On the heels of launching their credit card in August 2019, Apple recently announced Apple Cash Family, a service that allows adults to setup and control Apple Pay for their children and elderly parents.

If you happen to be shopping for a new phone at T-Mobile, you might be offered a T-Mobile checking account which features a higher savings rate for their mobile services’ customers.

And in past few months, Gusto began offering a checking account, Google enabled Maps users to pay for parking from within the app, and Microsoft announced an Excel integration with users’ bank accounts data.

What is happening? Is everybody getting into financial services? Well, sort of. The examples above are early instantiations of something we call Embedded Finance - Financial capabilities or entire products sold as-a-Service and embedded in a broader customer experience.

Investors look at the embedded finance opportunity both from the “provider” side (companies that supply embedded finance products), and the “customer” side (companies that use embedded finance products). On the provider side, embedded finance represents an opportunity to exploit platform economics in financial services. On the customer side, embedded finance enables any company to offer financial services that ultimately drive adoption of the core product of the firm (e.g. it’s easier to buy a new iPhone with the Apple Credit Card), and as such deliver non-linear returns.

Providers in the embedded finance economy

Amazon Web Services (AWS) and the ability to consume computing capacity on-demand was launched about 15 years ago. What makes the cloud so compelling is that it allows companies to shift capital costs to marginal unit costs [Figure 2]. AWS dramatically reduces the costs and risks of starting new businesses and has enabled business models that were simply not possible before. Consider Zoom, which runs on AWS: between January and April 2020, their run rate exploded from 100 billion to 2 trillion minutes per year. Without the cloud it would have been technically and financially impossible to scale up 20x in 3 months. Instead, Zoom was able to rent the additional capacity, without any capital expenditure and with only a small temporary decline in gross margins¹.

Those same economics and business models are now being applied in financial services, with capabilities or entire products being offered as-a-Service. By leveraging the cloud, Onfido [2012 / $269.04M], Alloy [2015 / $55.8M], Jumio [2010 / $15M] and others sell KYC as-a-Service. Ayasdi [2008 / $106.4M], Unit21 [2018] and others provide Anti-Money Laundering as-a-Service. Going even further, companies like nCino [2012 / $213M], Galileo [2000 / $86.05M], and UrbanFT [2012 / $15.5M] offer entire bank-as-a-service suites, and DriveWealth [2012 / $90M] and Atomic [2020] do the same for investing. [See appendix for a list of Embedded Finance providers]

Because delivering financial services no longer requires up-front capital investments to build an entire financial stack – after all, with embedded finance, most capabilities are now available off-the-shelf and on-demand – barriers to entry in our industry have dropped. But embedded finance also represents an opportunity for smart incumbents to mature from using cloud primarily to save IT costs, to leveraging it to build new digital business models. This is what companies like BBVA, Citigroup and Goldman Sachs are doing as they build and offer embedded finance services for third parties.

Customers in the embedded finance economy

Embedded finance strategies are not one-size-fits-all – different companies have taken different approaches. Embedded finance enables:

• Fintechs to build differentiating services on top of legacy financial products. Chime, a so called neobank founded in 2013 and now worth more than $15bn, is actually not a bank. It’s a digital user interface built on top of The Bancorp [NAS: TBBK / $550M Market Cap], one of the leading bank-as-a-service providers. Chime didn’t get an eye-watering valuation because they offer banking, but instead because they leverage the capabilities of a bank to create a superior customer experience. Deposits on a Chime account are available 2 days earlier than with a traditional bank. Overdrafts are interest free: customers who go into overdraft can tip Chime, and the tips enable Chime to offer free overdrafts to more customers. Their Credit Builder credit card [Figure 3], enabled by Stride Bank [OTC traded: CESO / $71M Market Cap], is offered without a credit check and at 0% APR (yes, zero). The card appears on the app as an account into which customers transfer money; the credit limit instantly adjusts based on the amount deposited. Technically a prepaid credit card, Credit Builder gives users a way of building credit history with no risk of overspending, no credit check, no fees and no interests.

