This is saying that there are companies that are enabling, that could be worth collectively something like 7 trillion. It’s creating a new market for new ventures and entrepreneurs, and big companies if they have the opportunity to create this value. But 7 trillion is double the value of the top 30 financial institutions that exist today, at today’s value. It’s doubled the top 30 financial institutions, and it’s 50% more than the top 30 software companies and platform companies today. It’s an order of magnitude.
[00:15:05] Ben: Okay, it’s the value creation number. Do you have a sense of where that value will accrue? To what extent they would accrue to the embedded brands versus the financial services companies?
[00:15:16] Simon: Great question. It will accrue to those who enable it, the tech companies that enable this new form of distribution.
[00:15:28] Ben: Some will accrue to the brands, and some will accrue to the underlying banking providers, and some would accrue to the technology companies enabling.
[00:15:35] Simon: Yeah. But that value is to those who enable it. There is other value, because the brands, be they small bike shops like I mentioned, or big retailers or car companies, whatever, they will be making money from using this infrastructure. There’s value for them, but that’s not the 7 trillion. The 7 trillion is for companies that enable this to happen. We can talk about what it means for the other players in the market.
[00:16:05] Ben: Let’s do that. Let’s start with the embedded brand then, the demand side. What are the prerequisites to successfully launching embedded finance, and what have you seen in your work are some of the practical obstacles? The way you make it sound, it’s super easy for the bike shop to start offering in better finance, but I’m sure it’s more complicated than that. To select the right vendors, to get the value proposition set up correctly, and so on. Take us through that. What are the prerequisites and what are some of the challenges that people find during this in practice?
[00:16:32] Simon: Let’s think about different types of organizations. Let’s start with big enterprises and then we’ll think about tiny businesses as well. I’ll start with big enterprises.
The number one issue, if you like, is understanding the art of the possible. For example, many retailers, as I mentioned before have been selling financial services. They sell credit, insurance, and they use payments a lot, of course. But to do that, they do deals in a very analog way. They think, we’d like to offer credit, let’s speak to the local bank, then we have a two year of negotiation and then we try and integrate that proposition in our website. It takes two years, or a long time. In many cases those retailers make very good profits from this. I think Walmart claims something like 11% of its total profits are from financial services. But they do it in a very analog way. It’s pretty labor intensive. They have whole teams of people managing regulation and compliance.
It’s quite interesting. I spoke to a very large UK retailer who’s been doing this for years, making good money out of it. I said, “Do you know what’s now possible? You can activate many more types of financial services, test and iterate them, engage much more deeply with your customers, for a fraction of the cost and the operational and compliance overheads you have today.” You can leave your banking data, which we can come back and talk about in a second, in new ways that wasn’t possible in the past.
Just even understanding that, that there are new ways of doing things, and for the small, tiny bike company, it’s completely new and different. I didn’t even know we could do it, and we could establish something in about two months and it would cost us very little or we’d pay a tiny fee for the platform company to set it up or maybe it’s revenue share. There’s no cost to us.
I’ll give one really good example that I like to use a lot. It is a very large European retailer. It’s maybe the biggest retailer in the country in which it operates. It’s a general retailer; it does food and all kinds of other things. They used to have their own bank and their own insurance company. They had to have the regulatory compliance and the balance sheet there to support that, at enormous cost. They were essentially adding a bad business model onto their existing business level with razor thin margins, because banking and insurance is not a great business model in the way it’s been done until now. Then a FinTech infrastructure company came along and says, “You can outsource all of that to us. We’ll provide a platform that orchestrates all the requirements you have for selling financial services. We will organize all the compliance, all the regulatory needs, and we will also source for you all of the financial service providers that you’ll need. We’ll source the best ones and we’ll do it in a revenue share way, so we have an incentive to make it really work for you.” There is virtually zero CapEx, and very limited OPEX compared to the previous model. That’s going extremely well at the moment. They’re selling now wealth management solutions, credit solutions, insurance solutions to the end customers of the retailer together. They’re doing it together. At one level, to answer your question, it’s just understanding that the capability exists.
The second though, is then the skills to take advantage of this infrastructure and platforms. Typically in the past, the brands will have a very small team of people, maybe not expert in this area, and they’re learning new skills and how to market and innovate on new types of financial service solutions, which can be very lucrative if you don’t have all the traditional overheads of banks or insurance companies.
