Fintech and SaaS - The Perfect Marriage Couple For Growth
In fintech terms, embedded finance refers to non-financial companies that significantly increase or even transform their value propositions through embedding associated financial products and services onto their platforms.
Today, about 90% of public SaaS companies and the 2019 Forbes Cloud 100 have subscription-based revenue models. Now the new infrastructure systems have made it possible for SaaS businesses to add financial services alongside their core software product. By adding fintech, SaaS businesses can increase revenue per customer by 2-4x and open up new SaaS markets that previously may not have been accessible due to a smaller software market or inefficient customer acquisition.
This trend is happening first in vertical markets (ie the market around a specific industry, such as retail). Vertical software markets tend to have winner-take-most dynamics, where the vertical SaaS business that can best serve the needs of a specific industry often becomes the dominant vertical solution and can sell both software and financial solutions to their core customer base. Moreover, while early vertical SaaS companies – Shopify– typically started by reselling financial services (primarily payments), they are now embedding financial products beyond payments – from loans to cards to insurance – directly into their vertical software.
The Lightyear Capital report estimates that embedded finance in the US alone will grow to nearly $230 billion (in revenue) by 2025, up from $22.5 billion this year.
In this article, we will look at why fintech is driving the next evolution of SaaS, why it opens new vertical markets, and the different business opportunities for fintech that can be leveraged.
Evolution Of Financial Services
In the last two decades with the penetration of internet and mobile phones apart from infrastructure and policy updates there has been a rapid evolution in financial services industry.On a high level, as per Saison Capital they are:
Firstly, financial services originated from banks and other financial institutions that were generalist financial institutions. For example, bank transfers as a means of transferring money from one entity to another.
Secondly, the un-bundling of banks resulted in a slew of first-wave fintech companies that were focused on using technology to enable financial services outside of/on top of a traditional banking process. For example, Paypal & Stripe to allow for payments online.
Thirdly, the democratization of financial services has resulted in specific financial transactions (potentially segmented by customer or industry type) that are better served or distributed by specific non-fintech platforms. For example, Paytm&Wechat pay for p2p payment transfers.
As per a report by Anthemis the core areas of fintech where the role of capital plays are :
- Transferring or storing value in space
- Transferring or storing value in time
- Managing the entropy in value (inflation, risk mitigation etc.)
Embedding of these verticals will lead to value addition as well as higher growth. We shall explore in detail below.
The Hierarchy Of Embedded Finance
The hierarchy basically has three participants :
- Providers or The Infrastructure Embedders : Embedded service providers plug offerings into platforms to increase distribution and improve customer retention. Examples of embedded finance service providers include Lemonade, WealthSimple, Raisin, Affirm, Drivewealth,Policybazaar and Finix.
- Enablers or The Pipe Builders : Enablers are the pipes through which providers and containers exchange information and data. Companies like Green Dot, Railsbank, Marqeta, Plaid, Qover and Finicity provide the data/technology infrastructure and connectivity capabilities via APIs and banking-as-a-service.
- Containers or The Ecosystem Providers : These firms—like Amazon, Gusto, Shopify, Uber, Udaan ,Grab —aggregate services across providers to offer a platform or network of interconnected solutions, allowing customers to access best-of-breed solutions through a frictionless experience.
Fintech+SaaS >>> SaaS
Higher Average Revenue Per User (ARPU) Potential :
Let’s assume the average vertical SMB customer spends about INR 25000/month on software and services. Of that, INR 10000 per month will typically be on traditional software (e.g., ERP, CRM, accounting, marketing), and the rest on other financial services (e.g., payments, payroll, background checks, benefits). In a traditional vertical SaaS business, the only way to capture more revenue from the customer was to upsell software. This left the INR15000 per month potential revenue from financial services to other vendors.
But with SaaS + fintech, a vertical SaaS company can capture a customer’s traditional software spend as well as the spend on employee and financial services.
- Traditional SaaS expansion – Upsell software products or add software modules
- Fintech opportunity – Add financial services, such as payments, cards, lending, bank accounts, compliance, benefits and payroll
In our hypothetical above, a vertical SaaS company that adds, or even embeds, financial products, can potentially earn 2.5x the revenue per customer from the INR 10000/month software spend to the full INR 25000/month for software and services.
Higher Product Margin and Customer Retention:
The vertical SaaS companies who initially added financial services primarily resold financial services from a third-party. For example, Byju's offered lending by referring customers to Capital Float.
With new fintech infrastructure players, however, companies can now go from reselling to embedding a variety of financial services, not just payments, directly into their products.
Reselling remains a viable option, and can be easier to launch or used as an on-ramp to embedding financial services. However, embedding results in higher margins and better retention. It creates a more seamless customer experience: a loan service through a familiar interface rather than being redirected to a third-party site. With an embedded service, the software provider can draw on a specific set of data – such as sales transaction data to inform lending – to underwrite risk, factoring in things like business cycles to better tailor the service to each customer’s needs and risk profile. Ultimately, that produces better margins on fintech products, better customer experience and new product strategies.
Lowering CAC and Increasing LTV :
Fintech also impacts the go-to-market channels for vertical SaaS by growing the revenue per customer and making the product stickier. Put another way: fintech holds, or even lowers, the cost of customer acquisition (CAC), while increasing the lifetime value (LTV).
Udaan Credit,fintech arm of Udaan for example, earned INR 14.1 Crore via interests payments on loans during FY19,which is ~4x higher than what it earns from sales of goods,licensing and cash collection fees. Thus, loan service meaningfully increased the lifetime value (LTV) of the customer, while the cost of customer acquisition (CAC) remained the same, if not lower, since the additional value provided to the customer could accelerate the sale.
Lowering CAC while increasing LTV makes a direct, inside sales go-to-market possible where it previously wasn’t, meaning SaaS companies can acquire new customers that would otherwise have been too expensive.
Better Engagement and Higher Conversion :
Recently financial services arm of Shopify , Shop Pay announced partnership with Affirm to enable installment loans or buy now pay later option on Shopify checkout for their merchants.
Kaz Nejatian, Shopify’s head of financial services, revealed on an online webinar that Shop Pay significantly reduces cart abandonment, which has been a massive problem for merchants. Shopify recently put out data that backs this up too. It turns out that Shop Pay converts 1.72 times better overall than regular checkouts, and 1.91 times better on mobile. For merchants, that difference adds up.Also as the company says Shop Pay also has increased checkout speed by 4x.
Shopify has essentially created a flywheel around Shop Pay and payments: merchants add Shop Pay and customers start using Shop Pay which lowers abandoned carts. Shopify adds installment loans to Shop Pay, which customers are already using, to make larger purchases which results in merchants selling more.
The above example is a clear indication of how embedding financial services have led to better engagement and higher conversion.
Opportunities and Beyond
As stated clearly in the above image there is a wide array of opportunities available to companies for leveraging financial technology in their products. The timing, right partnerships,financial service synergy and scaling of operations is the key mix for growth.
And this is just the beginning. As more companies incorporate financial services into their SaaS offerings, we will witness the unlocking of more markets and its global emergence.
As an enthusiast and keen industry observer, I am excited to see the combination of Fintech+SaaS evolve as the next generation of software businesses is to unleash their enormous potential.