• Established fintechs to expand along customers’ financial journey. At its core, Gusto [2011 / $521.25M raised], a leading HR platform used by more than 100,000 small businesses, is a payroll processor that embeds other fintechs’ products into its product suite. Gusto’s 401k offering is actually run by Guideline [2015 / $141M], their HSA is provided by Avidia, their 529 by Gradvisor [2015 / Undisclosed] and their Workers Comp by AP Intego [2003 / Undisclosed]. All of these products and more are embedded in the Gusto experience for both employer and employee, streamlining what previously required separate management and transactions. Gusto’s latest moves take them beyond workplace offerings into retail. Gusto Wallet offers direct deposit, banking tools, savings accounts, access to emergency funds, and the ability to access money in between paydays with no fees and interest, as the money is automatically deducted from the employee’s next paycheck. Gusto Wallet – which is only available to employees of employers that use Gusto -- is a digital user experience built on top of another bank-as-a-Service provider, nbkc, which also powers Betterment, Joust and Truebill.
• Non-financial companies to offer financial services. For most non-financial companies, embedding financial services is not actually about entering the financial services market, but instead about improving customer acquisition cost and/or lifetime customer value in their core business. 35% of Uber drivers in Mexico were previously unbanked, which prevented them from signing up. Uber Money, a checking account for drivers built on BBVA in Mexico and GoBankin the US [NYS:GDOT / $3.3B Market Cap], opened up that market. Uber Money can also make instant payments after every ride, saving Uber money transfer fees. And the related debit card comes with unlimited overdraft protection, allowing drivers to cover expenses like insurance and fuel and keep driving even when their bank account is in the red. Similarly, Apple’s credit card (powered by Goldman Sachs) makes it easier for customers to buy a new iPhone or Mac with 3% cash back and a convenient instalment plan. The card helps Apple sell more devices and at higher margins than if customers had bought them through mobile carriers. In both examples, the benefits come not just from collecting new financial services revenues from existing customers, but from improving the core business by embedding the most relevant financial services within the customer experience.

Characteristics of Embedded Finance

As we evaluate the evolving embedded finance marketplace, there are several characteristics that help distinguish true embedded finance offerings:

• Embedding is deeper than reselling. White-label reselling -- with its high costs to serve, long RFP-based sales cycles and lumpy revenue – is not embedded finance. The Apple Card isn’t a Goldman Sachs credit card with an Apple logo – it’s an entire set of experiences and functionality designed around Apple and its customers. Embedded finance abstracts financial services functionality via technology and enables any brand to seamlessly integrate those services into their own offerings and customer experiences, rapidly and at low cost. Moreover, substandard elements of the underlying embedded financial service can be eliminated at the user experience layer. By depositing money in your account when they receive the payment file, and not waiting until the payment has been processed – which typically happens 2 days later – Chime hides the non-customer friendly complexity of an ACH transfer to the benefit of their customer.
• Embedded finance is charged for as-a-Service. To be considered a truly embedded finance service, the provider of the service should charge on a consumption basis. Take Stripe [2009 / $1.89B], a service that allows any company to embed online payments in their experience by simply calling the Stripe API: there is no set-up cost and no monthly fee. Businesses using Stripe are only charged for each successful transaction (2.9% +30¢ before volume discounts). For a business using Stripe, the payment capability is a unit cost, not a capital expenditure.
• The embedded finance provider owns the regulatory liability. Embedded finance providers are positioning themselves as the ones responsible for regulatory and compliance requirements. For instance, as the issuer, Goldman assumes full regulatory responsibility for the Apple Card. And with the upcoming Google checking account, Citigroup will not just power the account, but will handle most of the financial and compliance requirements. At this point, regulators seem to be focusing on the embedded finance providers. Last year when Apple was accused of gender-bias in the approval process of their credit card, the New York State Department of Financial Services opened an investigation into the card’s issuer Goldman Sachs, not Apple.