A short decade after software started eating the world,
along came headlines about every company becoming a fintech thanks to
innovation and growth in embedded finance business models.
This narrative oversimplifies the evolution that’s happening
in the financial services sector. Storing and moving money and extending credit
in a regulated environment is difficult. And differentiating your offering from
incumbent financial institutions requires much more than superficial tweaks.
What really makes a fintech company extends far beyond user
interface enhancements and delivering financial services to end customers. It’s
what’s “under the hood” — the full-stack approach that allows fintech companies
to truly innovate for their customers.
Embedded finance helps companies and brands outside of the
core financial sector distribute financial services. This requires varying
levels of effort from the company and looks like anything from Starbucks
offering an integrated wallet and payments within its app to Lyft offering a
debit card to their drivers. But that doesn’t make Starbucks or Lyft fintech
The fallacy behind the hype
The “every company will be a fintech” stance investors are
bullish on conflates multiple approaches to inlaying financial offerings, coupling
the resurgence of white-labeled financial services (which have been around for
decades) with the rising banking, payments and lending-as-a-service players.
The latter approach allows companies to customize their financial product
experience while outsourcing many core financial services tasks. The former is
simply distribution through embedded delivery.
There are four core tenets to fully operate as a financial
services provider: a customer-facing product, transactional infrastructure,
risk management and compliance, and customer servicing. In the case of lending,
there is a fifth tenet: Companies also need to be able to manage capital.
Embedded financial services help companies sidestep the majority of what it
really means to be a fintech.
White-labeling versus “becoming a fintech”
While embedded finance is hot today, white-labeled financial
services have been around for decades. Branded credit cards, for example, are a
common paradigm for white-labeling. They quickly became a lasting way to incentivize
consumer loyalty but don’t signal real effort or know-how in financial
services. United and Alaska don’t run credit checks, configure billing or
handle disputes for cardholding customers, nor do they assume any risk by
embossing their logo on a card. The partnerships are major money makers for
airlines while the risk stays on the financial institutions’ side (Chase, Bank
of America and Visa). This risk can even account for significant loss on the
financial side: According to American Express, 21% of its outstanding credit
card loans belonged to people with a Delta credit card a few years ago.
This white-labeling approach is becoming common for other
services, coming to life in forms like banking offerings from cell carriers,
and it’s by design: Financial services are complex and highly regulated, so
brands prefer to defer most of the work to the experts. So while United, Delta
or T-Mobile offer financial services under their brand, they are definitely not
becoming fintech companies.
In contrast, some corporations are seeing the opportunity to
build financial services from the ground up. Walmart’s move to snag Goldman
Sachs talent to lead its foray into finance (with Ribbit at the helm) shows
promise for a true fintech spinout.
The investment in expertise in compliance and risk
management furthers the company’s potential to build detailed and relevant
infrastructure from the get-go — a significant step beyond the retailer’s many
existing white-labeled financial partnerships.
The limitations of platforms as a service
Tools and turnkey solutions that help non-finance companies
build financial applications more recently came into the mix: VCs are
enthusiastic about new players building embedded payments, lending and, more
recently, banking platform services (also known as BaaS) through APIs and
As opposed to financial infrastructure services provided
directly by sponsor banks or processors providing payments or ledger services,
these platforms abstract the underlying infrastructure, wrap them with
friendly-to-use APIs, and bundle core financial elements like risk management,
compliance and servicing. While these platforms do offer some self-efficacy for
companies to provide financial services, their major limitation is that they’re
general purpose by design.
Fintechs found an opportunity to serve customers overlooked
and underserved by traditional finance through specialization. Traditional
financial institutions long applied the generalist model, carrying hundreds of
SKUs and serving all segments. This strategy inevitably led banks to invest
more in services for their most profitable customers, optimizing for their
needs. Less profitable segments were left with stale and one-size-fits-all
Fintechs’ success with these underserved segments is derived
from a relentless pursuit and laser focus on addressing core customers’ unique
needs, building products and services designed for them. In order to deliver on
this promise, fintechs must innovate across all layers of the stack — from the
product experience and feature set to the infrastructure and risk management,
all the way down to servicing.
UI is not nearly enough to differentiate, and addressing
customers’ needs while minding overall unit economics is critical. One
fintech’s choices on these matters may be completely different from another if
they address different segments — it all boils down to tradeoffs. For example,
deciding on which data sources to use and balancing between onboarding and
transactional risk look different if optimizing for freelancers rather than
larger small businesses.
In contrast, third-party platform providers must be generic
enough to power a broad range of companies and to enable multiple use cases.
While the companies partnering with these services can build and customize at
the product feature level, they are heavily reliant on their platform partner
for infrastructure and core financial services, thus limited to that partner’s
configurations and capabilities.
As such, embedded platform services work well to power
straightforward commoditized tasks like credit card processing, but limit
companies’ ability to differentiate on more complex offerings, like banking,
which require end-to-end optimization.
More generally and from a customer’s perspective, embedded
fintech partnerships are most effective when providing confined financial
services within specific user flows to enhance the overall user experience.
For example, a company can offer credit at the point of sale
through a third-party provider to enable a purchase. However, when considering
general purpose and standalone financial services, the benefits of embedded
fintech are much weaker.
Building a product of choice
The biggest proponents of embedded finance argue that large
companies and brands can be successful with finance add-ons on their platforms
because of their brand recognition and install base.
But that overlooks the reality of choice in the market: Just
because a customer does one facet of their business with a company doesn’t
necessarily mean they want that company as their provider for everything,
especially if the service is inferior to what they can get elsewhere.
While the fintech market booms and legacy brands continue to
buy into the opportunity, verticalized, full-stack fintechs will trump their
generic offerings time and time again. Some aspects of embedded finance and
white-labeling will continue to crop up or prevail, like payment processing and
buy now, pay later services. But customers will continue to choose the
banks/neobanks, lenders and tools built for them and their own unique needs,
bucking the “every company is a fintech” fallacy.
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