[00:21:07] Ben: To what extent can they source that domain expertise from the provider?
[00:21:11] Simon: There is an increasing number of these let’s say platform or infrastructure providers, and this market is taking off quite considerably now. The amount of money that the VCs are pumping into is called FinTech infrastructure, B2B FinTech infrastructure, those companies are learning more and more and more becoming more sophisticated. You have companies like Stripe or Planner who’ve been at this for 10 years now, are super sophisticated. With one line of code, you can embed payments. Now, through Stripe, in the US and coming to Europe now, you can get credit for your customers as well. They’re adding more and more functionality on it. Planner is doing the same. It’s just so easy for a retailer to do buy now pay later now. Again, there are tens of suppliers. Now it’s moving into B2B as well.
The sophistication is getting bigger and bigger and bigger, and in many markets it’s way ahead of the demand side in terms of understanding.
[00:22:19] Ben: If I listen to you, what you’re saying is the demand side almost needs to catch up. Because anybody who’s got any large customer base and reasonably high engagement with that customer, they should be offering some form of financial services because it’s totally illogical not to do so, because you’ve got the audience and the need and the distribution channel.
[00:22:40] Simon: Yeah, absolutely. I’m doing quite a bit of work with lots of these types of brands. If we just think about traditional brands, they’re all under enormous pressure from digitalization in their sectors and across all sectors. As a sector digitalizes, it tends to shrink traditional profit pools, because there’s more competition, there’s new entrants in the market, there’s more price transparency, customer expectations about what they need in terms of interacting with the customer are raised, sometimes there are regulatory changes as well. Traditional business is under that significant pressure, and they’re looking for new ways to create value for their customers and generate new revenues as well. In some cases, it’s a bout just making that proposition much more attractive by providing some maybe product protection at point of sale, or even making it free. If you buy from us, you get free protection.
The buy now pay later craze has been a good example of that, just making it very easy for people to pay for something. It’s a cost. It’s a marketing cost in that case, but it’s well worth it because the average order values and conversion rates go up.
All those businesses are looking for new ways to create value, and financial services is a very attractive add-on or component if you don’t have to deal with any of the banks or the insurance companies, or have to look at the compliance risk or balance sheet risks yourself.
[00:24:19] Ben: If we talk about the supply side of it, in that example you used of the retailer that was working with a bank is a service provider, to what extent in those situations does that bank as a service provider source the underlying regulated products from incumbent financial services providers versus creating a new integrated stack themselves? The question is, are incumbent financial services coming along on this journey? I guess it requires quite progressive thinking to realize that you can generate more volumes, but it’s going to require you to lose the point of customer interaction. Most banks think vertical integrated. They do manufacturing and distribution. What’s happening with incumbent institutions in this?
[00:25:09] Simon: Let me give you a good example of this. It’s from Asia. Standard Chartered Bank is a really good example of this. They said, we want to get into the banking as a service market, but we don’t have the skills in our core business to do this. You need a new tech stack. The old tech stack is not going to work. It’s a different proposition. You’re selling something new to a new type of customer, so you need new people. They created a separate venture under their ventures arm, called Nexus. That venture created its own tech stack to do embedded finance or banking as a service specifically, and hired or attracted and incentivize entrepreneurs who didn’t work from the upper core bank. Their business is to go out to large brands and digital platforms in the Southeast Asian market, and say that we can embed financial services into your proposition. They set that up as a separate business to do that. Now that’s going pretty well. They’ve got deals with big digital platforms in Southeast Asia. You sometimes have a hundred million people on these platforms.
They provide the ability for those platforms to do payments in a different way, to offer credit, to do insurance, and other types of financial services. Very sticky for the platform and the brand, very attractive for their customers for the reasons we talked about: the convenience of accessing it through a brand they trust.
What Standard Chartered said, because there’s a danger that our core business sees this as a cannibalization of our business. But what’s really interesting, the new accounts, the virtual accounts that are set up by Nexus on behalf of that platform customers, are fulfilled by the local Standard Chartered Bank. Suddenly the Standard Charter Bank in let’s say Indonesia has a hundred million people. It could be a hundred million people getting new bank accounts with them, via Nexus selling its bank as a service platform capabilities to a large e-commerce retailer. They’re happy. The local bank is happy they’re getting new accounts without having to do anything, and the venture is happy in that it is allowed the freedom to operate in the way that it needs to without all the traditional banking metrics and culture and so on.
That’s a good example of a financial institution seeing the opportunity, and creating the right organizational structure in which to take advantage of it. That’s the number one barrier for traditional incumbent in this space, is that they sometimes try and do it within the core business and it gets crushed by the culture and the metrics and the lack of skills.
[00:28:10] Ben: How rare is Standard Chartered? To what extent are they representative of banks in general? Okay, so most banks are not yet embracing the embedded finance opportunity?
[00:28:23] Simon: No, they’re doing it half-heartedly, or they are set up to fail by trying to do it within the core business.
There are some good other good examples. Goldman Sachs is doing this really well with their transaction banking business, separate business unit, separate stack, and there’s a few others. But in general, it’s half-hearted or taking paralysis through analysis. But not taking this bold move of creating the space in which this can flourish.
[00:28:55] Ben: Sadly, we’re running out of time. I just want to move it on to capital markets, where Assure Hedge operates. All the examples you’ve given are much more retail orientated, or SME orientated. Is embedded finance coming to capital markets? And why do you think we haven’t seen more examples of embedded finance in capital markets so far?
[00:29:19] Simon: It’s a less consumer sector. It’s less small business. It’s more specialized. Maybe the skills require more human intervention. The more human intervention, the less embedded is appropriate. But the principles should still apply. Are there brands that have very close relationships with the end customer of the capital market solutions? If there are, then it’s probably a good idea to co-opt them to engage with the end user; educate, engage and sell to them, or understand their needs and create more interesting products, leveraging the data and the insights that that brand or that intermediary in this case might have.
Those principles should still apply; it’s just the nature of the market is different from some of those more retail markets that we’ve talked about.
[00:30:17] Ben: But the protection gaps definitely exist in capital, if we think about FX exposure, most businesses, most individuals at some point have FX exposure. That arises when they’re doing a transaction through a platform that could easily embed that protection. I think as you said, the principles that apply are more complex and more regulated and so on, so maybe that’s why it hasn’t happened so far.
[00:30:46] Simon: Yeah. But again, entrepreneurs will always find a way. If there’s a real problem, that is a high value problem that could be addressed using these principles, then you’ll probably see solutions there. You’re starting to see a few solutions in the treasury space. Again, that will probably take off but in a slightly different way.
[00:31:07] Ben: Two more questions for you. The first one is, what are you working on right now? What’s next for you? You’re always publishing content, so what have you got coming up?
[00:31:14] Simon: Lending is a really big interesting area at the moment, particularly unsecured consumer lending and SME lending. SMEs are the backbone of the economy. They cannot get capital at the moment, for all kinds of reasons. Essentially there’s this gap between the understanding of what they need and their real credit worthiness and the risks that banks are willing to take. SME lending is a really big one that good for everybody to close that gap.
Insurances is a huge area because none of us can afford to retire, unfortunately, and that gap is getting bigger. There’s a big noble cause to play that.
I think the other one is investment and wealth management. It ties into the one about not being able to retire. We need better ways to help people save and manage their money. I think those are going to be some really interesting areas to come.
[00:32:09] Ben: Wonderful. Then the last question then we’ll let you go because we’ve out of time, if people want to get in contact with you or they want to read some of the wonderful research that you’ve published, what’s the best way for them to reach you and find that content?
[00:32:25] Simon: Well, do connect on LinkedIn. That’s the way the easy way to do that. Or follow on LinkedIn, because I publish a lot of stuff there. Secondly, my website is www.embedded-finance.io. People can connect there. But follow on LinkedIn is a really good way, and connect if you’ve got something specific you’d like to talk about.
[00:32:45] Ben: Wonderful. Simon, thank you so much for spending the time with us. That’s been really enlightening. I think this has been a brilliant one-on-one on embedded finance. Thanks for sharing your insights and sharing your time with us. We hope to have you back on the show at some point in the future.
[00:32:58] Simon: Pleasure. Thanks Ben, really good to talk to you.
[00:33:01] Ben: Thanks, bye.
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